In a decision (file no. 21 Cdo 1961/2019) on 22 December 2019, the Czech Supreme Court confirmed the invalidity of an alternative arrangement for disposing of pledged collateral.
Any method for disposing of pledged collateral other than by a public auction or court sale must be negotiated in an agreement between the pledgee (pledge creditor) and the pledgor (debtor) so as to ensure that the method does not depend solely on the wishes of the pledgee and it enables the pledgee to realise its obligation to proceed with due professional care in the interests of both itself and the pledgor with the sale of the pledged collateral occurring at the usual price (cf. NS 21 Cdo 5983/2017). In the case at hand, the collateral arrangement was as follows: “In any case of a breach of contract, the pledge creditor is entitled but not obliged to dispose of the pledged collateral and to satisfy any secured claims from the proceeds of the liquidation of the pledged collateral by one of the methods stated in generally relevant binding legislation, as selected at its sole discretion, including direct sale under section 1365 of the Civil Code.” The question was, thus, whether this arrangement for satisfying the pledgee met the above requirement, i.e. that the method chosen (direct sale of the pledged collateral) did not depend solely on the wishes of the pledgee and satisfied its obligation to proceed with due professional care when disposing of the pledged collateral in the interests of itself and the pledgor.
The only relevant methods for disposing of pledged collateral under section 1315(2) (b) of the Civil Code (unless this is done by liquidation at a public auction or court sale) refer to an agreement. This is true of an arrangement allowing the pledgee to dispose of the pledged collateral and satisfy secured claims from the proceeds of the liquidation by direct sale under sec. 1365 of the Civil Code. Clearly, however, no specific method for disposing of the pledged collateral was negotiated, and thus, there were a wide range of liquidation options (directly by the pledgee, by a public auction, by a private auction, by a third party, etc.) from which the pledgee could choose (cf. the wording “at its sole discretion” in the pledge agreement). In other words, the method (form) of liquidation of the pledged collateral was determined at the pledgee’s discretion and the conditions for this decision were not specified; simply referring to a legal restriction did not suffice. The Court of Appeal’s finding that the arrangement in the pledge agreement contravened sec. 1315 (2) (b) of the Civil Code and was invalid under sec. 580 (1) of the Civil Code was therefore correct. A legal act that is invalid based on a conflict with sec. 580 (1) of the Civil Code will be null and void if it “manifestly disrupts public order” (first sentence of sec. 588). If an act does not disrupt public order or if the disruption is not "manifest," the legal act will only be relatively invalid. The term "public order" is not defined by law. In the context of private law, the explanatory notes on the Civil Code generally consider public order to be one of the essential requirements for the democratic rule of law under Article 9 (2) of the Constitution. Such order refers to a set of rules that must be strictly maintained, but which, unlike good manners, originate in the legal system and not in morality. These are fundamental values and guiding principles without which a democratic society cannot function and which are the basis for maintaining the rule of law. The Civil Code does not attempt a detailed definition of public order as a factor limiting autonomy since this is not possible in a legal guideline just as such a guideline cannot define good morality. The concept of public order, however, permeates the entire law and includes the rules underlying the legal foundations of the local social system. Generally speaking, the term “public order” refers not only to an interest in the stability of the state and in combating crime, but also to an interest in the protection of the legal status of third parties. A situation which would appear to be entirely socially unacceptable at a given time would, thus, be contrary to public order.
A potential breach of sec. 1315 (2) (b) of the Civil Code in a pledge agreement concluded between a pledgee and a pledgor which is neither a consumer nor a small- or medium-sized business does not constitute a manifest breach of public order under sec. 588 of the Code. As such, it only results in the relative invalidity of that conduct.