12.7 Chapter 7: credit bidding under Dutch law and the role of valuation

Distressed debt investors can have various investment strategies, one of which is the loan-to-own strategy. Briefly stated, this strategy consists of first buying a secured loan and subsequently, when the company faces severe distress and enters into default, executing the security right and buy the pledged good yourself. When buying the pledged goods yourself, it is possible under the U.S. system to credit bid. Credit bidding means that the secured party/the creditor offers to buy the underlying goods and will be setting off the purchase price with the amount of the (secured) claim it has against the debtor.

From the creditor’s perspective, credit bidding has the advantage that, after the purchase price for the (secured) loan has been paid, when the creditor is (in the process of the enforcement) purchasing the pledged goods no additional liquidity is required. The bigger the difference between the secured claim and the purchase price of the pledged goods, the more profitable the deal is. If the (purchased) loan is secured by a share pledge on the shares in the share capital of a certain company, it is in order to assess the profitability of a certain investment proposal essential that a valuation assessment of the pledged shares will be made, because this is the asset that eventually will be bought.

In case of the execution of the security pledge (pandrecht), the Dutch Civil Code does not prescribe that the purchase price has to be transferred to, for example, a civil-law notary or a bailiff. Therefore, when executing the security right the pledged goods can be sold to the pledgee and the outstanding (secured) claim can be set off against the purchase price of the pledged goods (including shares in the share capital of subsidiaries of the pledger, as noted above).

In respect of the execution of the right of mortgage, the Dutch Civil Code prescribes that the purchase price has to be transferred to a civil-law notary when the real estate is transferred, hence this mandatory rule makes it, in principle, not possible to credit bid. However, based on a broad interpretation of the Dutch Civil Code credit bidding has, in respect of the execution of mortgage rights, been approved, as follows from jurisprudence of lower Dutch courts.1