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Enforcement of a Pledge over the Shares of a Cyprus Company (“Cyprus Pledge”)

April 2018

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.

B. Charge

Unlike a pledge, the charge is a non-possessory security. It involves the creation of new proprietary rights of 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 chargor to the chargee. The chargor retains both ownership and possession of the asset; the chargee obtains neither. Instead the creditor obtains a new form of proprietary interest, a charge, over the secured property. Upon default by the debtor, the chargee 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, there can be no “second ranking pledge” in the strict sense. What can be done, is a conditional pledge agreement to the effect that the pledgor undertakes to pledge the shares to the prospective pledgee once and provided the existing pledge over the shares is discharged. Thus, the enforceability of such a “second ranking 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 prospective pledgee and necessary conditions of the law are met.

D. Validity and Registration of a Pledge under Cyprus Law

(a) Validity

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:

(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;

(b) A memorandum of the pledge needs to be entered in the register of members of the company whose shares are being pledged in respect of the shares pledged; and

(c) A secretary’s 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 relevant pledge agreement, (ii) it has taken all necessary corporate decisions to approve it, (iii) appointed a specified individual to execute the pledge agreement, and (iv) is in good standing and solvent.  For instance, the existence of a winding up petition against the pledgor  , provided the pledgor is a company incorporated in Cyprus, at the time of execution of the pledge agreement 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, a charge created by a Cyprus company is registrable with the Cyprus Registrar of Companies. To the contrary, where the chargor is a foreign company, the charge does not need to be registered with the Cyprus Registrar of Companies

A registrable charge 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.

A pledge created by a Cyprus company over the shares of a Cyprus company, is now exempted from the obligation to be registered with the Registrar of Companies, noting that this does not dispense with the other perfection requirements for a pledge over shares in a Cypriot company. It is still however necessary to register with the Cyprus Registrar of Companies a pledge created by a Cyprus company over the shares of a foreign company. It is highlighted that very often even share pledges over shares of Cypriot companies are still registered with the Registrar of Companies due to the fact that the document creating the pledge and/or charge usually provides in addition for the assignment of dividends, rights etc. which can be considered to be a form of charge not covered by the exception. 

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.

When drafting a share pledge agreement it is common to provide that certain documents will be delivered to the pledgee enabling the pledgee to enforce the pledge when the need arise (see section F below). Enforcement under a Cyprus Pledge is effected through implementation of the documents delivered under the relevant pledge agreement, (in particular the undated instrument of transfer and the share certificate).

Hence, the enforcement of the pledge can take place without the intervention of any other person or 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 the pledgee is entitle to challenge it in the courts. In such a case the pledgor will have to prove that 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 (the “Pledge Deliverables”) should be released to the possession of the Pledgee to allow and safeguard swift  and out of Court enforcement:

(i) Original share certificate representing the pledged shares;

(ii) Executed but undated Instrument of transfer in respect of the pledged shares;

(iii) Executed undated board of directors’ resolution of the company whose shares are being pledged approving the transfer of the shares.

The articles of association of a Cyprus company normally provide that a transfer of the company’s shares must be approved by its directors. This is why in the absence of such resolution the enforcement of the pledge may be prevented;

(iv) Irrevocable proxy by the pledgor to the pledgee;

This proxy is used in case directors of the company whose shares are being pledged refuse to resign or have not provided resignation letter in order to allow the pledgee to remove them from office.

(v) Executed but undated resignations of the company’s directors and secretary.

(vi) Executed resolution of the board of directors of the company (whose shares are being pledged) approving the share pledge agreement and the transfer of the shares in case of an enforcement event.

(vii) An undated certificate from the secretary that the changes in the structure of the company (expected to be made in case of enforcement) are in compliance with the records kept by the secretary;

(viii) 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)  In addition to the delivery of the abovementioned documents to the pledgee, special attention must be drawn to the following:

(i) Make sure that the Appendixes and especially the documents mentioned under point F (a) above, are properly drafted and that relevant documents to be executed are executed correctly. Numbers and dates must be checked. Also documents should be in original and handed over on execution. The instrument of transfer, the board of directors’ resolution approving the transfer of shares, the directors’ resignations and secretary’s certificate (that the changes correspond to the internal records) must all be undated. These documents will be dated and used if and when the pledge will be enforced.  Make sure you know where they are kept;

(ii) If administration of the company (whose shares are being pledged) is managed by a corporate administrator/“register agent” in Cyprus, it would be advisable such agent to be replaced by an independent one, preferably a reputable law firm, which will not be under the control of the pledgor.

