WE CONSIDER BELOW THE SHARE CHARGE ENFORCEMENT OPTIONS FOR PRIVATE CREDIT LENDERS, WHO MAY NOW COME TO PREFER 'APPROPRIATION' AS THE LESS FORMAL, MORE IMMEDIATE 'LOAN-TO-OWN' TOOL TO SOLVE FOR BORROWER JV DISPUTES, BREAK SHAREHOLDER DEADLOCKS, AND AS A PROACTIVE MEANS TO PRESERVE VALUE IN A CREDIT.
The recent High Court case of ABT Auto Investments Ltd v Aapico Investment Ptd Ltd and others  EWHC 2839 (Comm) (ABT v Aapico) helps to demonstrate just how fast acting and potent the option to 'appropriate' shares granted as security for debt can be in the current market, even where the charged shares are privately held and illiquid. So long as a method is followed for producing a valuation (based on what would reasonable participants in the relevant financial market might do within a range of options), the fact that a low valuation is achieved (leaving a slug of debt to still be repaid post enforcement) should not matter.
Whilst 'appropriation' has been available for 20 years, share charge receivership has to date remained the dominant mechanic. Below is a detailed comparison of the two formats to aid enforcement planning.
A. ABT V AAPICO
Aapico formed a joint venture with ABT Auto, creating a new JV entity (JV Company). To stem financial problems in a subsidiary of the JV Company, Aapico had provided rescue funding, secured over the 50.1% of shares held by ABT Auto in the JV Company. The JV Company's financial situation further deteriorated and Aapico enforced its share charge over ABT Auto's charged shares in the JV Company – by immediately 'appropriating' the shares (taking title to the shares) with notice to ABT Auto, based on a pre-planned share valuation performed by FTI Consulting (equivalent value of debt paid down).
Here, the Court considered the requirement for appropriated financial collateral (here, privately held shares in the JV Company) to be valued on enforcement in a “commercially reasonable manner” (under Regulation 18 of The Financial Collateral Arrangements (No 2) Regulations 2003 (FCARs)). This can be a problematic exercise when valuing illiquid private shares. Critically, the Court highlighted the speed and effectiveness of the appropriation remedy in taking shares into lender / delegate control, the fact that a share appropriation is not designed in law to be capable of being unwound or reversed, and went on to reject the need for a security taker to conduct the valuation in "good faith" – unlike the duties owed by a traditional share charge receiver appointed.
B. BACKGROUND TO FCARS
The FCARs provide simplified enforcement procedures for "financial collateral" (primarily cash, shares and bonds).
The FCARs covers two types of collateral arrangements but for the purposes of share charge enforcement we are concerned with "security financial collateral arrangements". This arrangement was contained in the Aapico share charge, using market language, versions of which will be present in most market form charges. To use the appropriation remedy of enforcement, the powers must be set out in the charge / debenture however. Not all contain the power, and should be scrutinised to make sure.
Financial collateral arrangements maintain numerous advantages over more traditional security formats (usually all set out in the same security document), including the swift and less formalised 'appropriation' method of enforcement, and exemptions from certain insolvency restrictions which would otherwise apply to security (e.g. the statutory moratorium in Administration).
The security taker would 'appropriate' shares in this case in discharge of an equivalent amount of debt on a pound for pound basis. It is a potentially invaluable alternative to a security taker exercising a mortgagee's power of sale or appointing a share charge receiver. However, upon exercising a right of appropriation, the security taker must thereafter account to the collateral provider for any surplus value of the financial collateral over and above the amount of the secured obligations.
C. HOW DO YOU 'APPROPRIATE' SHARES IN PRACTICE?
Case law requires (under Regulation 17 of FCARs) for there to have been an "overt act" showing intent to exercise appropriation, and which has been notified to the borrower.
In practice, the shares should be in the possession or control of the security taker / security agent before they can be appropriated. Appropriation is contingent on the security taker / security agent having 'real legal control' of the shares (i.e. able to prevent the borrower from using or disposing of the assets). Holding share certificates and transfers executed in blank will likely satisfy the 'real legal control / dispossession' requirements for the purposes of FCAR – these requirements would form part of any market form share charge. Whilst an 'event of default' is continuing under the finance documents, simple written notice will typically allow the security taker / security agent to appropriate the shares to themselves / their nominee and divest the security provider of all ownership – and there will be no formal registration or notification requirements at any registry for private shares to achieve this.
D. RECEIVERSHIP AND APPROPRIATION COMPARED
Applying the learning from the successful appropriation of the shares in the JV Company in ABT v Aapico, we set out here a comparison between appropriation and fixed charge receivership over shares:
E. POINTS TO NOTE
Q: Must a valuation take into account any "special value" placed on the shares by the security provider?
The FCARs do not speak to whether a "commercially reasonable" valuation should take into account any "special value" placed on the shares by the security taker. It was suggested in argument late in the proceedings in ABT v Aapico that the secured shares had a special value to Aapico outside of the ordinary market value for third parties and that this should have been taken into account by FTI. The Court did not look at the point directly and it remains a point for future cases – however, given the goal of the FCARs is to promote speed and market efficiency in enforcement, and where the Court stressed a wholly objective test for "commercial reasonableness" (what would reasonable participants in the relevant financial market do within a range), permitting special valuations of this kind to be taken into account in a way that an open market format would not seems perhaps counter-intuitive / contradictory.
Q: Can a security taker express a desire for a third party valuer to deliver a depressed valuation?
Whilst Aapico had notified FTI of its preference that the valuation produced would be depressed, this of itself did not mean Aapico acted in a commercially unreasonable manner. The Court agreed that Aapico's preference for a low valuation would have been implicit given the context in which FTI were engaged to act. Crucially, FTI were not captive - Aapico did not seek to restrain FTI and did not at any time seek to influence FTI to act in an un-professional manner. In the end, Aapico requested FTI provide a robust and defensible report given the anticipated challenge.
F. A LOAN-TO-OWN TOOL FOR 2023?
The ABT v Aapico case will be of most use to private credit providers who have the benefit of a financial collateral arrangement contained in their share security. For example, where a lender might wish to control risk by converting a debt position into an upside equity stake, or take out underperforming existing management of a defaulting borrower, or wish to solve for borrower JV disputes, break shareholder deadlocks. It is a proactive and powerful means to preserve credit value.
The case highlights the power and speed of the appropriation remedy, and further shows that: where share charge collateral is difficult to value down to it being illiquid (either by its nature or down to market volatility) – that these valuation problems can ordinarily be overcome. The power to overreach an Administration moratorium, the limited nature of the valuation duties sitting with the security taker (perform a commercially reasonable valuation process), and that the Court would not be inclined to unwind any share appropriation even if the valuation exercise was deficient, provides day-1 speed and certainty and reduces the number of moving parts, formality, and appointees (cost leakage) for a pre-planned enforcement process.