Setting aside of a bank's security in real property

Date 12 nov. 2012
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21 June 2012, the Maritime and Commercial Courts Bankruptcy Division set aside a mortgage provided by a property company to a bank. The court considered the mortgage to constitute an unfair advantage to the majority shareholder in the pledging company, and the court found the mortgage to be contrary to the company’s articles of association.

The decision calls into question when banks must obtain the minority shareholders’ consent when a company mortgages its assets.

 

Factual Background

In connection with another company’s (the “Debtor”) debt, a property company (the ”Mortgagor”) provided security to a bank (the “Bank”). A pledge in four mortgage deeds registered to the mortgagor was provided as security.

 

When the security was provided, the management of the Mortgagor was made up of a CEO (“A”) and a board of directors formed by the following people; the CEO, an attorney (“B”) and one of the CEO’s business partners (“C”), who was chairman. The Debtor was ultimately owned by C. Under the Mortgagor’s Articles of Association, inter alia, A and C together or A, B and C together had the power to bind the company.

 

Different guarantees and other types of securities were provided between A, C and their respective companies.

 

In addition to A, who indirectly owned 57.5% of the shares in the Mortgagor through two fully controlled companies, the circle of owners consisted of a number of minority shareholders. C had no ownership in the Mortgagor.

 

The object of the Mortgagor was to buy, own, administrate, lease and sell real estate, conduct business in that relation and to pursue alternative investment activities as directed by the Board of Directors.


In relation to the pledging of the mortgage deeds registered to the mortgagor, the bank requested confirmation that all shareholders in the Mortgagor accepted that the mortgage deeds registered to the mortgagor were provided as security for the Debtor’s debt. However, the bank did not receive any such confirmation from the minority shareholders.


The lawsuit was initiated during the winding-up proceedings in relation to the Mortagor because the liquidator during the determination of claims could not recognise the pledge in favour of the Bank.

 

The applicable Rules

In accordance with the Danish Public Companies Act Section 63 (1) (now Section 136 (1) of the Danish Companies Act), a contract signed on behalf of a company by a person who has the power to bind the company is in principle legally binding for the company. 


However, there are three exceptions to the above. If the person with the power to bind the company has exceeded his powers under the Danish Public Companies Act (now the Danish Companies Act), then the contract will not be binding. Further, if the contract falls outside of the objects of the company and the company in addition can also prove that the third party was in bad faith, then the contract will not be binding. In addition, a disposition will not be binding for the company if the person with the power to bind the company has exceeded his powers or significantly infringed the company’s interests, and the third party was aware of that or should have been aware of that.


Further, is it stated in Section 63 (1) of the Danish Public Companies Act (now Section 127 (1) of the Danish Companies Act) that the person with power to bind the company may not on the company’s behalf of make dispositions which are obviously suited to provide certain shareholders with an unfair advantage at the expense of other shareholders or the company itself.

 

The Bankruptcy Court’s Decision

The Bankruptcy Court found that the purpose of the mortgaging of the mortgage deeds registered to the mortgagor was to provide security for the Debtor’s debt in order to prevent any consequences for A’s and C’s other companies, should the Debtor breach his debt. Based on the above, the court stated that the mortgaging was only in A’s and C’s interest, that the measure was missing sufficient business justification and that the mortgaging did not fall within the alternative investment business under the objects of the company. Further, it was stated that the bank was aware that the mortgaging was not in the minority shareholders’ interest.


The Bankruptcy Court took into consideration that it is common banking practice to ensure that a company’s minority shareholders accept a mortgage if the mortgage is not already adopted at the general meeting. This particularly applies if the mortgaging is beyond the objects clause of the company.

 

On that background, the Court found that C and A, who were majority shareholders in the Mortgagor, had acted in a way where C, A and their companies had obtained an unfair advantage at the expense of the Mortgagor and the other shareholders. Consequently, and due to the bank being aware of the situation without insisting on the minority shareholders’ accept of the mortgage, the Court concluded that the mortgage was a clear breach of Section 63 (1) of the Danish Companies Act.


Further, the Court found that the measure fell outside of the object stipulated by the company’s articles of association and that the bank was aware of that fact.

 

As there was no basis to assume that the minority shareholders had accepted the mortgage, the court set it aside.

