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Can you gain control of a target through a share charge?

In a decision delivered on 30 January 2013 (Cukurova Finance International Limited v Alfa Telecom Turkey Ltd), the Privy Council, one of the highest courts in the UK whose judgments are of great persuasive authority both in England and in Hong Kong, threw light on some aspects of this question.

The Cukurova Group had a 26.8% stake in Turkcell Iletisim Hizmetleri AS, Turkey's largest mobile telecommunications company, whose shares are traded on the Istanbul and New York Stock Exchanges. Cukurova came under considerable cash flow pressures and agreed with the Alfa Group, a substantial Russian conglomerate, to:



issue to Alfa convertible bonds in respect of its 13.2% interest in Turkcell for just under US$1.6 billion; and


borrow US$1.352 billion under a facility agreement, secured by charges (governed by English law) over its 13.6% interest in Turkcell, and another US$355 million on a clean basis.


The court found that from the outset, Alfa entered into these transactions with a view to acquiring control of Turkcell.

Alfa had anticipated that Cukurova would fail to meet its liability to pay interest, but payment was made when due. Alfa then sought to achieve its commercial aim by accelerating the borrower's liability to repay the secured loan by declaring 16 events of default (without any prior indication of any of the matters complained of). A day later, it held a press conference in Istanbul, during which reference was made to the 16 events of default, and the issue of two writs in the British Virgin Islands against Cukurova. Alfa also made statements suggesting that Cukurova was in financial difficulties.

A month later, Cukurova gave notice to repay the loan. The money was then tendered to Alfa. The tender, if it had been within time, would clearly have been valid. Alfa refused to accept the tender, saying that it was made too late. Alfa had exercised its right to accelerate the loan and had appropriated the charged shares (that is, convert its rights under the share charges into ownership of the shares).

Three issues in particular are of interest:

  1. The relevance of Alfa's motive in gaining control of Turkcell

    Cukurova contended that, Alfa's decision to appropriate the charged shares was void, even if there was an event of default, because it was vitiated by its improper and collateral reasons.

    The Privy Council decided that if a chargee enforces his security for the proper purpose of satisfying the debt, the mere fact that he may have additional purposes, however significant, which are collateral to that object, cannot vitiate his enforcement of the security.


  2. Should Cukurova nevertheless be permitted to regain the shares?

    Cukurova argued that if Alfa was entitled to give notice of acceleration and was therefore in principle entitled to appropriate the charged shares, the court should give Cukurova relief in equity and restore the shares to them (on appropriate terms).


    The Privy Council first decided that the courts have power to intervene, in the case of a mortgage in which the primary object of the bargain was to secure the repayment of the loan together with interest, and the forfeiture provision, namely the power to appropriate, was added in order to secure that result. This power is not limited to mortgages of an interest in land, but extends to charges over shares.

    The Privy Council then said that equity is willing, in cases of security for the payment of money, to give relief on terms that the payment is made with interest, if appropriate, and also legal costs. Factors bearing on the appropriateness of relief include the borrower's conduct, in particular whether his default was wilful, the gravity of the breaches, and the disparity between the value of the shares as compared with the damage caused by the breach. In this case, the relevant factors included:



    The contractual basis of valuation of the shares for the appropriation was the weighted average market value of publicly traded Turkcell shares over the previous 60 day period on the Istanbul Stock Exchange. This made no allowance for the value of acquiring control over Turkcell. 


    The transaction was structured to preserve Cukurova's control over Turkcell. Despite Alfa's wish to acquire control, Cukurova was only willing to sell 49% of the shares in the shareholding subsidiary to Alfa.


    Alfa acted within its rights in voting against a distribution of dividends until audited financial statements were available. It also acted within its rights in remaining silent about its plans to call in the loan because it wished to spring acceleration on Cukurova, reducing the window within which Cukurova might be able to achieve a refinancing. The press conference statements, although designed to hamper Cukurova's refinancing, were not actually causative of its inability to complete its refinancing prior to the appropriation. But all these factors exposed the reality that Alfa was primarily concerned with the shares not as security, but for control over Turkcell.


    Even if all the alleged events of default could be relied on, they were limited in number and were not shown to have been caused wilfully.


    The event of default constituted by an arbitration award was of potential gravity, in that it was likely to (and did eventually) lead to a major financial liability in damages. But its actual gravity was diminished by the consideration that Alfa's financial position was never really threatened by the award. Alfa's financial interests as lender were protected by the share charges. At the material times, the value of the shares was sufficient to cover the entire loan.


    Within a month of the appropriation, Cukurova tendered payment.


     Relief was claimed only after a considerable period had elapsed. But the position regarding use of the shares and control of Turkcell had been frozen, so that relief to restore the status ante quo was in principle feasible.


    The traditional view had been that it should be very difficult to establish a case for relief in a commercial context involving a freely negotiated contract. In such cases courts should place considerable emphasis upon the need for certainty. The Privy Council accepted the need for commercial certainty, but nevertheless ordered restoration of the shares to Cukurova on the ground that the case involved a combination of "unusual features [as identified above] which are most unlikely to be repeated".  


  3. A clause which entitled Alfa to be judge in its own cause

    An alleged event of default relied on a clause of the facility agreement referring to an "event or circumstance which in the opinion of [Alfa] has had or is reasonably likely to have a material adverse effect on the financial condition, assets or business of [the borrower]". It is accepted that an event need not objectively have such an adverse effect to fall within the clause: all that is required is that Alfa honestly and rationally believes that it has such an effect. The result is, in the words of the Privy Council, "[t]he clause virtually entitles one contractual party, [the lender], to be judge in its own cause on the issue of whether the clause is satisfied, and, if it is so satisfied, has a potentially drastic effect on the economic position of the other contractual parties, [the borrower]." 

The decision highlights the need to pay careful attention to the particular circumstances of the transaction and for proper advice.


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