Substitution of Securities in Insolvency Proceedings: The Trial Judge Has the Final Say on Equivalence

Imagine: you own a rental property in Sanary-sur-Mer, let to several shopkeepers. One of your tenants, a company in difficulty, is placed in judicial reorganisation (redressement judiciaire). The court approves a plan which provides for the sale of part of its assets, but also the substitution of the mortgage securing your rent claim with a new security over another property. You wonder: is this new security truly equivalent to the old one? What is the value of those plots of land offered in exchange?

This question, seemingly ordinary, gave rise to an important judgment of the Court of Cassation on 20 October 2021 (No. 20-20.810). The High Court recalls that the trial judges (i.e., the magistrates who decide on the merits of the case at first instance or on appeal) have sovereign power to assess whether the proposed replacement securities are equivalent. In other words, the Court of Cassation will not re-evaluate: it merely checks that the judges have properly reasoned their decision.

This decision, which may seem technical, has very concrete consequences for creditors (banks, suppliers, landlords) and for debtors in insolvency proceedings. It secures restructuring plans by preventing abusive substitutions, but also requires creditors to remain vigilant as to the quality of substitute securities. Analysis.

The Facts: A Common Story

In this case, a company – let's call it SARL du Port – operated a business in Hyères. To finance its activity, it had taken out a loan from a bank, secured by a mortgage (real security over immovable property) over several plots of land. Unfortunately, the company encountered financial difficulties and was placed in judicial reorganisation. A continuation plan was drawn up: the company would sell part of its assets to pay off its debts, but the bank had to agree to release the mortgage on the sold plots, provided it received an equivalent security over the retained plots.

The judicial administrator (mandataire judiciaire in charge of supervising the management of the company) proposed to substitute the initial mortgage with a new mortgage over a remaining plot, plot [Cadastre 3], after division of another plot. But the bank contested: it considered that the new security was not equivalent because plot [Cadastre 3] did not have the same value as the entirety of the initially mortgaged plots. The Commercial Court (specialised jurisdiction for traders) ruled in favour of the bank, but the company appealed. The Aix-en-Provence Court of Appeal, in its judgment of 1 October 2020, upheld the judgment: the substitution was not equivalent.

The company then appealed to the Court of Cassation. It argued that the Court of Appeal had assessed equivalence at the wrong date and had not considered the possibility for the bank to register a new mortgage after the sale. The Court of Cassation dismissed the appeal: it held that the trial judges had sovereignly assessed the lack of equivalence, without needing to refer to a specific date. In short, the bank won: the substitution did not take place.

The Reasoning of the Court – Decoded

The dispute concerns the interpretation of Article L. 626-22, paragraph 3, of the Commercial Code. This provision allows, within the framework of a restructuring plan, to substitute the securities (mortgages, pledges, etc.) initially granted with equivalent securities. The idea is to facilitate the sale of assets while protecting creditors. But what is an “equivalent” security? The law does not define it. Therefore, it is for the trial judges to assess it on a case-by-case basis, depending on the value of the asset, its location, its liquidity, etc.

In this case, the Court of Appeal considered that plot [Cadastre 3] did not have sufficient value to replace the initial securities, which covered several plots with a much larger total area. The company argued that the bank could, after the sale, register a new mortgage over plot [Cadastre 3] and that, in any event, equivalence should be assessed at the date of substitution, not at a later date. But the judges held that the mere possibility of registering a future mortgage was not sufficient to create equivalence, as there was no guarantee that such registration would be possible or that the value would be sufficient.

The Court of Cassation validates this reasoning: it recalls that the assessment of equivalence falls within the sovereign power of the trial judges. In other words, the Court of Cassation does not review the assessment itself, but only the reasoning of the decision. Here, the Court of Appeal properly reasoned its decision by comparing areas, values, and the actual possibilities of security. However, this is not a blank cheque for trial judges. They must demonstrate why the securities are not equivalent, without merely making general statements. But as long as the reasoning is sufficient, the Court of Cassation will not challenge their assessment.

