Assistance crucial with shares pledge agreements in Cyprus

A pledge describes a contractual relationship whereby the physical possession of any asset capable of actual (or constructive) delivery is delivered by one person (the pledgor) to another (the pledgee) as security for payment of a debt or performance of a promise. In the context of a pledge agreement concerning the shares of a private company incorporated in Cyprus, such assets comprise the original shares certificate which evidences title to such shares as therein expressly mentioned.

A shares pledge is predominantly regulated by the Contract Law of the Republic of Cyprus, whose applicable provisions purport to codify the developed and long established UK common law principles in the field of bailment. In addition, the striking similarities of the Contract Law to similar enactments across ex-Commonwealth countries, plausibly explains the credibility enjoyed by the shares pledge agreement in cross-border financing transactions.

Trusted medium

The shares pledge agreement comprises a much trusted medium for creditors in securing a loan or a deferred payment. On execution of the shares pledge agreement, the pledgor hands over to the pledgee the share certificate of the shares used as security. The ownership of the pledged shares remains with the pledgor, as it is only the possession of the shares certificate that is delivered to the pledgee. The pledgee (or any other person nominated by the pledgee) shall become the registered owner of the pledged shares once, and if the pledgor is in default (or in continuous default) of the terms stipulated in the shares pledge agreement.

In order for a shares pledge agreement to be valid and enforceable between the parties thereto, certain statutory formalities relating to the attachment of the security interest to the asset and its perfection would need to be strictly adhered to. In particular, a shares pledge agreement would need to be expressed in writing and be signed by the pledgor in the presence of at least two competent witnesses.

Prudent practice

Although Contract Law does not require the signature of the pledgee on the contract of pledge, prudent practice would invariably advise for the signatures of both parties thereupon.

Once executed, a notice of such pledge, along with a certified copy of the shares pledge agreement, would need to be delivered by the pledgee to the company whose shares have been the subject matter of the pledge.

Memorandum

Upon receipt of the aforesaid, the company enters a memorandum against the shares pledged in the register of members it maintains internally and delivers to the pledgee a certificate declaring that the said memorandum has in fact been entered therein.

The rationale behind the memorandum recorded in the register of members is primarily to caution the officers of the company by way of notice from procuring any unauthorised transfers of the pledged shares.

No specific format and/or wording of the notice or the memorandum is provided by Contract Law.

Security document

As the shares pledge agreement is a security document intended to serve and protect the interest of the pledgee, it comes as no surprise that it is drafted pro-pledgee.

A bundle of essential ancillary documents annexed to the shares pledge agreement purport to facilitate and compliment the prompt and transparent enforcement mechanics of the contract of pledge, thereby enabling the pledgee to transfer the pledged shares into its name without the need of any further consents or intervention of the court.

Whilst all ancillary documents therein contained are signed by the pledgor, many will remain to be dated by, and at the option of, the pledgee, should and when an event of default trigger the enforcement of the security.

Bundle of ancillaries

Depending on the needs of each financing transaction, the bundle of ancillaries annexed to the shares pledge may include inter alia:

1. a signed, yet undated, instrument of transfer concerning the transfer of the pledged shares from the pledgor in favour of the pledgee;
2. a signed, yet undated, board resolution approving the transfer and registration of the pledged shares evidenced by the instrument of transfer mentioned in point (ii);
3. an irrevocable proxy and power of attorney in respect of the pledged shares granted from the pledgor in favour of the pledgee;
4. undated resignation letter of the directors and secretary of the company whose shares are the subject of the shares pledge agreement;
5. a letter of authority and undertaking from the secretary and each director of the company.

Preparing an agreement

The assistance of a legal professional licensed to practise the laws of the Republic of Cyprus will prove invaluable in the context of preparing a valid and enforceable shares pledge agreement.

Apart from opining on the need to register and stamp the share pledge agreement in the Republic of Cyprus, legal comfort ought to be sought by the creditor as to the capacity of the body corporate to validly enter into the shares pledge agreement.

Articles of association

In addition, the articles of association of the company whose shares are pledged should further be thoroughly and proactively examined pre-execution.

Pre-emption rights, director’s right to decline the registration of a transfer of shares at their absolute and sole discretion, as well as reserved matters requiring an increased majority threshold for shareholder resolutions may, amongst others, become insuperable obstacles upon, or after, enforcement for the unwary creditor if not tuned alongside the ambit of the shares pledge agreement.

Nick Tsilimidos is an associate at L Papaphilippou & Co in Cyprus