Pledged share certificates and negotiable promissory notes leaving Sweden – what is the impact on the Swedish law pledge?

A common situation

A group borrows from a syndicate of banks. The security package includes the shares in the Swedish subsidiaries and, frequently, intra-group negotiable promissory notes (Sw. löpande skuldebrev). For both instruments, Swedish law requires that the pledgor be deprived of control, which is achieved by delivering the share certificates or the notes to the pledgee. Delivery and perfection take place at closing in Stockholm. A few weeks later the security agent has sent the documents to its head office in England, Norway, Finland, Denmark or Germany.

The question tends to surface when the Swedish legal opinion is being negotiated. The Swedish law firm advising the lenders has included a qualification to the effect that the pledged instruments have been handed over in Sweden and are thereafter retained in Sweden or in another jurisdiction where the pledge is recognised and enforceable. The non-Swedish security agent reads this as a requirement of Swedish custody, finds it impractical and asks whether the qualification can be removed. The law firm is reluctant to do so, pointing out that it opines only on Swedish law. To resolve the question one needs to separate what the relocation means under Swedish law, what it means under the law of the custody country, and when the difference matters at all.

The problem is confined to physical documents that embody a right. For book-entry financial instruments the EU has settled the matter through the PRIMA rule in the Financial Collateral Directive: the applicable law is the law of the country where the relevant account is maintained, and it is irrelevant where anything is physically located. Share certificates and negotiable promissory notes fall outside the directive. For them, the general conflict rule for proprietary questions, lex rei sitae, applies instead.

Lex rei sitae is a rule about timing

Proprietary questions are governed by the law of the country where the asset is located. What is often overlooked is that the rule points to the law of the country where the asset was located when the relevant legal act was carried out. If the pledge was perfected by delivery in Sweden, Swedish law decides whether that delivery was sufficient for perfection, and that question is thereby answered. A later relocation cannot undo the delivery.

What the relocation does raise is what the literature calls the conflit mobile. The asset changes country while the proprietary right continues to exist, and the question becomes which country’s law thereafter governs the effects of the pledge. The prevailing view in Swedish private international law is that a proprietary right validly created under the law of the old situs is recognised after the relocation, but that its continuing effects as to content, priority and enforcement are governed by the law of the new country. The Swedish Supreme Court has reasoned along these lines in relation to foreign retention of title in goods brought into Sweden, and Germany has codified the same principle in Article 43 EGBGB.

As far as Swedish law itself is concerned, the matter is straightforward. The perfection requirement is about the pledgor being deprived of control, not about where the pledgee or its security agent keeps the documents. A share certificate in a safe in Oslo or London is as inaccessible to the pledgor as one in Stockholm. What may matter is whether a court applies the law of the custody country as the new lex situs and that law says something different.

A further circumstance often works in the pledgee’s favour. It is not self-evident where a share is located. Swedish doctrine follows the share certificate. Other legal systems, English law among them, follow the company’s country of incorporation, and the EU Insolvency Regulation locates registered shares in the Member State where the issuing company has its registered office, regardless of where the certificates are kept. To the extent the custody country follows the company rather than the document, its conflict rules point back to Swedish law. For negotiable promissory notes there is no company to point to, and a move from one country to another is therefore of greater significance in principle.

When it becomes real

As between pledgee and pledgor, the pledge agreement applies wherever the documents are. Location becomes relevant only when someone else claims the asset and a court has to decide who has the better right. In practice it is almost always the pledgor’s insolvency that triggers that assessment, and protection against the estate is assessed as of the opening of the insolvency proceedings.

That has a consequence that is easy to overlook. Insolvency proceedings are opened where the pledgor has its seat, and it is that court’s conflict rules that determine which law tests the pledge. If the pledgor is Swedish, the question ends up before a Swedish court, which applies Swedish law on rights in rem as its frame of reference and has a tradition of recognising rights validly created. The scope for disregarding a pledge perfected under Swedish law is small. If, on the other hand, the pledgor is foreign, say a Norwegian parent that has pledged the shares in its Swedish subsidiary, the bankruptcy is opened in Norway. If the documents are also kept with a security agent in Oslo, there is no longer any foreign element for the Norwegian court to take into account other than that the issuer is Swedish. That is where the question comes to a head.

