The UK persons with significant control regime (the PSC Regime) continues to cause uncertainty for lenders seeking to take security over shares in Scottish companies. The main concern is whether the security could cause the security holder to become:
- a registrable "relevant legal entity" (if a corporate); or
- a registrable "person of significant control" (if an individual),
under the PSC Regime in respect of the issuing company (a Registrable Person). This note explains the problem, and what lenders can do in practice to address it.
PSC Regime – background
The PSC Regime was launched in April 2016 to provide greater transparency on who ultimately owns UK corporate entities. Entities subject to the PSC Regime now include most UK companies, all UK LLPs, Scottish limited partnerships and some Scottish general partnerships. For a summary of the original form of PSC Regime, see What impact will the PSC Register have on banking transactions?
Why does it matter if a security holder becomes a Registrable Person?
Reasons a security holder may not wish to become a Registrable Person include:
- A Registrable Person must provide certain information about itself if requested by the company. A failure to do so within one month carries criminal liability for both itself and its officers in default. The company may also ultimately issue a "restrictions notice" restricting or prohibiting the transfer of the shares without a court order.
- Any person or entity that knows (or ought to know) that it is a Registrable Person must take steps to notify the company accordingly; failure to do so is a criminal offence. Once registered, a Registrable Person is subject to ongoing obligations to provide information to the company – for example, on a change of its registered office.
- A Registrable Person can be criminally liable for any false information it provides in relation to the PSC Regime.
On what basis could a holder of share security be a Registrable Person?
The Registrable Person test is complex, but broadly a person will not be a Registrable Person unless, among other things, it satisfies at least one of the specified "significant control" tests in respect of the issuing company. These include:
- directly or indirectly holding more than 25 per cent of the shares (the Ownership Test);
- directly or indirectly holding more than 25 per cent of the voting rights (the Voting Rights Test); and
- having the right to exercise, or actually exercising, significant influence or control over the activities of a trust, the trustees of which satisfy one of the other conditions (the Trust Beneficiaries Test).
There is however an exemption (the Security Exemption) under which rights attached to shares held by way of security are treated as being held by the security provider where:
- apart from the right to exercise them for the purpose of preserving the value of, or realising, the security, the rights are exercisable only in accordance with the security provider's instructions; and
- where the shares are held in connection with the granting of loans as part of normal business activities and apart from the right to exercise them for the purpose of preserving the value of the security, or of realising it, the rights are exercisable only in the security provider's interests.
Why is this a particular issue when taking Scottish share security?
Lenders typically take equitable, rather than legal, mortgages over shares in English companies, with legal title to the shares staying with the mortgagor. As such, the security holder is unlikely to be treated as "holding" the shares under the Ownership Test and can typically rely on the Security Exemption in respect of the Voting Rights Test. However, under Scots law there is no option to take equitable security. To create a valid share pledge, the security holder must take legal title to the shares.
Some consider that the Security Exemption only applies to the Voting Rights Test. If that is the case:
- a security holder may still satisfy the Ownership Test; and
- if so, where security is being held on trust for a syndicate of lenders, those lenders might themselves satisfy the Trust Beneficiaries Test.
Others interpret the legislation more purposively and argue that the Security Exemption takes a security holder out of the Ownership Test too.
There is no obvious policy reason for treating this issue differently in Scotland than in England. However, unfortunately the legal position is simply unclear, generating significant market uncertainty.
What should lenders do?
Until the government provides further clarity, there are no straightforward solutions for lenders. One option on new transactions is to take an "unperfected" Scottish share pledge, such that title to the shares is not transferred to the security holder, at least pre-enforcement. However, this creates no security until it is perfected, leading to a number of risks. For example, the pledgor may enter an insolvency process before the security holder has an opportunity to perfect (and so create) its security.
Another method which may assuage a lender's concerns is for it to insist on a non-Scottish holdco being added to the borrower group structure and then take security over its shares. However, this may be commercially impractical.
A lender with existing transactions including Scottish share security should also review these transactions, and seek to develop a strategy to ensure it is dealing with this area of legal uncertainty consistently.