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Supreme court's approval of alternative method of enforcing mortgage over Polish property reduces bank risk

Polish Supreme Court resolution, 6 June 2014, case No III CZP 23/14

A Supreme Court ruling has paved the way for secured creditors to reduce risks associated with property foreclosure. Allen & Overy LLP (A&O) represented an international bank whose security interest over a third-party security provider's revenue-making property was jeopardised by: (i) the property's mismanagement; and (ii) the risk of fraudulent transfers.

The classic legal tool, bailiff-driven foreclosure, did not provide sufficient protection. A&O structured and implemented an innovative solution to realising the security which has now received the approval of the Polish Supreme Court.

Foreclosure and the risk of property mismanagement

Until now it has been thought that a secured creditor holding a mortgage over a Polish property (owned by a third-party security provider, who is not the borrower) could only realise that security by instructing the public bailiff to foreclose against it. Polish foreclosure is a court-supervised, multi-stage and lengthy action, which culminates in a public sale. A risk for secured creditors has been the poor management, by the owner of the property,
during the foreclosure process. Given that the bank is not allowed to take control over the seized property, the owner of the mortgaged property retains the management of the property until a purchaser is found. The owner is not prohibited from selling the property to another entity, which would then manage the property until the bailiff's auction. The downside for a bank which is seeking to realise its security over a revenue-generating property is this period of management can, if not done well, reduce the value of the property. At worst, a mortgagor may be so determined to delay and impair the bank's action that it fraudulently transfers the property to an associated party.

Insolvency liquidation – reduced risk of property mismanagement

In an insolvency liquidation, control over property is taken by a court-supervised insolvency administrator. All rent proceeds are paid directly into the account of the administrator and then distributed to the creditors. The bankrupt cannot dispose of its ownership title to the property, because only the administrator can auction it. This means, for banks, that commencing insolvency proceedings against a mortgagor eliminates the risk of property mismanagement and fraudulent transfers, and is therefore an appealing alternative to a bailiff-driven foreclosure.

Under Polish insolvency law, a petition for the bankruptcy of a company can be filed by the company itself or by any of its creditors. It was clear that where the mortgagor is also the borrower (ie full-recourse debtor of the bank), then the bank acting as a full-recourse creditor can file for its bankruptcy. However, it was traditionally believed that a bank could not file for the insolvency of a third-party security provider for another party's (ie the bank's borrower) debt. This view was based on a belief that a mortgagee could not be treated as a creditor in the traditional sense. There was no payment obligation between the mortgagee and mortgagor – the mortgagor simply had to endure ("suffer") the forced sale which the bank (the mortgagee) initiated against the encumbered property. A bank could therefore only resort to bailiff-driven foreclosure.

Supreme Court ruling

The Supreme Court held that a bank, acting as the mortgagee, is a "limited creditor" of a property owner acting as the mortgagor, and that a bank is entitled to file for the insolvency of any owner of a mortgaged property, even if the owner is not the bank's borrower.1 This means that any bank benefiting from a third-party security can tailor its enforcement strategy and either: (a) instruct a public bailiff; or (b) refer to the bankruptcy regime, should it choose to do so.


This ruling accords with our view that a property's owner becomes a limited debtor, with the mortgagee having a pecuniary claim towards the mortgagor. Thus, the bank should be treated as the property owner's creditor, which has the right to file for the mortgagor's bankruptcy.


1. As an aside, this issue of admissibility is naturally separate from the question of whether a specific owner of the mortgaged property meets the insolvency test and whether the court will ultimately deem it bankrupt. Note that there are two insolvency tests, and it is sufficient that only one is satisfied for a mortgagor to be declared bankrupt: (a) illiquidity, where the mortgagor is unable to meet its pecuniary obligations towards two creditors as they fall due; and (b) over-indebtedness, where the mortgagor's assets no longer cover its liabilities.