Cyprus: Memo On Taking And Enforcing Security In Cyprus

Introduction

The purpose of this memo is to describe the legal issues under Cyprus Law in connection with the taking and enforcement of security.

In recent times, the focus of attention with respect to security and secured transactions has been on the enforcement of security interests taken by banks and credit institutions as part of simple or complex financing transactions. However, a proper understanding of the legal issues on enforcement requires a thorough understanding of the issues associated with taking security.

The Cyprus law relating to the taking and enforcing of security is both statute and common law based. There is a dearth of Cyprus case law on the legal issues relating to the matters covered by this memo, so English case law which is either binding (pre-1960) or of persuasive authority (post- 1960) will be referenced throughout.

Further, this memo will principally look at the following types of security interest:

  1. mortgage;
  2. charge (fixed and floating);
  3. pledge; and
  4. assignment,

as these are the principle types of security encountered in practice when advising on financing structures. This memo will also briefly consider certain quasi-security interests and transactions that are like security in that they achieve the same economic or security like consequences.

Security Interests under Cyprus Law

Although this memo identifies the types of security interest to be considered, it is necessary, albeit briefly, to examine the essential characteristics of a security interest. There is no statutory definition of security interest and most judicial pronouncements can be considered as applying to the particular type of security at issue, although, there have been attempts to give a more all-encompassing definition.1 However, none of these have proven to be conclusive or exhaustive. Security can best be described as having the following characteristics:

  1. it arises from a transaction intended as security;
  2. it is a right in rem;
  3. it is created by grant or declaration not by reservation;
  4. it is fixed or specific, it implies a restriction on the debtor's dominion over the asset charged.

These characteristics will serve to distinguish security from quasi-security or transactions having a similar economic effect as security. The forms of quasi-security or transactions similar to security are:

i. Transfer of title

In such type transactions, the absolute title to the asset is transferred to the creditor as security for the performance of the obligations of the debtor. Under this form the creditor becomes the absolute owner of the asset without any obligation to account to the debtor or on the debtors' insolvency in respect of those assets. There may however be an obligation to re-transfer the assets or like assets consequent upon the performance by the debtor of his obligations2.

ii. Trust

Under a trust arrangement, property/assets can be held in trust for the benefit of the creditor pending the performance by the debtor of its obligations. This has the effect of taking the property/assets out of the estate of the debtor in the event of its insolvency and the creditor can claim its beneficial title to the property/assets.

iii. Retention of the title (Romalpa) clauses

A retention of title clause which can take many forms in a sale contract pursuant to which a seller/creditor retains title to an asset until payment in full by the buyer/debtor. The possession of the asset (as with a transfer of absolute title), is not held or retained by the creditor. These clauses3 do not amount to security as title never passes to the debtor until payment and security does not arise by retention. The debtor has no proprietary interest in the asset so as to enable him to grant or create a security interest in favour of the creditor.

iv. Flawed Asset4

Simply stated, a "flawed asset" is an arrangement between a bank and a customer pursuant to which a deposit held with a bank will not be repaid until a certain condition occurs. Unless and until the condition occurs, the depositor has no claim on the deposit and the bank has no liability to pay. Accordingly, the asset is "flawed". Although the economic result is the same as set-off, the legal nature is distinguishable from set-off since if the event has not happened, there is no liability (of the bank) against which the depositor can set-off his obligation. Flawed asset structures have been held to be valid and enforceable.5

v. Set-off

At the risk of over simplification, set-off is where amounts are set-off against each other to arrive at a single amount payable arising out of a series of mutual dealings between two parties. Set off can arise by law, by contract or in equity. Set-off does not grant or create a security interest as neither party has a right in any asset, however, it operates so as to achieve a similar result. Set-off needs also to be considered in pre and post-insolvency circumstances.

In pre-insolvency circumstances, it is a matter of giving effect to the right of set-off as it arose whether by law, equity or contract. In post-insolvency circumstances, the position is slightly different as set-off is mandatory. Section 35 of the Bankruptcy Law, cap 56 provides that:

"where there have been mutual credits, mutual debts or other mutual dealings between a debtor .... and any other person proving or claiming to prove a debt under a receiving order, an account shall be taken of what is due from the one party to the other in respect of such mutual dealings and the sum due from the one party shall be set off against any sum due from the other party...."

This provision cannot be contracted out of.

vi. Netting/Close Out Netting

This has the same economic consequences as set-off, however, it essentially involves, upon a default event, the closing out of open positions on executory contracts and then setting-off gains and losses on the contracts to arrive at a single amount payable.

vii. Negative Pledge

A negative pledge is a contractual undertaking not to grant any encumbrances over the debtors assets in favour of a third party or to give any security that would rank pari passu with the security granted to the creditor. No rights are granted in respect of the assets so the negative pledge does not amount to a security interest.

Types of Security Recognised Under Cyprus Law

This memo will not consider all security interests that are recognised in Cyprus law but will consider those most commonly used in practice which are:

  1. mortgages;
  2. charges;
  3. pledges; and
  4. assignments.

i. Mortgages

Mortgages are distinct from charges in that a mortgage grants to the mortgagee a proprietary right in the asset/property the subject of the charge subject to the equity of redemption of the mortgagor. A mortgage can be (and usually is) taken over immovable property but can also be taken over movable property or chattels (for e.g. aircraft or ships). A mortgage gives the mortgagee the power of enforcement by way of sale, repossession, foreclosure or the appointment of a receiver or receiver and manager (these rights on enforcement will be considered later).7

Mortgages fall into two classifications either (i) legal mortgages or (ii) equitable mortgages. Simply stated a legal mortgage gives a legal right in the asset/property whereas an equitable mortgage grants merely equitable rights only. The distinction has greatest significance when considered in the context of priorities which will be considered later in this memo.

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Footnotes

1 Re Paramount Airways Ltd. [1990] BCC 130 where it was suggested that security is created where a person ("the creditors").......... obtains rights exercisable against some property in which the debtor has an interest in order to enforce the discharge of the debtor's obligation to the creditors.

2 For e.g. under the ISDA Credit Support Annex (English Law) which does not create a security interest in the assets/property delivered thereunder.

3 For e.g. "current account form" covering all indebtedness of the debtor to the creditor; "proceeds or tracing form" which allows sale in the ordinary course and transforms the creditors claim to a claim in the proceeds of sale.

4 The next two types of quasi-security are considered separately although they have the same economic effect.

5 Re Bank of Credit and Commerce International (No. 8) [1998] AC 214

6 This also applies to Companies – see s.299 of the Companies Law, cap.113

7 It should be noted that Cyprus does not have any equivalent of the English Law of Property Act 1925 so therefore the mortgage instrument will have to expressly provide for all these powers.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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