The revival of the right of pledge
What happens in cases of commingling of similar goods, one of which is encumbered with a right of pledge? Is the right of pledge extinguished by the commingling? On 14 August 2015, the Supreme Court responded to these questions.
Bankruptcies of companies, however sad for those involved, can give rise to interesting case law. Just like the bankruptcy of the Dutch aluminium producer Zalco at the end of 2011. In the Zalco judgment rendered by the Dutch Supreme Court on 14 August 2015, the Supreme Court ruled that in cases of commingling of similar goods, one of which is encumbered with a right of pledge, a new right of pledge is created by operation of law over a share in the new good which has been created by virtue of commingling.
Background in Dutch law
Commingling is the mixture of (liquid) substances. Commingling occurs when separation of the resulting mixture into each owner’s original goods is impossible. The substances are united in one newly formed substance. Commingling is an original acquisition of property. The consequences of commingling are regulated by the rules of accession of two movable goods. Article 5:15 of the Dutch Civil Code concerns commingling and article 5:14 of the Dutch Civil Code is about accession of movable goods. Article 5:15 of the Dutch Civil Code states that when commingling of goods occurs, the same rules apply as in the case of accession of two movable goods. Article 5:15 of the Civil Code must therefore be read in the light of article 5:14 of the Civil Code. If one of the two commingled goods can be designated as primary, the owner of the primary good becomes the owner of the newly created good. Article 5:14 (3) of the Dutch Civil Code determines what can be regarded as the primary good. It is the good of which the value considerably exceeds the value of the other good, or the good that is regarded as primary in common opinion. If no principal good can be determined, article 5:14 (2) of the Dutch Civil Code states that a new good has been created and that the owners have co-ownership.
Dutch aluminium producer, Zeeland Aluminium Company N.V. (Zalco), had encumbered its stocks of aluminium by a non-possessory right of pledge. The non-possessory right of pledge over the aluminium had been granted to Glencore, a supplier of raw materials for Zalco’s aluminium production. When Zalco was declared bankrupt on 13 December 2011, there was an amount of fluid aluminium present in its smelting furnaces. After the declaration of bankruptcy, the production process was continued for a few days. The liquid aluminium that had been pledged to Glencore had been mixed with a considerably larger amount of liquid aluminium on which no right of pledge had been established. This started a discussion and the question arose as to whether Glencore’s right of pledge is extinguished by the commingling of the pledged aluminium with a non-pledged amount of aluminium.
Firstly, the Dutch Supreme Court answered the question of whether we can speak of commingling. After all, the pledged and non-pledged aluminium belonged to the same owner, namely Zalco, and not two different owners as covered by articles 5:14 and 5:15 of the Dutch Civil Code. The Dutch Supreme Court decided that the rules of 5:14 and 5:15 of the Dutch Civil Code apply ‘in all cases in which the question arises whether a right of pledge has extinguished due to commingling, irrespective of whether the goods involved in the commingling belong to different owners’.
Subsequently, the Dutch Supreme Court applied the rules of commingling. In the case of commingling of aluminium, it is not easy to determine the primary substance. According to the Supreme Court, the common opinion is therefore not a useful criterion. What is decisive is whether one of the substances considerably exceeds the other in value.
Because the legal consequences are significant – loss of rights – the Supreme Court ruled that it must not be readily assumed that the difference in value between the two goods is ‘substantial’. The Dutch Supreme Court does therefore not point to a primary substance. According to the Dutch Supreme Court, based on article 5:15 and 5:14 paragraph 2 of the Dutch Civil Code, a new good is created as a result of the operation of law; on behalf of the person who established the right of pledge (on the good that was extinguished in the process of commingling), a new right of pledge is encumbered on a share of the new good. The size of the share in the new good must be determined on the basis of the value of the various commingled quantities.
Finally, the Dutch Supreme Court considered: ‘This is no different in the case of bankruptcy of the owner of the good. In particular, the principle of fixation, which underlies in bankruptcy law, does not entail anything else, given the fact that the legal acquisition referred to here is legally effective’. Therefore, the bankruptcy of the owner does not disqualify a new right of pledge on a share of the new property to arise by operation of law.
The judgment of the Dutch Supreme Court is striking because it considerably strengthens the position of pledgees and removes much uncertainty about the status of a right of pledge in the situation described above. Before this judgment, in a situation in which no primary good could be designated, the pledgee lost his right to pledge in cases of commingling of the pledged good. Based on the judgment of the Dutch Supreme Court, the right of pledge of the pledgee is not extinguished, but ‘revives’ on a share in the new object. The ruling provides greater protection for the pledgee’s security right over specific goods that are commingled with other goods. Security rights established before commingling continue to exist and extend to the resulting mixture. This judgment is also relevant because it confirms that a new right of pledge is created by operation of law; this means that the bankruptcy of the owner whose good is commingled does not disqualify the valid creation of such a right of pledge after the bankruptcy of the person who created the original right of pledge. This is important because it is precisely in bankruptcy situations that suppliers, in this case Glencore, often get the short end of the stick. In this way, the pledgee retains his right of priority. Finally, the Dutch Supreme Court put an end to the theory that the person who obtains a good by original acquisition of property, will always receive that property free and clear of any encumbrances. Before this judgment, an owner of a newly created good could assume that the new good was unencumbered. After this judgment, an owner of a – by virtue of commingling – newly created good will, under certain circumstances, have to tolerate a right of pledge.
This blog is a result of an assignment of the master’s course Privatissimum Civil law, under the supervision of mr. Jeroen van der Weide. The subject of the course was dynamics in collateral law. In this course, students were asked to write a blog text about the Dutch Supreme Court judgment Zalco in 2015. The best blog would be published on the Leiden Law Blog. The author’s blog was selected as the ‘winning blog’. Therefore, the author was invited to publish the final blog on the Leiden Law Blog. The author sincerely thanks mr. Jeroen van der Weide for his valuable feedback on previous versions of this blog.