The Moveable Transactions (Scotland) Bill as proposed by the Scottish Law Commission in 2017 provided a welcome opportunity to reform the law concerning moveable property in Scotland. The Economy, Energy and Fair Work Committee recently called for written submissions on the draft bill. One key type of security that will benefit from the increased clarity of the proposed reforms will be the Scots law governed share pledge. It is yet to be seen when the proposed reforms will make it into law given the legislative demand of the Brexit process and now the impact of the coronavirus pandemic. In December 2019, the Minister for Parliamentary Business and Veterans noted that the bill may form part of the Scottish Government's Programme for Government, which will be announced in September this year. This update briefly sets out the key components of a Scots law share pledge, the potential risks and necessary drafting mitigations when taking a share pledge and the proposed reforms which would address these potential risks.
Scots law share pledge
This is a type of possessory security where the borrower will transfer the shares it holds in a company it owns to a lender in security for the repayment of a debt. A lender can exercise its rights as owner of the shares (including the right of sale) if the borrower defaults under the loan agreement. Unlike English law, Scots law requires the borrower to transfer these shares outright to the lender, in order to get an effective security. This requires stock transfer forms to be signed and dated and for the company's register of members to be updated to show the lender as the registered holder.
The need for reform
It is this outright transfer of shares that has resulted in some unintended consequences that the drafting of share pledges must mitigate where possible. While the terms of our share pledge documents will allow the borrower to exercise their usual rights to vote and take dividends, the lender is the registered holder of the shares in the company which has been transferred.
1. Liabilities under defined benefit pension schemes
The issue of determining who 'controls' the company was brought into sharp focus in the Box Clever Appeal Court decision. This case has raised doubt about whether typical drafting mitigations will be sufficient to avoid the lender being liable for contributions or under financial support directions. This case highlighted that even without the ability to exercise voting rights prior to an event of default, the registered holder still has control of the company in which the shares were held. There is now arguably a greater risk of exposure to pension liabilities contributions. Lenders should be sufficiently comfortable that potential issues regarding defined benefit pension schemes will not arise before taking a share pledge.
2. Group Company Implications
By transferring the shares into the name of the lender, without careful drafting, there is a risk the company will be considered a subsidiary of the lender. This can have legal implications as well as accounting and tax consequences. A lender will not wish to reflect the company in a set of consolidated accounts or to be considered its parent company under the Companies Act 2006. A suitably drafted share pledge ensuring that the borrower remains in control of the shares until the lender serves a notice of default pursuant to enforcement, will remove the risk of this happening as far as possible.
3. PSC Register
The introduction of the PSC regime has had some unintended consequences in relation to Scottish share pledges leading to the debate about whether the lender should be notified as a Person with Significant Control under a Scots law share pledge. The prevailing view is that the PSC legislation was not intended to catch Scottish share pledges, but it would be helpful for the new bill to definitively clarify the position. This unsettled issue can cause unnecessary debate and delay during the lending process and clarification of this point of law would be beneficial.
4. New allotments of shares
It is currently not possible to take a perfected security over shares not yet in existence. If the company were to issue new shares after being the subject of a share pledge, these new shares would have to be separately transferred to the lender in order to be part of the security, this would not be automatic. Any new shares will have to be pledged by way of a supplementary share pledge in order to form part of the security package.
The proposed solution
The solution proposed by the Scottish Law Commission was to create a new statutory register: the Register of Statutory Pledges. Rather than transferring the shares into the name of the lender, the shares would remain in the name of the borrower and instead, the security would be registered in the new public register. Consequently, there is no longer a need for a transfer and so the issues which currently arise about who is the 'true owner' are resolved: the borrower always remains the owner in control and the party responsible for the company. Consequently, the PSC register will not require to be updated and the potential liability for defined pension schemes will not arise. The new regime would also allow lenders to take security over future shares providing the pledge is registered in the statutory register.
Conclusion
While there are many competing demands on the Scottish Government's agenda, reform in this area is desired. It is especially important during these challenging times that the law governing security in Scotland is clear. The current position emphasises the importance of careful drafting as in many cases a share pledge can be drafted to mitigate the risks raised in this note. Clear legislation to give lenders and borrowers greater certainty will be welcomed.
If you would like to discuss anything raised in this update please contact Bruce Stephen (0131 656 0260; bruce.stephen@brodies.com), Alan Knowles (0131 656 0016; alan.knowles@brodies.com) or your usual Brodies contact.
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