- This is the first time that the English courts have had the opportunity to consider the meaning of the term 'commercially reasonable manner' in the context of its use in Regulation 18 of the Regulations, which governs how a collateral taker must value financial collateral that it is appropriating.
- The judgment is particularly significant because neither the Regulations, nor the EU directive behind them, contains a definition of or direction on what constitutes a 'commercially reasonable manner'.
- The judge provided the following guidance on the meaning of the phrase 'commercially reasonable manner' as used in the context of the Regulations:
- What is commercially reasonable, in any given case, is 'fact sensitive'.
- The statutory requirement is as simply stated: The valuation must be carried out (i) in accordance with the terms of the security financial collateral arrangement; and (ii) in any event in a 'commercially reasonable manner'.
- There is no room to imply any equitable or other duties associated with the English law of mortgage nor any additional requirement for the collateral taker to act in good faith.
- The requirement imports an 'objective standard', meaning that the views of the collateral taker (or any third-party valuer) is irrelevant. But the responsibility for the valuation lies solely with the collateral taker and it cannot discharge its duty in such respect by appointing a third-party valuer.
- The requirement applies to the way in which the valuation is made, and this does not mean that the resulting valuation itself must necessarily be a commercially reasonable one.
- The judge made clear that non-compliance with the valuation criteria set out in Regulation 18 will not in itself invalidate any appropriation effected in accordance with the right to appropriate under Regulation 17 and the relevant security financial collateral arrangement (as defined in the Regulations), although it may subsequently result in the valuation being set aside.
- Ultimately, the judge found that the appropriation by Aapico was entirely valid and that the valuation in the circumstance had been carried out in accordance with the security financial collateral arrangement and in a commercially reasonable manner as required by Regulation 18.
- These findings help to strengthen the value of the self-help remedy of appropriation that was introduced into English law by the Regulations, allowing a collateral taker to take ownership of certain secured assets without the need to turn to the courts.
- Lenders and borrowers alike should welcome the greater clarity that the guidance provided by the judge in this case has brought to the application of Regulations 17 and 18 of the Regulations and, in particular, the meaning of the phrase 'commercially reasonable manner'.
- The parties relied on separate expert valuations (with different outcomes), and the judge directed the valuers to prepare a joint memorandum setting out the matters on which they agreed and did not agree. This approach to valuations also has potential application for disputed valuations in other contexts (such as part of a restructuring plan), potentially reducing the number of issues that a judge needs to consider in complex disputes.
Facts of the case
At its core, the facts of this case are relatively straightforward. As part of a wider joint venture structure, ABT Auto Investments Limited (ABT or "Claimant") granted a share charge over shares it held in Sakthi Global Auto Holdings Limited (SGAH or "Third Defendant") in favour of Aapico Investment Pte Limited and Aapico Hitech Public Company Limited (collectively, "Aapico" or "First Defendant" and "Second Defendant", respectively) to secure loans provided by the First and Second Defendants to SGAH.
SGAH failed to fulfil its payment obligations under the loans. Ultimately, Aapico gave notice to exercise its rights, as set out within the share charge, to appropriate the charged shares in SGAH. ABT challenged Aapico's appropriation of the charged shares and the value that Aapico had ascribed to them, resulting in this case before the English High Court.
It was agreed between the parties that the charged shares constituted financial collateral (as defined in the Regulations) and the share charge and the obligations of ABT (as chargor) thereunder constituted a security financial collateral arrangement (as defined in the Regulations). The right of appropriation clause in the share charge provided that Aapico (as chargee) — upon the security created thereunder becoming enforceable and written notice being given — may appropriate all or any of the charged shares in or towards payment or discharge of the secured liabilities, "subject always to Regulation 18 of the Regulations". The clause then went on to set out how the chargee was permitted to value the charged shares and expressed that the chargor agreed that the method of valuation provided for was "commercially reasonable for the purposes of the Regulations".
