One of the most important issues connected with contracting a debt by borrowers is granting the creditor appropriate security for the repayment of that debt. The quality of the security granted has – apart from the potential borrower’s financial condition – a direct influence on the cost of the potential credit. The better and more valuable the security, the lower the credit cost. Local government institutions, which because of their broad access to EU funds have become some of the most important investors in Poland, have also had to face the decision of the form in which they are to grant security to creditors, so as on the one hand to ensure lower financing costs, and on the other not to permit any violation of the finance discipline rules binding them.
Subject of a pledge
One of the forms of security that local government entities (LGEs) can propose is a registered pledge on holdings or shares of municipality-owned companies. Ever since the urban economy is increasingly being realised through commercial law companies majority-owned or wholly owned by LGEs (municipality-owned companies), this form of security can be used by them also with regard to securing obligations – not only own ones, but also those contracted by municipality-owned companies.
In the latter case the LGE plays the part of the pledger, and the subject of the pledge is part of the municipal property in the form of holdings and shares of municipality-owned companies. This is a so-called “debt in rem”, where the person granting the security is not the creditor’s personal debtor.
Setting up an SPV
The latter case is not the only one, and is an example of the ever greater part played by municipality-owned companies in public utility investments through a form similar to the project finance formula. Briefly, this is a form of realising an investment with the aid of a special purpose vehicle (SPV) specially set up for that purpose.
The essence of investment realisation thus comprehended is the assumption that it is the SPV, not the LGE, which contracts the obligation. A municipality-owned company (SPV) also grants security to a creditor. In order to increase the certainty that they will get back the funds lent to a municipality-owned company, creditors require the parent local government entity to grant some form of guarantee or surety for the return of those funds. In practice, local government can choose between security in rem (e.g. in the form of a registered pledge) and personal security in the form of a guarantee or surety.
Establishing a pledge will not have much influence on a budget economy and the measured state of indebtedness of a local government entity. In contrast to sureties and guarantees granted by an LGE, a registered pledge will not have an influence on calculating the individual debt indicator of a local government entity. Its aim is to limit local government debt, and exceeding it entails setting appropriate recovery procedures into operation at the entity. One of the factors influencing the calculation of this, however, will be the potential (non-due) amounts of repayment of sureties and guarantees.
Excluding a pledge from measurement of the local government debt therefore means that this is a solution which is more favourable from the point of view of local government activity than other means of security, i.e. sureties and guarantees. A registered pledge established on constituents of municipal property such as holdings and shares will also not cause, in contrast to sureties and guarantees, budget expenses to be incurred, nor the need to block a specific amount in the budget.
The legal regulations on running an urban and financial economy by local government entities do not refer directly to a registered pledge as a form of securing creditors’ receivables. This means that creditors and local government entities have a certain amount of freedom regarding their decision to choose that instrument as security as well as shaping its content. A registered pledge is a kind of material security for a debt, which, in contrast to personal security (a surety, guarantee or bill of exchange), is closely connected with a specific constituent of property. By establishing a pledge in its favour, a creditor thus gains the possibility of satisfaction from the pledged subject with priority before a debtor’s personal creditors, also regardless of who will become the owner of the subject of the pledge.
Basis of an agreement
A registered pledge is established by virtue of an agreement between the pledger (in this case the LGE) and the pledgee (creditor of a municipality-owned company), for which the written form is reserved by act of parliament, otherwise being invalid. The entity concluding the agreement for the LGE is the managing authority, which should act on the basis of a previously issued resolution by the constituting authority. To establish the pledge, it is also necessary to make an entry in the register of pledges, which entails the supposition of correctness of and familiarity with the data included therein. The appropriate court will be the court of the region in which the pledger’s place of residence (registered office) is located. The entry is subject to a moderate fee of PLN 200.
Establishing a registered pledge should not have an influence on the company’s ongoing activities. It is true that detailed rights of the pledgee (creditor) in this respect – in particular, the right to vote and the right to a dividend – can depend on the provisions of the pledge agreement, as well as the provisions of a municipality-owned company’s founding act. However, the general rule contained in the Commercial Companies Code is to leave the exercise of rights under holdings and shares wholly with the owner.
It transpires that the registered pledge as a form of security, frequently made use of by creditors, does not cause any serious effects for the ongoing activity of a municipality-owned company and a local government entity.
Parliamentary legislation on commercialisation
Despite the lack of legal and budgetary restrictions, establishing a registered pledge can have the effect of a loss of control of a company in favour of an external entity, if the debtor (municipality-owned company) does not carry out its obligation. A registered pledge can entail a possible switch to the creditor of a constituent of local government property, often essential from the point of view of fulfilling local government tasks (privatising public property). It should therefore be borne in mind that, with reference to a registered pledge, appropriate regulations concerning the disposal of shares will apply, which are contained in the Act on Commercialisation and Privatisation, to which the Act on Urban Economy refers in Article 12, and whose assumption is that they are intended to increase the protection of public property. Disposal must therefore be comprehended in a broad sense, as each transfer of ownership, including in the context of establishing pledges.
The reference to the Act on Commercialisation and Privatisation particularly concerns the restriction of the ways in which the pledgee can be satisfied. This should be done according to one of the procedures provided for in the act, including a public offer or auction, public tender, negotiations undertaken on the basis of a public invitation, which are regulated in detail in a Council of Ministers regulation issued on the basis of the act. The Minister of the State Treasury’s role anticipated in the course of privatisation will be carried out by the chairman of the board of the local government entity, and in the case of a district this will be the district administrator (mayor, city president).
It is necessary to apply these norms, because failure to do so will mean that the actions carried out will be invalid. It also follows from this that, in exercising a right under a pledge, the general rules contained in the Act on the Registered Pledge should not apply, among others the procedure of court enforcement or the direct takeover of ownership of the subject of a pledge.
Commentary
Bartłomiej Bronisz, advocate at FKA Furtek Komosa Aleksandrowicz
The loss of control of some municipal property constitutes an effect which is only potential and removed in time for a local government entity. Thus, combined with a lack of particular statutory and budgetary restrictions referring to the establishment of a pledge on the holdings of municipality-owned companies, it seems that, similarly to the private sector, this can be a form which is widely used by creditors seeking a means of securing their claims towards local government entities. The only actual restriction imposed on the local government side with regard to establishing pledges on holdings of companies can be the statutory requirement to conduct the management of municipal property with all due diligence, i.e. with a proper consideration of public needs, targets and the essence of local government action.
Because establishing a pledge can mean getting rid of control over some municipal property, and there is a lack of detailed restrictions regarding its establishment on holdings or shares of municipality-owned companies, this requirement, as one of only a few, therefore becomes essential for assessing local government decisions with respect to establishing a pledge on holdings of companies or municipality-owned shares.