Summary and implications
The Privy Council has recognised a lender’s right to appropriate shares given as collateral, and has issued guidance on how the right can be applied in practice. The guidance follows the Privy Council’s decision in Cukurova Finance International v. Alfa Telecom*. Although technically a Privy Council decision is not binding on the English courts, it is considered to be highly persuasive authority. Lenders and borrowers should note that:
- This is the first time that a lenders’ right to appropriate shares has been tested in the courts.
- Right of appropriation is equivalent to foreclosure, but lenders do not have to get a court order (a court order is required for foreclosure).
- A lender can appropriate shares given as collateral even if the borrower is in administration.
The right of appropriation strengthens the lenders position
At present, if a share charge is created properly the lender will have the right tools to enforce the charge. In the case of an equitable mortgage, the lender will usually have: the share certificates; signed stock-transfer forms and a security power-of-attorney that makes it easy for the lender to complete the formalities of enforcement.
This puts the lender in a good position. But the Financial Collateral Arrangements (No 2) Regulations 2003 (the Regulations) gives the lender two extra advantages when enforcing a charge over shares.
Under the Regulations, provided that the share charge contains a power of appropriation, charged shares can be appropriated:
- without a court order; and
- when a borrower is in administration or entering another reorganisation procedure (e.g. a voluntary arrangement).
Lenders can appropriate charged shares without a court order
Firstly, under Regulation 17(1), if a lender has the power to appropriate shares (i.e. take the shares for himself rather than selling to a third party), the power may be exercised without a court order.
Prior to the Regulations, the lender would have to sell the charged shares to a third party unless he had a court order. The lender could use the proceeds of the sale to settle the debt, but could not take the charged shares for himself.
In contrast, the power of appropriation under Regulation 17 allows the lender to take the charged shares for himself without a court order. Regulation 18 requires lenders to value the charged shares in accordance with the terms of the share charge, and in a commercially reasonable manner.
The Regulations therefore enable a lender to be quite prescriptive in the share charge as to how it intends to value the charged shares in the event of appropriation. All the lender has to do is account for the value of the charged shares that it has appropriated.
Shares can be appropriated when a borrower is in administration
Regulation 8 disapplies those provisions of the Insolvency Act 1986 that prevent lenders from enforcing charges when a borrower enters a reorganisation procedure (e.g. administration, a voluntary arrangement).
In other words, lenders can still appropriate charged shares despite the statutory moratorium that comes into effect when a company goes into administration. Furthermore, Regulation 10 disapplies certain provisions of the Insolvency Act 1986 in respect of the avoidance of contracts.
The power of appropriation only applies in specific situations
The power of appropriation will arise if the shares are in the possession of, or under the control of, the collateral-taker, and the share charge:
- constitutes a legal or equitable mortgage;
- is not created by, or in favour of, an individual; and
- contains an express power of appropriation.
Jurisdictions: lenders may want to ask local counsel whether English law remedies to share charges would be useful
In this case, although the shares in question were shares in a British Virgin Islands (BVI) company, the share charge was governed by English law.
Under BVI law, mortgages over shares in a BVI company may be governed by a foreign law, and the remedies available to the lender will be determined by that foreign law.
In order to avail themselves of the right of appropriation, lenders may wish to consider with local counsel whether to take an English law governed share charge, even though the shares in question are shares in a non-English company. The value in doing this will depend on whether an English law share charge and its associated remedies will be recognised in the local jurisdiction.