In this client alert we set out some of the key lessons from the recent judgment in
An Overview of Appropriation under the FCARs
The FCARs represent the
Under Regulation 17 of the FCARs, where a security interest is created or arises under a financial collateral arrangement, the parties may agree for the collateral-taker to "appropriate" the financial collateral should the security become enforceable. By this act, the collateral-taker will become the absolute owner of the financial collateral, without the need for a court order (in the case of a foreclosure or through the exercise of the power of sale). Appropriation is therefore permitted under the FCARs so long as the security agreement provides for it and, in accordance with Regulation 18(1), the financial collateral is valued "in accordance with the terms of the arrangement and in any event in a commercially reasonable manner". It is intended to be a self-help remedy and a less formalised method of security enforcement.
Background to the Case
The case was brought by
ABT challenged the validity of the appropriation, alleging (1) that the relevant clause in the share charge did not confer a legally valid power of appropriation, since the method of valuation it provided was not commercially reasonable, and (2) the purported appropriation by Aapico based on a valuation by
The Validity of the Appropriation
The first argument brought by ABT was based on the premise that the power to appropriate contravenes two important English law principles - that of self-dealing, which prevents a mortgagee from selling mortgaged property to themselves, and the rule that invalidates any clog on the equity of redemption. On that basis, ABT argued that the FCARs should be interpreted restrictively, meaning that in order for the clause granting the right to appropriate to be legally valid pursuant to the FCARs, the requirements of both Regulations 17 and 18 of the FCARs would need to be complied with. This included the need for a commercially reasonable method to value the shares to be specified. However, since it provided Aapico, as chargee, with a discretion for determining the valuation, it allowed for methods of valuation that were not commercially reasonable, could be arbitrary, capricious, and/or self-serving, and thereby invalidated the right to appropriate.
It follows that the relevant clause in the share charge was sufficient to comply with the requirements of the FCARs, and therefore the appropriation was legally valid.
The Validity of the Valuation
The second argument brought by ABT was that the valuation prepared by
In addressing ABT's submission, the
The judge found that there were six key considerations to be taken into account when interpreting the requirements of Regulation 18(1) and what "commercially reasonable manner" in respect of a valuation conducted hereunder means:
- Irrespective of whether the valuation was undertaken by a third party (such as
FTI in this case), the duty of valuation remains with the collateral-taker. Therefore, simply appointing a competent third party will not necessarily make a valuation commercially reasonable. - The requirement is that the way the valuation is undertaken, and not its final outcome, be commercially reasonable. However, if the value arrived at is less than would normally be expected, this could be an indication that the valuation did not fulfil this requirement.
- Commercial reasonableness is an objective standard, and therefore the subjective views of the collateral-taker or valuer have no bearing. The standard cited by the judge was that of the "reasonable expectations of sensible businessmen". 1
- Having stated this, the court noted that the requirement of a valuation being commercially reasonable remained fact-sensitive and would, for example, depend on the type of asset being valued.
- There are no separate and independent requirements for a collateral-taker to act in good faith when undertaking the valuation, nor should any equitable or other duties associated with the law of mortgages be implied upon such valuation.
- Despite the above, this does not mean that the collateral-taker will normally be able to act primarily in their own commercial interest. Again, the court referred back to the objective standard of the requirement.
In determining these interpretive guidelines, and despite not having any truly analogous precedent, the judge did refer to previous cases where a requirement of commercial reasonableness had been interpreted. He found that the requirement was objective and, importantly, left open a range of possibly valid and "commercially reasonable" procedures, even if another party "carrying out the exercise itself, may have come to a different conclusion". 2
With this conception of the requirement of commercial reasonableness, the judge did not accept the remainder of ABT's argument, which rested on the perceived lack of objectivity on the part of Aapico, and that
The valuation itself was therefore deemed commercially reasonable and valid.
The judge once again placed great import on the commercial context of appropriation and the need for certainty of ownership in fast-moving financial markets.
Conclusions and Key Takeaways
With this decision, enforcement of a security financial collateral arrangement via appropriation, specifically over shares, has obtained a precedent and guidance. Concerns of how FCARs interact with the established English law on mortgages have been addressed and useful guidance on producing valuations in a commercially reasonable manner given. As long as valuations are well reasoned and substantiated, and their process meets the objective standard of the requirement, they appear likely to be valid. The guidance provided by the
It is worth stating that this is a first-instance decision so may be subject to appeal. However, the clarity and certainty it provides to the process of appropriation should not be dismissed. As economic conditions worsen, and enforcement actions likely increase, lenders may now see appropriation as a more feasible and reliable method of enforcement.
Footnotes
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Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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Mr
CityPoint
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E-mail: mcervantes@mofo.com
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