By way of background, the Regulations implemented into UK law an EU directive, whose purpose was to ensure that security over certain forms of financial collateral (broadly speaking, cash in a bank account, shares and bonds) was treated consistently throughout the EU, helping to create greater certainty. Regulation 17 introduced into English law the 'self-help' remedy of appropriation (where the secured party or 'collateral taker' takes ownership of the financial collateral), requiring simply that the terms of such power be set out in the security financial collateral arrangement (in this case, the share charge); and Regulation 18 sets out the duty for the collateral taker (i.e., the chargee) to value the financial collateral both (i) in accordance with the terms of the security financial collateral arrangement; and (ii) in any event in a 'commercially reasonable manner'. Neither the EU directive nor the Regulations provide a definition of or direction on what might constitute a 'commercially reasonable manner'.
ABT, as Claimant, claimed that the valuation of the charged shares did not comply with the requirements under the share charge and/or the Regulations, resulting in a significant undervaluation. As a consequence, the entire appropriation was invalid and legally ineffective, meaning that ABT remained the beneficial owner of the charged shares.
Court's key findings
Valid power of appropriation
In short, the judge dismissed ABT's claims in full, finding that the provisions of the share charge conferred a legally valid power of appropriation under Regulation 17.
ABT claimed the power was invalid because the method of valuation provided for was not commercially reasonable or could be exercised in a manner that was commercially unreasonable. ABT made this claim based on the words included in the appropriation clause of the share charge that, in certain circumstances, permitted the chargee to carry out the valuation by "such other process as the chargee may select".
The judge dismissed this claim, stating that the words did not permit the chargee to act in an "arbitrary or unreasonable manner" as it was expressly stated that the right of appropriation provisions were "subject to Regulation 18 of the Regulations" — providing the necessary protection to the chargor — and the Regulations also provided such protection. In order for the clause to be compliant with the Regulations, it was sufficient that the clause permitted the chargee to carry out the valuation in a commercially reasonable manner.
In addition, he concluded that any non-compliance with a required valuation method would not result in an invalid appropriation; to do so would create uncertainty as to ownership, in this case, of the shares, defeating one of the original intentions of the EU directive and the implementing Regulations. If a court concluded that a valuation had been non-compliant, the remedy would be for the court to substitute a compliant valuation.
Valuation carried out in a commercially reasonable manner
The judge rejected the claims that there should be implied terms as to the nature and conduct of the valuation. He also held that the obligation was simply the statutory requirement to conduct the valuation both in accordance with the terms of the share charge and in a commercially reasonable manner, "no more, no less". In particular, there is no room for the implication of any equitable or other duties associated with the English law of mortgage nor any additional requirement for the collateral taker to act in good faith.
The requirement for the valuation to be conducted in a commercially reasonable manner does import an objective standard into the process, which must be met. This would preclude the chargee from deliberately seeking to create a favourable outcome for itself, e.g., a low valuation, but it was decided that simply stating that its preference or desire would be for a lower valuation was not commercially unreasonable. This fact would have been obvious in itself anyway given the circumstances.
The judge dismissed ABT's claims in full, finding that the valuation had, in fact, been carried out both in accordance with the terms of the share charge and in a commercially reasonable manner. On the evidence presented in defence, the judge found that the conduct of both Aapico and the valuers had been professional and sought to produce a valuation that was "sufficiently well evidenced and reasoned as to be proof against challenge".
Finally, it is worth noting the direction provided by the judge that two valuation experts meet and produce a joint memo regarding their agreements and disagreements in relation to the valuation of the shares. In the context of the dispute, this greatly assisted the court in crystallising the differences in the expert evidence. From a market practice perspective, one can see the benefit of this approach being taken up and applied in the context of disputed valuations as part of a restructuring plan as a way of reducing the number of issues that a judge needs to consider in complex disputes. The additional time and cost of doing so will need to be balanced with the need to facilitate restructurings in a timely manner while at the same time protecting the interests of all interested parties.