Singapore Court Verifies Validity of Collateralized Securities Loans

In March 2018, a Singapore appellate court issued an opinion that verifies the validity of collateralized securities loans and the processes that borrowers and lenders rely on to administer those loans.

The facts in the case of Qilin World Capital Ltd. v. CPIT Investments Ltd. reflect one aspect of a lender’s hedging and risk management in a typical collateralized securities loan. In November 2015, Qilin loaned HK $31.25 million to CPIT, which pledged 25 million shares of Millennium Pacific Group Holdings stock to secure that loan. CPIT transferred those shares to a third-party custodian, Prominence Financials, Ltd., according to a stock secured financing agreement that Qilin and CPIT both executed. That agreement gave Qilin the right to “transfer, re-hypothecate, and assign” the collateral shares.

Between December 2015 and January 2016, Qilin directed the custodian to transfer approximately 90% of the total number of shares in the custodial account into a different account, from which those shares were then sold in the open market. CPIT sued Qilin over that transfer, arguing that it amounted to an improper disposal of the shares that was not allowed under the loan agreement.

The appellate court rejected CPIT’s argument, concluding that the matter turned on whether Qilin intended to acquire full legal right and title to the shares at the time of the transfer. It determined that Qilin had no intention to take ownership of the shares, as doing so would have increased Qilin’s exposure to the vagaries of the securities market. Rather, Qilin’s actions were a legitimate hedge against those vagaries and that CPIT still maintained an equity of redemption in the shares under the loan agreement. There was no evidence that Qilin desired to acquire full legal and beneficial ownership of the shares. The transfer of those shares was therefore allowed under the terms of the loan agreement.

Commentators have noted that the loan agreement language which allowed Qilin to “transfer, re-hypothecate, and assign” the collateral shares affirms a lender’s right to direct actions concerning the shares that protect a lender’s security interest in those shares. In all cases, the lender remains liable to return the collateral shares to the borrower at the end of the loan term and upon the borrower’s repayment of the principal balance of the loan.

The court also addressed, but rejected CPIT’s argument that Qilin’s actions led to a decline in the value of the collateral shares. Expert testimony persuaded the court that no single factor accounted for a reduction in the per-share price of the Millennium Pacific Group Holding shares that CPIT had pledged as collateral, and that the price of those shares had varied dramatically separately and apart from any actions that Qilin had taken.

More than just affirming the validity of collateralized stock loans, this case demonstrates the importance for both borrowers and lenders of having knowledgeable and experienced financial and legal counsel review and explain complex loan documentation. Collateralized securities loans are an appropriate debt financing mechanism only for those investors that have the financial knowledge and sophistication in the securities markets to comprehend the agreements and documents that memorialize the terms and conditions of complex transactions. No borrower should proceed with a stock loan unless and until that borrower is comfortable with the advice it has received from professional legal and financial counsel.

References:

https://www.supremecourt.gov.sg/news/case-summaries/qilin-world-capital-ltd-v-cpit-investments-and-another-appeal