Introduction
Procedure
Limitations in acquisition
Limitations in alienation
Benefits
Comment
It has been eight months since the Czech legislature made it possible to pledge an owner's account on which dematerialised securities owned by the pledgor are registered. This newly created and potentially attractive method of creating security under Czech law was discussed in a previous update (for further details please see "New possibility to extend security package"). However, at that time it could not be used and there was much uncertainty regarding its future development. The Central Securities Depository has since updated its rules and regulations, providing sufficient information that is essential to interpreting and evaluating the practicality of pledging an owner's account. This update outlines the security tools available and recommends when to opt for a pledge of the whole account, instead of a pledge of single shares.
The procedure of establishing a pledge on an account is uncomplicated and originates from the usual multi-level recording system of securities in the depository. The pledgor, or even a pledgee that obviously disposes of the pledge agreement, issues an order to the bank or broker (ie, the participant in the depository) that administrates the account to be pledged. Attached to the order must be the original pledge agreement, or a notarised copy thereof, by which the pledge of the account was concluded. After the order has been issued, the pledge is registered in the depository within a short period of time - usually one day. The procedure is generally similar to the pledge of a single share.
Under Czech law, no share can be pledged twice (ie, it is not possible to create a second ranking pledge on the shares). The depository has therefore limited the situations in which the account or shares can be pledged and sometimes even transferred:
- The account cannot be pledged in cases where it encompasses one or more already pledged shares;
- No single share can be pledged, provided that it is registered on the pledged account; and
- Provided that a share is pledged, it cannot be transferred to the pledged account.
These three 'no transfer, no pledge' rules set out all the economic drawbacks of this tool, as pointed out by a number of Czech banks. Based on these rules, the account becomes static, with an inflexible collection of shares, and loses the vital characteristics necessary for smooth and prompt trading with shares or securities on the stock exchange. The owner must constantly bear in mind that it is not allowed to acquire all the shares it might intend to buy and that not all shares can be transferred to the pledged account.
However, the depository has suggested a solution which, although affecting the exchange of shares, does not complicate the idea of a pledge on an account in general. All other possible solutions were extremely complicated and would likely result in disqualification of the whole legal instrument from business practice.
The owner of the pledged account must not only fulfil the above-described criteria, when transferring the shares to a third party (ie, selling or donating the shares), but also take into consideration that every such transfer from the pledged account must be approved in advance by the pledgee. Otherwise, although the property right will be transferred, the single share will still be pledged, even if owned by someone other than the pledgor.
This provision aims to prevent the pledgor from vacating the account and thereby decreasing the value or quality of the pledge (excluding stock exchange fluctuations). Economically, this provision also aims to decrease the monitoring costs borne by the pledgee, giving it certainty that, without its consent, the pledge will not be reduced by the pledgor's will.
Despite such implied limits, a pledge on an account offers a number of advantages, as a result of the flexibility it offers both creditors and debtors. The main advantage is that immediately after the account is pledged, every other share acquired in favour of the account since it was pledged will also become pledged. The value of the pledge can therefore only increase, but not decrease without the prior consent of the creditor. Notably, this feature entails a risk for the debtor - if vast amounts of shares are registered after the pledge agreement has been concluded, the value of the pledge could easily multiply and overgrow the value of the loan. The debtor is therefore recommended to establish more accounts and create a pledge over only some of them. This is a simple way of altering the price of the pledge before concluding the pledge agreement.
Furthermore, Czech law entitles the creditor to request an appreciation of the pledge in cases where its value decreases under the value of the loan. In such cases where the value of the shares registered on the account falls - for example, due to market fluctuation - the pledge of account instrument proves its quality and flexibility, as the value of the pledge can easily be increased within a few hours by the mere transfer of other shares in the account.
Since the instrument of a pledge on an account is rather new, and both laymen and public experts are not fully aware of all its potential advantages, it is not yet possible to assess the value of this tool. However, based on the above information and the flexibility it offers, it may be expected that the pledge on an account will become popular between creditors, and that its use will increase. Its application also gives creditors elastic means to meet their economical needs and, as such, will be used in surprisingly creative ways.
For further information on this topic please contact Pavla Křečková or Iva Baranova at CMS Cameron McKenna vos by telephone (+420 296 798 111), fax (+420 221 098 000) or email ([email protected] or [email protected]).