When lenders provide financing, a key element of any lending decision will be the availability and quality of any security provided, with the equity of a business often providing a favoured means of security. In the event of a borrower defaulting, equity security gives lenders the ability to “take the keys”, offering a direct path to recover their investments. But how and when can lenders enforce their equity security and what are the key considerations? 

In this short piece, we explore the most common circumstances in which lenders enforce share security, and how this takes place. 

Addressing defaults:

One of the most frequent reasons lenders enforce their security over shares is to address borrower defaults without triggering a more formal insolvency process. In these cases, a lender would be able to take control of the shares via an enforcement with a view of securing value for itself (for example through an M&A process) if there is a divergence of views with the existing shareholders or management as to required actions. 

A critical consideration pre-enforcement is accurately assessing the value of the underlying trading business and strategic options post-enforcement, for example whether an exit via M&A (or other) would provide a desirable and realistic option. A miscalculation here, particularly during a downturn in the business cycle, can result in outcomes that fall short of the lender’s expectations and may lead to further difficulty for the lender (e.g. running the business).  

Resolving Inter-creditor issues: 

When a group of creditors fail to resolve disputes amicably, subject to the terms of the inter-creditor arrangement, a senior lender may be able to appoint a receiver over shares to exercise a greater degree of control over the business, enabling the lender to safeguard its position.

Managing uncooperative or under-performing management:

Unlike some jurisdictions, UK law generally allows a receiver appointed over shares extensive rights to exercise the powers of a shareholder, including the ability to remove or appoint directors. If there is a shareholder agreement in place this should be carefully considered as part of any contingency planning exercise. 

Voluntary surrender of shares: 

In some instances, borrowers may voluntarily surrender their shares if they recognise their inability to meet debt obligations. This approach allows lenders to take control without the need for a formal enforcement process, preserving business continuity while working toward debt recovery. 

Key advantages of enforcing security over shares

Once a lender enforces their security over shares, it provides them with various advantages. The primary benefits include:

Enhanced debt recovery prospects:

The most immediate advantage for the lender is the potential for recovering the debt owed. Shares can often be sold or used as a means to pay off the loan at a better price than a sale of the underlying business and assets may yield, ensuring maximum recovery for the lender. If the shares belong to a listed entity, they may have a market value that can be easily realised, making it a more liquid option compared to other types of collateral. If the shares are held in a private company, the lender will need to consider the potential market value as part of any contingency planning exercise often prior to enforcement. 

Avoiding a more formal insolvency process and associated reputational risks: 

Enforcing security over shares can help the lender avoid an insolvency process of the trading company which could be damaging to value, for example if the business is assessed under the premise of a distressed or accelerated M&A process in any subsequent discussions. 

Operational control: 

In some cases, enforcement of security over shares allows the lender to take control of the business, either temporarily or permanently. This can be beneficial if the lender has specific expertise in managing distressed businesses and believes it can restore value to the company. In these cases, the lender may sell the business or rework its operations to maximise recovery, which will require careful strategic planning and value assessments.

Facilitating swift transactions: 

In some circumstances the Receivers appointed over shares may be willing to proceed with transactions based on valuation advice, even without undertaking a full M&A process. However, consideration must be given to valuation approaches and potentially challenges, particularly if the transaction is likely to be contested.   

Cost efficiency:

Given the appointment only extends to the shareholdings, a receivership generally may be a more cost-effective solution for a lender to consider as opposed to an appointment directly over the trading business itself. There may also be certain tax advantages. 

Preserving contracts: 

The trading company may be party to critical contracts which would automatically terminate if an enforcement was made at the trading company level. If a restructuring is contemplated, an enforcement over the shares may be helpful, but careful consideration should be given to Material Adverse Change clauses or similar.  

In summary, enforcing security over shares can be a powerful tool for lenders, providing a relatively straightforward method for recouping debts. It offers significant advantages such as enhanced control, cost efficiency and the ability to avoid formal insolvency proceedings. However, the process requires meticulous planning, accurate valuation, and expert advice to achieve favourable outcomes. 

By assessing these factors, lenders can effectively leverage share security enforcement as part of a broader strategy to manage borrower defaults and protect their financial position.