This article discusses a method of securing the performance of obligations that is relatively new, but gaining more and more popularity – the pledge of corporate rights in limited liability companies, certain practical problems and risks associated with such a pledge, ways to minimize them, as well as the practicability and effectiveness for creditors of using this method in action.

The first issue that a potential pledgee confronts is whether or not corporate rights may be accepted as a pledge and what exactly is to be pledged. According to legislation, the subject of the pledge may consist of a property right alienable by the pledgor (debtor) and which can be enforced. Taking into consideration the complex body of corporate rights (which entail both proprietary and nonproprietary elements) and the lack of uniform terminology in the legislation, from a practical point of view, it is not corporate rights that should be used as the subject of the pledge (i.e., their propriety aspect), but rather the share in the charter capital of the limited liability company, which essentially generates these rights for its owner, has monetary value and may unequivocally serve as an object of civil turnover. Thus, the first criterion of the "pledgeability" of corporate rights, i.e. the alienability of the pledged item, is met.

A series of difficulties arise in assessing the possibility of enforcing a pledge the subject of which is a share in the charter capital and in answering the question as to what exactly is being enforced. Based on the legislative norms regulating encumbrances on moveable property and the legislation on pledges in particular, the pledgee has the right to satisfy the claim secured by the pledge directly at the expense of the subject of the pledge, i.e. the share. Furthermore, no restrictions have been established on the possibility of foreclosing on the share similar to those existing in corporate legislation. Thus, a share is considered to be a completely "pledgeable" object.

However, a different interpretation arises from the norms of the Law "On Companies" and the Civil Code, according to which it is not the share as such that is being enforced, but the part of the company property that corresponds to such share.  However, this portion of property can only be taken in enforcement if the debtor does not have enough other property in order to satisfy the creditor's claim. That is, the law places substantial restrictions on enforcing a pledged share, and it is not practical to talk about an "immaculate" conception of a pledge in this situation. The foregoing effectively casts doubt on the "pledgeability" of a share.

Such ambiguity in interpretation arises, particularly from uncertainty in understanding norms of corporate legislation, legislation regulating encumbrances on moveable property and legislation on pledges as special and general norms or vice versa, and their inconformity on the whole. As a result, the creditor's position in the obligation is weakened and mainly depends on the courts' interpretation and application of the appropriate norms.  

One should approach the legal implementation of the pledge of a share with particular care and caution. Before signing a pledge agreement on a share in the charter capital of a limited liability company, the potential pledgee, if not a participant in the company, should make sure that the charter of the company does not restrict the alienation of shares to third parties and that a share which is to be pledged is fully paid by a participant-pledgor. It is also necessary to devote special attention to appraising the share as a subject of the pledge, considering the fact that the value of the share to a substantial extent is market-driven and mainly depends on the effectiveness of the company's economic activity.

Enforcing the pledged share against the debtor in the event that the latter violates the obligations secured by the pledge will perhaps be the biggest difficulty for the creditor-pledgee. Legislation does not provide for a specific procedure for enforcement of a pledged share in the charter capital. Nor are there any official explanations in this respect. Thus, in attempting to satisfy the claim at the expense of a pledged share, the pledgee is treading on shaky ground. Doubts arise even at the stage of assessing the possibility of implementing such (extrajudicial) methods of enforcing the share as transferring it to the pledgee's ownership or selling to a third person as provided for by general norms of the legislation on pledges and legislation regulating encumbrances with respect to moveable property.

Furthermore, in order to enforce the pledge of the share in the charter capital of the company by transferring it to the pledgee's ownership, a number of corporate actions is required – both on the part of the debtor and on the part of other participants in the company, as well as the state registrar. Their success is largely dependent on whether the participants are ready to render assistance to the pledgee, participating in the general meeting of participants, voting "pro" changes in the group of participants, and signing a restated charter reflecting the new composition of participants.

From a practical point of view, the risk associated with the company participants' refusal to accept the pledgee as a fellow participant can be lessened, but not eliminated, by receiving in advance the appropriate consents and powers of attorney from them authorizing the representative(s) of the pledgee to convene and participate in a general meeting of participants, to vote accordingly, and to sign all necessary documents. Otherwise, if the pledged share is less than 60+ percent of the charter capital, or the share(s) of participant(s) amicable to the pledgee and the pledged share combined comprise less than the aforesaid number, there is an increased risk that any opposition from existing participants will succeed.  

Even if the general meeting of participants was successful and the pledgee is accepted as a participant in the company, the state registrar continues to be an obstacle. The latter must formally demand a notarized document on the transfer of the share to the pledgee. It is not clear at the moment what particular document this should be and whether a notarized pledge agreement is sufficient.

Besides the foregoing, the pledgee who becomes the owner of a share providing 25 or 50 percent or more of the votes at the general meeting of participants, must bear in mind the necessity of receiving the prior approval of the concentration from the Antimonopoly Committee of Ukraine, if the assets/turnover of the pledgee and the company the share in the charter capital of which is being acquired, exceed the threshold values established by legislation.  

In choosing the enforcement method of selling the pledged share, aside from other procedural factors which may be fixed in the company's charter and need to be fulfilled, the pledgee has to observe the preemptive right of the remaining participants of the company to purchase this share. That is, before the share may be sold to a third party, the pledgee is obliged to offer it for sale to the participants and wait until they either exercise or waive this right. In practice, the aforementioned problem is often resolved by obtaining from the participants a preliminary (advance) waiver of the preemptive right to purchase the pledged share in the event it is sold in a foreclosure. Whether this mechanism is beyond reproach and how serious the consequences might be in challenging the sale of the share outside the group of participants having in hand such waiver will be shown, inter alia, by judicial practice.

If the enforcement of the pledged share is controlled by provisions of corporate law as special norms, which existing participants in the company may insist on, then the pledgee will not be able to directly take the pledged share in foreclosure from the debtor at all. Furthermore, the pledgee cannot even take its material equivalent (i.e. the part of the company property that corresponds to the pledged share), which is allowed by corporate legislation, if the debtor has other property sufficient to satisfy the creditor's claim. That is, besides changing the very subject of the pledge, in case the debtor does not want to cooperate, the creditor will face the necessity of ascertaining other property of the debtor in advance. Finally, since according to legislation the creditor may obtain the material equivalent of the share in an amount determined by the company's balance sheet at the moment the claim arose, then regardless of the value of the share which may be fixed in the pledge agreement, the issue remains open as to how much the creditor will receive in satisfaction of the claim in actual fact and what steps will need to be taken in order to enforce the remaining debt. In such a situation, the question arises, does the pledge of the share secure performance of the obligation at all?

In light of the aforementioned problems and risks associated with the pledge of corporate rights in limited liability companies, it is recommended to use the given instrument for securing performance of the obligation only as a supplemental mechanism, guided by the principle of "give-and-take". However, until all contradictions are eliminated and all gaps are filled at the legislative level, the feasibility of this working model appears doubtful, and the interests of the pledgee remain unprotected.