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Appropriation of financial collateral

19 June 2009

Comment on Privy Council's decision in Cukurova

The Privy Council in Cukurova has confirmed that the holder of security over shares can enforce its security and "appropriate" the shares pursuant to the Financial Collateral Arrangements (No 2) Regulations 2003 (SI 2003 No. 3226) by simply evidencing (by way of an overt act) the intention to exercise the power to appropriate, and it is not necessary for the charge holder to register as legal owner of the shares in order for there to be a valid appropriation.


The Regulations implemented the Financial Collateral Directive (Directive 2202/47/EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements) (the FCD) and came into force in England on 26 December 2003. The FCD was implemented to improve the integration, efficiency and stability of financial markets by, amongst other things, simplifying the process for taking and enforcing security over financial collateral (essentially cash, shares, bonds and other securities).

The FCD divides financial collateral arrangements into two mutually exclusive categories: (i) title transfer financial collateral arrangements (whereby the collateral-provider transfers full ownership of the financial collateral to the collateral-taker on terms that it, or equivalent assets, will be transferred back when the obligations are discharged); and (ii) security financial collateral arrangements (SFCA) (whereby financial collateral is provided by way of security but full ownership of the financial collateral remains with the collateral-provider [1]).

As well as disapplying certain formalities and restrictions in respect of existing methods of taking and enforcing security (e.g. the need to register the security interest over the financial collateral at Companies House), the Regulations created a remedy of "appropriation" - a novel remedy certainly as regards shares, which was previously unknown to English law [2]. Regulation 17 provides "Where a legal or equitable mortgage is the security interest created or arising under a security financial collateral arrangement on terms that include a power for the collateral-taker to appropriate the collateral, the collateral-taker may exercise that power in accordance with the terms of the security financial collateral arrangement, without any order for foreclosure from the courts".

"Appropriate" is not defined for these purposes and neither the FCD nor the Regulations provide for the manner in which the power of appropriation is to be exercised, although it is reasonably clear from Article 4(1), (2) and (4) of the FCD that appropriation is intended to be a self-help remedy so long as the security agreement provides for it, and contains provisions for valuation of the financial collateral. Notably, Article 4(4)(a) of the FCD states that enforcement shall not require prior notice of the intention to realise the financial collateral. Appropriation therefore allows a collateral-taker, as an alternative to selling the collateral, to become the owner of the collateral (i.e. to take the collateral in place of the debt) without the formality of a court order (which is necessary for the broadly similar remedy of foreclosure). It is however different to foreclosure in that appropriation is subject to the collateral-taker accounting to the collateral-provider for any surplus by which the collateral exceeds the secured liabilities according to an agreed valuation process which must be "commercially reasonable", and being able to claim for any shortfall to the extent the secured liabilities are not met.


Alfa Telecom Turkey Ltd (Alfa) and Cukurova Finance International Ltd (CFI), both incorporated in the BVI, were the owners of, respectively, 49% and 51% of the shares in another BVI incorporated company, Cukurova Telecoms Holdings Ltd (CTH). Cukurova Holdings AS (CH) was the 100% parent of CFI. CTH held, indirectly, a substantial stake in the largest mobile phone company in Turkey.

In September 2005 Alfa provided CFI with a US$1.325 billion loan facility (the Loan) which was secured in favour of Alfa by, inter alia, English law charges on identical terms over CFI’s shares in CTH and, as third party security, CH’s shares in CFI (the Share Charges). In accordance with Regulation 17, each Share Charge provided that, to the extent that it constituted a "financial collateral arrangement" under the Regulations, Alfa had the right, after the Share Charge had become enforceable, to appropriate the charged shares to discharge the liabilities owed to it under the Loan. The Share Charge also stated that such financial collateral was to be valued at its fair price.

The Share Charges did not provide for how appropriation was to be exercised. As is customary, the Share Charges (equitable mortgages) were accompanied by share certificates and blank stock transfer forms. Alfa was not however registered as the legal owner of the charged shares because of the obvious impracticalities that would result, e.g. voting rights and right to receive dividends.

On 16 April 2007, Alfa claimed that CFI was in breach under the Loan (which CFI denied) and called for repayment. An interesting chain of events then ensued.

Later the same day, Alfa sought through the BVI court to have the charged shares registered in its name on the basis that it had presented the share certificates and completed stock transfer forms (transferring the shares into its name), but registration had been wrongfully refused. On 27 April 2007, CFI and CH issued stop notices (addressed to CFI and CTH, the companies in which the charged shares were held) before the BVI Court Registry, directing that no transfer of the charged shares be registered without notice to CFI and CH. On the same day, solicitors acting for Alfa gave written notice to CFI and CH (the Notices) that it was exercising its power of appropriation with immediate effect. Later the same day, CFI and CH obtained an injunction against Alfa, preventing it from taking any action to enforce its security, but without prejudice to Alfa's assertion that it had appropriated the shares.

Proceedings were subsequently commenced on a number of issues and expert evidence was called by both parties (Lord Millett for Alfa and Professor Cranston for CH/CFI). The experts agreed on all relevant matters save for whether the power of appropriation had been validly exercised; that is whether the sending of the Notices had been effective to exercise the power of appropriation, without Alfa becoming the legal owner of the shares (which remained registered in the names of CFI and CH) or whether registration was required to perfect the appropriation.

