Pfandbrief

Brexit and the preferential right of Pfandbrief creditors in cases of insolvency involving mortgage loans

Andreas Luckow

Andreas Luckow

Association of German Pfandbrief Banks

German legislators took steps to prepare the German Pfandbrief Act (Pfandbriefgesetz, PfandBG) for Brexit as long ago as February 2019, however the United Kingdom is still a member of the EU. After being repeatedly postponed, Brexit is now scheduled to take place on 31 January 2020. Given that the recent parliamentary elections delivered an unequivocal result, this date is not likely to change. According to the terms of the withdrawal agreement, the UK will then enter a transition period until the end of 2020, during which time it will continue to be treated as a member of the EU. It is of course also conceivable that the transition period might be extended during the course of 2020.

With regard to the cover pools of Pfandbrief banks, sections 13 and 49 (4) PfandBG make it clear that loans secured by British real estate and security rights over real property in the UK remain eligible as cover without limitation if they were recorded in the cover register before the UK leaves the EU or before the end of the transition period (i.e. by 31 December 2020, as things stand today). British loans may also be recorded in the cover register after that date. However, the 10% limit in section 13 PfandBG applies to them unless it can be demonstrated that Pfandbrief creditors are assured a preferential right in cases of insolvency.

Although Pfandbrief creditors in the UK are currently assured a preferential right in insolvency (Credit Institutions (Reorganisation and Winding Up) Regulations 2004), draft legislation has now been prepared to abolish these regulations.

Therefore, the vdp is laying the groundwork for ensuring that the preferential right in insolvency can be achieved through contractual means.

The contract for accomplishing this is currently being drafted with the assistance of Professor Stürner, Professor Stadler, and English lawyers.

Under the contract, a bank or trust company in the UK will agree to hold a security right in mortgage cover assets for the benefit of Pfandbrief creditors. That will give the trustee the right, in situations of distress, to intervene against attachments and security measures taken by creditors of the bank who are not asserting any Pfandbrief claims, as well to take action against separate British insolvency proceedings that disregard the preferential rights of Pfandbrief creditors. In doing so, the trustee would follow the instructions of a cover pool administrator.

However, English law sets high requirements for such a security right. Although a floating charge for the trustee can readily be established and maintained on the portfolio of British cover assets, including where the portfolio changes, this security right does not have priority in a distress situation until insolvency occurs. First and foremost, therefore, a fixed charge should be established. To do so, however, English law requires that the holder, i.e. the trustee, is given control over payment flows. Principal and interest payments must be made to an account that the trustee controls and then remain there for two weeks.

The customer won’t be aware of this, because the account is maintained in the name of the Pfandbrief bank. For Pfandbrief banks, however, this will entail a considerable effort in the form of complicated payment methods and an adverse impact on liquidity, but they are ready to accept this in the interest of Pfandbrief security.

The many individual issues that this raises were able to be resolved in the past several months, e.g. where syndicates are involved. Payment method details and other issues are currently being clarified in discussions with institutions that are capable of assuming the role of trustee. When that step is completed, a final version of the contract will be prepared and then, out of an abundance of caution, reviewed again by highly experienced experts in English law.

This will ensure that the legal restrictions that Brexit is imposing specifically for Pfandbrief banks can be surmounted from the outset.