Enforcement of a Pledge over the shares of a Cyprus Company

Enforcement of a Pledge over the shares of a Cyprus Company (“Cyprus Pledge”) A. Pledge

A Pledge is by definition a possessory security interest and thus involves the delivery of possession, actual or constructive. A security interest is valid and enforceable once it has been attached to the asset and is perfected. A security interest that has been attached and perfected is enforceable as between the Pledgor and Pledgee. The effect of attachment is that the security interest fastens on the asset so as to give the creditor rights in rem against the debtor himself.

B. Charge

Unlike a pledge, the Charge is a non-possessory security. It involves the creation of new proprietary rights in the creditor. The essence of a charge is that the secured property is made liable for the repayment of a debt without there being any transfer of ownership or possession from the debtor (the ‘chargor’) to the creditor (the ‘chargee’). The debtor retains both ownership and possession of the asset; the creditor obtains neither. Instead the creditor obtains a new form of proprietary interest, a charge, over the secured property. Upon default by the debtor, the creditor is generally entitled by the terms of the security agreement to assume possession of the secured asset, sell it, and recoup the outstanding debt from the proceeds of sale.

C. “Second Ranking Pledge”

Since the Cyprus Pledge as explained above creates a possessory security interest the validity and enforceability of a second ranking Cyprus Pledge is limited and becomes enforceable so far and provided the first priority Pledge is discharged, the share certificate representing the pledged shares is released in favour of the pledgee and necessary conditions of the law are met.

D. Validity and Registration of a Pledge under Cyprus Law

(a) Validity

When shares of a Cyprus Company are pledged, section 138 of Contract Law, Cap. 149, applies.

According to section 138(1) of Contract Law, Cap. 149, in order for a Cyprus Pledge to be valid, the pledge must be:

•   made in writing

•   signed by the pledgor; and

•   signed in the presence of two witnesses each having contractual capacity

  (b) Enforceability

  In addition to the above requirements, in order for a Cyprus share pledge to be enforceable, the following requirements need to be satisfied, as stated in section 138(2) of Contract Law, Cap.149, namely:

  1. (a)  Notice of the pledge together with a certified copy of the deed of pledge needs to be given by the pledgee to the company whose shares are being pledged;

  2. (b)  A memorandum of the pledge is entered in the register of members of the company whose shares are being pledged in respect of the shares pledged; and

  3. (c)  A secretarial certificate is issued confirming that a memorandum of pledge has been entered in the register of members of the company whose shares are being pledged, evidencing the pledge.

(c) Capacity and Authority

Apart from the above, it must also be secured that (i) the Pledgor has the corporate capacity to enter the pledge, (ii) it has taken all necessary corporate decisions to approve it (iii) appointed a specified individual to execute the pledge and (iv) is in good standing and solvent. For instance the existence of a winding up petition against the Pledgor at the time of the pledge execution renders the pledge void unless a Court order is received validating the transaction.

(d) Registration/Priority

In the situation the Pledgor is a Cyprus Company, apart from the registration of the pledge in the register of members of the company whose shares are being pledged(see above D (b) (b) ), the pledge should be also register with the mortgages and charges registry of the Pledgor.

The perfection requirement is such as to give notice to the public of the existence of the charge created.

Pursuant to section 90 of the Cyprus Companies Law, Cap 113 charges are registrable with the Cyprus Registrar of Companies only if the pledgor is a Cyprus company.

Such charges and any amendment, assignment thereto must be registered with the registry of mortgages and charges of the Registrar of Companies (a) within 21 days, if executed in Cyprus, or (b) within 42 days if executed outside.

It is no longer obligatory to register with the Registrar of Companies pledges over shares in Cypriot companies created by chargors which are Cypriot companies noting that this does not dispense with the other perfection requirements for a pledge over shares in a Cypriot company. However, it is highlighted that very often share pledges over shares in Cypriot companies are still registered with the Registrar notwithstanding the amendments of the Cyprus Companies Law, Chapter 113 in July 2009 due to the fact that the document creating the pledge and/or charge usually provides for the assignment of dividends, rights etc which are not covered by the amendments. In any event, where the chargor is not a Cypriot company there is no need of registration of a charge with the Registrar of Companies.

Also, there is no need to register with the Registrar of Companies charges which come within the ambit of Financial Collateral Arrangement Law 43(7)/2004 (the ̎FCL)̎ . Under the FCL the Pledgee is allowed on the occurrence of an enforcement event, to appropriate the pledged shares and set off their value against the relevant financial obligations of the Pledgor, without having to apply to the court for an order. However, it is highlighted that appropriation is only allowed where this has been explicitly agreed upon by the parties in the share pledge agreement, and if the parties have agreed on the valuation method of the pledged assets. Also, it is important to note that the FCL is applicable to:

•financial collateral arrangements where one of the parties is either a supervised financial institution (including investment firms, insurance undertakings and mutual funds), a public authority, a central bank, a central counterparty settlement agent or clearing house (including regulated similar institutions acting in the futures, options and derivatives markets); or a person, other than a natural person (including unincorporated firms and partnerships), provided that the other party is one of the aforementioned institutions;

•financial collaterals that consist of cash or financial instruments (mainly shares and other transferable securities and interests in securities); and

•financial collateral arrangements evidenced in writing.

