Introduction to Patto Marciano:
A Comprehensive Analysis
In an attempt to overhaul the Italian Bank Credit system, the “Consolidated Banking Act”, also known as “Patto Marciano”, has been ratified by Italian Legislators. It compromises of two parts, Article 120-quinquiesdecies which deals with ‘Consumer’ Loans, and article 48-bis, regulating ‘Corporate’ Loans; passed by the Legislative Decree of April 21st, 2016, no.72 and Decree of May 3rd 2016, n.59 respectively.
Insertion of the “Patto Marciano” clause, allows the businesses or any legal persons to enter into contracts by pledging real estate assets as collaterals for loans and mortgages.
Prior to that, it was prohibited to pledge an immoveable asset (a property such as a house) as collateral for a secured debt. According of Article 2744 of the Italian Civil Code (Codice Civile), any contract violating this rule would have been declared void. This rule is also colloquially known as ‘Patto Commissorio’.
“Dievieto del patto commissorio” was deemed an impediment to effective allocation of resources and causing the Italian businesses and financial institutions to grind into a halt. It hindered the exchange of credits from potential creditors to potential debtors, prevented companies and entrepreneurs from accessing the funds they would otherwise get in absence of these obstacles, also impeded supply of accumulated money by banks, to satisfy the demand in form of loans and mortgages. It was a longstanding problem in the banking and financing sectors.
There were some reasons and rationales for implementing patto commissorio rule. It was considered to be a protective mechanism by which debtors who have less bargaining power would be protected against the creditors. Applying this rule was a way of compensating that imbalance of power and redressing (to some extent) the asymmetric and subpar situation.
Another rationale was protection of all the other creditors who may be deprived of their claim if the debtor colludes with one of his creditors by assigning his asset to him, to the detriment of the others.
However, even though the legislatures had these understandable reasons in mind, the Patto Commissorio path was practically less optimal than expected, and created lots of unnecessary restrictions which contributed to the contraction of the economy and the financial sector.
In order to circumvent these restrictions, legislators devised an exception to ‘Patto commisorio’ (article 2744 c.c.), which is ‘Patto Marciano’ or ‘Marciano’ pact. Pursuant to ‘Patto Marciano’, transactions based on pledging a property or immoveable good as a collateral is allowed.
It renders substantial implications and consequences on both Macroeconomics level as well as Microeconomics. On Micro level, it is recognized in terms of legal relation between a customer and a bank or any other Financial Institution acting as a creditor for a borrower; and the improvement of financial institutions’ ability to function their main objective which is acting as a financial intermediary for the effective circulation of credit between suppliers and demanders. The macro perspective and the overall effect on the country’s economy as a whole, takes into account the net positive effect of these vital revisions and omitting the cumbersome rules and overcoming the rigidity of the former system.
“Patto Marciano” – a word which has a Latin root – is a form of agreement that has been launched to combat these urgent problems and to facilitate financing and credit recovery.
Article 48-bis specifically regards to “Loans to businesses secured by conditional real estate transfer”; as opposed to article 120-quinquiesdecies which is merely applicable to personal consumers (natural persons).
Therefore, the emphasis has moved from the physical form of immoveable good, to its estimated value. However, having Marciano Pact clause in the contract does not mean that the property would automatically be transferred to the creditor in case of a default. It rather stipulates that the creditors can take legal action to recover their credit, by going in front of a judge at a court, and asking for the value of his credit, which would be obtained by selling the pledged asset. We have to bear in mind that the value of property is the main point, not the property itself.
The value of the pledged property needs to be assessed by an independent third-party inspector. The amount of finance the debtor is allowed to borrow from the creditor is maximum up to 80 percent of the estimated value of the pledged immoveable asset.
This cap is a crucial part of the validity of the contract. In case of a breach of this provision, the tribunal court must determine the validity of the agreement, and whether an elaborate scheme for fraud has occurred by either party.
