Security in one form or another is given by people who transact with each other on a daily basis. The bigger the transaction, the greater the security required. For instance, parties entering into a securities lending transaction in terms of a Global Master Securities Lending Agreement (GMSLA) regularly require security to be provided by the borrower. Fortunately the Supreme Court of Appeal has given some certainty on the provision of cessions in security in South Africa. At about the same time, the South African Securities Lending Association (SASLA) published a revised Schedule for parties entering into a GMSLA in terms of South African law. The consequences of following the advice SASLA received need to be fully understood.
The Schedule sets out a number of ways for a borrower in a securities lending arrangement to provide the lender with collateral. In particular, the Schedule suggests a method whereby, according to SASLA's external advice, a lender may cede uncertificated securities in securitatem debiti (forgive the use of Latin: there is no better way to describe this type of cession in security) without entering details of the cession in the borrower's securities lending account (statutory flagging).
A cession is a bilateral act by which an incorporeal right is transferred from a cedent to a cessionary. There are two types of cession to choose from namely:
- an out-and-out cession in terms of which the ceded right is transferred completely by the cedent to the cessionary and the cessionary is obliged to re-cede the right back to the cedent if the secured debt is discharged.
- a cession in securitatem debiti in terms of which the cedent retains a reversionary interest in the ceded right so that the ceded right automatically reverts to the cedent to the extent that the secured debt is paid by the debtor.
For years there has been some debate in South Africa on how a party who is ceding shares to secure a debt excercises the option of constructing the security cession as either an out-and-out cession or as a cession in securitatem debiti. This debate was resolved by the Supreme Court of Appeal in Grobler v Oosthuizen (2009) ZA SCA 51. The court made it clear that parties who intend an out-and-out cession of personal rights must clearly express an intention to enter into an out-and-out cession thus transferring full ownership. This intent must appear not only from the agreement itself but also from the way it is performed. Absent this clear expression of intention, the courts in South Africa will assume that the parties intended to enter into a cession in securitatem debiti. Therefore, an expressly intended out-and-out cession transferring full ownership of the right would have to be supported by the parties accepting the consequences of an out-and-out cession and performing all obligations in respect of these consequences. The consequences of an out-and-out cession of securities would include:
- the payment of securities transfer tax;
- making the appropriate balance sheet entries;
- in relation to banks, holding the required capital in relation to the consequent contingent liabilities;
- exposure to the insolvency risk because securities transferred to a cessionary out-and-out would fall within the cessionary's estate on insolvency; and
- an obligation to pay capital gains tax in certain circumstances.
The court in Grobler's case reaffirmed that if the cession is only a cession in securitatem debiti of personal rights, this type of cession is akin to a pledge of tangible property. Thus, the cedent of securities in securitatem debiti retains a reversionary interest in the ceded securities which means that if the principal debt is paid by the debtor, the ceded securities automatically revert to the cedent who has given security.
If the securities are dematerialised, the Securities Services Act specifies that any cession in securitatem debiti of the uncertificated securities "must be effected" through statutory flagging. Any cession in securitatem debiti of an interest in uncertificated securities not effected by means of statutory flagging would thus be invalid.
That, therefore, is the clear choice. Anyone pledging uncertificated shares as security must accept that notice of the cession as security must be given to third parties by statutory flagging or if an out and out cession is the real intention, by transferring the shares to the new owner with all the potentially adverse and costly risks and consequences.
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.