All about the pledge on shares listed on the WSE
Since the introduction of the registered pledge system in Poland, most people first consider that system when thinking about how to secure a loan. One of the easiest assets used for a registered pledge which provides collateral for a loan are shares of stock listed on the Warsaw Stock Exchange (WSE).
A simple pledge of publicly traded stock can be an attractive form of collateral both for borrowers and lenders. A simple pledge of stock entails relatively low costs for the borrower in establishing the security and provides for a somewhat easier method of satisfaction for the lender should the borrower default. Additionally, borrowers do not need to sell their shares (particularly when a bear market takes hold) to gain liquidity necessary for further investments.
Despite its attractiveness as collateral, a simple pledge on publicly traded stock listed on the WSE may cause problems and questions because of the complicated convergence of general provisions of civil law and very specific regulations of securities law. Not only does one need to adhere to the provisions of the Polish Civil Code, but also the securities law and corresponding regulations and the contractual rules of a brokerage house with whom the borrower has an account. Some of the key issues to keep in mind with this interplay of law are that:
Since pledges are classified as limited property rights, the rights and obligations resulting from the establishment of a pledge run with the pledge and are binding on all subsequent purchasers of the pledged item until the expiration of the pledge; and
The particular rules of a brokerage house need to be reviewed carefully, in particular, in structuring the pledge agreement.
As pledges are used mainly to secure loans from banks, let's walk through what provisions should be in a pledge agreement between a borrower (pledgee) and lender bank (pledgor). The formal Civil Code requirements are few. Of these, the most important is that the creation of a pledge on shares requires a written agreement with a date certain (the certification is usually made by a notary public). Additionally, the pledge agreement must include a precise description of the obligation whose repayment is secured by the pledge.
As publicly traded shares are being pledged, additional requirements arise. Above all, you should not underestimate the role of the brokerage house that holds the shares on account. Under law, public trading of securities, generally, must take place through a brokerage house. The pledge agreement must include the number, type and code of shares being pledged, the name and number of the brokerage house holding the securities account of the pledgor and the terms and conditions of the pledge.
Of course, the pledge agreement may be much more complicated. This type of agreement sometimes contains an obligation on the part of the pledgor to increase the number of pledged securities in case of a significant reduction in the share price. Often attached to the agreement are both a power of attorney for the bank to sell securities and an authorization to apply the purchase price toward the debt owed.
Parties to a pledge agreement also need to consider how to handle the underlying rights in shares. With a pledge, the shares are still owned by the borrower. Thus, in the case of publicly traded shares, they are kept on the account (blocked) of the borrower, and the borrower is named as an owner in a deposit certificate issued by the brokerage house. Because the borrower is still the owner, the borrower is still entitled to exercise corporate rights arising from the shares (such as participating and voting at the general shareholders meeting). However, the borrower may give a power of attorney to the pledgee to exercise corporate rights in its name.
In practice, there is usually a problem in determining whether the pledgee or pledgor should be entitled to collect the benefits (such as dividends) arising from the pledged shares. This should also be addressed in the pledge agreement. If a pledge agreement does not include clear provisions regarding who is to receive the benefits, the brokerage house must hold the benefits on behalf of the lender until the parties give it definitive instructions.
How does one specify the value and amount of the shares to be pledged? Usually, the price as listed on the WSE is controlling. However, the parties may agree otherwise. Additionally, the contract should include a provision allowing for fluctuation in the price in accordance with the stock exchange. How other costs, such as taxes and brokerage house fees, are treated can also have an effect on the value of the collateral.
According to prevailing interpretation, a pledge is created at the moment the brokerage house receives notification about the conclusion of a pledge agreement. Notification to the brokerage house implies a transfer of shares to a blocked securities account. Brokerage houses usually require a written transfer order from the owner of the shares. After the establishment of the pledge, the brokerage house must give notice about the transfer to the blocked account on every deposit certificate that is issued as a confirmation for the blocked shares.
Despite all of this paperwork, can pledged shares be sold? Presently, there is no prohibition in Polish law against the selling of pledged shares. The realities of public trading are such, however, that pledged shares are blocked by a brokerage house and cannot be traded on the WSE.
This article was prepared by Lejb Fogelman, managing partner of Hunton & Williams Poland, with the assistance of Daniel Kaczorowski, an associate attorney.
