In this client alert we set out some of the key lessons from the recent judgment in ABT Auto Investments Ltd v Aapico Investment Pte Ltd [2022] EWHC 2839 (Comm), which considers the validity of appropriation as an enforcement power pursuant to Regulation 17 of the Financial Collateral Arrangements (No. 2) Regulations 2003 (“FCARs”), the duty imposed on a collateral-taker by Regulation 18 of the FCARs in connection with the valuation of a collateral subject to appropriation, and provides useful guidance on what is “commercially reasonable” in this context.

An Overview of Appropriation under the FCARs

The FCARs represent the UK’s implementation of Directive 2002/47 EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements. The FCARs introduced into UK law the concepts of “financial collateral arrangement”, a form of security arrangement designed to provide rapid and simplified recourse to financial collateral across the EU. Under the FCARs, “financial collateral” means cash, financial instruments, or credit claims, with financial instruments including shares in companies, equivalent securities, bonds, and other tradable capital market securities.

Under Regulation 17 of the FCARs, where a security interest is created or arises under a financial collateral arrangement, the parties may agree for the collateral-taker to “appropriate” the financial collateral should the security become enforceable. By this act, the collateral-taker will become the absolute owner of the financial collateral, without the need for a court order (in the case of a foreclosure or through the exercise of the power of sale). Appropriation is therefore permitted under the FCARs so long as the security agreement provides for it and, in accordance with Regulation 18(1), the financial collateral is valued “in accordance with the terms of the arrangement and in any event in a commercially reasonable manner”. It is intended to be a self-help remedy and a less formalised method of security enforcement.

Background to the Case

The case was brought by ABT Auto Investments Ltd (“ABT”) against Aapico Investment Pte Ltd, Aapico Hitech Public Company Limited (and, together with Aapico Investment Pte Ltd, “Aapico”), and Sakthi Global Auto Holdings Limited (“SGAH”), concerning Aapico’s decision to appropriate shares in SGAH owned by ABT, which were provided as security under a share charge against the loans granted by Aapico to SGAH. SGAH is a joint-venture company formed by ABT and Aapico. Following an event of default under the loans, Aapico (as chargees) decided to enforce its security by appropriating the charged shares. It was not in dispute that SGAH was in default under the loans and that Aapico was entitled to enforce the share charge. The share charge also contained a clause that purports to grant the chargees the power to appropriate the shares.

ABT challenged the validity of the appropriation, alleging (1) that the relevant clause in the share charge did not confer a legally valid power of appropriation, since the method of valuation it provided was not commercially reasonable, and (2) the purported appropriation by Aapico based on a valuation by FTI Consulting (“FTI”) of US$27 million was ineffective because it was not carried out in a commercially reasonable manner.

The Validity of the Appropriation

The first argument brought by ABT was based on the premise that the power to appropriate contravenes two important English law principles – that of self-dealing, which prevents a mortgagee from selling mortgaged property to themselves, and the rule that invalidates any clog on the equity of redemption. On that basis, ABT argued that the FCARs should be interpreted restrictively, meaning that in order for the clause granting the right to appropriate to be legally valid pursuant to the FCARs, the requirements of both Regulations 17 and 18 of the FCARs would need to be complied with. This included the need for a commercially reasonable method to value the shares to be specified. However, since it provided Aapico, as chargee, with a discretion for determining the valuation, it allowed for methods of valuation that were not commercially reasonable, could be arbitrary, capricious, and/or self-serving, and thereby invalidated the right to appropriate.

The High Court held that this argument was a misinterpretation of the FCARs. The “rapid and non formalistic enforcement procedure” of appropriation, which is only available in a security financial collateral arrangement, should not be complicated by reference to existing principles of English law of mortgages. Further, the wording of the appropriation clause in the share charge, when read as a whole, does not allow Aapico to exercise its discretion as to valuation in any arbitrary manner it wishes – it has to be exercised subject to the requirements of Regulation 18. In any case, the court also separated the rights granted under Regulation 17, which is concerned with validating the contractual powers of appropriation, with that of Regulation 18, which is concerned with the valuation requirements of such appropriation. The High Court confirmed that any non-compliance with the valuation requirements under Regulation 18(1) does not in itself invalidate an appropriation permitted pursuant to Regulation 17 – rather, it could set aside or substitute such a valuation.

It follows that the relevant clause in the share charge was sufficient to comply with the requirements of the FCARs, and therefore the appropriation was legally valid.