At first instance, the BVI High Court found in favour of CFI and CH holding that Alfa had not validly exercised its power of appropriation; that effective appropriation required "full ownership" which in turn required registration in the share register. It also held that appropriation required an "autonomous meaning", such that it is capable of uniform application across the Member States of the EC, and as civil law countries have no concept of equitable ownership, the power to appropriate necessarily involved the collateral-taker becoming the absolute, legal owner of the collateral. As such, it was not enough to obtain full equitable ownership free of the equity of redemption. It was also held to be unacceptable that a collateral-taker could appropriate by simply determining to do so but rather an "overt act" was needed for valid appropriation.

Alfa appealed. The Court of Appeal held that the giving of the Notices (manifesting an intention on behalf of Alfa to appropriate) was sufficient to exercise the power of appropriation under Regulation 17 and the concept of "full" or "absolute" ownership (inherent in the remedy of appropriation) was capable of referring to the full or absolute ownership of the beneficial interest. The Court of Appeal rejected the concept that the term "appropriation" required uniformity throughout the Community as Regulation 17 expressly provides for financial collateral arrangements to be given in the form of legal or equitable mortgages (a concept unknown in civil law jurisdictions, making uniformity impossible). It held that appropriation could be exercised simply by the collateral-taker forming the intention to keep absolutely the collateral and therefore that the serving of the Notices had been a valid appropriation of the Shares.

The case was referred on appeal to the Privy Council.


The Privy Council dismissed the appeal and held that there is a valid appropriation of financial collateral for the purposes of Regulation 17 provided there has been an "overt act" evidencing the intention to exercise a power of appropriation which is communicated to the collateral-provider, but that there is no need for the collateral-taker to become the registered holder of the shares. The reasons were as follows.

  • The expression "appropriation" must be interpreted by reference to the general scheme and purpose of the FCD but, as the FCD did not have direct effect, Member States had been required to transpose the general concept into national law by reference to legal concepts in their own legal systems so as to provide for appropriation as a "rapid and non-formalistic enforcement procedure". The Court of Appeal had therefore rather overstated the importance of giving "appropriation" an autonomous Community meaning.
  • The Court of Appeal had been right to adopt a pragmatic interpretation and to conclude that it was not necessary for a collateral-taker to become the registered owner of the shares in order for valid appropriation to occur, even though, in practice, registration would ordinarily take place. Such a requirement would go against the FCD's purpose, to give collateral-takers a means of "rapid and non-formalistic enforcement".
  • However, the Court of Appeal had been wrong to say that the collateral-taker could exercise the power of appropriation merely by taking thought (without any overt act). Commercial practicalities dictate that there should be an "overt act" demonstrating the intention to exercise the power of appropriation, communicated to the collateral-provider before the collateral is appropriated. This was not inconsistent with Article 4.4(a) of the FCD which states that "prior notice" may not be made a prerequisite. In this instance, the overt act was the Notices served by Alfa which resulted in an effective exercise of their power of appropriation. 


The Privy Council's decision does not really say anything different to the Court of Appeal's decision apart from requiring there to be an overt act evidencing the intention to appropriate.  Even before the Privy Council's decision, a prudent charge holder would have given notice anyway so as to avoid any doubt about when appropriation took place.

Although there has been a lot of excitement over the Privy Council's decision in Cukurova (not least because it is the first English decision on appropriation, from a court at the highest level and because the decision is particularly interesting from an academic perspective), its practical relevance may be limited.  Charge holders will not usually choose to enforce their security over shares by way of appropriation and take the shares into their own name, particularly shares in an unlisted company. Ordinarily, a charge holder will exercise the power of sale (or get someone to exercise it for him) so as to sell the shares to a third party purchaser and realise the security in that way. In any event, not all security documents will contain an express right to appropriate, a prerequisite to appropriation under the Regulations.

One point on which the Privy Council's decision has been helpful is in clarifying that an equitable (rather than a legal) mortgage over shares is a security interest falling within the scope of the Regulations.  Previously, there was some uncertainty as to whether this was the case even though a "security interest" is defined as "any legal or equitable interest…created or otherwise arising by way of security". This uncertainty arose out of the fact that, to fall within the scope of the Regulations, the financial collateral must be "delivered, transferred, held, registered or otherwise designated to be in the possession or under the control of the collateral-taker (or person acting on its behalf)". It was not clear whether an equitable mortgage, pursuant to which only the beneficial interest in the shares is transferred to the collateral-taker (and not the legal title so that the collateral-taker is not registered in the share register), provides the necessary possession or control.  Cukurova has confirmed that an equitable mortgage over shares is a security interest in financial collateral for the purpose of the Regulations.


[1] As was discussed by the Privy Council, as well as by the lower courts in Cukurova and elsewhere, the idea of full ownership remaining with the collateral-provider does not lend itself easily to the legal concept of an English mortgage (legal or equitable) pursuant to which a proprietary interest (legal or beneficial, respectively) in the asset charged transfers to the charge holder (subject to the equity of redemption), but not full ownership.  Both the collateral-provider and the collateral-taker retain a proprietary interest in the collateral so long as the security remains in place.  Notwithstanding this, it was accepted as common ground in Cukurova that an English mortgage does constitute a security financial collateral arrangement.

[2] Previously, any attempt to appropriate (other than by way of foreclosure and a court order) would have breached the rule against self-dealing and would have been treated as a clog on the equity of redemption.

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