Potential civil and criminal liability
A lender's ability to enforce its security over publicly traded shares can be affected if it holds inside information about the company that has issued those shares. At its simplest, inside information is information of a precise nature, which:
- has not been made public;
- relates directly or indirectly to the shares or issuer of the shares; and
- if it were made public, would be likely to have a significant effect on the price of those shares.
If, while a lender holds inside information, it has:
- enforced its security over publicly traded shares; or
- (if the shares are dematerialised and held by an intermediary) directed the relevant intermediary to deal in the shares,
the lender and/or its employees could potentially incur criminal liability under Part V of the Criminal Justice Act 1993 (CJA) and/or civil liability under the Market Abuse Regulation (MAR). Any determination as to liability is particularly strained where the lender has taken equitable security and enforcement includes a transfer of legal ownership to the lender.
For a lender familiar with the relatively straightforward process of taking security over privately held shares, the risks of dealing with publicly traded shares may not always be obvious. However, recognising and addressing the issues at an early stage (and before taking security over the shares) is essential. A lender does not want to find it cannot enforce its share security at the crucial time because it has unwittingly become privy to inside information, particularly as neither the CJA nor MAR necessarily requires prior knowledge, intent or recklessness by the alleged abuser.
One solution could be for the lender to build "automatic" enforcement triggers into the loan and security documents. This could enable the lender's employees to argue that they would have enforced the security even if they had not had the inside information (using the defence under section 53(1)(c) of the CJA). However, for this to work the practice of automatic sale would need to be consistent: if the lender has delayed enforcement, or opted not to enforce, the defence may well not be available. Also, there is no directly equivalent defence under the MAR, although it may be possible to argue that such an arrangement is "legitimate behaviour" under Article 9(3). Nonetheless, it seems unlikely that an inflexible automatic sale procedure would generally suit the lender or security provider.
A more palatable solution might be for a lender to create a robust Chinese wall. This could serve to ensure that the lender's staff taking decisions over enforcement of the share security never have access to potential inside information. The arrangement may, for example, involve all information passing between frontline staff and those responsible for enforcement decisions being "filtered" via the compliance or legal team. Setting up robust procedures will not always be straightforward, but MAR lists use of an effective Chinese wall procedure as a category of "legitimate behaviour" under Article 9(2).
In taking security over publicly traded shares, a lender must also be familiar with a bewildering array of disclosure and notification obligations that could apply to it or its chargor. The precise rules that could apply will depend on several variables. These might include the market on which the shares trade or are listed, the percentage of the company's shares involved in the transaction and the role within the company performed by the chargor.
- Does Rule 5 of the Financial Conduct Authority's Disclosure Guidance and Transparency Rules Sourcebook (DTR) apply to the company? If so, a lender with security over the company's shares typically will not have to notify the company of the percentage of voting rights that it acquires (directly or indirectly) as a result of its security interest. However, an exercise of voting rights by the lender will trigger a notification obligation.
- MAR (Article 19(1) and (7)) imposes notification obligations on any person discharging managerial responsibilities (PDMR), or their closely associated persons, within a company to which MAR applies. If a PDMR, or a person closely associated with a PDMR, grants security over his or her shares he or she must disclose the transaction to the company. The company would then have to notify the market.
- MAR (Article 19(11)) imposes closed periods on PDMRs, or their closely associated persons, within a company to which MAR applies on dealing in its shares (including the grant of security). Clearance may only be provided in exceptional circumstances (such as severe financial difficulty).
- The AIM Rules dictate certain disclosure obligations and restrictions on dealings in the company's shares for directors and their families. The AIM Rules also contain significant shareholder disclosure obligations and dealing restrictions for directors and applicable employees during close periods.
- Does the Takeover Code apply to the company? If so, there are potential disclosure obligations under Rule 8 if a charge is taken over 1 per cent or more of the shares of the company. There are also significant potential consequences under Rule 9 (and related Rule 5). Security purported to be taken over 30 per cent or more of the voting rights of the company can trigger a mandatory takeover offer when enforced.
- Part 22 of the Companies Act 2006 allows a public company to serve notice on those "interested in" its shares. This is widely defined and may include a security holder. An interested person can be required to give information about not only its own interest but also any other concurrent interest of which he or she has knowledge. If an interested person fails to comply with the notice, the company can apply to court for an order that the shares in question be subject to restrictions. A chargee may therefore wish to build extra protections into the share security document. For example, it could require the chargor to comply with its disclosure obligations and to tell the security holder if it receives any relevant notice.
- Part 28 of the Companies Act 2006 contains "squeeze out" and "sell out" rules, which apply to takeover offers of companies that fall within the remit of the Companies Act 2006. The rules come into play when the offeror has acquired or unconditionally agreed to acquire at least 90 per cent in value of the shares in the target. The squeeze out rules give the offeror the statutory right to buy out the remaining minority shareholders and their application cannot be excluded.