What few people know is that this judgment is part of a consistent line of case law: the Court of Cassation is very attached to the sovereign power of trial judges in matters of assessment of securities. It does not wish to substitute its own view, because each situation is unique. Thus, a similar decision was rendered in 2019 (Civ. 2nd, 11 July 2019, No. 18-19.245) regarding the substitution of a personal guarantee (cautionnement) by a mortgage. In both cases, the trial judges are the only ones who can assess equivalence.

What This Changes for You – Concretely

For creditors (banks, landlords, suppliers): you must be particularly attentive when a substitution of security is proposed. Check the value of the proposed asset, its location, its liquidity (ease of resale). If you believe the security is not equivalent, you can contest it before the court. Note that the time limit to act is generally the hearing for approval of the plan (the hearing where the court approves the restructuring plan). After that time, it will be too late. undefined, I have encountered cases where a creditor accepted a substitution without checking the actual value, and ended up with a security over an asset that was hard to resell, for example, an agricultural plot in Hyères without access, whereas the original was a townhouse in the city centre.

For debtors (companies in judicial reorganisation): this decision reminds you that substitution is not an automatic right. You must propose genuinely equivalent securities. If you want to sell an asset encumbered by a mortgage, you must convince the judge that the replacement asset has at least equal value. Engage a property expert to value the asset and anticipate challenges. A concrete example: a company in Sanary-sur-Mer wanted to sell a commercial premises to finance its plan, but the mortgage was on that premises. It proposed a mortgage on a warehouse in a peri-urban area. The creditor contested because the warehouse was less liquid. The court followed the creditor, and the sale could not take place.

For landlord owners (like the one in our introduction): if your commercial tenant is in judicial reorganisation and the plan provides for a substitution of security on your rent claim, be vigilant. You must verify that the new security (mortgage, bank guarantee, etc.) has a value equivalent to the old one. Do not hesitate to consult a specialised lawyer before the hearing. The cost of a consultation is negligible compared to the risk of losing your security.

Four Tips to Avoid This Type of Dispute

• Have the assets valued by an independent expert. Before accepting a substitution, request a recent valuation of the asset offered as security. An expert report (costing between €500 and €1,500) can save you from losing a security worth several hundred thousand euros.
• Demand liquid securities. Prefer assets that are easy to sell (building plots, urban buildings) rather than specific assets (agricultural land, isolated warehouses). Liquidity is an important criterion for equivalence.
• Contest quickly. If a substitution is proposed, you must react before the approval of the plan. Afterwards, it is too late. Send a registered letter to the judicial administrator and the court setting out your grievances.
• Negotiate additional guarantees. If the proposed security seems insufficient, you can ask for a supplement: personal guarantee of the director, pledge of current account, etc. The substitution is not necessarily unique.

Further Analysis: Related Case Law and Developments

In addition to the commented judgment, the Court of Cassation has ruled on similar issues. For example, in a judgment of 11 July 2019 (No. 18-19.245), it held that the assessment of the equivalence of a personal guarantee (caution) compared to a mortgage also falls within the sovereign power of the trial judges. The trend is thus constant: trial judges are best placed to assess the value of securities because they have direct knowledge of the case and the assets.

However, there is a divergence as to the date on which equivalence is assessed. Some older decisions required that equivalence be assessed on the day of substitution. Others, like this one, leave judges some latitude. The Court of Cassation seems to want to avoid excessive rigidity: the main thing is that the reasoning is coherent.

For the future, it is likely that trial judges will continue to have a wide margin of appreciation. Creditors will therefore need to be particularly vigilant and well-documented in their challenges. The recent reform of security law (Ordinance of 15 September 2021) did not modify Article L. 626-22, confirming the stability of the rule.

Key Points to Remember

• Who decides equivalence? The trial judges (Commercial Court, Judicial Court, Court of Appeal) sovereignly assess whether the substitute security is equivalent to the original.
• What to do if a substitution is proposed? Check the value of the asset, its liquidity, and contest before the court before the approval of the plan.
• Can I refuse a substitution? Yes, if you demonstrate that the new security is not equivalent. The judge can then refuse the substitution or order additional guarantees.
• What is the risk if I accept without checking? You may lose part of your claim if the new security proves insufficient in the event of a further default by the debtor.
• How much does a contestation cost? Lawyer and expert fees vary, but an initial consultation (€45 with Maître Zakine) can already guide you.

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