This note is an overview of the topics we are frequently asked to cover with clients who are contemplating taking security over shares in Scottish companies.
The need for a share pledge typically arises when there is a Scottish private limited company sitting within a corporate group that is providing security for a loan facility and so, to illustrate the issues covered in this note, we will be referring to companies taking part in this scenario: Good Bank is providing loan facilities to Parent Limited. Parent Limited has a number of subsidiaries incorporated in England and one subsidiary incorporated in Scotland, ScotCo Limited. Parent Limited and its subsidiaries are providing security over all its assets to Good Bank which will include Parent Limited giving security over the shares it holds in its subsidiaries in favour of Good Bank.
The share pledge
Security and perfection
A Scots law share pledge is a fixed security over the shares issued by a Scottish company and is granted by its shareholders.
It must be perfected by a transfer of the shares to the security holder, otherwise no fixed security is created. So, in our scenario, Parent Limited will enter into the share pledge with Good Bank and grant fixed security over the shares in ScotCo Limited to Good Bank.
Entry into the share pledge is not enough and in order to have a perfected security right over the shares the security holder has to hold them in its own name. Therefore, in addition to entering into the share pledge, Parent Limited will also deliver a stock transfer form to Good Bank and ScotCo Limited will reflect that transfer within its own company books by updating its register of members to show that its shares are held by Good Bank. ScotCo Limited would provide Good Bank with a share certificate in its name. Some lenders and security trustee entities have a nominee company (usually within its own corporate group) which they use to hold the shares on its behalf for the duration of the security rather than holding the shares in its own name. Where this is the case, the share pledge security document will need to reflect the nominee arrangement.
As a result, the set of documents that make up Scottish share security and that should be provided to Good Bank as part of taking security over the shares in ScotCo Limited are:
- the Share Pledge between Parent Limited and Good Bank;
- a stock transfer form between Parent Limited and Good Bank;
- a share certificate in the name of Good Bank issued by ScotCo Limited; and
- a copy of ScotCo Limited's register of members updated to show the transfer of shares from Parent Limited to Good Bank.
Common contractual provisions
Aside from the provisions creating the security over the shares and the obligation to deliver the various ancillary documents (being numbers 2 to 4 in the above paragraph), a share pledge will include most of the usual contractual provisions one would find in security documents generally, which regulate the relationship between chargor and security holder before and after enforcement of the security.
However, there are a number of additional provisions that should be included as a result of the security being over shares which cover the following arrangements:
Voting rights – a consequence of the transfer of shares to Good Bank in our scenario means that, on the face of matters, Good Bank holds the legal right to exercise the voting rights attached to the shares in ScotCo Limited. As the transfer is in security the terms of the share pledge will provide that Parent Limited is permitted to exercise those voting rights itself. Good Bank is protected by an obligation on Parent Limited not to exercise voting rights to the prejudice of Good Bank's interest and Good Bank is under an obligation to provide Parent Limited with the necessary documents it needs to exercise the voting rights, such as proxy forms or a power of attorney. The delegation of voting rights back to Parent Limited will normally end if the security is enforced (following the occurrence of an event of default or similar trigger event within the underlying loan agreement).
Dividends – similarly to voting rights, as a result of the transfer of the shares, Good Bank is the party entitled to receive dividends. As with voting rights, the provisions of the share pledge will provide that Parent Limited is entitled to retain any dividends paid, again usually until the security is enforced.
In addition, the terms of the share pledge will oblige Parent Limited to take responsibility for performing any obligations relating to the shares (monetary or otherwise) and Parent Limited would be expected to represent that the shares secured are owned by it, are fully paid and that they represent all the shares that have been issued by ScotCo Limited.
When contemplating taking security over shares it would be expected that the security holder or its lawyers would review the constitutional documents of the company whose shares are to be secured. In our scenario, this would be the constitutional documents of ScotCo Limited. The purpose of this is for Good Bank to ascertain whether there are any provisions that might delay or interfere with the perfection or enforcement of the share pledge. For example, a lien on unpaid shares or an obligation to offer transferred shares to someone specific before they are transferred to someone else. Similarly, the articles of association of ScotCo Limited might allow the directors discretion to refuse to register share transfers. If there are such restrictions the constitutional documents would be amended to dis-apply such restrictions where the transfer relates to their share pledge.
