When security is taken over shares in an English company it is important to check the articles of association of the company which has issued the shares. The articles are the rules that govern a company, and include things like the procedure for transferring shares.
This blog will look at two of the main restrictions contained within the articles of a private company that can impact on the enforcement of security:
- the directors’ discretion to refuse to register a transfer of shares; and
- a company’s lien over shares.
We will look whether these restrictions really can affect a lender’s ability to enforce its security and how these restrictions are removed.
On enforcement, a lender will want to be able to sell the shares and transfer legal ownership to a buyer. This is why lenders usually take a signed but blank stock transfer form so the transferee box can be completed with the buyer’s details. Many security documents also contain a power of attorney so that the lender can sign any necessary documentation on the shareholder’s behalf to complete the transfer of shares.
It is also recommended that lenders take the original share certificate to reduce the risk of the shareholder selling or creating new security over the charged shares.
A potential issue is that a private company’s articles usually give its directors the discretion to refuse to register the transfer of shares. This restriction is contained within both the “standard” Table A articles (for companies incorporated before 1 October 2009) and the model articles (for companies incorporated since 1 October 2009 and often since adopted by older companies).
Legal ownership is only transferred once the transfer is registered and the register of members is updated so if the directors refuse to register the transfer, legal ownership of the shares will not be transferred to the buyer.
A lesson on liens
A lien is the right for a creditor to keep possession of an asset until a debt is repaid, for example, a garage may not release a car until the repair bill is paid. There is no right to sell the asset unless a power of sale is expressly agreed.
The same principle can apply to shares. The articles often give a company a lien over its shares with a power of sale so it can sell the shares if a shareholder owes money to the company and does not comply with an enforcement notice.
The lien over shares usually applies to shares that have not been fully paid, which is the case with Table A articles, but bespoke articles can grant the company a lien for “all monies” owing to it. The model articles for private companies do not include a lien but can be amended to do so.
Lenders should be especially careful of taking security over shares that are not fully paid. Most security documents therefore include a representation that the shares are fully paid, it being an event of default if not.
Amending the articles
Removing the restrictions is thankfully a straightforward process, provided at least 75% of members of the company are on-board about the security being taken or the company is a fully owned subsidiary of the chargor. The company can pass a special resolution to amend the articles to either remove the restrictions or carve out “secured” shares so the restrictions do not apply to those shares.
Lenders can include a requirement to amend the articles within the conditions precedent to the loan agreement (although it may be necessary anyway so as not to breach representations made in the finance documents).
Does it really matter?
When a lender wants to enforce its share security, the security document typically gives the lender a power of sale which overrides any existing interests in the shares, so the company’s lien would not affect the sale of the shares.
Usually the security documents give the lender the right to appoint a receiver with a wide range of powers such as the right to take possession of the assets, a power of sale and to deal with the assets as if he was the legal owner.
Some security documents give the receiver the power to use the voting rights attached to the shares so a well drafted share charge (if over at least 75% of shares in the company) would allow a receiver to remove any restrictions in the articles himself before selling the shares, although this can add to the time and cost of enforcement.
If the directors refuse to register the transfer of shares, the lender can go to court for an order forcing them to do so, if necessary.
To conclude, having these restrictions in the articles is unlikely to affect enforcement through the courts or if a receiver is appointed but commercially it is best practice to ensure a company’s articles are amended before taking security over its shares and obtain the original share certificates and blank stock transfer forms as this can often make enforcement simpler and quicker. Ideally ensure that your security also contains a power of attorney.