Legal Business. Shares As Security. Memoranda on legal and business issues and concerns for multiple industry and business communities

Transcription

1 Memoranda on legal and business issues and concerns for multiple industry and business communities Shares As Security Lina Lau & Terrence Choo Boon Liang Rajah & Tann 4 Battery Road #26-01 Bank of China Building Singapore Tel: Fax: eoasis@sg.rajahandtann.com Website:

2 Shares As Security NATURE OF SHARES Shares Are Choses In Action A member of a company has no legal or beneficial interest in the property of the company. The ownership of shares in a company merely confers upon the shareholder two rights: while a company is a going concern, the right to participation based on the terms of the Memorandum and Articles of Association of the company; and if and when the company is wound up, the right of participation in the assets of the company remaining after all the debts of the company have been paid. However, ownership of shares may also involve the shareholders in certain liabilities, eg liability to pay calls if the shares are not fully paid up. Therefore, a share may be regarded as a bundle of rights and obligations, the exact scope of which is dependent on the company's constitutional documents. As choses in action, shares are not capable of possession. It is therefore not correct to speak of a pledge of shares, unless when dealing with bearer shares. Type Of Shares Private Company Shares Restriction on transfer The transfer of shares in private companies is required to be restricted. Section 18 of the Companies Act (Chapter 50) provides that: Private company 18. (1) A company having a share capital may be incorporated as a private company if its memorandum or articles (a) restricts the right to transfer its shares;... The most common way of restricting transfer of shares in the Articles of Association is by providing the directors with the discretion not to register certain transfers. Such a restriction may, for example, be in the following terms: Page 1

3 The Directors may in their discretion refuse to register any transfer of any share and shall not be bound to give any reason for such refusal or specify the grounds upon which any transfer is declined. If security is taken over private company shares, this restriction would inhibit the exercise of the bank's power of sale. Furthermore, it is not uncommon for the Articles of Association of private companies to provide for pre-emption rights. (ii) Lien Companies will invariably have a lien on the shares for monies owing by the shareholder to the company. For example, the Articles may provide: The Company shall have a first and paramount lien on all the shares registered in the name of a Member (whether solely or jointly with others) for all moneys due to the Company from him or his estate either alone or jointly with any other person, whether a Member or not, and whether such moneys are presently payable or not. The Company's lien (if any) on a share shall extend to all dividends payable thereon. Liens would affect the value of the shares. If loans are made by the company to the shareholders (especially in the case of private exempt companies), the shares of the borrower shareholder may be subject to the lien. Some liens may be restricted only in respect of amounts unpaid on shares, in which case, confirmation from the company should be obtained to ensure that the shares have been fully paid up. Public Company There are generally no restrictions on the transfer of public company shares. But issues of lien may still arise. Public Company Listed On The Stock Exchange Listed shares are preferred since their value can be easily ascertained. Also, shares are required to be fully paid up before they can be listed. Shares In Foreign Corporations The nature of such shares (eg the rights of shareholders, transferability, etc) would generally be dependent on the law of the place where the corporation is incorporated. Page 2

4 SOME ISSUES TO CONSIDER WHEN TAKING SECURITY OVER SHARES Memorandum & Articles Of Association The rights of members are contained in the Memorandum and Articles of Association of the company. Before taking security over shares, the Memorandum and Articles of Association of the company should be reviewed to determine what these rights are. Among the provisions which have to be reviewed would be (a) transfer restrictions; (b) preemption rights; and (c) liens over shares. Exercise Of Membership Rights For the duration of the security, consider who gets to exercise the rights of members, for eg to receive notices and to vote at general meetings. Usually if a bank takes a mortgage of the shares and registers itself or its nominee as a member of the company, it or the nominee (as the case may be) will be treated by the company as a member. Where a charge is taken and the chargor remains the member, the chargor will be treated by the company as the member. Where a bank takes a mortgage, it may be possible to appoint the chargor as the bank s proxy and allow the chargor to vote as it pleases. Accruals Dividend / Distribution / Rights / Bonus Etc Accruals would generally refer to (a) dividends; (b) rights issue; or (c) bonus issues. When taking security over shares, the following has to be determined: Who has the right to the dividend, the chargor or the bank? Would the chargor be compelled to exercise its rights under any rights issue? (Bonus issue is usually not a problem since no additional funds are required.) Would the bonus / rights share be subject to the same security? Moratorium Shares Chapter 2 of the new SGX Listing Manual imposes restrictions on the disposal of shares of a company seeking listing by the promoters of the listing company. Promoters in this context refers to: controlling shareholders, and their associates; and Page 3

