Taking charge in Bermuda: some tips for cross border security arrangements

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1 BERMUDA BRITISH VIRGIN ISLANDS CAYMAN ISLANDS CYPRUS DUBAI HONG KONG LONDON MAURITIUS MOSCOW SÃO PAULO SINGAPORE conyersdill.com December 2010 Taking charge in Bermuda: some tips for cross border security arrangements Security can be given over intangibles by various means, but the grant of a charge is undoubtedly one of the most popular. For practical reasons, most lenders will not want to take possession of the security providerʹs assets and nor will the security provider want to lose control of them, especially if they are used in the day to day running of its business. As a result, charges over shares, contractual rights and other intangible assets are commonly taken as part of a bank s security package. Local law considerations will inevitably arise where a borrower or chargor is incorporated outside England or the assets subject to the security are located overseas. Choice of governing law and jurisdiction Charges granted by Bermuda companies, or by foreign companies over assets in Bermuda, will often be governed by Bermuda law and subject to the jurisdiction of the Bermuda courts. This is usually in order to minimise any procedural and/or or conflicts of laws arguments being raised by the chargor in an enforcement situation. However, it is not uncommon for security to be granted under the laws of another jurisdiction and subject to the jurisdiction of overseas courts, even where the assets and/or the grantor is/are located in Bermuda. This arises principally, although not exclusively, in connection with financings where the main credit and security package is governed by foreign laws. Although such arrangements are generally recognised in the Bermuda courts, it is beyond the scope of this article to cover the potential conflicts of laws or enforcement issues which may arise in each particular set of circumstances. Whatever the choice of governing law, a chargee s position may still be affected by elements of Bermuda law by virtue of the location of the assets which are the subject of the charge and/or the chargor. Although English common law is in force in Bermuda, statutory intervention in both jurisdictions means that the law does differ in various respects, and only Privy

2 Council decisions are formally binding (as opposed to merely persuasive) on the Bermuda courts. As the similarities in terms of taking security in both jurisdictions by far outweigh the differences, in this note we have outlined the main areas where the practical or legal effect of a charge taken in Bermuda may differ from an equivalent charge taken in England. Registration Unlike the position under the English Companies Acts and in certain other common law jurisdictions (where registration of a charge is required in order to preserve its validity), registration of a charge in a public register in Bermuda goes only to priority. On registration, to the extent that Bermuda law governs the priority of the relevant security, such security will have priority in Bermuda over any unregistered charges, and over any subsequently registered charges, in respect of the assets which are the subject of the security. This is not affected by notice of the prior interest and effectively suspends the usual rules on notice. This is the case for registration of charges under the Bermuda Companies Act 1981 (the Companies Act ) as well as the various specialist registers. Priority is only established as between other charges which are capable of registration and will not, in itself, afford priority over any interest that cannot be registered. Section 55(8) of the Companies Act provides that for these purposes a charge includes any interest created in property by way of security, including any mortgage, assignment, pledge, lien or hypothecation. Like in the UK, the terms charge and mortgage are used interchangeably for the purposes of determining what is capable of registration but possibly because security interests created under foreign laws are often registered in Bermuda the Bermuda definition is broader than its UK equivalent (in Section 861(5) of the UK Companies Act 2006) and includes other types of security interest. These statutory definitions do not alter the technical common law meaning of these different forms of security interests for other purposes, and are for the sole purpose of ensuring that they are caught by the relevant statutory regime on the registration of security. In the context of registration, references in this article to a charge are to the broader definition in the Companies Act. Bermuda law looks to the English common law definitions of a charge, mortgage, etc. in order to determine whether a given security interest is registrable. Although registrability is not determined by the governing law of the charging document, the question of whether a document governed by the laws of another jurisdiction Page 2 of 6

3 possesses the requisite characteristics will be determined under the relevant foreign laws. Charges which are registrable under the Companies Act include charges (a) granted over the assets of a Bermuda company, (b) created by a Bermuda company over overseas assets, and (c) acquired by an overseas company over property in Bermuda. It should be noted that unlike the system in England and certain other common law jurisdictions, in Bermuda a security interest granted by a company which is registrable in certain specialist registers (namely land, ships and aircraft) is not also registrable under the Companies Act. As well as preventing a trap for the unwary, this avoids conflicts between the priority effect of non simultaneous registration in different registers. It bears repeating that the priority afforded by registration in Bermuda will only be applicable where conflicts of laws rules stipulate that Bermuda law will determine priority. Some of the situations where this will generally be the case for intangibles include charges over registered shares in a Bermuda company or partnership interests in a Bermuda limited partnership (unless there is an overseas branch register where such shares or partnership interests would normally be transferred), rights arising under a debt governed by a Bermuda law, and rights arising under a bank account held in Bermuda. Even where Bermuda law does not govern the priority of a charge, registration of the charge in Bermuda may nonetheless be effective in certain circumstances for the purposes of the relevant governing law, according to the common law doctrine of notice, as a means of seeking to ensure priority. Subordination of claims to certain creditors Despite the virtues of the floating charge, one of its major weaknesses from the chargee s viewpoint is that it is subordinated to the claims of preferential creditors, whereas the latter do not rank ahead of debts secured by a fixed charge over the chargor s assets. In Bermuda, as was previously the case in the UK, a floating charge which crystallises otherwise than by reason of the chargor s insolvency also takes priority over preferential debts arising subsequent to crystallisation. This is because in relation to these debts the charge has ceased to be a floating charge and is thus outside the scope of the statutory protection of preferential creditors. The result: a rise in popularity of automatic or semi automatic crystallisation clauses, where crystallisation of a floating charge into a fixed charge was triggered by events other than possession, winding up or the appointment of a receiver. This loop hole was closed by statutory intervention in the UK via the Insolvency Act 1986 but remains Page 3 of 6