E. Enforcement and Procedure

The Cyprus Pledge will usually provide for the circumstances in which the pledge and the security created thereunder becomes enforceable e.g. the occurrence and continuation of an event of default.

A creditor can look to the security for the purpose of discharging the obligation owing to it at the time of an event of default. Enforcement under a Cyprus Pledge is effected through implementation of the documents delivered under the pledge, in particular the undated instrument of transfer and the share certificate.

The enforcement of the pledge takes place without reference to any other person or without the need for a Court order. It is not usual or indeed required to appoint a receiver since the pledge is enforced through implementation of the documents delivered under the pledge which allow the Pledgee or whomever it nominates to become the registered owner of the pledged shares. However, the Pledgee owes a duty to act reasonably and if enforcing by way of sale to another party, owes a duty to obtain the best price possible. A Pledgee, however, does not owe a duty to wait until conditions improve. The ‘best price possible’ is the best price obtainable on the day of enforcement. If the shares are listed then this is obviously the average price of the day. In the case of private company, it is the best price the Pledgee could obtain acting reasonably – i.e. the price a willing buyer is prepared to pay.

If the Pledgor does not agree with the price obtained then it can be challenged in the courts, however the Pledgor will have to prove the Pledgee acted unreasonably. Such challenge in any case does not invalidate the sale of the shares unless there is fraud involved.

All cost incurred in the enforcement of the Pledge are for the account of the Pledgor and are recoverable out of the sales proceeds of enforcement.

On enforcement, the Pledgee owes a duty to account to the Pledgor for any surplus realised.

F. Practical issues in drafting and enforcing a Cyprus Pledge:

(a) The following document should be released to the possession of the Pledgee to allow and safeguard swift and out of Court enforcement:

(i) Original share certificate;

(ii) Executed undated Instrument of transfer;

(iii) Executed undated BoD resolution of the company approving the transfer of shares. Normal articles of a Cyprus company provide that a transfer of shares must be approved by the Directors. Thus the pledge may not be enforced in the absence of such resolution which in any case will be rendered completely ineffective in the event that the Directors of the Company have, at the time of enforcement, been replaced;

(iv) Irrevocable proxy by the Pledgor to the Pledgee; This proxy is used in case Directors refuse to resign or have not provided resignation letter for a general meeting to be convened and remove them from office.

(v) Executed undated resignations of the Company’s Directors and Secretary.

(vi) Executed resolution of the Board of Directors of the Company approving the share pledge agreement and transfer of shares in case of an enforcement event.

(vi) An undated certificate from the secretary that the proposed changes in the structure of the Company (in case of enforcement) are in compliance with the records kept by the secretary;

(vii) a certified copy of the register of members of the Company;

(Drafts of the majority of the abovementioned documents are usually included as appendixes in the share pledge agreement so that the format and content of them is agreed between the parties (the “Appendixes”)

(b) Make sure that the Appendixes and especially the above documents are drafted and that the documents to be executed are executed correctly, check numbers and dates. Also documents should be in original and handed over on execution. The instrument of transfer, BoD resolution, Directors resignations and Secretary’s certificate must be undated. Make sure you know where they are kept;

(c) Make sure the «register agent»/ secretary of the Company does not remain the same and to change into an independent one, preferably a reputable law firm.

(d) Enforcement clause to provide that Pledgee is entitled to buy itself the pledged shares not only to register them in its own name or it’s nominee in view of a sale.

(e) Directors and the Secretary [see below (ia)] of the Company cannot change without Pledgees approval during the period of validity of the pledge, and the new ones to execute undated resignation letters and a new BoD resolution approving the transfers should be released. Monitor regularly (on line) the public records of the Registrar.

(f) Pre-emption rights allowed in the articles of the Company need to be modified. Unless the articles are so modified and the Pledgee has the voting power to prevent further amendments, the Pledgee may face difficulties in disposing of the shares pledged.

(g) Request amendment of the Articles of the Company for Directors not to have a discretion in approving a transfer of shares in the case of a pledge enforcement. Instead to be obliged to approve and ratify such transfer. Use the following wording:

«Notwithstanding anything contained in these Articles, the directors shall not decline to register any transfer of shares, nor may decline the registration thereof where such transfer is executed by any bank or institution or any other entity or person to whom such shares have been pledged and/or charged by way of security, or by any nominee of such a bank, institution entity or person pursuant to the power of sale under such security, and a certificate by any official of such bank, institution, entity or person that the share were so charged and the transfer was so executed shall be conclusive evidence of such facts».

(h) Request pledge over 100% of issued share capital or at least 75% to avoid in case of enforcement becoming a minority shareholder.

(i) Make sure proper registrations in the Company’s books and records and with the Registrar, if necessary.