5 executive directors who own 5% or more of the issued share capital of the listing applicant at the point of listing. The period of moratorium imposed depends on whether the company applies to list on the Main Board or the SESDAQ. The marketability of the share are affected during the moratorium. Compliance This used to be an issue under section 32 of the Banking Act (Chapter 19), which prevents banks from holding more than 20% of the share capital of any company. However, section 32 was recently amended. The relevant part of the new provision reads as follows: Investments in companies undertaking non-financial businesses 32. (1) No bank in Singapore shall acquire or hold a major stake in any company without the prior approval of the Authority [MAS]. (2) The Authority shall not ordinarily grant its approval under subsection (1) if the company carries on, whether as its principal business or otherwise, any prohibited business. (3) Notwithstanding subsection (2), the Authority may, in the circumstances of a particular case, grant its approval for a bank in Singapore to acquire or hold a major stake in a company which carries on any prohibited business, subject to such conditions as it may impose. (4) This section shall not apply to - (a) any interest held by way of security for the purposes of a transaction entered into in the ordinary course of the business of the bank in Singapore; and (b) any shareholding or interest acquired or held by a bank in Singapore in the course of satisfaction of debts due to it which is disposed of at the earliest suitable opportunity. Section 32(4)(a) is a new provision, and serves as a carve out for banks taking shares as security. Page 4

6 SECURITY OVER SHARES Pledge Of Shares A Misnomer A share certificate constitutes prima facie evidence that the person in whose name it is issued owns the stated number of shares in the respective company. The certificate is not a document of title and its delivery does not transfer the property in the shares covered by it. Moreover, the share itself is not an item of property, such as chattel or a negotiable instrument. In common usage, a pledge of shares simply means depositing the share certificates (with or without executed transfers) for creating a mortgage. Mortgage Of Shares Legal Mortgage Most commonly, a security over shares is effected by way of a legal mortgage, ie, by transferring the ownership in the shares to the mortgagee or his nominee. This is done by registering the mortgagee / nominee as the owner of the shares in the company's register of members. It is the most secured and comprehensive form of security interest as it transfers legal title to the mortgagee and prevents the mortgagor from dealing with the shares while they are subject to the mortgage. Equitable Mortgage An equitable mortgage transfers only the beneficial interest to the mortgagee with legal title remaining with the mortgagor. When shares as security are transferred to and become registered in the name of the mortgagee, the mortgagee acquires a legal mortgage over them. Before the registration, although the mortgagee has received the share certificates and executed transfers in his favour, he only has an equitable mortgage. All the more, if the share certificates have been merely deposited as security with the mortgagee (whether with or without the blank transfers), only an equitable mortgage is created. An equitable mortgage over specific shares may also be created by virtue of the shareholder agreeing to mortgage them to the mortgagee even though there is no delivery or depositing of the share certificates. Charge A charge does not confer legal or equitable interest in the asset to the chargee. In the context of shares, pure charges over shares are rare. Usually, the security document would grant the chargee powers similar to those of a mortgagee. A fixed or floating charge created by a company over its assets can also be effected over any shares or stock held by that company. Page 5

7 Advantages And Disadvantages Advantages Of Equitable Mortgage Or Charge Speed and Flexibility If the borrower wishes to redeem the security, the share certificates can be returned to him. There is no need to transfer them back into his name or that of his purchaser. Disadvantages Of Equitable Mortgage Or Charge Priority An equitable charge does not defeat the title of a bona fide purchaser of the securities for value without notice. An equitable charge will be defeated by a prior equitable interest (Ireland v Hart [1902] 1 Ch 522). It may be subordinated to a legal mortgage over the shares even where that legal mortgage is created after the equitable charge. Advantages Of Legal Mortgage Priority The advantage of procuring a legal mortgage is that the mortgagee would obtain a good legal title to the shares against all prior adverse claims of which he has no knowledge at the time of registration. (ii) Control If the shares are registered in the name of the mortgagee / nominee, all communication concerning bonus and rights issues, dividends and other matters (eg notices) will be sent to the mortgagee / nominee as registered holder. Also the mortgagee / nominee will be entitled to voting rights attached to the shares. (iii) Fraud A legal mortgage also reduces the chance of the mortgagor inadvertently or fraudulently obtaining new share certificates from the company, disposing of the shares to a third party and giving that party rights of an innocent purchaser. Page 6