A share pledge would typically become enforceable upon an event of default or other trigger for repayment or security enforcement as contained in the facility letter or loan agreement between Parent Limited and Good Bank. Enforcement action is taken by the security holder in its own name, usually by selling the shares.
There are a number of related issues that arise with share pledges and these tend to be the frequently asked questions that lenders and borrowers have when taking security over shares.
Will any future shares issued by the subsidiary company be covered by the share pledge?
The terms of a share pledge might provide to also assign and pledge shares issued by the subsidiary company to the chargor in future and have obligations to provide appropriate stock transfer forms and share certificates at that time. Rather than rely solely on these provisions it is common for security holders to take a new or supplemental share pledge that covers those future shares at the time they are issued.
Does the transfer of shares mean the subsidiary company becomes part of the security holder's corporate group?
No - provided the share pledge covers all the issued shares in the subsidiary company and there are provisions that permit the chargor to exercise voting rights and retain dividends prior to enforcement of the share pledge, the Companies Act 2006 will deem the chargor to continue to be the holding company of the subsidiary company notwithstanding the transfer of the shares.
Should the subsidiary company's PSC register be updated?
There is no settled view on this in Scotland. Following the introduction of the relevant legislation for the PSC regime there followed some criticism of the drafters of the legislation for not properly considering how Scottish share security works and omitting the express provisions that exist elsewhere in the Companies Act 2006 that deem the holding company of a subsidiary as continuing to be the holding company notwithstanding a transfer of the subsidiary's shares in security. Further information on the interaction between the PSC regime and a Scottish share pledge can be found within our article here.
Will the security holder become liable for any pension deficits if the subsidiary company or another company within its group operates a defined benefit pension scheme?
Due to the transfer of the shares, the security holder could fall within the categories of person that the Pensions Regulator can issue a contribution notice to if there is a deficit in a pension scheme. It is highly unlikely and a very remote risk that a security holder taking title to shares in security would find itself being asked to make a contribution. This is because the Pensions Regulator must consider that it would be reasonable to impose liability and it has previously stated that, where voting rights have not vested in the security holder or have not been exercised, it would not be reasonable to impose liability on a security holder.
Listed/dematerialised shares and financial collateral
Where the shares in question are listed or held in dematerialised form (for example with CREST) additional provisions relating to the transfer of the shares may be required, and it may be necessary to consider how feasible it will be to identify the shareholder (where the shares are listed) and to take fixed security over these shares.
Shares may also fall within the definition of "financial collateral" for the purposes of the Financial Collateral Arrangements (No.2) Regulations 2003 and consideration will need to be given on a case-by-case basis as to the impact of these regulations and whether additional provisions (for example, in relation to enforcement) and structuring is required.
For one reason or another, some lenders and borrowers will consider having to transfer title to shares as impractical or undesirable to the point that those factors outweigh the benefit of having a perfected fixed security. When this is the case, parties have a couple of alternatives.
Firstly, they may choose to not perfect the share pledge on day one and instead agree that the transfer of the shares will not occur until an agreed trigger event. However, delaying perfection comes with its own risks depending on the surrounding circumstances and solvency position of the chargor at the time of perfection.
Secondly, the lender may choose to forego fixed security in favour of relying solely on its floating charge to secure the shares and looking to the other security it is receiving from the overall security package.
Looking to the future, the taking of security over shares in Scottish companies is one of the many areas that would benefit from the implementation by the Scottish Parliament of the Scottish Law Commission's reform proposals to introduce the statutory pledge as a form of security over moveable assets. The anticipated reforms would mean the share pledge (and the perfection acts outlined above) would be replaced by a statutory pledge perfected by public registration - the requirement to transfer the shares to the security holder and the consequences and implications that come with that being dispensed with entirely. More information about this (much hoped for) reform can be found here.
In contrast to other forms of Scottish fixed security, share pledges can appear overly complex; particularly with those more familiar with the process for taking share security in the UK's other jurisdictions.
While there are a number of additional considerations for participants to be mindful of and a hands-on practical process to be arranged in order to perfect the security, none of these is insurmountable with early engagement and guidance, and the Scottish share pledge remains a frequent feature in security packages.
Originally Published by Shepherd and Wedderburn, November 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.