The High Court has dismissed a claim made by a borrower that a lender’s appropriation of certain shares secured by a charge, upon default in a loan arrangement, was invalid and that the valuation of the appropriated shares was commercially unreasonable: ABT Auto Investments Ltd v Aapico Investment PTE Ltd & Ors [2022] EWHC 2839 (Comm).
The decision is interesting for two reasons:
- It considers the validity of the appropriation of shares in a private company under the Financial Collateral Arrangements (No 2) Regulations 2003 (the FCARs) and their valuation; and
- It is an addition to the growing body of case law considering the threshold to be satisfied when exercising contractual discretions in the context of a borrower’s default. You can find our previous blog posts considering similar issues here.
The FCARs introduced the concept of a “security financial collateral arrangement” into UK law, which in the context of security arrangements disapplies various formalities and provisions of UK insolvency law in relation to the taking and enforcing of security over cash, financial instruments and credit claims, where such arrangements are made between entities other than individuals. They also provide for remedies on security enforcement which are different from those usually seen in UK law, including, most notably, the enforcement technique of appropriation. They are most frequently used in the financial markets, and there are relatively few cases on their application. There is some long-running academic debate on various aspects of the FCARs, including their scope of application to certain categories of parties and assets.
In the present case, the court considered the validity of the appropriation of the shares by the lender (which is a relatively novel self-help remedy in UK law), and their valuation in a “commercially reasonable manner” as required by Regulations 17 and 18 (respectively) of the FCARs. The court was satisfied both that the appropriation was valid, and that the valuation of the appropriated shares had been made in accordance with the FCARs.
The court underlined that the FCARs imported an objective standard in valuing the shares. In the current context, the word “commercially” indicated that the standard to be applied was that of reasonable participants in the relevant financial market. In other contexts, the manner of valuation must be one which conforms in that context to “the reasonable expectations of sensible businessmen”. However, it specifically did not have to consider the effect of the special value that the shares in a joint venture (JV) company would have to one of the JV partners as part of the overall valuation.
We consider the decision in more detail below.
Background
In 2017, the claimant company (ABT), through one of its subsidiaries, set up a JV with the defendant companies (Aapico). The JV was funded by Aapico and the arrangements between the parties were set out in a suite of documents which included loan agreements made in 2017 and 2018 (the Loan Agreements). As security for the loans, ABT gave guarantees and a charge over its shares in the JV (the Share Charge).
In 2019, the JV defaulted on certain payments due under the Loan Agreements. Aapico sent four notices of default to the JV and notices of acceleration to ABT declaring both loans to be repayable on demand. Aapico then made further demands to the JV for immediate repayment of the loans and to ABT for repayment of the debt under its guarantees. No payments were made by either the JV or ABT. Aapico consequently gave notice purporting to exercise the power under a specific clause in the Share Charge to appropriate the charged shares. In that notice, Aapico ascribed a value of USD 27 million to the charged shares. That figure was based on a valuation carried out in 2019 of ABT’s shareholding in the JV (the FTI Valuation) at Aapico’s request by FTI Consulting (FTI).
ABT subsequently brought proceedings against Aapico challenging the validity of Aapico’s appropriation of the charged shares and of the value which Aapico had subscribed to them. ABT’s case was that the specific clause relied on in the Share Charge was not effective to confer a legally valid power of appropriation since the method of valuation for which it provided was not commercially reasonable. Further, the appropriation which Aapico purported to carry out was in any event legally ineffective because the valuation of the charged shares had not been carried out in a commercially reasonable manner.
Aapico denied the claim.
Decision
The High Court found in favour of Aapico and dismissed the claim. The key issues of interest are examined below.
(1) The validity of the appropriation
The court held that there had been a legally valid appropriation by Aapico. The specific clause of the Share Charge relied on by Aapico was effective to confer on Aapico a legally valid power of appropriation. Appropriation is a relatively novel but very useful self-help remedy in English law: it allows a collateral taker to effectively acquire the financial collateral itself without an order from the courts, when self-dealing by a mortgagee is usually prohibited, and on that acquisition, the equity of redemption of the collateral provider is extinguished (as per Çukurova Finance International Limited v Alfa Telecom Turkey Limited [2009] UKPC 19). The court held here that appropriation would therefore only be available in accordance with the FCARs, that is where there is a security financial collateral arrangement that includes a power of appropriation and there is a provision for valuation.
Regulation 18 of the FCARs
The court noted that the specific clause of the Share Charge relied on by Aapico expressly stated that Aapico’s right to appropriate the charged shares was subject always to Regulation 18 of the FCARs, which requires that the methods of valuation are “commercially reasonable”. However, the FCARs do not contain any description of what constitutes a “commercially reasonable manner” of realisation or valuation. Nor is there any express indication in the FCARs about whether a “commercially reasonable manner” of valuation should reflect any special value of the collateral to the collateral taker.
The drafting of the Share Charge
The court commented that the specific clause of the Share Charge relied on by Aapico on its face gave the collateral taker a discretion as to the method of valuation if no public index or independent valuation was “available or reasonably practicable given the then current circumstances”. However, it did not follow that the collateral taker was thereby permitted to act in an arbitrary or unreasonable manner. In the court’s view, when the clause was read as a whole it was implicit that the valuation methods permitted in this case, were methods conforming to the requirements of Regulation 18(1). On that basis, no further restrictive implication was necessary.