8 Limitations Of Legal Mortgages If the mortgagor has a defective or void title, the mortgagee does not acquire a better title. Moreover, the legal mortgagee may lose out even if the defect is discovered after the shares have been registered in his name (Sheffield Corporation v Barclay [1905] AC 392). The case also establishes that a person who presents a share certificate for registration, warrants its genuineness. (ii) If the shares are not fully paid, the legal mortgagee becomes liable to meet calls on the shares. Security Over Scripless Shares Section 130N Of The Companies Act The security that can be created over scipless shares is set out in section 130N of the Companies Act, which provides as follows: Security interest. 130N. (1) Except as provided in this section or any other written law or any regulations made under section 130P, no security interest may be created in book-entry securities. (2) A security int erest in book -entry securities to secure the payment of a debt or liability may be created in favour of any depositor in the following manner: (a) by way of assignment, by an instrument of assignment in the prescribed form executed by the assignor; or (b) by way of charge, by an instrument of charge in the prescribed form executed by the chargor: Provided that no security interest in any book-entry securities subsequent to any assignment or charge thereof may be created by the assignor or the chargor, as the case may be, in favour of any other person and any such assignment or charge shall be void. Modes Of Taking Security Over Scripless Shares There are generally three modes of taking security over scripless shares as listed below: Statutory assignment under section 130N(2)(a) of the Companies Act Form H is lodged with the Central Depository Pte Ltd ( CDP ) after which CDP will transfer the securities from the assignor's account to the assignee's account. The Page 7

9 assignee becomes the registered holder of the securities. All rights accruing to the book - entry securities assigned accrue to the assignee. A separate security agreement is signed between the assignor and the assignee setting out the terms of the security arrangement. (ii) Statutory charge under section 130N(2)(b) of the Companies Act Form I is lodged with the CDP after which CDP will register the charge in the Register of Charges maintained by it. The charged securities will be transferred to a Charge balance in the securities account. No transfers of charged securities may take place until the charge is released. As the charged securities remains in the chargor's account, all rights accruing to the charged securities accrue to the chargor. A separate security agreement is also signed between the assignor and the assignee setting out the terms of the security arrangement. (iii) Common law security Permitted under Regulation 23 of the Companies (Central Depository System) Regulations, which provides: Creation of certain security interests by sub-account holders and depository agents under common law not precluded. 23A. (1) Nothing in section 130N of the Act or these Regulations shall be construed as precluding (a) a sub-account holder from creating under any rule of law any security interest in book -entry securities in favour of any other sub-account holder who maintains a sub-account for such book - entry securities with the same depository agent as the sub-account holder; or (ii) the depository agent with whom the sub-account holder maintains the sub - account for such book -entry securities; or (b) a depository agent from creating under any rule of law any security interest in book -entry securities in favour of the depository agent itself, except that the Depository shall not be required to recognise, even when having notice thereof, any security interest so created in such book -entry securities. Page 8

10 While the statutory security can only work where the parties have direct accounts with the CDP, the common law route enables security to be created over shares held via depository agents. SOME PROVISIONS IN SHARE SECURITY DOCUMENTATION Scope Of Charged Securities This provision sets out the scope of the shares covered by the security. Modern standard forms are drafted very wide, and cover stocks, bonds, debentures, etc, which are scrip based and scripless. The crucial element in these documents is control. The securities are generally those that are (a) in the possession of the bank; (b) held in the name of the bank or to its order; (c) deposited with the bank; or (c) lodged with the bank, etc. Perfection Scrip Based Delivery of share certificates with blank transfers. Covenant to procure consent of directors for transfer (if necessary). Waiver of pre-emption rights. Scripless Execution of Form H or Form I Accruals The issue to consider here is whether the security over shares extends to cover dividends, bonus and rights issues, and if so whether the mortgagee is under an obligation to exercise right to subscribe for rights shares. Fully Paid / Calls Representation and warranty that all shares are fully paid, and / or that the mortgagor shall pay all calls promptly. Exercise Of Voting Rights That the mortgagee may exercise the voting rights attached to the mortgaged shares. Page 9

11 Title The mortgagor's warranties as to unencumbered ownership of the mortgaged shares. Power Of Sale That the mortgagee may exercise the power of sale upon default and employ brokers or agents for this purpose, without being responsible for loss. Rajah & Tann is one of the largest law firms in Singapore. It is a full service firm and given its alliances, including US premier firm Weil, Gotshal & Manges, is able to tap into a number of countries. Rajah & Tann is firmly committed to the provision of high quality legal services. It places strong emphasis on promptness, accessibility and reliability in dealings with clients. At the same time, the firm strives towards a practical yet creative approach in dealing with business and commercial problems. The information contained in this newsletter is correct to the best of our knowledge and belief at the time of writing. Specific professional advice should be sought before any action is taken. In this regard, you may call the lawyer you normally deal with in Rajah & Tann or the Knowledge Management team at eoasis@sg.rajahandtann.com Rajah & Tann Knowledge Management. All rights reserved. Page 10