While the continuing crisis in the international financial markets and the attendant credit crunch have not gone unnoticed in Sweden, most Swedish banks have by and large avoided the worst effects of these phenomena. The fact that most Swedish banks have thus far got away relatively unscathed is primarily due to the business model of our banks. Most banks (including the big four) are at heart commercial and/or retail banking operations with relatively small capital markets divisions. The security portfolios of Swedish banks are primarily held for liquidity purposes and are not a major part of the business mix. Superior management, then, has had little to do with the fact that the balance sheets of Swedish banks are in good shape and that they are still very much open for business on otherwise unpopular credit lines such as leveraged loans.

Although true in some respects, the rosy picture of Sweden being insulated from the broader trends of international finance belies the overarching trend of increasing convergence with the culture of the Anglo-Saxon transaction-oriented model of financial capitalism. This trend has been pronounced in many areas, but from the law firm perspective, it has for obvious reasons been particularly noticeable in terms of the way financial transactions are structured and documented.

An open approach

Traditionally, Swedish banks have been intent on keeping things as simple as possible and taking a light approach to documentation. Most deals have been done in-house on simple standard-form documentation and this has in many cases meant less negotiation and little room for borrower bargaining. Coupled with a strong – legitimate – faith in the background rules of Swedish law, the approach has in many respects served the banks well. While this Swedish tradition is still alive and well, practices similar to, or inspired by, those prevalent in the UK/London market have made serious inroads in the Swedish banking market over the last 10 to 15 years.

The reasons for this are several and varied. Firstly, Sweden is a small open economy. It is the Nordic region's financial centre with an open and efficient regulatory environment. This means that trends across many business sectors are picked up quickly in Sweden. Secondly, there is the obvious reason of globalisation in general and the fact that the number of foreign participants of all kinds (banks, investors, funds) on the Swedish market increases all the time. With respect to foreign banks established in Sweden, the number has increased dramatically since the beginning of the nineties when foreign banks were allowed to set up branches in the country. Sweden's fifth largest bank is Danish (Danske Bank).

The openness to new trends and ideas partly explains another reason for the increasing prevalence of UK-style lending practices, which is that Sweden was one of the first countries in Europe to develop a private equity market. Today it has the largest proportion of venture capital to gross domestic product of any European nation (the UK included). The leveraged finance boom has been one of the main drivers of the different approach to doing transactions, both in terms of structuring and documentation. As far as structuring goes, even a basic leveraged-loan transaction is quite complicated compared with straightforward corporate lending.

English dominance

In more complicated transactions involving many layers of debt, structural subordination and, perhaps, foreign innovations such as second lien debt, it is of course only natural to look abroad where such transactions are more common and the experience much greater. In this connection we should also mention that secondary debt market pressures have also contributed to greater conformity with international practices although Swedish banks do not depend on origination of loans to the same extent as foreign institutions. Loans made by a Swedish bank are typically kept on the balance sheet of the bank. Securitisation is also not as common as in the UK, for example. This is partly due to the absence of the trust institution and the fact that beneficial ownership is not recognised under Swedish law.

When it comes to documentation, the predominance of the English language in the banking sector has of course done much to push Sweden towards adopting UK-style documentation. The standard form documents developed by the Loan Market Association (LMA) has become widely used and has had a major impact on that various types of transactions are now documented in a much more comprehensive UK fashion than has been the case previously. Again, the trend is particularly strong in the leveraged finance context where we have seen a very widespread use of the LMA's leveraged document. In many instances, though, the LMA document is used in a slightly trimmed-down lighter version (in keeping with the traditional Swedish way).

Even security documents, the most national documents in the financing context (see below), have not escaped the trend and have become ever more comprehensive.

Intricate

An example from our practice of the general trend towards greater complexity and comprehensiveness is a German mortgage bank, which we have acted for during many years. When the Swedish branch was established in the mid-nineties, the bank was intent on respecting local culture and practices and doing business in a way comparable to the traditional Swedish way. This approach was quite swiftly abandoned, however, in favour of LMA-inspired documentation.

All this augurs well for international firms coming to do business in Sweden in the sense that the environment will seem strangely familiar. There will always be certain differences in lending terms (for example, in the case of the degree of leverage and default interest, which are generally higher in Sweden than in many other jurisdictions), but all in all, the similarities dominate.

What remain distinctly national, though, are the property law aspects of secured financing. The Swedish system for secured credit is quite peculiar and intricate and we will devote the balance of this article to outlining the main features of that systems.

Secured credit system

At the outset, it should be noted that the Swedish rules which govern the taking of security over moveable assets or rights are predicated on the assumption of there being no system for registration of security interests. In lieu of registration, the general perfection requirement under Swedish law is that an assignor or a pledgor may not, legally or practically, retain any independent control over, or access to, an asset or right which is assigned or pledged (the Non-Recourse Principle). The Non-Recourse Principle means inter alia that any asset pledged (or any instrument representing such asset) must be physically handed over to the pledgee.

