Pledges and Charges: Distinction and Enforcement under Cyprus Law

Pledge

A pledge constitutes a possessory security interest and it can be simply defined as a form of security ensuring, for example, that the debt created under an agreement will be settled.

The pledges over shares in a Cyprus company are governed by the Cyprus Contract Law, Cap. 149. Commonly, in order to obtain a security over shares in a Cyprus company, this is perfected through the execution of a share pledge agreement between the pledgor, who is the legal registered owner of the shares being pledged, and the pledgee, who is the legal entity or individual in favour of whom the shares will be pledged.

 

Perfection of a Pledge

For a pledge to be created, possession, actual or constructive, must be delivered to the pledgee. In order for such a security interest to be valid and enforceable it must be perfected and become attached with the assets. The purpose of attachment to the assets is to afford to the creditor rights in rem against the debtor. However, the pledgee does not have any right of ownership over the pledged shares until an event of default occurs.

In accordance with the provisions of section 138 (1) of the Cyprus Contract Law, Cap. 149, in order for a share pledge agreement to be valid and enforceable it must be in writing, signed by the pledgor and must be made in the presence of at least two competent witnesses, capable to contract, who must fully state their names.

Provided that the conditions set out in section 138 (1) of the Contract Law, Cap. 149 and set out above are satisfied, a pledge of shares is only considered to be valid and enforceable provided that the following additional requirements set forth in section 138 (2) of the Contract Law, Cap. 149 for the pledge of shares are satisfied:

(a) a notice of pledge, is delivered to the company by the pledgee together with a certified copy of the share pledge agreement; and

(b)  a memorandum of such pledge is entered in the register of members of the company against the shares for which a notice of pledge has been delivered; and

(c) a certificate issued by the secretary of the company that a memorandum of pledge has been entered in the register of members of the company against the pledged shares, shall be delivered to the pledgee.

 

Enforcement of a Pledge

It is common practice under share pledge agreements to include as ancillary documents undated documents which must be executed and delivered to the pledgee either by the company or by the pledgor, for example undated instrument of transfer, undated resignation letter etc.

The said documents are to be set out as appendices to the share pledge agreement and upon execution of the share pledge agreement by the pledgor and the company, as applicable, be delivered to the pledgee in order for the pledgee to be able to enforce the pledge in the event of default.

The share pledge agreement must clearly stipulate the grounds on which the agreement can be enforced, for example, upon the occurrence or continuation of an event of default. Enforcement by the pledgee under a share pledge agreement can be achieved by merely putting into effect the undated documents that have been delivered to the pledgee under the share pledge agreement. Having said this, there is no need to obtain a court order for a pledge to be enforceable and thus for the pledgee to take ownership of the pledged shares.

 

Charge

It is common that in many occasions a pledge over shares creates a charge against the pledgor.

A charge is considered as a non-possessory security which means that the creditor (the “chargee”) does not retain ownership or possession of the secured property owned by the debtor, instead, it gives the right to the chargee to claim the repayment of the debt from the secured property, namely a charge over the secured property. In the case of default, the chargee retains the right to assume possession of the secured property and sell it in order to recover the debt from the proceeds of the sale.

 

Registration

Charges shall come into force once they are perfected and in order to be perfected they must be made enforceable as against creditors or a liquidator. Perfection is accomplished when notice is given to the public of the existence of the charge.

Under the provisions of section 90 of the Cyprus Companies Law, Cap. 113, registration of the charge must be made with the Registrar of Cyprus Companies within 21 days from the date of creation of the security interest.

In the case where the agreement for the creation of the charge is executed outside the Republic of Cyprus, such charge must be registered with the Registrar of Cyprus Companies within 42 days from the date of execution of the security interest. If the 42 days set by the Law expire, an Order of the Court extending the time for filing the application to record charge as a charge with the Registrar of Cyprus Companies must be obtained.

The purpose of registration of the charge is to ensure perfection, thus ensuring that such charges are not rendered void as against creditors or a liquidator.

The registration of a pledge of shares, with respect to shares held by a Cyprus company in another Cyprus company with the Registrar of Cyprus Companies, is not compulsory. However, in order for the chargee to secure his interests over the charge created, it is advisable that the said charge is registered with the Registrar of Cyprus Companies.

In addition to the above, the relevant entries must be made in the Register of Mortgages or Charges of the company whose property is being affected. Such entry must include a short description of the property charged, the amount secured, the names of the persons entitled to the charge as well as the agreement creating the charge.

 

Priority

In order for a charge to have priority over other charges the particulars of the charge together with the instrument by which the charge is created must be delivered to the Registrar of Cyprus Companies pursuant to the provisions of the Cyprus Companies Law, Cap. 113, section 90. The charge and any rights or claims derived therefrom will rank pari passu against the liquidator of the Company, together with other not registered charges and unsecured claims.

In simple words, a preceding and registered proprietary interest in an asset will take priority over all proprietary interests that may arise at a later stage and which may not be registered.

Termination of pledge of shares and charge on shares

A pledge will be terminated, inter alia, on the following occasions:

-          When the secured obligations as defined in the share pledge agreement are fulfilled and the pledge is released;

-          When the date of termination of the agreement is reached;

-          When the pledgee decides to waive his rights and decides not to enter into the share pledge agreement and he delivers a written notice of termination to the pledgor;

-          When the pledgee decides to enforce the pledge under the share pledge agreement.

 

Once the pledge is terminated, all documents held by the pledgee, under the share pledge agreement, must be returned to the pledgor. All registrations of charges made to the Registrar of Cyprus Companies must be cancelled and the memorandum of pledge entered in the register of members of a company must be cancelled by sending the relevant notification to the secretary of the company.