Equitable Relief from Appropriation - Secured Lenders Take Note
In 2009 the Privy Council held that it is not necessary for a secured lender first to become the registered owner of shares, in order validly to appropriate them under the Financial Collateral Arrangements (No. 2) Regulations 2003 ("the Regulations"). In a further ground-breaking decision in the same British Virgin Islands ("BVI") case, handed down on 30 January 2013, the Privy Council has held that once appropriation has taken place, a borrower may nevertheless obtain relief in equity – restoring the borrower’s ownership of the forfeited collateral – upon payment of the debt and interest and upon satisfaction of any other conditions imposed by the Court.
The Facts and the First Privy Council Decision
In 2005, Alfa Telecom Turkey Limited ("Alfa") lent Cukurova Finance International Limited and Cukurova Holding AS ("Cukurova")1 US$1.35 billion on the terms of a facility agreement secured by English law-governed equitable mortgages over shares in BVI companies in the Cukurova structure which conferred an indirect shareholding in Turkcell Iletisim Hizmetleri A.S ("Turkcell"), Turkey’s largest mobile telecommunications company. Mortgages or charges over shares in BVI companies may be governed by foreign law, in which case the remedies available to a mortgagee or chargee are also governed by that foreign law. The charges in favour of Alfa imported the remedy of appropriation under the Regulations. In April 2007, Alfa alleged that Cukurova was in breach of the facility agreement, demanded immediate repayment of the loan and 10 days later stated that it had appropriated the charged shares. At the time of its purported appropriation, Alfa had not, however, been registered as legal owner of the charged shares. In May 2009, the Privy Council decided that registration of legal ownership was not a prerequisite to a valid appropriation.
The Main Trial and the Appeal
Once it was established that Alfa’s appropriation could not be challenged on a point of law, the case proceeded to trial on the question of whether Alfa had been entitled to exercise the remedy in the first place: had Cukurova actually committed an event of default under the facility agreement? Part of Cukurova’s defence was that if it had committed a default (which it denied) then either the appropriation was invalid (because Alfa’s motives in seizing the shares had been to obtain control of Turkcell, rather than to secure repayment of its loan) or that it should be granted relief in equity if it paid that which was outstanding under the loan, together with interest.
At first instance, Bannister J held that none of the alleged events of default had been proven and did not, therefore, consider the question of relief from appropriation. The Court of Appeal overturned his decision, holding that three events of default had been established. Only one Justice of Appeal considered the 'relief in equity' point, but held that it could not succeed, as Cukurova had been unable to show that Alfa’s enforcement of its security had been tainted by bad faith or an improper motive.
The Second Privy Council decision
The Privy Council held that one event of default had been made out by Alfa, and that Alfa had, therefore, been entitled to call in the loan. With regard to bad faith and improper purpose, the Court emphasised that if a chargee enforces its security for the proper purpose of satisfying the debt, the mere fact that it may have other purposes, however significant (but collateral to that object) cannot vitiate the enforcement. Alfa’s desire to control Turkcell did not, therefore, affect either the acceleration of the loan or the appropriation of the security.
Relief from Forfeiture
The Privy Council held that it was not correct to link the question of bad faith and improper purpose to the question of relief in equity, as the Court of Appeal had done. Relief from forfeiture should be considered on its own terms as a freestanding remedy. Whether or not relief should be granted depended on: (a) the jurisdiction of the Court in equity; (b) the effect of the Regulations; and (c) the relevant facts of the particular case.
(a) The Court’s jurisdiction in equity
The Privy Council emphasised that the paradigm case for relief was where the primary object of the bargain between the parties was to secure a stated result which could still be achieved when the matter came before the Court, and where the forfeiture provisions were added by way of security for the production of that result. That was the case here: the primary object of the mortgages was to secure the repayment of the loan and interest, and the power to appropriate was added in order to secure that result. Relief would, in principle, be available against the forfeiture of proprietary or possessory rights, as opposed to merely contractual rights, regardless of the type of property concerned.
(b) The effect of the Regulations
The Privy Council accepted that the power of appropriation was intended to be rapid and non-formalistic and that it could be exercised by a lender without any court order for foreclosure, but noted that EU members were permitted to introduce or retain domestic post-appropriation control in relation to the realisation of financial collateral. It was also noted that the UK Treasury, when introducing the Regulations, appeared to have been under the misapprehension that the remedy of appropriation was already available under English law, when in fact this was not the case. In such circumstances, it seemed unlikely that the Treasury had contemplated that the Regulations would alter the Court’s inherent power to grant relief.
The Privy Council concluded that the incidents attaching to the grant of a security interest, and the Court's power to intervene to protect the borrower, were "quintessentially matters for domestic law" and there was nothing in the Regulations, nor in the EU Directive to which they gave effect, which excluded the Court’s ability to grant relief.
(c) The relevant facts
Alfa argued that granting relief from appropriation would cause general uncertainty in the financial markets. The Privy Council was not persuaded. Whilst it accepted that the need for certainty was a very relevant consideration, the particular features of this case (and those which made the grant of relief appropriate) were most unlikely ever to be repeated. Those features, which included the conduct of the parties, were:
(a) The method of valuation, contractually agreed in the share charges, made no allowance for the value of acquiring control of Turkcell, so Alfa would obtain the shares at a significant discount to market value;
(b) The transaction had been structured so as to preserve Cukurova’s control of Turkcell;
(c) From the outset, Alfa’s aim and expectation was that Cukurova would default and that the shares would fall into Alfa’s lap;
(d) Although Alfa had acted within its legal rights, its conduct – attempting to stifle Cukurova’s ability to repay the loan, commenting adversely on Cukurova’s financial health at a press conference in Istanbul when it knew Cukurova was attempting to refinance, and springing the acceleration of the loan on Cukurova so as to reduce the time within which Cukurova could refinance – exposed the reality that Alfa was primarily concerned with shares, not as security, but as a means of gaining control over Turkcell;
(e) Even if all the events of default alleged by Alfa could be made out, they were limited in number and had not occurred wilfully. The one event of default upheld by the Privy Council did not prejudice or threaten Alfa’s financial position. The value of the shares exceeded the sums outstanding under the loan, even ignoring any control premium;
(f) Cukurova had tendered the full amount due under the facility agreement within one month of Alfa’s appropriation, but Alfa had rejected the tender;
(g) Although there had been some delay by Cukurova in claiming relief from forfeiture, the shares had essentially been frozen since the proceedings began, and the claim for relief would have inevitably ended up before the Privy Council.
The Privy Council has invited further submissions from the parties on the precise conditions on which it should grant relief, and further useful guidance will, therefore, be forthcoming.
For further information please speak to your usual Maples and Calder contact or one of the partners listed above.
1Maples and Calder acted for Cukurova.