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First published in Global Securitisation and Structured Finance 2003, published by Globe White Page in association with Deutsche Bank"


Securitisation – which has only truly emerged in Bulgaria since the shift to a market economy – is still perceived more as a method of granting security over debts incurred, than as a technique for financial engineering. Direct creation of security is still understood as the essence of securitisation.
Generally, true securitisation transactions were completed in relation to the restructuring of Bulgarian foreign debt. The most significant transaction is the issue of Brady Bonds in connection with the agreement with the London Club of creditors executed on 28 July 1994.Bulgaria has issued three types of bonds, listed at the Luxembourg stock exchange, with a total face value of US$5.1 billion. These are front loaded interest reduction bonds (‘FLIRBs’); discount bonds (‘DISCs’) and interest arrears bonds (‘IABs’). FLIRBs and DISCs may also be used as payment instruments in privatisation. Further to that, another important transaction was the restructuring of these issues. In March 2002 Bulgaria issued new bonds with a face value of ˆ835.5 million and new bonds with a face value of US$513 million. These new bonds were offered to the holders of the three types of Brady Bonds (denominated in US$) in exchange for the old ones. Such bonds with a total face value of US$1.327 billion were actually swapped (US$348.7 million IABs, US$376.5 million FLIRBs and US$602 million DISCs).
Securities law development in Bulgaria
The provisions of Bulgarian law on security are marked by several general principles.
As a continental legal system, Bulgarian law does not recognise the English law concept of ‘trust’ and instead favours the concept of ‘possessory security’. There is no tradition of reliance on contractual security. Also, there is no transfer of title to assets for security purposes, except by endorsement of negotiable instruments to create a pledge.
Secondly, the modern development of banking law and practices has resulted in banks lending on ‘external’security only. That is to say, a project and the cash generated from such a project are not considered to be sufficient security by the banks; they require the creation of security rights over assets that are separate from the project itself. Therefore, the general understanding of securitisation is closer to creation of security over the performance of a debt, rather than to securitisation as an aspect of financial engineering.
Immovable property is highly respected (as evidence of this, the Bulgarian population has one of the highest percentages of homeowners in the world). Therefore, hypothecation of real estate is perceived as providing first-class security. This is not just because there is a stable property market, but also for its psychological effect as a driver to ensure that loans perform. Typically, a hypothecation on the home of the manager of the credit applicant will be requested, although the value of such immovable property may be immaterial to the amount of the loan.
The legacy of a centralised economy means that exact performance is encouraged and expected by legislation. Security, therefore, was not actually relied upon. This notion has had a long-lasting effect on the legal and commercial mindset of Bulgarian society. This aspect of the legislative heritage is being compensated for through commercial and banking practices and behaviour, rather than by effective amendments to relevant legislation.
Bulgarian law is, in general, highly protective of debtors. This is a throwback to the centralised economy era when the sole ‘commercial’ players were state-owned entities, and private citizens could not engage in commercial activities. Foreclosure is generally available through court bailiffs, and true sales are rarely available. Also, a defaulting debtor has a number of tools (i.e. court procedures) at his disposal, which he can use to slow down enforcement.
Last, but not least, the creation of security is regulated only as an auxiliary right to an existing main obligation. Where there is no valid debt, or where the secured debt was extinguished in any manner (including novation, repayment, and so on), security rights will be unenforceable.
Given the above, the development of a modern concept of security (to say nothing of securitisation) has been slow in Bulgaria when compared to other important branches of the law of a market economy – such as company law, banking law, etc.
Company law and banking law are wholly new branches of the law in Bulgaria. However, one of the problems relating to securitisation is that certain relevant legal provisions already exist, and there are certain practices thereunder, which make the transition in such a field even more difficult. However, a strong influence for the development of security concepts in Bulgarian law has been provided by the international financial institutions, which, upon lending to the Bulgarian government, have requested amendments to legislation. In addition, Bulgaria’s aspiration to join the European Union means that a degree of harmonisation with European law is essential.
Bulgaria now has a number of tools and instruments to help towards the creation of security and – to a certain extent – securitisation as well. These are able to provide a creditor with a decent level of protection in instances where a debtor fails to perform.
