Enforcing a pledge over shares: how a creditor obtains satisfaction when the debtor does not pay

In financing secured on shares, a great deal of attention goes to the creation of the pledge and its registration at the central securities depository. What happens when the debtor stops paying is often considered only once it happens. Yet enforcement of a pledge over securities has its own regime in the Securities Act, which differs in material respects from enforcement of a pledge over real property or a movable asset.

When enforcement may begin

A pledgee may begin enforcing a pledge if the claim secured by the pledge is not duly and timely discharged (Section 151j(1) of the Civil Code), including where it is already time-barred (Section 151j(2)). A securities pledge agreement is governed by the Commercial Code and the Civil Code, unless the Securities Act provides otherwise (Section 48(1) of the Securities Act). It is precisely as regards the method of sale that it provides otherwise.

Sale through a securities dealer

The basic rule for an ordinary pledge over securities reads as follows:

If a claim secured by a contractual pledge over a security is not duly and timely discharged, the pledgee is entitled to sell the pledged security through a securities dealer. The pledgee must inform the pledgor of the intended sale in advance, unless otherwise agreed in the securities pledge agreement.

— Section 51(5) of Act No. 566/2001 Coll. (unofficial English translation)

The method of sale depends on whether the shares are listed. Securities admitted to a stock exchange’s listed securities market are sold on the exchange by way of an anonymous trade; if no one has traded in them for the last three months, they are offered through a dealer at the highest price obtainable (Section 51(6)). Unlisted shares, that is, the shares of most private companies, may be sold only through a securities dealer at the highest price obtainable with due professional care (Section 51(7)). A creditor therefore cannot simply sell the shares itself, to anyone and at any price.

With book-entry shares, the sale is not blocked even by a suspension of the right of disposal registered by the creditor when the pledge was created: the depository records termination of the suspension also on the instruction of the dealer selling the securities under Section 51 (Section 28(9)). For registered shares with restricted transferability, the company’s consent is not required for a transfer in the course of enforcing a pledge (Section 156(11) of the Commercial Code).

Forfeiture of the shares in the creditor’s favour is generally not available

Creditors would often prefer simply to take over the shares. The Civil Code rules this out:

Any agreement concluded before the maturity of a claim secured by a pledge, on the basis of which the pledgee may obtain satisfaction by acquiring ownership of the thing, flat or non-residential premises, or another right or other asset over which the pledge is created, is invalid unless the law provides otherwise.

— Section 151j(3) of Act No. 40/1964 Zb. (unofficial English translation)

An exception is contained in the special regime for financial collateral. If both the pledgee and the pledgor are among the persons listed in Section 53a(1) of the Securities Act, typically banks, securities dealers or insurers, the pledge may also be enforced by forfeiture of the collateral, provided the parties agreed on this when concluding the agreement and also agreed a method of valuation (Section 53b(4)). When enforcing under this regime, the creditor need not inform the pledgor in advance (Section 53b(5)). The condition applies to both parties: if the shares are pledged by a shareholder who does not itself fall within that group, the financial collateral regime will generally not apply, not even in the case of a bank loan, still less a loan from a private investor or another company. The prohibition of forfeiture generally is dealt with in the ban on forfeiture of collateral.

Proceeds, surplus and the acquirer

While the pledge subsists, it also extends to the proceeds of the pledged security (Section 51(3)), so it is useful to agree in the agreement what happens to dividends during a period of default. The Securities Act regulates the method of sale and the information to be given to the pledgor; in all other respects the general rules apply. It is therefore sensible to allow also for the duties under the Civil Code, in particular a written report on enforcement of the pledge and the payment to the pledgor of any part of the proceeds exceeding the secured claim and the necessary costs (Section 151m(9) and (10)).

A buyer who acquires the shares in the course of enforcing a pledge is not obliged to register the change in the person of the pledgor (Section 51(1)), and once satisfied, the creditor submits an instruction to register termination of the pledge (Section 50(5)). For certificated registered shares, the buyer becomes a shareholder as against the company only upon entry in the shareholder list (Section 156(7) of the Commercial Code); the details are set out in the article pledges over certificated shares.

What belongs in the agreement at the time of signing

How enforcement will proceed is largely determined in the pledge agreement itself. In particular, the agreement should contain:

• a definition of when the right to begin enforcement arises and whether the pledgor waives prior information about the sale,
• for book-entry shares, the creditor’s entitlement to give an instruction to suspend the right of disposal (Section 28(3)(d)), so that the shares cannot be transferred to a third party while the loan is outstanding; a transmission, for example on inheritance, is not prevented by the suspension (Section 28(8)),
• rules for dividends and other proceeds while the pledge subsists and during a period of default,
• for financial collateral, agreement on forfeiture and the method of valuing the shares.

An alternative to a pledge is a security transfer, under which the shares are transferred to the creditor and returned once the obligation is discharged; it is governed by the Securities Act and by the provisions of the Civil Code on securing obligations by transfer of a right (Section 53(1) of the Securities Act). Whether it is more suitable depends chiefly on who is to exercise shareholder rights during the financing.

We prepare the pledge agreement with rules for enforcement and register the security through our pledges over securities service. Registration of the termination of the pledge, cancellation of the suspension and other filings with the depository after enforcement are handled through representation before CDCP.