Insight

ECJ interprets financial collateral on bank accounts

June 07, 2017


In November 2016 the European Court of Justice (ECJ) issued a preliminary ruling on the interpretation of the Financial Collateral Arrangements Directive (the FCA Directive).

In that ruling (which is the first ECJ ruling on the FCA Directive) the ECJ held inter alia that the requirement under the FCA Directive that the collateral must be “in the possession” or “under the control” of the collateral taker means that the collateral taker must have not only practical control over the account, but also the right to prevent the withdrawal of cash by the collateral provider in so far as is necessary to guarantee the relevant obligations.

What that means for lenders who want to take a financial collateral over a bank account is that the lenders should have a contractual right (enforceable also against the bank where the account is held) to limit withdrawal of funds from the account, if such withdrawal is contrary to the contractual restrictions in the financial collateral agreement. The account bank should also agree not to allow withdrawals without consent of the collateral taker. Without this there is a significant risk that the financial collateral will be void or unenforceable.

In addition the ECJ ruling makes it clear that, although the financial collateral is generally “insolvency-safe” (i.e. the ability of the collateral taker to enforce the financial collateral by withdrawing cash from the account despite the commencement of insolvency proceedings in respect of the collateral provider) it does not protect any cash that was transferred to the account after the commencement of the insolvency proceedings of the collateral provider. So the financial collateral applies only to the cash which was in the account prior to the commencement of the insolvency proceedings of the collateral provider (and at the latest on the day of commencement of the insolvency proceedings if the collateral taker was not aware and could not have been aware of such commencement).

Further the ECJ ruling confirms that the obligations secured by the collateral may consist of or include future obligations, including obligations arising under a master agreement or similar arrangement or obligations of a specified class or kind arising from time to time.

What this means for borrowers is that when they give financial collateral for a debt they should make sure that the financial collateral secures also any potential future refinancing of the debt. This would save them the costs of creating new financial collateral over the same assets for a refinancing of the original debt.

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