The Validity of the Valuation

The second argument brought by ABT was that the valuation prepared by FTI was not prepared in a commercially reasonable manner, for reasons such as Aapico failing to provide FTI with access to management and relevant information, including business plans, financial statements, and third party valuations. Moreover, the valuation produced did not consider the full range of valuation methods, nor did it provide a result within a commercially justifiable range. Finally, ABT argued that Aapico was motivated by bad faith and/or did not act in a commercially reasonable manner by wanting FTI to produce a low valuation.

In addressing ABT’s submission, the High Court went to lengths to clarify what is meant by “commercially reasonable manner” as required by Regulation 18.

The judge found that there were six key considerations to be taken into account when interpreting the requirements of Regulation 18(1) and what “commercially reasonable manner” in respect of a valuation conducted hereunder means:

1. Irrespective of whether the valuation was undertaken by a third party (such as FTI in this case), the duty of valuation remains with the collateral-taker. Therefore, simply appointing a competent third party will not necessarily make a valuation commercially reasonable.

2. The requirement is that the way the valuation is undertaken, and not its final outcome, be commercially reasonable. However, if the value arrived at is less than would normally be expected, this could be an indication that the valuation did not fulfil this requirement.

3. Commercial reasonableness is an objective standard, and therefore the subjective views of the collateral-taker or valuer have no bearing. The standard cited by the judge was that of the “reasonable expectations of sensible businessmen”. [1]

4. Having stated this, the court noted that the requirement of a valuation being commercially reasonable remained fact-sensitive and would, for example, depend on the type of asset being valued.

5. There are no separate and independent requirements for a collateral-taker to act in good faith when undertaking the valuation, nor should any equitable or other duties associated with the law of mortgages be implied upon such valuation.

6. Despite the above, this does not mean that the collateral-taker will normally be able to act primarily in their own commercial interest. Again, the court referred back to the objective standard of the requirement.

In determining these interpretive guidelines, and despite not having any truly analogous precedent, the judge did refer to previous cases where a requirement of commercial reasonableness had been interpreted. He found that the requirement was objective and, importantly, left open a range of possibly valid and “commercially reasonable” procedures, even if another party “carrying out the exercise itself, may have come to a different conclusion”. [2]

With this conception of the requirement of commercial reasonableness, the judge did not accept the remainder of ABT’s argument, which rested on the perceived lack of objectivity on the part of Aapico, and that FTI’s valuation amount was itself commercially unreasonable. FTI’s valuation was found to be well substantiated and carried out according to normal commercial formulae and processes. Aapico’s request that FTI produce as low a valuation as possible was also not commercially unreasonable – such desire is to be expected of a collateral-taking party, and importantly, Aapico did not ask FTI to conduct the valuation in any way “other than in a proper, independent and professional” manner. FTI was also asked to produce a well-evidenced and reasoned valuation. Again, the judge emphasised that the subjective desires of the parties have no bearing on the objective standard of the requirement, and the test was one of procedure rather than outcome.

The valuation itself was therefore deemed commercially reasonable and valid.

The judge once again placed great import on the commercial context of appropriation and the need for certainty of ownership in fast-moving financial markets.

Conclusions and Key Takeaways

With this decision, enforcement of a security financial collateral arrangement via appropriation, specifically over shares, has obtained a precedent and guidance. Concerns of how FCARs interact with the established English law on mortgages have been addressed and useful guidance on producing valuations in a commercially reasonable manner given. As long as valuations are well reasoned and substantiated, and their process meets the objective standard of the requirement, they appear likely to be valid. The guidance provided by the High Court in determining whether a valuation is conducted in a “commercially reasonable manner” will likely have a wider application beyond the FCARs.

It is worth stating that this is a first-instance decision so may be subject to appeal. However, the clarity and certainty it provides to the process of appropriation should not be dismissed. As economic conditions worsen, and enforcement actions likely increase, lenders may now see appropriation as a more feasible and reliable method of enforcement.

Case: ABT Auto Investments Ltd v Aapico Investment Pte Ltd [2022] EWHC 2839 (Comm)

Kyle Howard, Trainee Solicitor in our London office, contributed to the drafting of this Client Alert.

[1]G Percy Trentham Ltd v Archital Luxfer Ltd [1993] 1 Lloyd’s Rep 25.

[2]Lehman Bros International (Europe) (in administration) v Lehman Bros Finance SA [2012] EWHC 1072 (Ch).

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