 

The Consequences of the Decision

The Bankruptcy Court’s decision is in line with the company law regulation of when a company is bound by a contract signed by a person with the power to bind the company.

 

The Court took into account that the disputed mortgage was beyond the company’s objects and that the bank was aware of that fact. On that basis, the court concluded that the company was not bound by the signature of the person with the power to bind the company, cf. Section 61 (1) of the Danish Public Companies Act.

 

Furthermore, the Court found that the measure provided certain shareholders with an unfair advantage at the expenses of the other shareholders and that the bank was aware of that fact. Consequently, the company was not bound, cf. Section 63 (1) of the Danish Public Companies Act.

 

The decision is interesting due to the fact that the Court took the following into account:

 

”The Bankruptcy Court finds that it is normal banking practice to ensure that minority shareholders accept a mortgage when this mortgage has not been adopted at a general meeting, and particularly when it cannot be ruled out that a such a mortgage is outside of the company’s objects clause. This applies even if it relates to measures which may fall within a grey area.”

 

In that connection, it should be noted that there were two expert judges, who both work in Danish banks, on the Bankrupcty Court’s panel of judges. The first part of the Bankruptcy Court’s statement concerning common banking practice seems to be quite extensive. It is stated that it is common banking practice to ensure that minority shareholders have accepted a mortgage. Such a general practice can be interpreted as a distrust of banks’ management structure in Danish companies where the management and the central governing body are the decision-making body of a company, unless specific types of decisions are made by the general meeting.


However, the general statements expressed in the first part of the decisionare subsequently modified, as it is stated that it is particularly common in cases where it cannot be ruled out that the measure is contrary to the company’s objects clause. In that connection, it should be noted that it is quite obvious that a bank will request the shareholders’ confirmation of the disposition if it falls outside of the objects of the company, as the measure in such a case will not be binding for the company.

 

The general statement is modified further, as the Bankruptcy Court states that this applies even though the pledge relates to measures which may fall within a grey area. This implies that the threshold for when a request for acceptance from the minority shareholders is made starts in the grey area. Conversely, it is not necessary to obtain acceptance in situations where it is clear that the mortgage falls within the company’s objects clause. If the Bankruptcy Court had found that it is common banking practice to obtain accession from minority shareholder in situations where the mortgage is undoubtedly beyond the company’s objects clause, the Bankruptcy Court should have used a formulation indicating that the foregoing applies even if the disposition clearly falls within the objects.

 

Therefore, there does not seem to be any basis for banks to require accession by all shareholders in cases where there is no doubt that the measure falls within the objects of the company and where there is no suspicion that the measure will lead to an unfair advantage for certain shareholders or others at the expenses of the other shareholders or the company itself.

 

Therefore, it is our opinion that the judgment should not result in banks automatically having to require acceptance from minority shareholders, but that they should only have to do so if the factual circumstances necessitate this. It should also be noted that banks do not necessarily provide the needed security by simply obtaining an acceptance from minority shareholders. If the measure falls outside of the company’s objects or if it grants an unfair advantage to certain shareholders over others, and the bank is in bad faith, the measure will, inspite of the obtained acceptance, still not be binding on the company, which, as this case illustrates, can be made topical if the company goes bankrupt.

 

The decision focuses on the inappropriateness of unprecise provisions in company statutes. In the articles of association in the present case, the objects clause contained the following conclusion:

 

              "... to pursue alternative investment activities as directed by the Board of directors."


Such provisions do not create clarity on the range of the objects clause and should be avoided.

 

The judgment relates to a public limited company, but the above will also apply to other limited liability companies.


 

Should you have any questions or wish further information on the judgment on about companies’ mortgaging for a third party’s debt, please contact partner, Dan Moalem (dmo@mwblaw.dk), partner, Christian Bredtoft Guldmann (cbg@mwblaw.dk), attorney Henning Hedegaard Thomsen (hht@mwblaw.dk) or junior associate Henrik Rasmussen (hra@mwblaw.dk)

 

The above does not constitute legal counseling and Moalem Weitemeyer Bendtsen does not warrant the accuracy of the information. With the above text, Moalem Weitemeyer Bendtsen has not assumed responsibility of any kind as a consequence of a reader’s use of the above as a basis of decisions or considerations.