(j) Separate and Independent Security: the pledge shall need to be clearly a standalone document capable of being enforced by itself without any reference to any other security document.
(ja) The Registrar ready annual that changes in the structure of Companies (transfer of shares, change of directors etc) to be allowed and new certificates from the Registrar to be issued, a certificate from the previous secretary at the Company shall need to be also provided.

(k) Stamp Duty: a pledge over share in a Cyprus Company is subject to stamp duty which is dependent on the value of the transaction with a maximum of €20.000. Failure to pay stamp duty does not affect the validity of the document/s but merely its admissibility as evidence before the Cyprus courts.

(l) Governing Law/Jurisdiction: Use Cyprus law as the governing law of the pledge and Cyprus Courts to have non exclusive jurisdiction.

(m) Event of Default: to include as an event of default any breach under the Pledge Agreement itself not only under the Facility or Loan Agreement.

(n) Commercial Benefit: Clearly state that the pledge provides commercial benefit to the Pledgor and not to its group or affiliates etc and such acknowledgement to be reflected in the minutes of the Pledgor approving the pledge. Pledgor’s resolution to reflect “commercial benefit”.

(o) In case out of Court enforcement cannot be achieved then as a necessity a Court action needs to be filed. An interim mandatory injunction forcing the Pledgor to register the shares in the name of the Pledgee may be issued ex parte (without notice to the other side). The interim mandatory injunction may be issued without delay i.e. the same day the application is filed. A summary judgment is also possible in these cases allowing the case to come to a full conclusion in less than six months.

(p) Pledgor’s Interests:

The Pledgor’s interests are safeguarded by a number of common law and equitable principles that have been developed through the case law. Amongst others the pledgee’s duties on a sale of the pledged shares are to:

 Act in good faith (Downsview Nominees Ltd and another v First City Corporation Ltd and another [1992] UKPC 34).

•   Take reasonable steps to obtain a proper price for the shares (Cuckmere Brick Company Ltd v Mutual Finance Ltd [1971] Ch 949).

•   Obtain the best price reasonably obtainable (Den Norske Bank ASA v Acemex Management Co Ltd [2003] EWCA Civ 1559).

•   Act with reasonable care and skill (Standard Chartered Bank Ltd v Walker [1982] 1 WLR 1410).

•   Act fairly towards the Pledgor (Palk v Mortgage Services Funding plc [1993] Ch 330).

•   While there is no statutory obligation to obtain a valuation, a prudent Pledgee would make a valuation in order to be able to show that it has discharged its duty to obtain a proper price.

•   If the Pledgee wasto sell the shares to an affiliate, the Pledgee and the Purchaser would need to show that the sale was made in good faith and reasonable precautions were taken to obtain the best price reasonably obtainable at the time of the sale (Tse Kwong Lam v Wong Chit Sen [1983] 1 WLR 1349). We strongly also advise the pledge to allow in specific the Pledgee to sell either through a public auction or a private sale.

•   While a secured party is free to consult his own interests on whether and when to exercise his power of sale (Raja v Austin Gray [2002] EWHC 1607) it was held that a secured party cannot act in a way that unfairly prejudices the Pledgor (Palk v Mortgage Services Funding [1993] Ch 330).

  (q) Appropriation

  The issue of whether the Pledgee has acted in good faith may arise where it retains the shares over which security has been granted in discharge or reduction of the secured debt (in essence, the Pledgee is exercising the power of sale in favour of itself). This point was considered in the case of Royal Bank of Scotland plc v Highland Financial Partners LP and others [2010] EWHC 3119 and in this instance the bank was found to have breached its duty of good faith. In accordance with Financial Collateral Arrangement Law 43(7)/2004. The remedy of appropriation is available provided the parties have in specific contractually agreed: (i) that it is applicable and (ii) the method of evaluation of the assets and the obligations..

  (r) Sale Notice

  Finally it should also be borne in mind that the Pledgee before enforcing the security by a sale of the pledged shares it must give reasonable notice to the Pledgor (i.e. it must call on the Pledgee to pay the secured obligations and if he fails to do so within the time specified the Pledgeecansell). Oursuggestionistohavethisperiodfixedinthepledgetoallownogrounds

for interpretation. In this respect bear in mind that the Pledgor is also protected by the principle of “equity of redemption” which allows the Pledgor to discharge the secured obligations at any time prior to the sale of the shares and seek to release the pledge.

G. Release of charges

The Registrar of Companies, on evidence being given to his satisfaction with respect to any registered charge:

(a) that the debt for which the charge was given has been paid or satisfied in whole or in part; or
(b) that part of the property or undertaking charged has been released from the charge or has ceased to form part of the company’s property or undertaking,

may enter on the register a memorandum of satisfaction in whole or in part, or of the fact that part of the property or undertaking has been released from the charge or has ceased to form part of the company’s property or undertaking, as the case may be. Such evidence may be provided by the creditor or the company.

Please contact a member of our staff for further information and/or clarifications.