Olger Kaelep, an attorney-at-law at Law Firm TEGOS, writes about the surprising connection between the most famous hero’s journey of the ancient world and a pledge-related problem hampering the business environment in Estonia
This past summer was characterised by a number of keywords; in the cultural sphere, one such word was undoubtedly ‘The Odyssey’. The last time there was such intense worldwide interest in Homer’s epic poem was probably back when the fastest way to travel involved a strong tailwind and vigorous rowing. The reason for such widespread enthusiasm was no doubt the film adaptation by Sir Christopher Nolan, liberally sprinkled with Hollywood stardust. Although a powerfully crafted and entertaining experience, this writer managed to be a lawyer even in the darkness of the cinema, drawing parallels between events unfolding on screen and a far more mundane topic: the share pledge.
Deceptively calm waters
If one reads the laws superficially, everything seems quite simple and clear. If a company’s shares are registered in the Estonian Securities Register, they can be pledged as security for a loan or other debt obligation. Registering a pledge requires the pledgee to have a securities account, which they can open through a securities account administrator, usually a bank. So it would seem that the pledgee has nothing more to do than set the right course and calmly sail home (read: towards the share pledge). Unfortunately, real life is not quite so straightforward, and even the best-laid plans may fail to materialise.
If the pledgee is local, their road to the share pledge should not be particularly winding. An Estonian company that already has a current account can relatively easily and quickly open a securities account with a bank. The situation is quite different for a foreign pledgee (from another EU Member State or a so-called third country). In recent years, the process of opening a current account with an Estonian bank has become increasingly complex and time-consuming for foreign companies, whilst the volume of required information and documents has risen at the same rate. It is not uncommon for a prospective pledgee to be unable to provide data to the bank’s satisfaction even after months of correspondence, or for the bank to decide not to open an account based on the data submitted. If the pledgee themselves or their beneficial owners are from outside the European Union, the likelihood of a negative decision is higher.
The lesser of two evils
One of the most difficult moments in Odysseus’s arduous journey was undoubtedly the choice between two deities threatening the sailors: the deadly whirlpool Charybdis, sailing into which, according to prophecy, would mean certain death for the entire crew, and the monster Scylla, lurking in the rocky caverns, whose territory, if traversed, would ‘merely’ extinguish the lives of six men. Odysseus took responsibility as a leader and chose Scylla, although his guilt over the loss of his comrades long continued to gnaw at the tormented film hero – or rather, anti-hero – portrayed by Matt Damon. If opening a full-scale securities account represents, for a similarly beleaguered foreign pledgee, Charybdis, from which there is little hope of emerging alive, then what might be their Scylla?
The answer lies in the phenomenon commonly known as a ‘pledge account’. A pledge account, as referred to in this article, is an internal, ‘technical’ account opened at a bank solely for the purpose of pledging. In practice, this may simply mean a pledge notation on the securities account of the securities holder aka the pledgor, or the blocking of the pledgor’s shares within the bank’s system, the existence of which enables the bank to make the pledge entry in the securities register. (To add to the confusion, Estonian law uses the same term ‘pledge account’ in connection with another rather specific term ‘financial collateral’, which, however, applies to a very limited group of participants and is not relevant to the context of this article.) The advantage of a ‘technical’ pledge account for the pledgee, compared to an ordinary securities account, is undoubtedly the fact that it is not necessary to first open a current account to open a pledge account. As a result, the volume of data and documents to be submitted to the bank before establishing a customer relationship is significantly smaller and, therefore, less burdensome for the pledgee.
It sounds wonderful, but an attentive reader will surely recall that Scylla represented both an opportunity and a threat to Odysseus’s crew. The same applies to the pledge account.
An imperfect sense of security
Unlike a standard securities account, in the case of a technical pledge account the pledgee does not have the option, when enforcing the pledge by selling the securities, to temporarily transfer the shares to their own account and from there to the buyer’s securities account. Instead, all transactions must be carried out via the pledgor’s securities account, and their execution depends on the cooperativeness of the bank acting as the pledgor’s account manager. The pledgee can only hope for prompt communication and good cooperation with the bank throughout the entire term of the pledge.
A new tangled web of risks may arise in the situation where the bank acting as the administrator of the pledge account becomes insolvent. Although rare nowadays, a bank’s bankruptcy is by no means impossible, and in such a case it is important that the pledgee’s rights in relation to the pledge account are not included in the bankruptcy estate but are treated as separate from the bank’s own assets. The operating principles of a technical pledge account are not regulated at all at the legislative level, let alone the fate of the pledge in the event of the account manager’s insolvency.
In addition to these concerns, pledges linked to a pledge account are also plagued by other typical problems associated with share pledges: unlike with mortgages or commercial pledges, the securities register lacks the technical capability to record pledges with different priority rankings, although the law does not expressly preclude this option, and the description and time limits of the activities relating to pledges carried out by banks acting as account managers are largely left to be regulated by the banks’ internal procedures, which makes them non-transparent to the pledgee.
How to reach home sooner
Share pledges, as a form of collateral, are characterised in Estonia by largely inconsistent regulation at the legislative level, regardless of the type of account the pledgee intends to use to establish the pledge (a standard securities account, a nominee account available to professional participants in the securities market, or the technical pledge account that is the focus of this article).
Most of these obstacles could be removed through legislative clarifications and amendments, and through the joint goodwill and efforts of the legislature, state authorities, banks, and the registrar. For example, the Securities Register Maintenance Act would benefit from being amended with transparent and unambiguous rules concerning the process of establishing a pledge using different types of securities accounts. A review of the provisions relating to share pledges in the Bankruptcy Act, conducted with a similar approach, would provide necessary clarity and certainty for the pledgee that their rights secured by the pledge are protected, regardless of the approach used to establish the pledge.
An even more pressing issue is what could be done (and who could do it) to ensure that opening current and securities accounts with Estonian banks for the purpose of creating a pledge does once again become more than a hopeless prospect for many foreign companies. The ‘Know Your Customer’ measures that banks apply to potential new clients are absolutely essential but should not hinder the local business environment by preventing Estonian companies from receiving the loans they need in a timely manner, simply because it is impossible to set up collateral within a reasonable timeframe.
Of course, some intrepid pledgees, with sufficient resolve and a great deal of good fortune, will manage to navigate these treacherous waters even now, offering sacrifices to Scylla rather than Charybdis, and eventually make it home – which for the Estonian economy usually means a revitalising injection of cash in the form of financing secured against collateral. At the same time, it is worth asking whether their journey really needs to be so long and perilous, or whether we might leave Odysseus to wander through pages of verse and the silver screen and find more sensible and simpler solutions for everyday life.
