In the Singapore Court of Appeal’s judgment in Qilin World Capital Ltd v CPIT Investments Ltd and another appeal [2018] SGCA(I) 1 (available as of 8 March 2018 on Singapore Law Watch here) (the “Judgment“), the Court was tasked to determine the nature of security granted by one party to another in consideration of a loan. In this case, certain shares were regarded as being “pledged” by the borrower to the lender.

This was held by the court below as incorrect as no physical share certificates existed. Consequently, a pledge being a possessory form of security could not be said to have been granted.

As noted by Dyson Heydon IJ at [4] of the Judgment, the Court held:-

While share certificates, which were once common, can be treated as choses in possession, there is no evidence that there were any share certificates involved here. By “Pledged Shares” the parties meant “shares used as security for the Loan”. The Pledged Shares were shares in Millennium Pacific Group Holdings Ltd (“Millennium”). CPIT also owned 1.27 billion shares in Millennium which were not used as security for the Loan.”

Instead, the court below held that the borrower had granted the lender an equitable mortgage over the shares. Reversing that finding, the appellate court held that the borrower intended to grant a legal, rather than equitable, mortgage over the shares to the lender.

At [41] and [47] of the Judgment, the Court held as follows:-

41 It is therefore crucial, in analysing the nature of the 2 December Transaction, to decide what the intention of Qilin was. Was Qilin’s intention to acquire full legal and beneficial title to the Pledged Shares, thereby destroying CPIT’s beneficial rights and interest? It is Qilin’s intention that is crucial to the question: Was the 2 December Transaction a disposal of the Pledged Shares or a transfer?

47 It makes no sense to treat Qilin as having intended through the 2 December Transaction to acquire the whole legal and equitable interest in the 25 million shares. That is so for the following reasons:

(a) Qilin had already parted with HK$31.25 million in favour of CPIT, being the advance of the Loan, just a short while before. That advance was secured solely by the Pledged Shares. Qilin’s sole means of securing repayment was to exercise its rights as a mortgagee against the Pledged Shares.

(b) Qilin had gone to considerable lengths to ensure that it had security that on the face of it was worth at least twice as much as the HK$31.25 million loan. This built in a buffer against volatility and the vagaries affecting the market price of the shares.

(c) If CPIT is correct in its submission that the 2 December Transaction was a “sale” by Qilin qua mortgagee to Qilin 

qua purchaser of the entire legal and beneficial interest in those shares, even assuming this could be done in law, which is questionable, given the difficulties facing self-dealing by a mortgagee without the mortgagor’s consent, the net position would be that Qilin had acquired the shares for itself for a price of HK$62.5 million. This increased its original exposure in the sense that it would, on this basis, have taken the equity risk on the shares to the tune of HK$62.5 million in addition to having already paid CPIT the Loan advance of HK$31.25 million. If the shares proved worthless, it would lose the HK$62.5 million it had “paid” for the acquisition. It would also have to pay CPIT HK$31.25 million because CPIT’s position would have been crystallised by the sale and this was the net amount payable to CPIT on this basis (being the sale proceeds of HK$62.5 million minus the loan amount of HK$31.25 million which it would be entitled to recover from the sale proceeds).

(d) Nobody else could have had any interest in the HK$62.5 million on the hypothesis outlined in (c) above because the transaction had to cover both the legal and beneficial interest in the shares and it was and is common ground that CPIT had the beneficial interest subject only to Qilin’s security interest.

(e) To conclude that Qilin intended to increase its exposure in this way would make no sense. The end result of this would have been to lock in the value for CPIT and transfer the equity risk in relation to the 25 million shares for which Qilin had “paid” HK$62.5 million to itself. This would have been inconsistent with its desire to have security of a value double the amount of the Loan.

(f) The only basis on which this could make sense would be if Qilin believed that the value of the Pledged Shares was going to go up. But it clearly did not believe this. That is revealed by its actual conduct in the market. The transfer to Haitong was effected as a means of increasing its ability to sell the shares. Days after the 2 December Transaction, Qilin started to sell shares on a falling market for less than HK$2.50. If Qilin had believed that the shares were going to go up in value, it would have been buying shares when the price fell rather than selling them. No reason has been suggested why Qilin would suddenly go from being extremely bullish to being extremely bearish in the space of those few days.

(g) If Qilin’s entire strategy was driven by the view that the shares would increase in price it could not possibly have thought it could limit CPIT’s rights to HK$62.5 million and reap the rewards of a massive windfall in the event that the price did go up.

(h) On 2 December 2015, the stock market price was HK$2.42. It is improbable that Qilin intended to buy the 25 million shares for HK$2.50 through the 2 December Transaction when it could perhaps have bought them on the stock market for HK$2.42.”

[emphasis added]

This finding was critical as a legal mortgage empowers the mortgagee to sell the mortgaged property, an act which was challenged in the present case.  Central to the court’s analysis was the Court’s interpretation of the parties’ objective intentions taking into consideration the nature of the transaction(s) in question, namely that the borrower had intended to pass legal title in the shares to the lender, such that the lender had the legal right of sale.

The takeaway is that substance will trump form in characterising the nature of security granted by one party to another.

8 March 2018

*The contents of this article represent the views and observations of the author alone from a Singapore law perspective and are subject to copyright protection under the laws of the Republic of Singapore (as may from time to time be amended). No part of this article may be reproduced, licensed, sold, published, transmitted, modified, adapted, publicly displayed and/or broadcast (including storage in any medium by electronic means whether or not transiently for any purpose save as permitted herein) without the prior written permission of the author.

Please note that whilst the information in this article is correct to the best of the author’s knowledge and belief at the time of writing, it is for academic reference, does not constitute legal advice and is only intended to provide a general guide to the subject matter. It should therefore not be treated as a substitute for specific professional advice for and/or in respect of any particular course of action as such information may not suit your specific business, operational and/or commercial requirements. You are therefore urged to seek legal advice for your specific situation. All the author’s rights are expressly reserved and nothing herein shall be construed as a waiver thereof.