Even if the court was wrong on that point, then on the true interpretation of the clause the collateral taker’s contractual discretion as to the method of valuation would be “limited, as a matter of necessary implication, by…the need for the absence of arbitrariness, capriciousness, perversity and irrationality” (as per Socimer International Bank Ltd (In Liquidation) v Standard Bank London Ltd (No.2) [2008] EWCA Civ 116).
(2) Were the charged shares valued in a commercially reasonable manner?
The court held that the valuation had been made in accordance with the terms of the arrangement and in any event in a commercially reasonable manner. It was satisfied that both Aapico and FTI complied with the requirements of the specific clause relied upon by Aapico in the Share Charge and of Regulation 18(1).
Commercially reasonable manner
The court highlighted the following key legal principles from the authorities:
- It is the manner of the determination which must be commercially reasonable; it does not follow that the outcome has to be commercially reasonable although, if it is not, that would no doubt cause one to look critically at the manner of the determination (as per Barclays Bank plc v Unicredit Bank AG [2014] EWCA Civ 302).
- Reasonableness as a concept may be deployed in a contract to require from a decision maker either rationality or entirely objective criteria of reasonableness. Both rationality and (wholly objective) reasonableness allow for a result that falls within a range. So here, even if using the concept of (wholly objective) reasonableness, a number of results may be commercially reasonable. On the other hand, the fact that there is a range does not mean that the determining party can simply take the result that suits it best at one end of the range (as per Lehman Brothers Special Financing Inc v National Power Corp [2018] EWHC 487 (Comm), see our blog post).
- An objective standard could be applied by the court itself, for example on the application of a party (as per Lehman Bros International (Europe) (in administration) v Lehman Bros Finance SA [2012] EWHC 1072 (Ch)).
In the court’s view, each case emphasised the need to consider the particular words of the relevant provision in the particular context (both contextual and commercial) in which they are used, and the danger of interpreting one provision in a particular context by reference to a different provision in a different context.
The FCARs context
The court noted that the relevant context in this case was that of the FCARs. In giving effect to Regulation 18(1), the court’s task was to review, after the event, a valuation of financial collateral carried out by the collateral taker in the context of the “rapid and non-formalistic enforcement procedures” provided for in the FCARs, in order to ensure for “the protection of the collateral provider and third parties” and that the valuation has been conducted in a commercially reasonable manner.
Having regard to that context and to the wording of the FCARs, the court drew a number of conclusions about what Regulation 18(1) requires. In particular:
- The clear words of Regulation 18(1) place the duty of valuation on the collateral-taker, even if it has used a third-party valuer.
- It is the way in which the valuation is made which must be commercially reasonable. It does not necessarily follow that the result itself must be a commercially reasonable one. Nevertheless, if the value produced is less than what could reasonably be expected, that may of itself be evidence that the manner of valuation has not been commercially reasonable.
- The requirement for the valuation to be made in a commercially reasonable manner imports an objective standard. The subjective view of the collateral taker (or of its third party valuer) about what is commercially reasonable is irrelevant. The word “commercially” indicates that the standard to be applied is that of reasonable participants in the relevant financial market. In other contexts, the manner of valuation must be one which conforms in that context to “the reasonable expectations of sensible businessmen” (as per G Percy Trentham Ltd v Archital Luxfer Ltd [1993] 1 Lloyd’s Rep 25 and First Energy (UK) Ltd v Hungarian International Bank Ltd [1993] 2 Lloyd’s Rep 194).
- The question of what, in any given case, is commercially reasonable is fact-sensitive. Depending upon the nature of the collateral and the circumstances of the case, there may perhaps be only one commercially reasonable manner of valuation.
- In the context of the valuation required to be made on appropriation, there is no separate and independent requirement for the collateral taker to act in good faith, and no room for the implication of any of the equitable or other duties associated with the law of mortgage in English law.
- The process of valuation is not one in which it will normally be commercially reasonable for the valuing party to have primary regard to its own commercial interests. The valuation of financial collateral for these purposes is essentially an objective exercise.
The present case
Failure to provide information
The court noted that there was simply no evidence that anyone at Aapico had placed any limits on the information and documents which FTI could request, and no suggestion in the FTI Valuation itself that any important requests for information made by FTI were refused. There was, however, positive evidence that certain employees at Aapico were instructed to provide FTI with whatever they asked for.
The court also said that Aapico’s omission to provide FTI with certain financial statements, or the supporting documents, or with particular DCF valuations, did not either establish or indicate that the valuation was not done in a commercially reasonable manner. Further, the court stated that Aapico’s omission to make arrangements for FTI to have discussions with the management of certain companies did not itself establish or indicate that the valuation was not done in a commercially reasonable manner.
Instructing and/or encouraging FTI to arrive at the lowest possible result
In the court’s view, FTI were keen to produce a valuation which was as well reasoned and as well supported as possible. The court concluded that there was nothing in Aapico’s conduct in relation to the valuation exercise which would properly be characterised as commercially unreasonable.
FTI’s valuation methodology
The court accepted that the information that FTI had was sufficient to perform a valuation of the charged shares. None of the documents identified by ABT Auto that were not provided to FTI included new information that a reasonable valuer would have considered to have a material impact on the valuation FTI undertook.
Special value of the collateral to a collateral taker
For various procedural reasons, the court specifically did not have to consider the effect on the valuation of the special value that shares in a JV company might have to one of the JV partners. Accordingly, for all the reasons above, the court found in favour of Aapico and dismissed the claim.
For further information, please contact:
Nick May, Partner, Herbert Smith Freehills
nick.may@hsf.com