The non-compliance to pay the debt triggers the remedies agreed upon in the contract. Banks (or any other creditor) will acquire the pledged property to compensate the outstanding debt.
In order to commence the transfer of the pledged property from debtor to the creditor in case of a default, under article 120-quinquiesdecies, the debtor must have failed to pay at least 18 monthly installments. In addition, the creditor can pull the plug and terminate the agreement if the debtor fails to pay at least 7 installments.
According to article 48-bis, in case of Corporations as debtors, default of the corporate loans occurs when the borrower fails to pay: (1) for more than 9 months, also non-consecutive ones in case of monthly installments, or (2) more than 9 months pass the deadline in case of dealing with Bullet Loans.
As we have mentioned previously, we can observe that Patto Marciano has shifted the emphasis from the physical immoveable property itself, to its intrinsic value. It’s a mechanism by which the concept of immoveable collateral has changed, since a mortgage is a burden and limitation on the collateral; however, by developing Patto Marciano we now deal with the corresponding value of the immoveable good rather than the physical aspects of it.
Therefore, Patto Marciano facilitates financial transactions and helps especially businesses to obtain the funds and credits needed for their activities through loans mortgaged against their immoveable assets as collaterals.
The question that arises with respect to this law is that in the case of default by the debtor and when the creditor proceeds to obtain the property, if there is a discrepancy between the value of the loan and value of the collateral, who bears the risk?
In case of default by the debtor, the creditor can exercise its right to seize the immoveable collateral.
The controversy surrounding this issue is that if the present value of the immoveable collateral diminishes significantly (due to numerous external and inevitable conditions, such as decay of the building, or natural disasters, diseases and pandemics, etc.) which party bears the risk?
In other words, does the creditor have the right to demand compensation or is the debtor discharged from the loan without any further obligation to close the gap?
Similarly, if the value of the immoveable collateral deviates significantly from its original value, but this time excessively in the opposite direction due to some unforeseen events, for instance housing market bubbles, does the bank (or any creditor) have the right to keep all the proceedings it acquires form selling the collateral? Or is it obliged to give back the surplus amount?
For the excess value, article 120-quinquiesdecies stipulates that the creditor must return the surplus number of proceedings to the creditor. Moreover, even if the property value becomes less than the value of the credit, the consumer (debtor) is still discharged of the agreement and bears no further obligation.
Contrary to Article 120-quinquiesdecies, Article 48-bis has no mention of the discharge of the borrower in case of discrepancy between the value of the secured asset and the loan.
There is no consensus among legal scholars on this issue. Some interpret it as an indication of discharge of the debtor after seizure of the immoveable collateral, with disregard to the present value versus the old one; the other group disagrees.
The former group states that since the aim of the Italian Legislators is to protect the borrower, the debtor has no further obligation to pay in excess of its property’s value. Even if it falls short of matching the creditor’s funds.
However, if one aims for the objective “fairness” of the transaction and execution of contracts in good faith, they may have to agree with the latter. We would argue that debtor is not completely discharged if their collateral and its proceeds do not cover the value of the credits and the transaction, and monitoring, and the opportunity costs imposed on the creditor.
It seems rather unfair (and discouraging) to the creditors to risk lending their funds to a debtor, and even if we discount the transaction costs, monitoring costs, and the potential devaluation of the initial amount due to inflation, they would still get less than what he had given in the first place.
Nevertheless, there is no concrete remedy for this discrepancy dilemma. Some are in favor of extrapolating the provisions in case of ‘consumer loans’ and stretching them to ‘corporate loans’ as well. While others disagree and cite the lack of specific and direct mentioning of this issue by lawmakers as an indication that the corporate debtors ought not to be completely discharged automatically.
Patto Marciano is the modernized version of ancient Roman credit laws. It has been adopted in line with recent trend of reincarnating ancient Roman laws in order to fill in the gaps where the Civil Code was not equipped to properly deal with and redress newly risen problems, and to increase functionality and efficiency of the legal system.
