The law of guarantees and security plays a fundamental role in the world of contract law and commerce. In simple terms, a guarantee can be described as a form of protection or assurance granted by a debtor to a creditor securing the performance of an obligation. In the event that a debtor defaults in his obligations towards the creditor, such creditor would be able to enforce the guarantee or security enabling him to realise the fulfilment of the obligations in question.
Generally speaking, creditors under Maltese law can be granted two categories of guarantees:
(a) real security – a guarantee attaching to particular property of the debtor allowing the creditor to obtain payment out of such property, such as in the case of pledge of hypothec; or
(b) personal security – a guarantee which does not attach to any particular property but is enforceable against a person, such as in the case of the contrary of suretyship.
Traditionally, Maltese law, being heavily influenced by Civil Law jurisdiction principles in the sphere of private law, has been notoriously restrictive and limiting insofar as the law of guarantees, especially in the realm of real security. Here, the law often displays a ‘pro-debtor’ tendency by imposing rigid enforcement procedures often carried out necessarily through the courts, a position which can be contrasted with that adopted in Common Law jurisdictions. Creditors are thus precluded from freely appropriating such property or selling it freely on the open market.
The rationale behind this position is to protect the interests of the debtor in such contractual arrangements. This is because the value of the property granted as security oftentimes exceeds the value of the secured obligations. The law therefore seeks to prevent situations whereby a creditor is able to either sell the relative property as a significant undervalue by only ensuring that the price procured is sufficient to cover the value of the secured obligations, or appropriate such property by offsetting it with the secured obligations, thus prejudicing the debtor.
This restrictive position contrasts quite markedly with the contractual liberty which underpins Maltese contract law generally, where parties are largely free to regulate their contractual relationship through any means they wish so long as it is not contrary to law or public policy, even though contracts which are not expressly recognised or regulated by law. Against the backdrop of this apparent clash of principles, the question arises as to how freely may contracting parties regulate their relationships by inserting security mechanisms which are not expressly recognised and regulated by law. That was the question before the court in Gordon’s Motor Dealer Limited vs Alberto Angelo Antonio Bassu (First Hall of the Civil Court, 8th of November 2024, 496/2022 per Honourable Justice Henri Mizzi).
The case in question concerned a contract of sale in virtue of which the applicant company sold a vehicle to the respondent for a price to be paid in future installments. The contract stipulated, however, that in the event that the respondent defaults in fulfilling his payment obligations towards the applicant company, such company would be entitled to re-appropriate the vehicle, “whereby the vehicle will be valued at the cost of the outstanding balance to be paid by the customer.” The re-appropriation of the vehicle would therefore act so as to extinguish the payment obligations due by the respondent through by offsetting the amount due with the value of the vehicle appropriated.
By means of these proceedings, the applicant company requested inter alia that the Court enforces this clause. When such proceedings were adjourned for the delivery of judgment, however, the Court ex officio highlighted that this clause might pose an issue of public policy and invited the parties to make submissions on this point before proceeding with delivering judgment.
When ultimately delivering judgment, the Court considered that, while there is no provision of law expressly precluding an arrangement such as that envisaged in the clause in question, the validity of such clause must necessarily be examined in light of the general principles buttressing the law of guarantees and security, which the Court considered as forming part of Maltese public policy. Such provisions, the Court noted, cannot be derogated from by contract. The Court proceeded to list a number of such provisions included in the Civil Code relating to security law.
The Court here noted that in the case of a contract of pledge, the law expressly precludes and condemns as null any clause which purports to allow a creditor to appropriate the property pledged or to sell it freely on the open market to obtain satisfaction of the secured obligations. A creditor must necessarily resort to a judicial auction of such property to obtain payment out of the proceeds. With respect to the hypothec, the Court noted that no similar express provisions expressly mandating enforcement through a judicial auction and precluding any other form of enforcement. However, as the Court noted, no such provisions are necessary, as a hypothec grants a creditor neither the physical detention nor title to the property. It is therefore understood, the Court considered, that enforcement must nonetheless necessarily take place through a judicial auction.
The court then considered the relatively new institute of security by title transfer, introduced by virtue of Act No. VIII of 2010. Contrary to the aforementioned institutes of pledge and hypothec, the provisions on security by title transfer allow the contracting parties considerable liberty in regulating their arrangement in this respect, even expressly stating that a clause allowing the creditor to appropriate the property given as security by offsetting its value with the outstanding secured obligations is valid. However, the Court noted that this faculty is an exception to the general principles set out in the law of guarantees, where enforcement must generally be carried out through a judicial sale as aforesaid. The Court further noted that even in the exceptional scenario where a creditor is granted security by title transfer and is allowed to appropriate such property upon default, the creditor is still subject to considerable safeguards guaranteeing that the property is not appropriated through set-off or sold at an undervalue.
On the strength of these considerations, the Court concluded that in order for a sui generis contractual security arrangement not to be afflicted by a breach of public policy, it must, at the very least, satisfy two basic elements. Firstly, a creditor cannot appropriate the property granted by security and offset its value with the outstanding secured obligations, unless such possibility is allowed by an express provision of law, Secondly, even where such a set-off can take place, the value of the relative property must be near market value, or at least objectively determinable, so that its value cannot be such so as to only guarantee satisfaction of the creditor’s debts, preventing any excess value or proceeds from being reintegrated in the debtor’s patrimony.
Accordingly, the Court considered the security mechanism inserted in the contract in question as contrary to public policy and condemned the same as null and without effect. This judgment was not appealed within the timeframe allowed by law and is now res judicata.
In light of the relatively limited jurisprudence of the Maltese Courts on the validity and enforceability of such sui generis contractual security arrangements falling outside of those expressly acknowledged and regulated at law, this judgment is a welcome addition to the body of Maltese jurisprudence by succinctly outlining the overarching principles and rules which must be observed both in the drafting and enforcement stages of such security arrangements, as well as by shedding light on whether a court would be likely to enforce or deem as null certain contractual security arrangements depending on their terms, conditions, and effects.
VB Advocates did not act as legal counsel for any of the parties involved in these proceedings.