Enforcement of Pledges of Shares and of Participatory Interests
Head of Group
The current economic climate has sparked a wave of new Russian legislation relevant to creditors trying to recover borrowed money from defaulting debtors.
The legislation includes new rules on the enforcement of pledges of shares and of participatory interests, an alternative building framework to unclear and general rules which prescribed complex and time consuming court and out-of-court procedures for enforcing pledges.
This article examines to what extent these new rules protect creditors when enforcing pledges made to them.
Under the new rules, a creditor (pledgee) now has, subject to certain exceptions, a prescribed right to enforce (in or out of the court) when the debt due exceeds the value of the pledged property by 5 percent or more and/or when the debtor (pledgor) has been in default for three months or more.
Specifically regarding the enforcement of a pledge of shares or of participatory interests, the new rules set out a clear and simple procedure for enforcing out of court. On an event of default, the pledgee can notify the pledgor that he is starting the enforcement procedure. The notification must include a description of the pledged property, the amount due and the method that the pledgee will use to recover the pledged property. On the expiry of the time period specified in the pledge agreement, the pledged property can then be recovered.
The pledgee is entitled to transfer the title to the shares or participatory interest to himself or to sell the pledged property (by public auction, under the commission contract or direct to a third party). The exception is in the case of pledged listed shares that can only be sold on a stock exchange.
While the new rules filled some of the legislative gaps regarding the enforcement of pledges, therefore increasing the protection of the pledgee, there are still outstanding legal uncertainties facing creditors wishing to enforce pledges. The uncertainties addressed here apply to legal entities, and separate issues must be considered when the pledgor is an individual.
Issues remain regarding the transfer of the rights to both pledged shares and participatory interests to the pledge and/or third parties. For shares, the transferee can only obtain the title once an entry has been made on the shareholders register. Such an entry can only be made with a supporting set of documents prescribed by law, including a pledge deed transferring the title signed by the pledgor. If the pledgor is uncooperative, then issues will arise when effecting the transfer of the title. For participatory interests, any pledge on the participatory interest must be registered in the state register of local entities requiring the involvement of the pledgor and a notary. It is unclear how and when the transfer of the participatory interest to a pledgee and/or a third party would occur without the involvement of the pledgor or a notary. Obtaining the consent to the transfer from the other participants is required and therefore presents another obstacle.
Arguably the biggest outstanding issue for a creditor enforcing a pledge of participatory interest is regarding the pledgor’s ability to withdraw from an LLC that it has a participatory interest in. This is prohibited under legislation, but the prohibition can be excluded under the LLC’s charter. In such a circumstance, the participant can transfer his participatory interest to the LLC (in return for payment from the LLC) and walk away leaving the pledgee with issues regarding both the pledge itself and enforcing against it. While clearly a creditor can review the LLC’s charter before signing the pledge agreement, this offers very limited protection because the charter of the LLC could always be changed subsequent to the pledge agreement and prior to enforcement.
Therefore while the changes in the law have improved the position of creditors by clarifying the procedure for enforcing pledges, plenty of outstanding issues remain that will cause concern for creditors who find themselves needing to enforce a pledge.