These reforms occurring in Italian, French and Spanish legal systems (i.e., the Civil Law systems), show that these European countries have realized that it was necessary to depart, to some extent, from civil law traditions and adopt a new approach.
Another instance is the concept of “Fiducia”. Fiducia, a legal device first established in Roman Law, is a contract between a constituent (i.e., the settler), and the “fiduciario” (i.e., the trustee), and a determined property is transferred to the fiduciario, who manages it on behalf and in the interest of either the constituent or a third-party.
The fiduciario has the obligation to manage the properties and assets according to the instructions and agreements established in the contract and with good faith. This fiducia law was especially crucial in ancient Roman era when a Roman soldier was deployed to war, he would acquire a fiduciario’s service on his behest to manage his properties to the benefit of his family, heirs and offspring.
In Common Law systems, the concepts of immoveable collaterals, and also “trustee” has already existed. So, Fiducia and other recent reforms inspired by some aspects of Common Law, are clear indications of convergence of civil law and common law traditions.
What we also need to take into consideration is the fact that we must not look at Patto Marciano or other Italian statues as isolated laws; since Italy, as a member of the European Union, has voluntarily given up some parts of its legislative power upon joining the Union. There will always be a trade-off between each member state’s legislative power and authority, and the power of the Union. EU laws enacted by the Commission and ECJ preliminary rulings also affect the member states to some extent, especially if the transactions happen intra-Union, i.e., among the member states, or with international trading partners which impacts the overall European common market’s situations; and the EU competition laws trump the national laws (they enjoy a higher priority).
The integration of EU legislation with national one ought to be considered when talking about applicability of aforementioned laws and their effects. We cannot look at the laws in isolated cases and through a one-dimensional lens.
The provision of ‘abitazione principale’ establishes that the pledged real estate property “cannot be the main residence of the debtor, his/her spouse, children, or a close relative.” However, this provision does not apply to natural persons, only the businesses and corporations pursuant to Article 48-bis.
This ambiguous principle may leave so much room for misinterpretation or unscrupulous behavior by the debtors.
Lawmakers consider this specific provision as a mechanism to protect the borrower; however, it may raise other concerns.
Only a business already in possession of at least one property can apply for a mortgaged loan. So, in this case, an entrepreneur cannot get access to money needed to acquire a property or a headquarter, by using his house as a collateral. Furthermore, in case of partnerships, unlimited liability partners, who are willing and capable of securing a loan by using their personal house, (since there is no partitioning among the partnerships and the partners’ personal asset) will not be able to pledge their residence house. This provision seems to still impose a burden to get funding from the creditors to purchase a house.
So even though this new approach (Patto Marciano) has lifted the restrictions and unnecessary burdens put on the banking sector by the previous regulations, it still seems inadequate to completely respond to, and satisfy the people’s needs of entering into new contracts with willing creditors to finance their endeavors. For example, a potential buyer cannot acquire a house by getting a mortgage on it and using it as collateral for the transaction. In our view, this provision limits people’s freedom of contract and their ability to freely exercise their in-rem rights with regards to their assets, without giving them substantial benefits. The trade-off does not seem symmetric. If the aim was to facilitate financing and boosting access to funds, in this area it falls short of its objective.
Advocates of this approach however, point out to the Protection objective, and mention that protecting debtors is of utmost import for the Italian legislators.
However, according to this provision the creditors are barred from recovering their credit by asking for the residence property or proceedings followed by selling of a residence property; in that case there might be a legal loophole as the aftermath of these so-called protective measures.
Debtors can convert all or most of their assets to real estates, and allocate them in a way for them to be considered the “main residence” of him, his husband or wife, their children or even their close relatives. Since the broad applicability of this principle considers even close relatives (without any clear-cut definition), it creates a hotbed of opportunities for unethical behavior.
