Contractual securities NAGY, Csongor István ncsi@eik.bme.hu

Some rules of thumb of contracts and securities We conclud contracts because we fear that they will be breached. The law of marriage starts with the end of marriage. Always word your contract under the assumption that the other party is a deceiver and something will go wrong. „Tattaglia: But I must have strict assurance from Corleone. As time goes by and his position becomes stronger, will he attempt any individual vendetta? Barzini: Look, we are all reasonable men here. We don't have to give assurances as if we were lawyers.” (Godfather)

Securities Earnest money/down payment Deposit Liquidated damages (penalty) Mortgage Pledge Suretyship

Earnest money/down payment Ancient Semitic concept: „arrha”. It was adopted by Roman law, too. Definition: payment of a particular amount of money at the time of the conclusion of the contract as a symbol/sign of your commitment. If the transaction works out, the payment is counted in. If the transaction does not work out due to the fault of the seller: the double is to be paied back. If the transaction fails due to the buyer: the money is lost.

Deposit Sum of money paid to the other party serving as a collataral for future claims (e.g. leasing a flat). The deposit may be used to satisfy the emerging claims. Reason: if there is no deposit, the lessor would be required to sue the lessee; if the retention of/reduction from the deposit is unjustified, it is the depositor who bears the inconvenience of the law-suit.

Liquidated damages and penalty If the other party does not perform the contract or breaches it otherwise, you may be entitled to compensation for your loss. Nevertheless, you have to prove the breach of contract, the occurrence of damages and a causal link between the two. E.g. you run a pub and your beer supplier delivered the beer to you with a one week delay (assume that you ran out of your reserves on the very first day of the week). How would you calculate the amount of loss you suffered?

Liquidated damages and penalty Since the calculation of loss is ambiguous and speculative, you may want to fix the amount of presumed damages in advance, in order to avoid any uncertainty. E.g. the contract declares: if the beer supplier is late, he/she has to pay 500 EUR per day. If the contract contains a liquidated damages clause, the only thing you have to proove is the breach of the contract.

Basic rules of mortgage The mortgage rights follow the property. It is priority in time, which matters (even if there are two mortgages on the property). The bank may satisfy its claim from the price of the property. Difference to pledge: the property remains in the possession of the mortgagor (debtor), so he/she can use it.

The mortgage follows the property Owner: James James gets credit from the bank and the bank requires security. James encumbers the flat with mortage. Owner: Jerry James sells the flat to Jerry, who acquires legal title. The flat remains mortgaged irrespective of the sale. James stops paying the credit. The bank auctions off the flat and reduces the amount of debt from the inccoming price. The rest goes to Jerry.

Pledge Pledge is similar to mortgage with the crucial difference that in the former case the creditor acquires possession over the collateral. Advantage: the collateral cannot disappear (this might be a reason in case of movables; immovables are normally registered anyway) Disadvantage: neither the owner, nor the creditor can use the collateral.

Suretyship Definition: James receives credit from the bank; Jerry promises to the bank that if James fails to pay back the credit, he will do it in place of James. Mostly used between family members. You may also pay to a bank to assume suretyship (e.g. your contracting partner asks for security but you have no collateral; at the same moment, the bank knows you and knows that your business is going well).

Credit insurance Legally, it is not a security, nevertheless, it may serve similar purposes. The insurer promises that in exchange for a fair amount of money (insurance fee) it will redeem the debt in case the debtor goes bankrupt or disappears. Of course, afterwards, the insurer will chase the creditor.