In cases where the relevant asset or right is in the possession of, or otherwise under the control of, a third party (for example, a bank in the case of a bank account), notification must be given to the third party with a stipulation that the pledgor may not dispose of or be granted access to the pledged asset or right (without the prior consent of the pledgee). The rationale usually invoked in favour of the Non-Recourse Principle is that it operates to limit fraud and transactions made under false pretexts.

If independent access or control to a pledged asset is granted to the pledgor, the Non-Recourse Principle provides that the relevant security interest will not be upheld in distraint- or bankruptcy proceedings of the debtor.

While the Non-Recourse Principle and the attendant requirement of transfer of possession constitutes the foundation of Swedish property law as it concerns moveable assets, Sweden has, for certain classes of assets and rights, gradually introduced registration as the relevant perfection measure. This is the case for intellectual property rights (patents and trademarks), aircraft, vessels and publicly traded shares and financial instruments. Notwithstanding these developments, the Non-Recourse Principle informs the entire system for secured credit, even in areas that do not strictly concern moveable assets. A case in point is the relatively new phenomenon of computerised mortgage certificates, which in essence is a system for registration of mortgage security. It is nevertheless based on digital mortgage certificates that are deemed transferred to the mortgagee upon registration of the mortgagee's possession of the certificates.

Now, obviously, the Non-Recourse Principle will operate, at the practical level, to limit which assets are available as collateral. In cases where it is an operational necessity that the pledgor retains control over the relevant asset, the Non-Recourse Principle may cause difficulties. In practice, this is especially so with respect to goods (stock-in-trade) and bank accounts. In some cases, such difficulties may be addressed by the pledgee's (most frequently, the security agent) giving its prior written consent to a transfer from a bank account (for example) but in many cases this may prove too cumbersome and/or may raise liability concerns.

In practice the Swedish approach to secured credit may cause difficulties for foreign lenders expecting to receive full security. In our experience, it is a common assumption among foreign lenders with limited experience of the Swedish market that they will receive some kind of security over all the assets of a Swedish company (like an English law debenture). Credit committee approval is often predicated on such security being available and we have seen many term sheets drafted without Swedish assistance where the scope of the security to be provided is summarised as full.

For the reasons explained above, this is in most instances not feasible in relation to a Swedish company. In the extreme case, no direct asset security at all may be available for the lenders. Take the example of a large retail business, which does not own any real estate and has no registered trademarks. The only assets of the business are employees, lease agreements and operating bank accounts. In such cases, no security interest would be available that would not be unduly business disruptive except for a business mortgage.

Heavily criticised

Traditionally, Swedish banks have overcome the difficulties flowing from the Non-Recourse Principle by resorting to the floating charge or, as it is known nowadays, the business mortgage. This has long been a mainstay of basic Swedish corporate lending but it is also quite often used in the leveraged finance context where there is little in the way of chargeable assets. The business mortgage is often resisted, though, due to the stamp duty payable upon issuance of business mortgage certificates (1% duty of the face value of the certificates). In conformity with the Non-Recourse Principle, perfection of the security interest represented by the business mortgage is achieved by handing over the business mortgage certificates to the beneficiary of the business mortgage.

This is something of an anomaly, since the business mortgage does not attach to a specific asset. Rather, the business mortgage is a security, which affects all the present and future assets of the company but which permits the company to deal freely with the undertaking and assets of the company (including disposing of assets) in the ordinary course of business. The granting of a business mortgage would thus be the nearest equivalent to providing full security using one instrument under Swedish law.

It should be noted, though, that the business mortgage creates only a secondary security interest with a general right of priority in bankruptcy. It is thus only enforceable in the event of bankruptcy and, in addition, only in respect of assets corresponding to 55% of the total value of such assets of the bankrupt's estate that remain after creditors with higher ranking priority have received payment in respect of their claims. Any secured amounts not satisfied after enforcement of the mortgage will constitute unsecured obligations ranking pari passu with all other general unsecured claims of the debtor.

These features of the business mortgage have been heavily criticised, and are novelties in the sense that they were introduced only in 2003 when the floating charge was replaced by the business mortgage. To provide an idea of how the Swedish business mortgage will transform and develop in the near future it is necessary to briefly describe how the current rules came to be.

About-face

In June 2003 the Swedish Parliament adopted changes to the Swedish insolvency legislation and the Swedish Floating Charges Act. The floating charge was replaced by the business mortgage, with the result that the security was transformed from a first priority security interest over 100% of the value of the debtor's moveable assets (with some exceptions such as cash in hand), into a secondary security interest over 55% of the value of all of the debtor's assets.

