In this Law-Now we discuss the recent case of ABT Auto Investments Ltd v Aapico Investment Pte Ltd  EWHC 2839 (Comm) which involved the remedy of appropriation, an enforcement option available under the Financial Collateral Arrangements Regulations (“FCARs”). Appropriation may be used where security is created or arises under a security financial collateral arrangement and this is agreed between the parties.
The FCARs were introduced in the UK to implement EU directives, the purpose of which was to simplify the process of taking security over financial collateral across the EU. “Financial Collateral” is defined as cash, financial instruments (such as shares, bonds and other debt instruments) or credit claims.
The self-help remedy of appropriation allows the collateral-taker the right to become the absolute owner of the collateral in the event that the security becomes enforceable, without needing a court order. Where this right is exercised, the collateral-taker must account for any excess balance where the value of the appropriated financial collateral is valued at more than the amount of the collateral-provider’s financial obligations, and should the value of the appropriated financial collateral be insufficient to discharge the financial obligations, the collateral-provider remains liable for any balance due. The collateral-taker must value the appropriated financial collateral in accordance with the terms of the arrangement, and in any event, “in a commercially reasonable manner” (Financial Collateral Arrangements (No.2) Regulations 2003/3226, Regulation 18).
The facts of this case involved the collateral-taker enforcing a share charge and appropriating the shares in the collateral-provider’s subsidiary. The collateral-taker ascribed a value of US$ 27m to the shares on the basis of a valuation from a third-party. The collateral-provider claimed that the value of the shares was US$ 90m, and that the appropriation was invalid as the valuation had not been carried out in accordance with the requirements of the share charge and/or the FCARs in that the valuation had not been undertaken in a commercially reasonable manner. The collateral provider also claimed that as the purported appropriation was invalid, the collateral provider was and had always been the owner of the shares.
The court rejected the claims, and held that:
- it is the collateral-taker that is responsible in law for the valuation, even if it has used a third-party valuer; if the third-party valuer has not carried out the valuation in a commercial reasonable manner, then it will not have been carried out in a commercially reasonable manner (that the collateral taker has acted reasonably in retaining an apparently competent third party to undertake the valuation is irrelevant);
- it is the way in which the valuation is undertaken which must be commercially reasonable; the result itself may not be commercially reasonable;
- the statutory requirement in exercising the remedy of appropriation is simply that the valuation must be undertaken in accordance with the terms of the financial collateral arrangement and in any event in a commercially reasonable manner: ‘no more, no less’;
- the requirement for the valuation to be made in a commercially reasonable manner imports an objective standard;
- the question of what is commercially reasonable in any given case is fact-sensitive;
- there is no separate and independent requirement for a collateral-taker exercising the remedy of appropriation to act in good faith;
- the collateral-taker is not permitted to act in an arbitrary or unreasonable method in choosing the method of valuation;
- even if the valuation had not been conducted in a commercially reasonable manner, the appropriation would not have been void from the beginning. The primary remedy would have been for the court to set aside the valuation, to substitute a compliant valuation, and to make any necessary consequential orders.
The judgment highlights the importance of careful consideration and drafting of the valuation provisions in a financial collateral arrangement. Had these provisions been considered and negotiated in the context of the collateral being shares in a private limited company, then in the absence of a recognised market index, the chargor could have argued for specific valuation criteria or mechanics which would have resulted in a higher valuation being ascribed.
A chargor entering into a share charge, or financial collateral arrangement, could consider arguing against the remedy of appropriation on the basis that the chargee or collateral-taker will be able to rely on the other methods of enforcement available to it under English law. If it is agreed that the power of appropriation will be permitted, then the chargor should carefully consider the appropriate valuation method and document this in the security.
As ever, this case reminds us that it is important to pay attention to the drafting of “standard” provisions in security documents bearing in mind the characteristics of the secured assets.