COVID-19 Advice: Post-Default Enforcement Against Equity Collateral 

The pledge of equity interests of a privately held company as collateral is a common occurrence in a wide variety of financing structures. What is not as common perhaps is for secured creditors to analyze, at the initial stages of a transaction, the road maps that may serve to mitigate any meaningful delays or diminution in the value of such collateral in a foreclosure scenario. When a secured party takes as collateral equity interests of privately held companies, the potential for a drawn out and difficult foreclosure process should be vetted at the structuring stage of a transaction. In connection with such vetting, the secured party should analyze the applicable provisions of Article 9 of the Uniform Commercial Code, as enacted pursuant to applicable state law (the ‘‘UCC’’). In particular, the secured party should be aware of the parameters and uncertainties regarding the permitted scope of its conduct after a default but prior to a foreclosure with respect to such collateral, especially in light of the 2019 Novel Coronavirus (“COVID-19”) pandemic and the resulting effects on general commercial activity and volatility in financial markets across the world.

In order to manage and mitigate such risks while simultaneously avoiding any lender liability claims after a default, a secured creditor needs to consider (i) its rights under the applicable UCC provisions and the applicable loan documents and (ii) the scope of the power of attorney and proxy in relevant security documents. Such considerations will help to formulate a well-informed foreclosure strategy going into the applicable transaction.2

When a secured creditor takes equity interests as collateral, it is not uncommon to hear such creditor speak as though it will simply take over the rights to such equity interests and control the issuer upon an event of default. In practice, foreclosing on equity interests of a privately held company, such as those representing ownership interests in limited liability companies, limited partnerships or other non-public entities, is not quite as cut and dried.3

 


Footnotes:

Craig Unterberg is a partner in Haynes and Boone, LLP’s New York office, where he leads the firm’s Margin Lending and Structured Equity Group. He concentrates his practice in the representation of borrowers and lenders and can be reached at [email protected] Alex Grishman is a partner in Haynes and Boone, LLP’s New York office, where he is a member of the firm’s Margin Lending and Structured Equity Group. He concentrates his practice in the areas of commercial and corporate finance transactions and restructurings. Alex can be reached at [email protected].


2 In addition, for a secured party that plans to take equity interests in limited liability companies, partnerships or foreign entities as collateral, it is also important to determine whether the secured party must obtain the consent or acknowledgement of the underlying issuers, general partner, or managing member in order to obtain the economic or non-economic rights (such as voting) related to the applicable equity interest. In certain situations, a failure to obtain such a consent can eliminate a secured party’s ability to enforce or foreclose on the non-economic rights related to such equity interests.


3 For publicly traded equity interests that are listed on an exchange that satisfies the recognized market requirement under the UCC (which most U.S. listed equities will satisfy), the foreclosure process is significantly less restrictive. This is due to the fact that a commercially reasonable determination of the price has already been established by such recognized market. So, foreclosing on publicly listed shares can be relatively simple by just selling them on the relevant exchange (assuming there are no securities law restrictions on such sales). As a result, this Article will focus on collateral consisting of privately held equity interests as collateral). 

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