BACKGROUND

Complexities arise when arranging financings to co-investment structures, especially if the credit support includes security over shares granted by some (but not all) of the shareholders.

Examples of these types of transactions include:

• a founder or the early shareholders of an emerging company seeking to leverage their individual shareholdings for personal borrowings; and
• leveraged co-investments in which an investor secures its shareholding as security for any debt financing.
  
  

In APAC, Cayman Islands and British Virgin Islands companies are often used as co-investment vehicles due to their flexibility, ease of administration and tax-neutrality.

Co-investment vehicles will normally have in place shareholder agreements with bespoke provisions. It is therefore important to be aware of the types of issues that may arise in order to structure these deals successfully.

COMMON QUESTIONS

Some common questions asked at the structuring stage include:

• What happens if the shareholder providing the share security (the Chargor) is a minority shareholder who does not want disclose the existence of the security to the other shareholders?
• How to deal with a situation where the memorandum and articles (M&A) or the shareholder agreement (SHA) restrict the creation or enforcement of share security?
• If the M&A or the SHA contain “drag and tag,” “right of first refusal” or other provisions that impact share transfers, how would these apply to a transfer of shares by the security taker in an enforcement situation?
  
  

DUE DILIGENCE

When it comes to due diligence, transactions involving co-investment structures require an enhanced approach.

Shareholder provisions

It is crucial to carefully review the terms of any SHA and the M&A (the provisions of the former are often transposed into the latter) to identify all restrictions on the creation or enforcement of share security.

Shareholder agreements often contain transfer restrictions. The concept of “transfer” is usually widely drafted to catch not only an outright legal transfer of shares (which could affect a transfer to the secured party or a receiver following default) but also a grant of a security interest over shares or any transfer of beneficial ownership.

Even if a transfer is permitted, the terms of the SHA usually require a new transferee to accede to the SHA by way of a deed of adherence. There may also be particular conditions an incoming shareholder must meet which the security taker may be unable to satisfy.

Secured parties will also need to understand any 'drag and tag', 'right of first refusal' or similar provisions in favour of other shareholders which could impose limitations on marketing and disposal of the secured shares.

Routine due diligence

Of course, routine transactional due diligence should always be undertaken. This includes confirming ownership of the shares, capacity of the entities to enter into the transaction and grant security, ensuring the due authorisation of relevant signatories for the deal and carrying out customary litigation and commercial registry searches.

DOCUMENTATION

Transfer restrictions

Any provisions in the M&A or SHA that may restrict the creation or enforcement of the share security must be considered and, if necessary, waived. Depending on the nature of the financing or investment, it may be possible to add carve-outs into the M&A or SHA to permit the share security.

It is in the parties' interests to ensure any necessary carve-outs or waivers are obtained at the outset to avoid potential disputes that may be disruptive to the business. Where applicable, carve-outs or waivers should be made a condition of the financing and appropriate representations should be contained in the transaction documents.

In some situations, a minority shareholder may not be in a position to obtain consents, waivers or carve-outs from the other shareholders. If so, the potential security taker should carefully consider its position and risk appetite. Ultimately, the route to realising value from a secured minority shareholding subject to a SHA may involve the security taker selling to another shareholder.

Future listing

For businesses hoping to list, provisions for the release of the share security upon a qualifying IPO (which will often be a prepayment event under the finance documents) should be considered.

Share security documentation

We recommend documenting any share security under a local law share security agreement drafted by offshore counsel. It is customary for the following suite of signed, undated deliverables to be provided to assist the secured party in transferring the shares (typically to a receiver or its nominee) on enforcement:

• share transfer form (with any share certificates);
• proxy and power of attorney in favour of the secured party (to allow the secured party to vote the shares on enforcement);
• director resignation letters (to allow the secured party to appoint its own directors on enforcement); and
• undertakings from the charged company and its registered office provider to register a transfer of shares on enforcement.
  
  

However, where a minority shareholding is being secured, the scope of deliverables will often be reduced to a share transfer form, share certificate (if applicable), director resignations only for directors appointed by that shareholder and a proxy, as a minority shareholder will normally be unable to procure the other items from the company (e.g. resignation letters from any directors appointed by other shareholders). While not insurmountable, the absence of a full suite of deliverables may make complicate the process of registering the transfer of shares on enforcement, particularly if the company or registered office provider (who maintains the register of members and whose co-operation is necessary to reflect a share transfer) is not co-operative.

Registrations

Lenders will normally require customary registrations in connection with the share security. These can include an annotation of the register of members of the secured company noting the existence of the security. Parties should also be aware that corporate registry filings may be publicly search[1]able. However, an annotated private register of members is not usually required to be publicly filed and creating the annotation is negotiable (particularly if a minority shareholder does not want other shareholders discovering the security and related financing arrangements).

Conclusion

The corporate landscape in Asia is always evolving. Lenders and investors who can understand, structure and evaluate complex offshore shareholding and co-investment structures will be well-placed to offer financing to and develop valuable early relationships with early-stage ventures.

Experienced offshore counsel can add significant value by providing commercial and pragmatic advice to allow parties to get deals done while managing risk.

An original version of this article was first published in ICC Magazine, July 2021.