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Security for future and contingent debts ineffective on Czech insolvency

In a case concerning, among other things, bank guarantees issued under a secured credit facility, the Czech Supreme Court recently ruled that a Czech law governed pledge securing future and contingent debts will not withstand the opening of insolvency proceedings.

The case concerned the old Bankruptcy and Composition Act, but it appears that the court’s reasoning would apply equally under the current Insolvency Act.

Czech law explicitly allows future and contingent debts to be secured by a pledge. The Supreme Court has held on several occasions that such security, even if perfected, comes into existence only when the future or contingent debt comes into existence, although priority is then determined retrospectively as at the moment of the perfection of the pledge. The Supreme Court has now applied this concept in insolvency proceedings and concluded that, where the future or contingent secured debt arises or becomes unconditional after the opening of insolvency proceedings, it will be treated as unsecured, because insolvency law does not allow for the creation of new security after the opening of insolvency proceedings 

In the present case, this meant that the bank, which issued bank guarantees under a secured credit facility, was left unsecured with respect to its recourse claims against the borrower arising as a result of payments made by the bank to the beneficiary of the bank guarantees after the opening of insolvency proceedings against the borrower.

Whilst the case concerned pledges, it is quite likely that the Supreme Court would adopt the same approach in relation to transfers by way of security. It should be noted, however, that the case turned more on the court’s interpretation of the relevant (Czech law) substantive rules governing the security, than on its interpretation of the relevant insolvency rules. It therefore remains to be seen how the court would decide if the security were governed by foreign law.

Legal and Regulatory Risk Note