An Efficiency Analysis of the Legal Conflict between Floating Charge Security and Retention Right

Sven Hannibal Smedegaard Pedersen

Student thesis: Master thesis

Abstract

In 2006 a new form of floating charge security was implemented in Denmark. With inspiration from England, business owners are given the opportunity to secure the debt of their business by offering everything the business owns and will own in the future as security. To ensure the business can continue its normal operations, the pledge does not hinder the business in selling its assets, given the sale falls within the business’ regular activities. This of cause leads to the question: When is the sale of assets part of regular activities?
As with all new regulation, the implementation of a new type of security for debt creates doubt as to how the new rules interact with existing regulation and judgements. Especially the relationship between owner of the secured debt, typically a bank or financial institute, and the debtor’s contracting partners becomes a cause for concern: Can the debtor’s contracting partners exert retention over the debtor’s assets when the assets are covered by the security given to the debtor’s loan givers?
The new regulation naturally affects how businesses and loan givers interact with each other both before and after conflicts arise. Since legal conflicts tend to be expensive to solve in courts, both for the disagreeing parties, who incur expenses from legal fees and lawyer fees and for society due to the increased strain on the court system.
An analysis of the economic effects of the new regulation seems worthwhile. This thesis examines the implementation of the new type of debt security in Denmark. First, the law itself is analyzed and compared with court judgments made before and after the implementation of the law. Based on this, a set of conditions is found to be required fulfilled before retention can be exerted over assets covered by an older floating charge.
Next, effect of increased security for debt is modelled as reducing the debtor’s total asset volatility and the effects hereof in terms of business valuation is examined. As expected, reduced asset volatility reduces the interest rate of debt and increases valuation, assuming profitable businesses. Lastly, game theory is used to analyze the incentive to settle between the conflicting parties when one party is the owner of the floating charge covering an asset, over which the other party exerts retention. With incorporation of the legal and economic analysis, the efficiency of simple and complex rulings is evaluated. It is concluded that simple legal rules with clear implications for both parties are superior to complex rulings that creates uncertainty

EducationsMSc in Commercial Law, (Graduate Programme) Final Thesis
LanguageDanish
Publication date2020
Number of pages88