4 the case for charges granted by Bermuda companies. Bermuda also has no equivalent to the UK Enterprise Act 2002, whereby a percentage of the assets subject to a floating charge granted by a UK company are now ring fenced for payment to ordinary unsecured creditors of the chargor. Of course, the mischief which was addressed by these statutory interventions in the UK is usually less relevant to offshore companies featuring in cross border finance structures, as these are often non trading holding companies. Reviewable transactions Security can be vulnerable to being set aside in the context of insolvency of the grantor. Reviewable transactions include transactions at an undervalue, preferences, onerous transactions and floating charges. The position may differ depending on whether the grantor is a company, natural person or other unincorporated body (e.g. a partnership). Transactions at an undervalue Dispositions of property at an undervalue are voidable at the instance of an eligible creditor thereby prejudiced (Part IV A of the Bermuda Conveyancing Act 1983). These provisions are not restricted to transactions entered into by companies and apply uniformly to any legal person, whether or not the property that is the subject of the disposition is situated in Bermuda or elsewhere, subject to a Bermuda court accepting jurisdiction and determining that Bermuda law would apply. In order to apply, the disposition must have been made at an undervalue and with the dominant purpose of putting the relevant property beyond the reach of the claimant. These provisions have no direct equivalent in the UK, although parallels with various elements of Sections 238, 339 and 423 of the UK Insolvency Act 1986 clearly do exist and the Bermuda courts would most likely look to English authorities for guidance for these purposes, to the extent relevant. An eligible creditor is any person to whom the transferor owed an obligation which either (a) existed at the date of the disposition or arose within two years after the disposition, (b) was contingent at the date of disposal and later became unconditional, or (c) arises from a cause of action accruing at any time prior to or for up to two years after the date of disposal. Where the obligation did not exist at the date of the disposal, the disposition will not be set aside by a court unless it is satisfied that it was reasonably foreseeable on the part of the transferor that an obligation might become owed by him to the creditor in question. The limitation period for an eligible creditor to make a claim to set aside such dispositions is six Page 4 of 6

5 years from the date of transfer, or (where sub paragraphs (a) or (c) apply) from the date when the obligation arose or cause of action accrued, if later. Preferences, onerous transactions and floating charges The rules on preferences, onerous transactions and floating charges will only apply where the grantor of the charge is a Bermuda entity. These rules are generally equivalent to the rules in the UK although there are some differences, for example: In relation to preferences, transactions involving payments to creditors within 6 months prior to a winding up petition being presented may be set aside if made with the dominant intention of preferring those creditors over others (Section 237 of the Companies Act). Unlike Section 239 of the UK Insolvency Act 1986, it is not a requirement that the company in question must have actually been insolvent at the time of the transaction, or have become insolvent as a result of it, but the court would need to be satisfied that the requisite intention existed. The rules governing preferences for individuals (under the Bankruptcy Act 1989) are broadly analogous to those for companies. There is no equivalent in Bermuda to the UK extension of the extended two year hardening period in the case of a preference or floating charge in favour of a connected person. Unlike the UK, there are no rules in Bermuda specifically dealing with reviewable transactions for partnerships, irrespective of whether a partnership has elected to have legal personality. An unpaid creditor could petition for the winding up of corporate partners (or for the bankruptcy of individual partners) which could lead to the dissolution of the partnership. However, the question as to security granted by a partnership would be reviewable as property of any of the partners would generally depend on the terms of the relevant partnership deed. Conclusion To the extent that the laws in Bermuda on taking security may differ from the English position, these differences can in certain circumstances allow the parties greater freedom of contract under Bermuda law, and may simplify matters and provide greater certainty. In any event, early awareness of these issues on the part of lenders, borrowers and their respective advisers may facilitate risk management as well as the most effective and timely structuring of cross border security arrangements. Page 5 of 6

6 Claire McConway Associate +1 (441) This article is not intended to be a substitute for legal advice or a legal opinion. It deals in broad terms only and is intended to merely provide a brief overview and give general information. About Conyers Dill & Pearman Conyers Dill & Pearman advises on the laws of Bermuda, British Virgin Islands, Cayman Islands, Cyprus and Mauritius. Conyers lawyers specialise in company and commercial law, commercial litigation and private client matters. Conyers structure, culture and expertise enable responsive, timely and thorough service. Conyers provides clients with the highest quality legal advice from strategic global locations including offices in the world s leading financial centres in Europe, Asia, the Middle East and South America. Founded in 1928, Conyers comprises 600 staff including more than 150 lawyers. Affiliated companies (Codan) provide a range of trust, corporate secretarial, accounting and management services. For more information please contact: Naomi Little +1 (441) naomi.little@conyersdill.com Page 6 of 6