Within the EU the problem is mitigated by the Insolvency Regulation. The shares are deemed located in the company’s country of registered office, and rights in rem over assets located in another Member State are not affected by the proceedings. The bankruptcy of a Finnish or German pledgor therefore does not affect the proprietary position of a pledge over Swedish shares, wherever the certificates are kept. Norway and the United Kingdom are outside the Regulation, as is Denmark by virtue of its opt-out, and for pledgors in those countries there is no equivalent protection.

Between the Nordic countries the Nordic Bankruptcy Convention of 1933 adds a rule of its own. Whether a pledge gives priority in property that was located in another Nordic country at the time of the bankruptcy order, and how the pledge is enforced, is governed by the law of that country. A Swedish court dealing with a Swedish pledgor’s bankruptcy will therefore look to Norwegian law if the share certificates are in Oslo on that day. The rule cuts both ways. If a Norwegian pledgor’s certificates are kept in Sweden, the Norwegian court should, as we understand it, be referred to Swedish law, which is a further argument for Swedish custody.

A question security agents like to ask is whether the documents cannot simply be brought back to Sweden when things turn serious. That helps up to a point. Enforcement is governed by the lex situs at the time of enforcement. But protection against the estate was frozen at the opening of the proceedings, and returning the documents afterwards does not change that assessment. The possibility of returning the documents is an argument that the risk is manageable, not a reason to disregard it.

The custody countries

Five jurisdictions account for most of the cases involving Swedish financings. In all five, a pledge perfected under Swedish law with the pledgee in possession is recognised. Norway, Finland and Denmark perfect the corresponding pledge in essentially the same way as Sweden, by delivery and deprivation of control, with the addition that a pledge over shares in a Norwegian company is perfected by notice to the company. German law recognises pledges over securities by delivery and protects rights created before the thing came to Germany. English law differs most in substance, since the deposit of share certificates gives only an equitable mortgage, but English courts apply the law of incorporation to shares and therefore test the pledge under Swedish law. The position can be summarised as follows.

For the purposes of the table, “minimal” means that local law is identical and the Insolvency Regulation protects the pledge, “low” means that the pledge is recognised under local law and would be tested either by a Swedish court or with the protection of the Insolvency Regulation, and “moderate” means that the pledge is recognised under local law but would be tested by a court in the custody country under its own law, without the protection of the Insolvency Regulation.

Conclusions

The theory is more dramatic than the practice. Moving a pledged share certificate or negotiable promissory note out of Sweden does not affect the pledge’s perfection under Swedish law, and the countries where security agents in Swedish financings most often sit recognise a pledge perfected under Swedish law with the pledgee in possession. What remains is a risk during the time the instruments are abroad, and it is greatest where the pledgor is foreign, the Insolvency Regulation does not protect the pledge and the law of the custody country may have to be satisfied.

For the security agent, the custody country is a choice. A Swedish custodian bank, trustee, notary or law firm holding the instruments on the security agent’s behalf removes the question and costs little. If the instruments are moved anyway, they should never pass through the pledgor or any member of its group, and it should be documented who holds them and on whose behalf. For the lenders, the qualification in the Swedish opinion is a confirmation of perfection upon delivery and an allocation of the relocation risk to whoever decides where the instruments are kept. For the Swedish adviser, a qualification addressing the continued validity, perfection and priority of the pledge in the event of relocation, combined with an express statement that under Swedish law the pledge remains perfected for as long as the pledgor is deprived of control, is easier to accept than a bare requirement of Swedish custody.

The greatest practical risk with physical instruments kept abroad has, incidentally, nothing to do with conflict of laws. It is that they get lost. A lost share certificate or negotiable promissory note must be cancelled under the Act on the Cancellation of Lost Documents before a replacement document can safely be relied on and the pledge enforced, and that process takes at least one year and in practice considerably longer. That argument usually carries more weight with the security agent than any discussion of the conflit mobile.

This is a shortened version of a longer article, which sets out the statutory references, case law and the position in each of the five custody countries in more detail. The full version is available on request from RE:FI STHLM.

We thank Tor Johan Hovden Norheim of Thommessen in Oslo, Päivi Toivari of Krogerus in Helsinki, Henrik Kure of Plesner in Copenhagen, Nadine Bourgeois of Addleshaw Goddard in Frankfurt and Christopher O’Hara of A&O Shearman in London for their valuable comments on how pledges over share certificates and negotiable promissory notes are perfected and recognised in their respective countries. Any errors are our own.