Enforcement of margin loans: drawing a line between a valid transfer and an unauthorised disposal

Introduction

On 6 March 2018, the Singapore Court of Appeal ("Court of Appeal") in Qilin World Capital Ltd v CPIT Investments Ltd and another appeal [2018] SGCA(I) 01 delivered its first judgment on an appeal from the Singapore International Commercial Court ("SICC") of the year.

Facts 

On 16 November 2015, Qilin World Capital Ltd ("Qilin") as lender entered into a Singapore law HK$31.25 million Loan Agreement with CPIT Investments Ltd ("CPIT") as borrower. The loan was secured on 25 million shares (the "Secured Shares") in Millennium Pacific Group Holdings Ltd ("Millennium").

The Loan Agreement provided:

• in clause 5(f) that Qilin "shall have the right to transfer, re-hypothecate and assign the shares. In the event of a default, the Lender shall have the right to dispose of the shares"; and
• a decrease in the price of the Secured Shares of more than thirty-five (35%) percent for three (3) consecutive trading days is an event of default which CPIT has the right to cure within three (3) calendar days, following which CPIT will have no rights, claims or interest in the Secured Shares.

CPIT, Qilin and Prominence Financials Ltd ("Prominence") as depository broker entered into a Singapore law Control Agreement which provided for the Secured Shares to be held in a brokerage account maintained by Prominence for CPIT (the "Account"). The Control Agreement provided that Qilin may from time to time during the security period notify Prominence "directing it to transfer, pledge, hypothecate, withdraw or redeem any funds or other property" in the Account.

On 2 December 2015, on the instructions of Qilin, Prominence created a sub-account in the name of Qilin (the "Sub-Account") and transferred the Secured Shares from the Account to the Sub-Account. On 3 December 2015, again on the instructions of Qilin, Prominence transferred the Secured Shares from the Sub-Account to Qilin's account with Haitong International Securities Company Ltd.

On 4 December 2015, CPIT became aware of these transfers (the "Transfers") but took no action.

Between 8 December 2015 and 14 January 2016, Qilin sold most of the Secured Shares on the open market.

The SICC at first instance found that there was no event of default entitling Qilin to sell the Secured Shares between 8 December 2015 and 14 January 2016. This was a repudiatory breach that entitled CPIT to treat the contract as terminated. Qilin as equitable mortgagee therefore held the proceeds from the sale of the Secured Shares less the value of the loan on trust for CPIT and  the SICC ordered Qilin to pay such net proceeds to CPIT. Qilin appealed the order.

Decision

Were the Transfers allowed?

The Court of Appeal held that:

• each Transfer was a transfer permitted under clause 5(f) of the Loan Agreement and did not amount to a disposal which may only be made following the occurrence of an event of default; and
• a transfer or an assignment is a transaction subject to CPIT's equity of redemption in respect of the Secured Shares. On the other hand, a disposal would be a conveyance of full unrestricted ownership which destroys CPIT's equity of redemption.

In distinguishing between a transfer and a disposal, the Court of Appeal considered the intention of Qilin on the date of each Transfer to be crucial. If Qilin intended to destroy CPIT's equity of redemption, that would constitute a disposal, not a mere transfer.

The Court of Appeal held that the Transfers were made with the intent to prepare for any attempt to sell the Secured Shares on the open market to third party purchasers. Qilin did not intend to obtain legal and beneficial title to the Secured Shares because to do so would mean that Qilin would have sold the Secured Shares to itself thereby exposing itself to the credit risk of CPIT for the amount of the loan and the equity risk in respect of the Secured Shares should they fall in value.

Accordingly, the Court of Appeal concluded the Transfers were permitted under the terms of the Loan Agreement.

Did the unauthorised sales by Qilin cause the decline in share price?

In relation to the unauthorised sales between 8 December 2015 and 14 January 2016, the Court of Appeal addressed the issue as to whether there was a causation link between those sales and the fall in the share price.

There was a great deal of expert evidence provided. Even though the number of shares sold by Qilin was large in comparison to the average daily trading volume of Millennium shares generally, such as to lead to an inference of the sale by Qilin moving the market, there appeared to be a multitude of factors which led to the overall decline in the share price of Millennium shares. The share price appeared to have risen and fallen on days on which Qilin did not sell any shares. Sometimes, the share price remained static or even rose on days on which there was heavy selling by Qilin.

Accordingly, the Court of Appeal agreed with the SICC that CPIT failed to establish the causation link. As such, even though the sales were not authorised, there was no evidence that Qilin failed to obtain the market price when it sold the shares and CPIT did not suffer any loss as a result of the sales.

Conclusions

Transfers permitted

From a lender's perspective, this decision is to be welcomed, as it affirms the right of a lender to require that secured shares be transferred into its sub-account or its own account pending the enforceability of its security over those shares, provided that the terms of the finance documents permit it to do so.

Right of use permitted?

It should be noted that by stating that the right to "transfer, re-hypothecate or assign" the shares is consistent with a security interest, the SICC appeared to have implicitly recognised that a right of use is permissible in a security document.

However, the Court of Appeal appeared to have suggested otherwise. Although the Court of Appeal did not address the point of re-hypothecation directly, in the course of analysing whether the Transfers breached the terms of the Loan Agreement, it made clear that the Transfers did not purport to transfer equitable title to Qilin and CPIT's right of redemption remained intact. In other words, it may be possible to read the Court of Appeal's judgment as suggesting that a right of use is not permissible under common law because it would destroy the security provider's equity of redemption.

This is different from English law which, having implemented the Financial Collateral Directive, now permits a security interest financial collateral arrangement to provide for a right of use. The pre-Financial Collateral Directive position under English law was unclear at best. It would appear that, under Singapore law, until the point has been fully argued before the Singapore courts, it would be difficult to state with certainty that a right of use would be permissible in a security document.

Sale to self / appropriation permitted?

It should be noted that if a transfer were to amount to a disposal such that it becomes a sale by the lender as mortgagee of the shares to itself as purchaser, the Court of Appeal has expressed doubt as to whether this could be done in law.

This is consistent with the notion that appropriation is not a remedy recognised under common law and the closest equivalent is the remedy of foreclosure which requires a court order. Unlike English law which has implemented the Financial Collateral Directive, Singapore law has no equivalent statutory basis for recognising appropriation.

Indeed, the Court of Appeal recognised that, even assuming a sale to oneself is possible, it will raise issues of self-dealing and more generally the question as to whether the lender has discharged its duties as a mortgagee.