Enforcing share security by way of appropriation under the uk financial collateral regulations: what is a "commercially reasonable" value?

The High Court has issued helpful first-time guidance for secured lenders on the method of valuing shares in an appropriation under the UK Financial Collateral Arrangements (No.2) Regulations 2003 (FCAR) in the recent case of ABT Auto Investments Ltd v Aapico Investment Pte Ltd [2022] EWHC 2839 (Comm). 

Background

ABT Auto Investments (ABT) and Aapico (Aapico) formed a joint venture called Sakthi Global Auto Holdings Limited (SGAH) to facilitate and support the expansion of the Sakthi group’s automotive business in the United States.

Aapico provided loan funding to SGAH in 2017. ABT and one of ABT’s directors guaranteed this loan. Aapico injected further loan funding into SGAH in 2018. This additional funding benefited from supplemental guarantees and ABT also charged its shares in SGAH in favour of Aapico (the Share Charge). The Share Charge gave Aapico the right to “appropriate” (i.e. to take title and effective ownership of) the shares in certain circumstances and in exercising that right Aapico was required to value the SGAH shares both:

• in accordance with the provisions set out in the Share Charge and
• in any event in a commercially reasonable manner (as required by regulation 18 of the FCAR).

SGAH failed to repay the two loans. Aapico claimed on the ABT guarantee but ABT did not pay either. Aapico obtained a valuation of the shares and exercised its right under the Share Charge to appropriate the SGAH shares. ABT challenged Aapico’s appropriation of the SGAH shares, arguing that clause 9.3 of the Share Charge (which contained the right of appropriation) did not provide a “commercially reasonable” method of valuing the SGAH shares. Therefore, the requirements of regulation 18 of the FCAR could not be met and, as a result, Aapico’s appropriation was invalid. Clause 9.3 is reproduced in its entirety below. Most appropriation clauses in English law security documents are drafted like this or in a very similar way.

9.3 Right of appropriation

• [Aapico] or any receiver or delegate may, by giving written notice to [ABT] upon, and at any time after, the date the security created under [the Share Charge] has become enforceable, appropriate all or any [secured assets] in or towards payment or discharge of the [secured liabilities], subject always to Regulation 18 of the [FCAR] [emphasis added].
• The value of any [secured assets] shall be determined by [Aapico] and, for this purpose, the parties agree that the value of any [secured assets] shall be, in the case of any [shares], the market value of such shares determined by [Aapico] by reference to a public index or independent valuation or if neither such option is available or reasonably practicable given the then current circumstances, such other process as [Aapico] may select.
• [ABT] agrees that the method of valuation provided for in this clause is commercially reasonable for the purposes of the [FCAR].

Decision

The judge dismissed ABT’s case, concluding that Aapico, together with its valuation agent (FTI), had valued in the shares in a commercially reasonable manner as required by regulation 18 of the FCAR and, as a consequence, its appropriation of those shares was valid.

The judge remarked that regulation 18 of the FCAR imposes two cumulative requirements on a secured lender when valuing financial collateral for the purposes of an appropriation. That valuation must be carried out both:

• in accordance with the terms of the arrangement (in this case, the Share Charge) and
• in a commercially reasonable manner.

In this case, as clause 9.3 of the Share Charge included the words “subject always to Regulation 18 of the [FCAR]”, it was implicit within its terms that the valuation methods available to Aapico would have to conform with the FCAR. Accordingly, the valuation of the shares would have to be carried out in a commercially reasonable manner, and as long as Aapico valued those shares that way, it would meet the two cumulative requirements. Aapico engaged FTI to carry out the valuation of the shares. The judge established that Aapico provided sufficient information to enable FTI to carry out the valuation, and FTI were keen to produce a valuation which was as well reasoned and well supported as possible. Accordingly, the judge concluded that the valuation of the shares had been conducted in a commercially reasonable manner.

The judge also provided some useful general guidance on the context and wording of the power of appropriation in the FCAR:

• Regulation 18(1) places the duty to value shares using a commercially reasonable method of valuation on the secured lender (not any third party valuer engaged by that secured lender).
• The method of valuation must be commercially reasonable, not the result of that method.
• What constitutes a commercially reasonable method of valuation is determined objectively. Use of the word “commercially” indicates the standard to be applied is that of reasonable participants within the relevant financial market.
• The question of what is “commercially reasonable” is fact sensitive.
• There is no separate and independent requirement for a secured lender to act in good faith. It has to act only in an objectively commercially reasonable manner.

Practical implications of the right of appropriation for secured lenders

Ordinarily, secured lenders avoid enforcing security by way of appropriation because they will become the legal owner of the secured shares following the appropriation. This is because of real and perceived disadvantages which come with legal and beneficial ownership of the relevant company whose shares are subject to the appropriation, e.g.:

• potential pension and environmental liabilities
• shadow director issues
• possibly being considered a person with significant control (PSC) of the relevant company and having to be included in its PSC register and take on various PSC duties.

However, the right of appropriation as a method of enforcing security may be favoured by secured lenders in rare circumstances, like those in the Aapico case. Here, it was advantageous for Aapico to appropriate ABT’s shares in SGAH to take full ownership and control of the joint venture vehicle.