As a general caveat, cross-border securitisation is valid only upon prior registration of the security (whatever the instrument may be) with the Bulgarian National Bank under s.4 (2) (3) of the Currency Act (1999,in force since 1 January 2000).This registration (which will not be unreasonably refused) is a preceding condition for the validity of any securitisation where a Bulgarian person or entity would grant security rights to a foreign person, even where the actual obligation may be between foreign persons only. The only exemptions available under section 4 (4) of the Currency Act are where the Bulgarian security grantor is a bank, licensed to operate abroad, or, where the value of the transaction is below Bulgarian leva 2,000 (i.e. ˆ1022.58 under the exchange rate fixed under the currency board legislation). Registration is not required in the case of domestic securitisation, i.e. in favour of a Bulgarian person or entity.
Hypothecation Bonds Act
In Bulgaria, the closest legislation to the concept of securitisation in the modern legal world is the Hypothecation Bonds Act (2000) (‘HBA’). This piece of legislation allows banks with a portfolio of loans secured by first-rank hypothecation, to package these loans and offer bonds secured by the pool of receivables from such a portfolio to investors. These bonds are negotiable instruments and are registered into a public register, maintained by the issuing bank. The bonds may be offered to the public, in which case the issue falls under the regulation of the Public Offering of Securities Act (1999,in force 31 January 2000, as amended), or may be placed privately, under the general rules of the Commercial Act (1991,as amended) for issue of bonds by a shareholding company. Where the pool of assets may decrease, including through repayment of the secured loans included therein, the issuing bank is obliged to supplement the pool with adequate coverage. It is not allowed to substitute more than 30 per cent of the portfolio by claims, which are not secured by hypothecation.
Importantly, the claims of the bondholders are insolvency remote, i.e. the pool of assets under the register of hypothecation bonds will not be amalgamated into the insolvent estate, should the issuing bank become insolvent.
In any instance of insolvency, the pool of assets, and the claims of the bondholders, are managed separately by a special trustee, and not by the official representative of the bank’s insolvent estate. Where there may be funds available after the full satisfaction of the bondholders, these will be directed towards the insolvent estate of the issuing bank.
Specific Pledges Act
Aside from this true securitisation, expressly recognised by a special piece of legislation, it ought to be mentioned that in 1996 the Specific Pledges Act (in force 1 April 1997,‘SPA’) was adopted. This piece of legislation broadly follows the European bank for Reconstruction and Development’s ‘Model Act for Secured Transactions’ and introduces concepts of security, which are quite removed from the Bulgarian legal tradition. For example, SPA recognises non-possessory pledge (registered pledge) and, as a type thereof, a floating charge. In order to trigger the application of SPA, the security grantor has to operate as a trader (or to be exempt from the duty to register as a trader under s.2 of the Commercial Act). The assets subject to SPA are expressly itemised, and these are: claims; dematerialised securities; chattels (ships and aircrafts being expressly excluded); shares in commercial companies (except paper-backed shares of shareholding companies); aggregation of assets; industrial and intellectual property rights; and business enterprises.
The rules of SPA are flexible enough to allow the pledging of rights, which are not yet available to the pledgor, as well as to create security over future claims and also towards conditional claims. It is very important to note that where a security secured by such a pledge claim is assigned or even pledged itself, the original pledge follows the secured claim.
The SPA allows the pledgor to retain possession of the pledged assets and use these in its business. It may even dispose of such assets in the normal course of its business.
Creation of a specific pledge is effected through making a contract in writing and by entry of the pledge into the Central Registry of Specific Pledges - an institution that operates under the auspices of the Ministry of Justice. Such an entry will be made on the application of the pledge grantor and will be valid for a maximum period of five years, unless a shorter period is requested. The Registry operates on the basis of priority of entries, and the term of an entry may be extended before the expiration of the original term, which would protect the benefit of priority. The nature of the particular asset may necessitate its entry into other registers. Such other registers are:
• the company register, where the business enterprise of a trader may be pledged or where shares into a company may be pledged;
• the land registers, where an immovable may be pledged; and
• the Patent Office, where industrial and intellectual property rights may be pledged.
It is important to note that a pledge is perfected towards any third persons upon the entry made in the relevant register, different from the Central Registry of Specific Pledges. A Pledge on dematerialised securities will not be registered with the Central Registry of Specific Pledges, but with the Central Depository instead. The latter is a special purpose company, entitled to maintain the registers of dematerialised securities. Among other specific rules, it is worth mentioning that pledge of claim must be notified to the debtor under such claim.