(iii) Make sure that the enforcement clause provides that the pledgee is entitled to buy itself the pledged shares and not only to register them in its own name or  its nominee in view of a sale to a third person.

(iv) Change of the directors and the secretary of the company (whose shares are being pledged) should be restricted without the pledgee’s approval during the period of validity of the pledge. This is because some of the Pledge Deliverables may be rendered ineffective in case of such a change. Thus, it is important, in case of a change to ensure that the new secretary and/or director will execute on their part, undated resignation letters and a new board of directors’ resolution approving the transfers.  It is also advisable to monitor regularly (online) the public records of the Registrar to ensure that no change has been made without the pledgee’s consent.

(v)Pre-emption rights allowed in the articles of the Company whose shares are being pledged (which do not allow a shareholder to transfer its shares to a third party unless, these have been first offered to the existing shareholders and the existing shareholders rejected his offer) need to be modified.  Unless the articles are so modified and any change to the articles of associations is prohibited without the pledgee’s consent, the pledgee may face difficulties in disposing of the shares pledged.

(vi)Articles of association of the Company whose shares are being pledged is advisable to be amended in a way that the company’s directors will not have any discretion in approving a transfer of shares made in the context of the pledge enforcement.  Instead, they should be obliged to approve and ratify such transfer.

(vii)The pledge is advisable to be over 100% of the issued share capital or at least 75% to avoid the company being controlled by a third party as well as to ensure that in case of enforcement the pledgee/the buyer of the pledged shares will not be a minority shareholder.

(viii)Make sure proper registrations in the Company’s books and records and with the Registrar (if applicable) are made.

(ix) 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.

(x) It is advisable to be provided with an undated letter from the secretary of the Company addressed to the Cyprus Registrar of Companies confirming that any transfer of shares, removal or appointment of any officials of the Company is in accordance with the statutory books and records of the Company, which as per the requirement of the Cyprus Registrar of Companies, may be needed in case there will be such changes in the structure of the Company.

(xi) 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.

(xii)/,U> Governing Law/Jurisdiction:  Use Cyprus law as the governing law of a pledge over the shares of a Cyprus company and provide that Cyprus Courts will have non-exclusive jurisdiction over any dispute arising under such a share pledge agreement.

(xiii) Event of Default: make sure to include as an event of default any breach under the pledge agreement itself not only under the underlying facility or loan agreement.

(xiv) Commercial Benefit: Clearly state that the pledge provides commercial benefit to the pledgor and not only to its group or affiliates etc. and make sure that such acknowledgement is reflected in the pledgor’s resolutions approving the pledge.

(xv) In case out of Court enforcementcannot be achieved then as a necessity a Court action will need to be filed. Under certain circumstances, on an application made by the pledgee, it may be possible for an interim mandatory injunction to be issued ex parte (without notice to the other side), forcing the pledgor to register the shares in the name of the Pledgee.  The interim mandatory injunction can 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.

(c)  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 is to sell the shares to an affiliate, the pledgee and the purchaser will need to show that the sale is made in good faith and reasonable precautions are 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).
  • 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).

 (d)  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), (see Royal Bank of Scotland plc v Highland Financial Partners LP and others [2010] EWHC 3119).

(e)  Sale Notice

It should also be borne in mind that the pledgee before enforcing the pledge by selling 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 only if he fails to do so within the time specified the Pledgee will be entitle to sell). Our suggestion is to have respective periods fixed in the pledge agreement allowing no grounds for interpretation. Article 134 of the Contract Law Cap. 149 provides that “if the pawnor makes default in payment of the debt, or performance, at the stipulated time of the promise in respect of which the goods were pledges, the pawnee may bring legal proceedings against the pawnor, upon the debt or promise, and retain the goods pledged as a collateral security; or he may sell the thing pledged, on giving the pawnor reasonable notice of the sale.

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. Financial Collateral Arrangement Law, Law 43(7)/2004 (the “FCL”)

The scope of the FCL is limited to financial collateral arrangements evidenced in writing in which the financial collateral consists of cash or financial instruments and in which the parties are certain categories of legal entities (such as supervised financial institutions (including investment firms, insurance undertakings and mutual funds), public authorities, central banks, central counterparty settlement agents or clearing house.

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 in the cases where the FCL applies is only allowed where this has been explicitly agreed upon by the parties in the relevant share pledge agreement, and if the parties have agreed on the valuation method of the pledged assets.

H. 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 whose property was charged.

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