2.3. Third-party effectiveness and priority of a pledge

The title of draft article 342 is "subsequent pledge". However, in reality, it deals with priority conflicts among competing pledgees and provides that the order of priority is to be determined on the basis of the time of conclusion of the respective pledge agreements. This means in essence that hidden pledges would be effective, as there is no objective way for a pledgee to know that there has been another pledge in the same assets. The obligation of the pledgor to inform pledgees of pledges previously created, which is foreseen in draft article 342.3, does not help as in case the pledgor violates it, the subsequent pledgee has a personal claim, not a property right (which means that, if the pledgor defaults and cannot pay all creditors, only those with a pledge are likely to be paid). In addition, draft article 342 or subsequent draft articles fail to deal with conflicts of priority with other types of competing claimants (e.g., transferees of the pledged asset, judgment creditors and the administrator in the insolvency of the pledgor). Without clear and comprehensive priority rules, these draft provisions are unlikely to achieve the purpose of any modern pledge law, that is, to facilitate secured credit. It seems that the scope of application of draft article 342 is limited by the new Russian law on pledge registration which deals with priority based on the time an application for a notice is submitted to a notary public (which creates other problems discussed below). However, there is lack of clarity which, in view of the importance of priority for the availability and the cost of credit, is a serious problem and should be fully addressed.

Draft article 342 is regrettable for another reason. Draft article 342.2 upholds negative pledge clauses ("a subsequent pledge is allowed if it is not forbidden by a prior pledge agreement"). The exact legal consequence of the violation of a negative pledge agreement is not clear. It seems though that, where a powerful lender includes a negative pledge clause in the pledge agreement, a subsequent pledgee has no property right at all (only a personal claim against the pledgor). These clauses are typically explained by reference to party autonomy. But they have very little to do with party autonomy, as party autonomy cannot result in affecting the rights of third parties such as a third-party pledgee who receives a pledge from the pledgor without knowledge of the negative pledge agreement. Party autonomy would mean that, if a pledgor violated a negative pledge agreement and gave a second pledge, the pledgor would be liable to damages for any loss that the first pledgee may suffer. But the second pledge would be effective, because an agreement between two parties cannot affect third parties. That is the essence of party autonomy. Draft article 342 also does not clarify whether only pledges created by the same pledgor are meant (where A first creates a pledge in favour of X and then in favour of Y), or also pledges created by different pledgors (where A gives a pledge to X and then transfers the pledged property to B, who in turn gives a pledge to Y).

Finally, draft article 342.4 deals out of order again with a different issue, enforcement (which is also the subject of draft article 348). It seems to provide in essence that the initiation of enforcement proceedings by a subsequent pledgee is an event of default allowing the prior pledgee to enforce its pledge; if the pledgee with priority does not exercise this right, the transferee of the pledged assets in the context of the enforcement of the subsequent pledge acquires the assets subject to the prior pledge.

First of all, it should be reiterated that the Guide draws a clear distinction between creation, third-party-effectiveness, priority and enforcement. Even if the draft pledge provisions deal with creation and third-party effectiveness as one issue (in line with the erga omnes effect of security rights in civil law jurisdictions), a clear distinction among creation, priority and enforcement is not foreign to any legal system. In addition, it is important to emphasize that the Guide deals in a comprehensive way with all possible priority conflicts <1>. The reason is that, in the absence of ex ante certainty as to its priority position in the case of default, no secured creditor can part with money or, if it does, the amount of the credit is likely to be lower, its cost higher and its repayment period shorter. Moreover, allowing in essence hidden pledges (that is, pledges about which there is no notice registered in the general security rights registry) means that these negative effects will affect all transactions, as a potential lender would have no objective way of knowing whether there is a hidden pledge (or an equally hidden retention of title) in a particular case. Relegating the matter to an obligation of the pledgor does not help at all. First, there is no assurance that the pledgor will provide complete and accurate information; second, a personal claim for breach of contract will be of no use to the pledgee when it would be needed the most, that is, in the case of the pledgor's insolvency.

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<1> Recommendations 76 - 100.

Like recommendation 76 of the Guide, article 342 should make it clear that it deals with competition of pledges granted by the same pledgor in the same pledged assets. A competition among subsequent pledges granted by different grantors (i.e. the transferor and the transferee of the pledged assets) needs to be addressed separately. The Guide leaves it first to the nature of a security right as a property right (which means that the property right follows the asset in the hands of the transferee) and to the nemo dat rule (which means that, if the transferee of a pledged asset took it subject to the pledge, so did the pledgees that took a pledge from the transferee) <1>.

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<1> Guide, chapter V, para. 6 - 8.

Finally, as already mentioned, article 342 should leave enforcement chapters to a separate provision or set of provisions, as is done in the Guide with the chapter on enforcement (see below).