IntaCapital: Security for Credit Lines in ‘lease or leasing of Bank Guarantees and Collateral Transfers
Posted on by IntaCapital Swiss
When applying to a bank or private lender to receive a credit line against a leased bank guarantee (often called ‘monetization’), banks and private lenders alike may also request the applicant (borrower) to offer a pledge over his share holding as security for the repayment of the credit. A bank or lender will not want to call the bank guarantee unless it is absolutely necessary in the event of default of payment of the credit line or loan. By taking a lien or mortgage over the borrower’s shares, the lender will have greater control in events of default.
A lien over shares takes on two different forms:
The shares are transferred into the name of the mortgagee who is registered as a member of the company. There must be a charging document reciting that the charge is by way of security, providing for a re-transfer on redemption, setting out the mortgagors obligations, the events of default, dealing with dividend and voting rights if these are to be removed from the mortgagee and perhaps containing a topping up clause obliging the mortgagor to mortgage further securities if the value of those charged falls below the outstanding amount of the debt plus a certain margin.
Equitable mortgage of shares
It may be created by:
- simple deposit of the share certificate in which case the mortgagee will need to apply to the Court for an enforcement order for sale or foreclosure; or
- a deposit of the share certificate together with a blank transfer form undated but signed by the mortgagor. The mortgagee can insert his name or another’s name as the transferee in the event of default. However if the articles requires transfers to be made by deed then the mortgagee does not have the implied authority to fill up the blanks except if he has a power of attorney under seal to do so; or
- deposit of the share certificate coupled with a blank transfer and a memorandum of deposit under seal containing an irrevocable power of attorney by way of security pursuant to s.4 of the Powers of Attorney Act 1971. Thus the mortgagee will be able to complete and execute the transfer on behalf of the mortgagor.
Points to note:
The mortgagee becomes a member of the company and
a) he is liable for calls on partly paid shares;
b) remains a contributor if the winding up commences within a year of the re-transfer of his shares to the mortgagor;
c) if he receives dividends he will be liable to account to the mortgagor for this income;
d) he runs the risk of acquiring a subsidiary (interestingly the company may be a subsidiary both of the mortgagee by virtue of his holding and of the mortgagor by virtue of his control if the voting rights have been assigned to the mortgagor under the charging document);
e) stamp duty is not payable if the transfer is by way of security for a loan or re-transfer to the original transferor on repayment of a loan (please see form of certificate on the back of stock transfer form);
f) a transfer of shares by way of security is not a capital gains tax disposal until the security is enforced, if this indeed applies in the jurisdiction of Bronte;
g) where the mortgaged shares represent a controlling interest there may be tax implications flowing from a company being or not being connected, grouped or linked with another company.
(a) Capitalisation issues need to be brought into the charge. This cannot be done of course if there is mere deposit of the share certificate with or without blank stock transfer form or the equivalent.
(b) It is not secure. However, the mortgagee can serve a stop notice on the company by filing an affidavit and a notice in the central office of the Supreme Court or a District Registry and serving them on the company. Whilst the stop notice remains in force the company will be obliged to give him notice of proposed transfers which will enable him to apply for an injunction.
Points to note in both types of mortgages
1) There may be restrictions in the articles of association where the mortgage is over shares of a private company relating to:-
(a) directors’ powers to refuse registration (in order to avoid this risk, it is advisable to make them parties to the charge wherever possible);
(b) pre-emption rights on transfer (waivers will need to be obtained when taking the mortgage and also when realising the security);
(c) the creation and enforcement of mortgages over shares (a special resolution may be necessary to avoid a specific restriction in the articles).
(2) Registration at Companies House may be necessary if the mortgage over shares constitutes a charge over book debts (ie dividends).
(3) Notification of interests of directors under s.324 Companies Act 1985 (‘CA’) may be necessary if the mortgagor or the mortgagee is a director of the company (or the company’s subsidiary or holding company or the holding company’s subsidiary) as the granting of the mortgage may constitute the entering into a contract to sell shares.
(4) Disclosure of interests in shares under s198 (1) CA may be necessary if the mortgage gives certain voting rights on shares in a public company (or on shares of a company which is, or through a subsidiary is, a shareholder in a public company).
(5) If the shares are vested in the mortgagee, as shareholder he will share last in a return of capital after the secured, preferential and the unsecured creditors of the company have been repaid. Coupled to the lack of marketability of a minority interest a mortgage on shares may not be an attractive security.
(6) The articles may give liens over the shares not only for unpaid calls but also for any moneys due from the shareholder to the company.
(7) Priorities of legal and equitable mortgages over shares or between such mortgages and liens may need to be considered.
As indicated a mortgage on shares is not always a popular security instrument. The legal mortgage on shares gives better formal security than the equitable mortgage. However the mortgagee’s name appears on the register of members of a company and this can mislead creditors into thinking the company has a substantial shareholder and endanger the mortgagee’s reputation. Thus equitable mortgages while more risky are generally more common.