Foreclosure under a specific pledge is effected by registration with the Central Registry of Specific Pledges (or with the Central Depository, accordingly). Upon foreclosure, the pledgee is entitled to seize the pledged assets and make any relevant notices or undertake protection of the pledged assets and their value. Where a pledgor will not cooperate, the pledgee has to resort to the bailiff, and the latter will proceed with enforcement under the rules of the Civil Procedure Code (1952,as amended). Foreclosure is organised by a depositor (administrator) appointed by the pledgee. Such a depositor must be a qualified accountant, and is empowered to sell the pledged property and administer the proceeds thereof. The depositor must accommodate the received funds into its special bank account and pay the pledgee (and eventual other creditors who may have joined the procedure) from this account. Thus, foreclosure under the SPA does not actually amount to a true sale.
The procedures under the SPA provide for certain advantages in cases of pledgor insolvency, although upon such insolvency foreclosure proceedings will be terminated. First, a claim secured by non-possessory pledge ranks, in insolvency, immediately after claims secured by possessory pledge and hypothecation. Secondly, non-possessory pledge extends, upon express provision of the law, to the amounts of money paid in consideration of the sale of the pledged assets (whether in foreclosure or otherwise). Thirdly, where the pledged assets could not be separated from the other assets of the pledgor, the pledgee is entitled to privilege in the amount of the pledged assets’ price. In the latter case, upon the insolvency of the pledgor, the privilege extends to all the assets within the insolvency estate of the pledgor, except where possessory pledge, hypothecation or retention rights exist.
The Commercial Act and general law
The Commercial Act provides for a commercial pledge, which is a kind of possessory pledge, different from the general pledge under the Obligations and Contracts Act (1950,as amended) (‘OCA’). Commercial pledge is available as security towards commercial transactions only, and is effective upon delivery of the pledged asset – chattels or negotiable instruments. Upon assignment of the secured claim the pledge is deemed to have been assigned as well. True sale is available in case of default only upon meeting certain additional requirements, i.e. where there is express consent for such, the date the pledge contract was made is prima facie evidence and where the pledged assets have a market price or a stock exchange quotation.
More classic types of security are hypothecation and possessory pledge. While possessory pledge has no particular differences from the other ‘continental’ jurisdictions, hypothecation is made only by way of a notarial act and registration into the relevant land register. Land registers are maintained by each regional court, and, at present, there are 111 of them. At present there is no national information system of land registrations. Registrations are made in the name of the acquirer of real estate rights and not on the basis of a property plan. Hypothecation is valid for a maximum of 10 years from the date of entry, and may be renewed before the expiration of the original term. Given that, there may be only legal rights in security and no beneficial rights in security, even where there may be no other secured creditors.
Some particular issues of Bulgarian law related to security are worth mentioning. Bulgarian law and practices of securitisation are not prepared to accommodate revolving credits. Where an amount of money was repaid, the original obligation is considered to be extinguished, and further re-borrowing of a repaid amount will be treated as a new loan. Where security was granted to the original loan, it will be extinguished by the repayment of the first draw-downs, and the subsequent borrowing will be treated as an unsecured loan. There are some court practices, which reinstate this understanding.
Insolvency implications
Insolvency procedures have an impact on the legal status of security under the general rules of the Commercial Act. The creation of pledge or hypothecation of an asset of the insolvency estate is invalid if made after the date of the court decision for opening of the insolvency proceedings, unless it is made in compliance with the insolvency regulation.
While such a rule is logical, more threatening to the secured creditors’ interests is the rule that the creation of any security interest by the insolvent trader is invalid if made after the initial date of the insolvency. The point here is that such a date will be determined by the insolvency court and may be imposed retroactively, i.e. some time before the opening date of any insolvency proceedings, which is hard (if possible at all) to foresee by the secured creditor. There have been court practices to declare a security granted invalid, because the insolvency court set the initial date of insolvency before the date the security was created. Court practices have set the initial date of insolvency years before proceedings were actually initiated.
Further, the creditors of the insolvency estate may enjoy claims to rescind security granted, where security was created within one year before the initiation of insolvency proceedings, if such security was created after the secured debt originated. Where security was created in favour of a shareholder with more than 20 per cent control, a manager of the insolvent company or other controller of the insolvent company, the “suspicious” period is two years before the opening of the insolvency proceedings.