The new rules came into force on January 1 2004 and have had a significant impact on secured credit in Sweden. The new business mortgage was received as somewhat of a sea change by the Swedish banking community. All creditors of a company have been affected, though, and not only parties benefiting from security arrangements. Banks and other financial institutions, as well as other creditors that hold security in the form of business mortgages, have in many instances made a thorough overhaul of existing security packages. Concurrently with a review of existing security, new transactions have seen other types of security arrangements, with stronger rights of priority gaining in popularity despite impracticalities (for example, pledge of accounts receivables, pledge of movable assets, and security assignments). We have seen that banks are increasingly asking for guarantees from owners.

Following intensive lobbying from various interest groups, the Swedish Parliament commissioned the government in 2006 to restore the floating charge regime, in as much as enhancing the 55% limit. The Swedish government, elected in 2006, has recently proclaimed that it aims, without delay, to increase the 55% limit to 100% in order to strengthen Swedish companies' supply of capital and place different creditors on an equal footing with one another.

This about-face, which is currently under review by the Council on Legislation, suggests that the floating charge regime will be more or less fully restored. The floating charge concept would thus be re-introduced and regain its status as a first ranking security interest, providing security in 100% of all of the company's moveable assets (thus excluding cash in hand, monies standing to the credit of a bank accounts, financial instruments and assets which may be pledged under a specific charge such as aircraft and vessels). The changes are expected to take effect as of January 1 2009.

Resistant to change

The restoration of the old floating charge regime of course has many implications for all participants in the Swedish market. For one thing, it means it will be somewhat easier to obtain something akin to full security over the assets of a Swedish company. A floating charge in the requisite amount together with pledges or mortgages (as the case may be) over specific assets will go some way towards achieving full security. The Non-Recourse Principle will still cause difficulties in terms of business disruption. This is especially so with respect to operational bank accounts.

Depending on the nature of the business, it might prove cumbersome to pledge such accounts and to implement an account structure and a mechanism of consent from the pledgee, which will allow pledgors to conduct their business without undue disruption. In some cases, though, this will not be a problem. In cases where one cash-flow generating asset is being financed, it will be possible to set up a waterfall mechanism and to handle the problems associated with consent to use of bank accounts.

However, it should be noted that springing perfection mechanisms (that is, where the lender is granted the right to perfect security in cases of an actual or anticipated default) will not hold up in bankruptcy (although they may be useful before that time). In the case of bankruptcy, the Swedish rules on fraudulent conveyances and hardening periods will provide that the security at issue may be subject to claw-back/recovery following a demand of the administrator to that effect (or, if the demand is contested, an order by the relevant court).

The Swedish system for secured credit has proved resistant to change. The basic principles accounted for here continue to hold and inform the mind-set of all participants in the system. It will be interesting to follow developments in Sweden and the EU, where changes are discussed that may affect the Swedish system. The government has commissioned a review with a view to transforming the Swedish system of insolvency and reorganisation proceedings, which is bound to have an impact. Other influences, such as the continuing work on a common European Civil Code, will also affect the Swedish system.

In the long-term, it is to be hoped that Sweden will move towards a registration-based system for secured credit. This would be beneficial for all parties concerned and would save substantial transaction costs. More often than not, bearer instruments are missing and considerable time and effort are spent negotiating and implementing alternative solutions. The costs for replacing missing instruments are also a factor. Given that the historic rationale for the Non-Recourse Principle (prevent fraud) is no longer convincing, we would welcome a development towards an alignment of the Swedish system with other more transparent registration-based systems.

Author biographies

Carl Schwieler DLA Nordic Carl Schwieler is a partner in DLA Nordic. He is admitted to the Swedish Bar Association and holds an LLM degree from Uppsala University. He has worked with GE Money and as a foreign trainee with Holland & Knight in New York. Schwieler practises in the structured finance team within the DLA Nordic banking and finance group. He specialises in banking and finance law (mainly transactional work). In particular he works on asset-based finance with an emphasis on domestic and cross-border leasing transactions – asset types include rolling stock and commercial aircraft. Schwieler has represented participants in a wide variety of transactions, including loans, sale and leasebacks, operating and finance leases, receivables financing and portfolio acquisitions. Björn Sjöberg DLA Nordic Björn Sjöberg is a partner in DLA Nordic and a member of the Swedish Bar Association. He studied law at Uppsala University (LLM) and New York University (LLM). Sjöberg is mainly active in DLA Nordic's banking and finance group, where he represents arrangers, lenders and borrowers on various types of leveraged finance, structured asset finance and real estate finance. Sjöberg advises on all aspects, structuring, negotiating and documenting national and cross-border transactions. He also has significant experience with different types of capital market transactions, such as bond issues and securitisation.