Shares are among the most commonly offered forms of security in a private company sale or a shareholder borrowing. The Companies Act 1997 permits it, but gives the lender no help on the register.
Section 36 — a share is personal property
A share in a company is personal property.
Everything follows from that. A share may be sold, assigned, held on trust, taken in execution — and given as security, either by a legal mortgage (transferring the shares to the lender, who is registered as holder) or by an equitable charge (leaving the borrower on the register).
Because a share is personal property, a security interest in it is capable of registration under the Personal Property Security Act 2011, which governs priority between competing security interests.
Section 72 — the register will not record it
No notice of a trust, whether express, implied, or constructive, may be entered on a share register.
There is no caveat over shares and no facility to note a charge on the share register. Under section 69(2), the company may treat the registered holder as the only person entitled to vote, receive notices, receive distributions and exercise the other rights attaching to the share. A lender holding an unregistered equitable charge is therefore invisible to the company and to anyone searching the register.
Sections 73 and 74 expressly permit a personal representative and the trustee of a bankrupt to be registered in that capacity, and section 73(3) confirms that this does not constitute notice of a trust. No equivalent exists for a mortgagee.
Legal mortgage or equitable charge
| Legal mortgage | Equitable charge | |
|---|---|---|
| Register shows | The lender as registered holder | The borrower as registered holder |
| Who votes | The lender — s 69(2) — usually with a contractual undertaking to vote as the borrower directs while no default subsists | The borrower |
| Who receives dividends | The lender, subject to the security agreement | The borrower |
| Enforcement | Simple — the lender is already the holder and can sell | Requires the deposited signed transfer to be completed and registered |
| Lender’s exposure | Carries the s 79 shareholder liabilities, including unpaid amounts and s 82 calls | None as shareholder |
| Transfer restrictions | Must clear the constitution’s restrictions at the outset | Must clear them on enforcement — when the borrower is least co-operative |
| Group risk | If the lender is a company, check section 64 — a subsidiary cannot hold shares in its holding company | Less exposed |
Both section 7(d) and section 64(5) disregard shares held by way of security only for a transaction entered into in good faith in the ordinary course of a money-lending business. A bank taking a majority stake as security does not thereby acquire a subsidiary, and is not caught by the cross-holding prohibition. Documenting the security as security — not as an outright transfer — is what preserves that protection.
What a lender should do
- Search the constitution. Under section 40(1) a share is transferable subject to any limitation or restriction in the constitution. Pre-emption rights, directors’ consent and compulsory transfer clauses can make the security unenforceable in practice.
- Check the register entry. Section 67(1) requires the register to state whether there are restrictions on transfer and where the document containing them may be inspected.
- Check for unpaid amounts. Under section 65(5) the board may refuse registration where money is owing on the shares — which would block enforcement.
- Take the share certificate. Under section 75(2) a transfer shall not be registered unless the form of transfer is accompanied by the certificate, or evidence of loss and an indemnity. Holding the certificate is the single most effective practical control.
- Take a signed blank transfer form, executed by the borrower, to be completed on default.
- Obtain board consent in advance to registration of a transfer on enforcement, and if possible a waiver of pre-emption from the other shareholders.
- Register the security interest under the Personal Property Security Act 2011 — that is where priority is determined.
- Consider Part XIII where the security is given by a company: a charge created by a company over its property is registrable under section 222, and the register of charges is maintained under section 225.
- Take covenants on voting, dividends, further issues and pre-emptive rights — a borrower who allows the company to issue new shares can dilute the security to nothing.
Points for the shareholder giving security
- You remain the shareholder under an equitable charge, and carry the section 79 liabilities either way.
- Negotiate the voting undertaking. Under a legal mortgage the lender is the registered holder and, absent contract, may vote — including on a removal of directors or a major transaction.
- Watch section 64 if the lender is a related company.
- Tell the co-shareholders if the constitution requires it — enforcing a security is a transfer, and the pre-emption machinery will apply.
Under section 40(2) a share is transferred by entry of the transferee’s name on the share register. Until that entry is made, a lender who has sold the shares has delivered nothing. If the board refuses registration without satisfying all three limbs of section 65(4), the remedy is an application under section 71 for rectification and compensation — which may be ordered against the company or a director.
Sources
- Companies Act 1997 — ss 7, 36, 40, 64, 65, 67, 69, 71–75, 79, 82, 222, 225
- Personal Property Security Act 2011
Before relying on anything here, read the current text of the Companies Act 1997 and check for later amendments. If a decision matters to you, get advice — start with the Office of the Public Solicitor, or find a firm in the law firms directory.