In Kuwait, it is not unusual for lenders to set in place certain contractual arrangements with their borrowers which create a pledge-like over shares owned by the borrowers in the capital of certain high value companies.
By virtue of such private arrangements, which remain typically un-authenticated or un-notarized, the lenders will lock-up these shares for the entire term of the facilities granted to the borrowers and dispose of the same in the event of default or breach of contract. However, such arrangements, in conjunction with the actions of the lenders pursuant to the same, are not necessarily valid and enforceable.
There are two methods under which a pledge over shares can be made, as follows:
Under Article 225 of the Kuwait Law of Commerce, a pledge of shares is made by a contract and is perfected by a notation on the share certificate and in the share ledger of the company issuing such shares indicating that such shares are pledged to the pledge. In addition, for listed shares, pledges must be also noted at the Clearance Chamber with the Kuwait Stock Exchange (“KSE”); or
A floating pledge of a portfolio (account) with a custodian or the lenders can be made by a contract. Title to every asset in the portfolio must be transferred to the custodian. In case of shares, the pledgor would transfer (i.e., by direct transfer and not a trade) the shares through the KSE to the custodian which would be the registered owner of the shares but, being a custodian, the shares in the portfolio would be “off balance sheet” assets. As such, the custodian would hold the shares in its name but for the benefit of an undisclosed client which is the beneficiary owner of the portfolio.
A pledge over the portfolio is established by a contract whereby the beneficial owner agrees to the pledge for the benefit of the pledgee. The custodian would be acting on trust on behalf of the pledgee in holding the security.
The portfolio contract usually includes self-remedies such as:
A pledge over the portfolio (which assets is composed of shares) as opposed to a direct pledge over shares is usually a preferred structure for lenders and borrowers because it enable both parties to replace/trade the underlying shares in the portfolio with simple procedures without a need to release the pledge and then noting a new pledge over the new shares each time there is a trade of the shares deposited in the portfolio.
However, any private agreement executed between the lenders (or a Security Agent representing the lenders), the borrower and the custodian (the “Private Agreement”) granting the lenders (or the Security Agent acting on their behalf) the right or prerogative to “liquidate” the shares contained in the custody account (outside the scope of a pledge set forth through one of the mechanism described above) in the event of default or breach of agreement under the loan agreements or the Private Agreement is deemed null and void pursuant to the provisions under Article 237 of the Kuwait Law of Commerce. Said provisions are mandatory and may not be set aside by an agreement between the parties.
Further, in practice, we note that many pledgees (under a duly structured pledge, regardless of notarization) generally prefer, in case of default of the pledgors, to sell the shares that are deposited in portfolios directly without referring the same to the court in accordance with the procedures set out in the Commercial and Civil Pleadings Law. In this regard, the pledgees rely on the fact that in any action by the pledgor nullifying the sale procedures for violation of the enforcement rules outlined above, the pledgor would be entitled to damages in an amount equal to the value of the shares sold which would be then set-off against the pledgor’s indebtedness to pledgee. However, we are aware of some cases where pledgors request damages higher than the value of the shares sold which include for example the difference between the sale price by the pledgee or the custodian and the market price of the shares when the pledgor files the legal action if such price appreciates.
Foreclosure procedures over any pledged assets would require:
In conclusion, we recommend that a Court order is obtained prior to any enforcement procedures.
We also recommend that the portfolio pledge contract is notarized by the Kuwaiti Notary Public. Notarization of the contract is not required for the validity of the pledge but to have the Notary Public’s stamp of the “writ of execution” in favor of the pledgee on the contract. This writ of execution would enable the pledgee to deposit the original portfolio pledge contract with the Execution Department at the Ministry of Justice for enforcement of its rights under the contract directly without a prior judgment. This would be required for enforcement of any other rights other than the foreclosure over the shares.