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This article was included in issue 1 of the Finance Brief.
In each issue of The Finance Brief, we intend to look at a recent or upcoming case that is significant in the context of finance. We start with the Supreme Court decision in Farstad Supply AS v Enviroco Limited [2011] UKSC 16, where taking security over shares produced a very curious result.
Lenders usually take security over shares in an English registered private company in the form of a charge, but they may also take a legal mortgage, which involves having the shares transferred to the lender or its nominee. It has always been recognised that doing so, and having the lender or its nominee registered as holder of the shares in the company’s books, may have unintended consequences, and so it proved in this case.
A company named Enviroco was sued for damaging a ship it was cleaning. It would escape liability if it was a subsidiary of a second company, because it would then fall within the terms of an indemnity given by the owner of the ship. However, that second company had pledged its shares in Enviroco as security for a loan, and transferred them to the lender’s nominee. The court held that Enviroco was no longer a subsidiary, and so fell outside the terms of the indemnity. Although it was a Scottish company, the definitions of terms such as “subsidiary” are the same in England and Scotland.
The facts were unusual, but of course it is very common to take security over shares, and the case demonstrates that it is important to consider whether doing so may have unexpected consequences. It has also caused a great deal of hard thought about how terms such as “subsidiary” should be defined in legal documents, to avoid any unwelcome or unexpected consequences.