Enforceability of intercreditor agreements in Poland
Sept/Oct 2013
Finance parties who share an interest with other lenders (investors or other finance parties) in a particular borrower often enter into an intercreditor agreement, or a subordination agreement, to regulate the ranking of their respective conflicting interests in the event of the borrower’s illiquidity. This is to avoid competition between high-ranking lenders and low-ranking lenders over the borrower’s assets. However, when the enforcement assets are located in Poland and are not secured in rem, litigation practice dictates that such agreements may not be easy to enforce before a Polish court, unless the parties provide in advance for a specific mechanism to enhance the agreed distribution of cash flow.
Intercreditor agreement
Intercreditor agreements or subordination agreements often take the form of a tripartite agreement between the creditors and a borrower which aims to prioritise payments from a debtor to different classes of pari passu creditors in the event that the debtor has insufficient assets to satisfy all claims. This will typically mean that the debtor is bankrupt, but may also cover ordinary enforcement, if it leads to the debtor’s illiquidity.
A typical intercreditor agreement will contain a ranking of claims (subordination) clause whereby one class of lenders (junior lenders) agrees to subordinate its claims, which otherwise would be pari passu, so that it does not receive anything from the debtor until the senior class of lenders (senior lenders) has been repaid in full. Thus, the senior lenders would ordinarily expect the ranking of claims clause to have an effect on the ranking of claims or the distribution list drawn up by the relevant court or bankruptcy administrator. In many developed markets, the proceeds from the debtor’s estate will be transferred directly to senior lenders pursuant to the contractual ranking. As a last resort, an intercreditor agreement will also typically include a turnover clause so that, to the extent that the junior lenders receive any amount contrary to the subordination clause, they will be obliged to turn over any such amount for the satisfaction of the outstanding senior debt.
Bankruptcy courts’ practice and statutory ranking of claims
Polish law comes into play when the debtor has assets in Poland, irrespective of whether a particular intercreditor agreement is governed by Polish law or not. The Bankruptcy Law will govern the procedure of satisfying creditors from these assets and determine the enforceability of the contractual ranking of claims. Practice shows that Polish courts and bankruptcy administrators are reluctant to take into account the contractual ranking either when allowing claims against the debtor’s assets or when distributing proceeds to creditors. Their key argument is that the subordination is only a matter of contract and thus it does not affect the statutory rules of liquidation of the borrower’s assets, which also concern third-party creditors. Therefore, it is likely that only the statutory subordination and ranking of claims will be taken into account, with the effect that the liquidation proceeds will be distributed in the following order: (i) super-priority claims (eg costs, taxes and employees’ claims); (ii) secured claims (if any), which are paid from the sale proceeds from the relevant assets; (iii) unsecured claims and secured claims, to the extent the latter were not settled against the secured assets, divided into ranks; and (iv) shareholders’ loans which were drawn up within two years of the borrower’s bankruptcy and shareholders’ equity claims on the debtor’s assets. The distribution of proceeds follows the ranking on a pro rata basis.
As a consequence, junior lenders’ share of the bankruptcy proceeds will correspond to their statutory ranking of claims. Whether a junior lender will voluntarily turn over these proceeds to the senior lenders under the intercreditor agreement largely depends on its financial standing, reputation and other relationships with the senior lender as well as the prospects of enforcing the turnover clause in separate court proceedings. The jurisdiction clause of the intercreditor agreement will, in principle, determine which country’s courts are competent to hear such claim. In any event, any such claims run the risk that the junior lender is, like the debtor, in financial distress. It may thus turn out that the junior proceeds have already been transferred out or were initially wired by the bankruptcy administrator to a foreign bank account of the junior lender ’s choice. To counter such action, the senior lenders may seek preliminary injunctions before the competent court. However, to the extent that any proceeds are to be transferred out of Poland by the bankruptcy administrator directly to the junior lender’s account, the chances of success before Polish courts are relatively low. This is because, as a matter of court practice, protection against an anticipatory breach (here, of the turn-over clause) can be granted only in exceptional cases.
Solutions
With the usual disclaimer that each transaction must be analysed on a case-by-case basis, generally under Polish law there are three mechanisms to enhance the enforceability of intercreditor agreements in advance: (i) making the junior lenders’ claims conditional on the satisfaction of the senior lenders’ claims; (ii) providing for an irrevocable power of attorney from the junior lenders to the senior lenders; and (iii) providing for a security assignment of the junior lenders’ receivables.
Regarding (i), making the junior lenders’ claims conditional on the satisfaction of the senior lenders’ claims will prevent the junior lenders from receiving
any money from the debtor’s estate in breach of the subordination agreement. The problem is that it is doubtful whether this will actually be for the benefit of the senior lenders. This is because, depending on the court’s interpretation of the Bankruptcy Law, in the worst case scenario, the proceeds for the satisfaction of the junior lenders’ conditional claims will be seized by the State Treasury; in the best case scenario, they will increment the pool of assets for the satisfaction of not only the senior lenders, but also all other creditors of the same statutory standing, excluding the junior lenders. Regarding (ii), an irrevocable power of attorney may have limited effects under Polish law as it does not resolve conflicting instructions from the principal and agent. Only the third mechanism seems to give the senior lenders adequate protection as it allows the senior lenders to bypass the uncooperative junior lenders and control cash flows from the debtor ’s liquidation. Once the junior claims are ef fectively assigned to the senior lender, the senior lender will be entitled to lodge and administer these claims before the court, just like its senior claims. The only disadvantage here is that the senior lenders, as a security assignee, will be responsible for collecting and preserving the assigned receivables.
