Pledge of corporate rights

Pledge of corporate rights — this is a mechanism that allows you to ensure the fulfillment of obligations by pledging a stake in the company’s authorized capital or shares.

Corporate rights can be used as collateral for credit agreements or other financial obligations.

It is an important tool in business because it provides lenders with additional guarantees and corporate rights holders the opportunity to obtain financing without immediately selling their shares.

Corporate rights have both property and non-property aspects:

• Property rights –the right to receive dividends, as well as a share of the company’s property in the event of its liquidation.
• Non-property rights –the right to participate in the management of the company, the right to vote at the general meeting, the right to receive information about the company’s activities.

Both property and non-property corporate rights can be transferred within the pledge. However, the right to vote or control is not always transferred to the mortgagee, as this may create a conflict of interest or violate the rights of other participants.

Pledge of corporate rights requires compliance with certain conditions and procedures, which are regulated by both legislation and internal documents of the company (for example, the charter):

• Assessment of corporate rights. Before transferring corporate rights as collateral, it is necessary to determine their value. The valuation of corporate rights is carried out on the basis of the book or market value of the assets of the company to which the share or shares belong. To ensure the objectivity of the evaluation, independent evaluators may be involved. In cases of pledge of corporate rights in an LLC, the company’s charter may provide for a special procedure for the valuation of shares.
• Conclusion of a pledge agreement. The contract is concluded exclusively in writing and must have the following key provisions:
• Subject of pledge (corporate rights).
• Appraisal of mortgaged property.
• Duties and rights of the parties.
• The procedure for the exercise of rights arising from corporate rights during the pledge (for example, the right to vote at shareholders’ meetings).
• The procedure for repayment of debt and foreclosure on the subject of collateral.
• Notarial certificate of pledge agreement. Pledge of corporate rights usually requires notarization of the contract. This is necessary to ensure the legality of the pledge and protect the interests of the pledge holder. In addition, in the case of a pledge of shares in an LLC, notarization of the contract is mandatory for making changes to the state register of legal entities.
• Registration of pledge. After concluding the pledge agreement, it is necessary to register the pledge in the State register of movable property encumbrances or in other registers provided for by law. Registration is necessary to give the lien legal force and ensure its priority over other possible creditors.

Pledge of corporate rights has its own characteristics depending on the organizational and legal form of the company: LLC or joint-stock company (JSC).

Pledge of corporate rights in LLC

In limited liability companies, corporate rights are expressed in shares of authorized capital.

Pledge of a share in an LLC requires compliance with a special procedure:

• Preceding right: Other members of the partnership may have a preferential right to redeem the pledged share. This implies that the mortgagor must offer his share for redemption to other participants before pledging it.
• Consent of participants: The statute of the LLC may require obtaining the consent of other participants to transfer the stake as a pledge.
• Management right: During the validity of the pledge, the right to manage the share (including voting at the general meeting) may remain with the pledger or be transferred to the pledgee, depending on the terms of the pledge agreement.

Pledge of shares in joint-stock companies

Pledge of shares in joint-stock companies is regulated by the legislation on joint-stock companies.

Key features include:

• Stock turnover: Shares are liquid assets that can be freely transferred, so pledging shares has fewer restrictions than pledging shares in an LLC.
• Right to dividends: The right to receive dividends during the term of the pledge may remain with the mortgagor or pass to the pledgee, depending on the terms of the contract.
• Franchise: As in the case of shares in an LLC, the right to vote at shareholders’ meetings may remain with the mortgagor or be transferred to the mortgagor.

Pledge of corporate rights, like any other financial transaction, is associated with certain risks:

• The risk of losing the right to manage the company in the event of foreclosure on pledged corporate rights. This can lead to a loss of influence on the company’s strategic decisions or even a loss of business share.
• Impairment of corporate rights. In the event that the value of corporate rights decreases significantly (for example, due to the deterioration of the company’s financial condition), this may affect the ability of the lienholder to recover its funds. The mortgagor may also suffer losses due to a fall in the value of his share in the company.
• Legal disputes. The transfer of corporate rights as collateral may lead to conflicts with other members of the company or shareholders. This is especially the case when the pledgee receives the right to vote at the general meeting or other important management functions.