In the current economic climate, banks are increasingly looking at what steps they need to take to enforce their security over Jersey situate collateral under security interest agreements ... and borrowers are looking at how to delay them whilst refinancing options are explored. What are the issues that are likely to arise?
The process begins with reconsidering the security interest agreement itself. Is it valid? A floating charge will not work over Jersey situate assets. All security interest agreements over intangible assets in Jersey must comply with certain formalities set out in the Security Interest (Jersey) Law 1983 (the "Security Interests Law"). Therefore security interest agreements must:
- Be in writing;
- Be dated;
- Identify and be signed by the debtor;
- Identify the secured party;
- Enable the collateral to be sufficiently identified;
- Specify the events of default;
- Enable the secured payment or performance obligations to be sufficiently identified.
These formal requirements appear simple enough but they have been challenged in one case. The Formula One security interest case (EMTV & Merchandising AG v Bayerische Landesbank and 10 others [2003 JLR80] considered the meaning of "specify" the events of default. It held that they could be specified even if not set out in the security interest agreement in full but instead the events of default were identified or incorporated by reference to other agreements. The court took a pragmatic view reflecting and upholding common practice. It may well have to do so again if the other formalities are tested before the courts in the coming months.
The Security Interests Law also lays down particular methods to be used when taking security over different types of collateral. For example, bank accounts may be secured by the "control" method when the secured party and the account holding bank are one and the same. Otherwise security is taken over bank accounts by assignment of title to the account and notice given to the "third party" account holding bank.
Similarly security may be taken over shares and other securities either by possession of certificates of title or by assignment of title with appropriate notice being given to the company issuing the shares or securities. Whether or not the control, possessory or title method has been used to create the security will have implications for the enforcement of the security.
Moving from possessory to title security?
Many banks prefer to take security by possession of share certificates and only to put the shares into their own name if an event of default occurs. It is worth considering this as a preliminary step. This is because if the borrower goes into liquidation or becomes bankrupt (désastre), the collateral will not automatically fall into the hands of a liquidator or the Viscount (who administers désastre and acts rather like an official receiver here) if security has been taken by title. (As long as the secured party has a valid security interest, its position would be protected on a désastre or liquidation in any event but there are likely to be delays in realisation.)
Banks usually hold pre-signed stock transfer forms and relevant powers of attorney to facilitate putting shares into their own or purchasers' names. Articles of association and any conditional control of borrowing consents which might otherwise impede transfers of shares have usually been checked and amended at the time the security was taken. But any other regulatory consent required will need to be obtained before any transfer takes place.
Notice of event of default
Before the exercise of the power of sale, notice of the occurrence of an event of default must be given to the debtor under the Security Interests Law. The bank needs to be clear that a default has occurred. In some situations this will be harder to establish than in others, particularly with cross defaults or margin calls in volatile markets where any particular valuation of the collateral may be disputed by the borrower.
The bank also needs to ascertain if the default is one that is capable of remedy or not. As there is no Jersey case law on the point, it is likely that we would follow the English authorities – even if there is only a technical or theoretical possibility of remedy, the default is still capable of remedy.
If the default is capable of remedy, the bank must allow the debtor 14 days grace in which to remedy it under the Security Interests Law. It should not exercise its power of sale until it has done so. There is not usually any requirement to obtain a court order before exercising the power of sale as most security interest agreements waive that right of the borrower.
Power of sale - timing and valuation issues
The Security Interests Law provides that the secured party must take "all reasonable steps" to exercise the power of sale "within a reasonable time" and "for a price corresponding to the value on the open market" at the time of sale of the collateral being sold. This can be problematic if there is no ready and established market for the collateral.
There is little Jersey authority on the duties that a secured party owes to the debtor and other interested parties (such as related parties, other creditors etc). The cases have, however, acknowledged that the secured party may be liable for any sale of the collateral at an undervalue - see for instance the Formula One case (this time [2002 Jersey Unreported 243] and also Brown v HSBC, Scally and Viscount [2003 JLR Note 50]. Interestingly in the Formula One case, interim injunctions were obtained to prevent the exercise of a power of sale pending the resolution of the main issue of the validity of the security.
The Security Interest Agreement sets out the order in which the sale proceeds must be applied. Essentially after the costs and expenses of the sale and the discharge of any prior security interests, the bank may discharge the secured obligations and any subsequent security interests before accounting for the balance to the debtor or, if the debtor is en désastre or in liquidation, the Viscount or liquidator.
Inevitably with the economic downturn we are seeing more enforcement action as defaults occur and refinancing eludes borrowers. The steps to be taken on enforcement may seem simple, but banks may be challenged where the stakes are sufficiently high.
This article first appeared in the autumn 2008 issue of Appleby Jersey's Finance newsletter.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.