In the wake of a financial problem or even prior to going bankrupt, the prescient debtor (for instance, the unlimitedly liable business owners), can misuse and abuse this principle as a safeguard to protect their assets and to convert their liquid or semi-liquid assets (such as investments in the stock markets) into the immoveable properties. This way, since there has never been an explicit prior agreement in the contract (i.e., lack of Patto Marciano pact), the creditors would not be able to get their credits back.
Unlimited Liability partnerships/ Sole proprietorships/ Entrepreneurship:
In these economic entities, unlike corporations and limited liability partnerships, there is no asset partitioning; meaning that there is no distinction between the assets of the business and the personal assets of the entrepreneur, sole proprietorship, or unlimitedly liable partners. So, in case of default in these instances, all partners and owners are jointly and severally liable, and the creditors of the business can compensate their losses by attacking the personal assets of the partners.
By contrast, in corporations and limited liability partnerships, there is an “affirmative asset partitioning”. These business structures enjoy distinct legal personalities. Creditors of the business cannot go after personal assets of the owners in case of default. Symmetrically (and more importantly in terms of economical consequences) personal creditors of the owners cannot attack the assets of the enterprise. Therefore, in this case there is a mechanism in place for the stability of the business and smooth exchange of credits in the market.
The “affirmative asset partitioning” is a crucial part of Company Law, because if there was not such an apparatus in place, huge burdens would have fallen on the companies, corporations and their owners and managers.
They would have had to negotiate individually a deal with each of their distinct personal creditors and made them agree to a waiver any rights on the assets and properties of the company.
Similarly, the owners would have had to convince the creditors of their company not to recover any of their credits by taking a legal action against the owners’ personal assets in case of the undertaking’s default. Debts related to the economic activity of the company would have been in the same pool of personal assets and liabilities of the owners; and they had to enter an agreement with each one of the company’s creditors not to attack their personal assets for the company’s debts.
It would have been a colossally burdensome procedure, to enact and even enforce such contracts. The high costs of each negotiation and also the costs incurred by monitoring and controlling the conducts of creditors and debtors, would have prevented reaching efficiency in the markets.
In case of hybrid Partnerships, there are one or more partners who enjoy limited liability, and one or more partners who are unlimitedly liable for the partnerships and its economic activity. There is no legal partitioning between the partnerships’ liabilities and their personal ones. Although, according to the form of registration and the by-law of the partnership, the proportional allocation of the assets or profits among the partners may differ from one partnership to another.
The name of the limited partners and their contribution must be precisely stated in the deed (constitution) of the partnership and its articles of association.
In most legal systems, the limited partner cannot take managerial roles, and in some countries, he cannot even be granted the power of attorney on behalf of other unlimited partners; and when dealing when third partners, he must always inform those third parties about his limited liability status.
However, in case of Unlimited Liability Partnerships, sole proprietorships, and entrepreneurs, this legal “asset partitioning” does not exist. They will be personally liable for the conduct of their businesses; and their personal assets and liabilities are combined in the same pool as their business and economic activities.
So, how will Patto Marciano come into play in these cases? When we consider the unlimited liability and lack of “asset partitioning”, can we extend it to property and immoveable goods?
For instance, can the creditors of an entrepreneur try to reclaim their credit form his personal assets in case of default of his business?
The answer is a qualified no. Patto Commisorio prohibits such a remedy if a provision is not put in place in the contract to explicitly allow for this course of action.
We can speculate that it might create a way for unscrupulous legal or natural persons, to get around their obligations to their creditors and try to shield their assets by turning them in other forms, such as real estate properties or lands, without technically losing or surpassing their unlimited liability.
Then the burden of proof will fall on the creditors to prove the unethical and quasi-fraudulent nature of their debtors’ acts and convince the court that these actions were taken by the debtor solely in order to relinquish themselves of their obligations towards the creditors; and since it is quite hard (if not impossible) to prove intent in court, the creditors will face much difficulty.