This content is from: Local Insights

Trustees: security without surety?

Where security is being held by a security trustee for the benefit of a group of financiers, a natural sentiment of these financiers is to want to be sure that the proceeds of the security will come their way in an enforcement scenario. The very term security trustee inspires trust that this will be the case. Recent developments, such as the collapses of Lehman Brothers and Landsbanki, have led financiers to look more closely at financing and security arrangements using an agent or trustee, and the risk financiers may run if these parties are no longer capable of performing their obligations. Can the rights of financiers be affected if a security trustee is declared bankrupt? And if so, to what extent?

The position under Dutch law on this point is uncertain. Although the term security trustee is widely used in the Netherlands, Dutch law does not have a trust concept. The existence of a separate fund (afgescheiden vermogen) is not recognised. Accordingly, security and any proceeds of security held by a security trustee become part of the trustee's bankrupt estate, if the trustee is declared bankrupt. Furthermore, the prevailing view is that financiers, for whose benefit the security has been given, do not have a special right to the security or proceeds held by the security trustee. Therefore, if the security trustee acts in breach of its obligations towards the beneficiary financiers, the financiers' remedies do not go beyond those available to an ordinary contracting party for breach of contract.

A number of different methods can be used to minimise the risk of a security trustee becoming insolvent. In practice, the most common method is to use a special purpose vehicle (SPV). This is a legal entity that, according to its objects clause in its articles of association, only has the authority to perform the specific acts necessary for the particular task to which it is appointed – that of security trustee. A Dutch law SPV usually takes the form of a Dutch law foundation (stichting) or private limited company (besloten vennootschap met beperkte aansprakelijkheid).

However, some amount of extra time, effort and costs will be involved in incorporating or finding a suitable SPV and residual risk remains. There is always a possibility, although remote, that the SPV will become insolvent or otherwise does not comply with its obligations. Under Dutch statutory law, an act performed by the SPV that is outside its corporate objects cannot be annulled if the party with whom the vehicle was dealing was not, and need not, have been aware of this. Furthermore, an SPV will inevitably incur some liability vis-à-vis third parties (such as management fees, registration fees and legal costs), even if it does not act in accordance with the restrictions contained in its articles of association.

Despite these drawbacks, the use of an SPV is the most straightforward and conventional way to minimise the risk of a security trustee's insolvency under Dutch law. However, an SPV as security trustee will often not be practical in other types of finance transactions. For example, in a secured syndicated loan facility, participants traditionally consider the use of an SPV as security trustee to be too much hassle and a strong borrower may not be willing to bear the costs involved.

It remains to be seen whether this will change in light of market circumstances, although most loan agreements are now drafted to include a right of the lenders and sometimes the borrower to replace a security trustee if the trustee becomes or threatens to become insolvent. Legislation dealing with this issue is not expected. A solution would therefore have to come from case law. But as the Dutch courts have so far been reluctant to recognise a separate fund without an express statutory basis, it seems unlikely that they will make an exception where security trustees are concerned.

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