Vietnamlawmagazine

Bui Duc Giang[1]

Audier and Partners Vietnam LLC[2]

KEY POINTS

 Although the law is unclear, the most appropriate form of security over shares is a mortgage, which unlike English law does not entail transfer of ownership in favor of the secured creditor.

 Two consensual enforcement options available to the holder of a mortgage over shares are sale to a third party and appropriation.

 If the purchaser or the mortgagee appropriating the shares subject to the mortgage is a foreign entity, it must carry out the required investment procedures to give effect to the share transfer.

The question, addressed by this article, considers what form of security a creditor may take over shares in a Vietnamese company and how it can enforce the security. This question is rather complex, and this article can do no more than sketch the outlines. It should be also noted that marketable securities such as shares of public companies may be pledged in compliance with specific regulations (notably, Article 31 of the Regulations on registration, depository, clearing and settlement of securities issued by Decision No. 87/2007/QD-BTC of the Ministry of Finance dated 22 October 2007 as amended in 2010, Articles 31 to 34 of the Regulations on depository of securities issued by Decision No. 38/QD-VSD of Vietnam Securities Depository dated 25 April 2012 and Article 19.3 of Decree 163). The creation and enforcement of security over such shares are quite different from the position regarding shares in a limited liability company or a shareholding company which is not a public company and are beyond the scope of this article.

Attachment and perfection

What type of security to take?

The Civil Code provides a general principle that property rights over capital contribution into an enterprise may be used as security assets (article 322). Although it seems difficult to pin down the meaning of the expression property rights over capital contribution into an enterprise, it can be inferred that the Civil Code recognizes the validity and enforceability of security over shares.

Article 140 of the Law on Enterprises No. 60/2005/QH11 dated 29 November 2005, as amended in 2009 and 2013 (the “Law on Enterprises”) provides that a partner of a partnership is entitled to mortgage/pledge its contributed capital in the partnership[3]. Nevertheless, the Law on Enterprises says nothing with respect to the possibility to take security over the contributed capital in a limited liability company or shares of a shareholding company. For ease of reference, we will refer to contributed capital in a limited liability company and shares of a shareholding company as “shares” in the later developments below. As partnerships are not a common type of company in Vietnam, we will focus only on security over shares of limited liability companies and shareholding companies.

Under Decree No. 163/2006/ND-CP dated 19 December 2006 on secured transactions as amended by Decree No. 11/2012/ND-CP dated 22 February 2012 (“Decree 163”), it is possible to take a pledge over share certificates (Article 3.9 and Article 19.3). Delivery of the share certificate would help meet the requirement of delivery of the possession of the pledged asset to the creditor by way of security as provided in Articles 326 and 328 of the Civil Code. However, pursuant to Article 85.1 of the Law on Enterprises, share certificates are certificates issued by a shareholding company or book entries which certify the ownership over one or more shares of such company. The document does not itself embody the rights of action against the company since the benefits flowing from an interest in the shares, such as the right to vote, to receive dividends and to participate in a surplus on liquidation, and all other contractual rights against the company depend on registration in the register of the company[4].

Shares are an intangible asset[5], which are not susceptible to the delivery of possession to the secured creditor. Furthermore, they represent a debt owed by the company to the holder of the shares (members or shareholders). A mortgage appears to be the most suitable security over shares in the sense that a mortgage does not require delivery of the secured property to the secured creditor and Vietnamese law expressly recognizes mortgage as the unique security over debt claims[6].

Secured obligations

A debt may be fully or partly secured. If there is no agreement on, or if the law does not provide, the scope of the security, the obligation is deemed to be fully secured including the obligation to pay interest rates and to compensate for damage (Article 319.1 of the Civil Code).

In theory, the secured obligation can be a liquidated obligation or an unliquidated obligation. However, because of the prohibition against unjust enrichment set out in Article 256 of the Civil Code and the obligation on the secured party to remit the balance between the price or value of the secured asset and the secured amount provided in Articles 355 and 338 of the Civil Code as well as Articles 64a. 2 (b) and Article 64b. 2 of Decree 163, it appears that the realization of the secured asset may take place only if the value of the asset is used to pay (i) the payment obligation, (ii) the interest rates, (iii) the damages and (iv) contractual penalties.

Article 319.2 of the Civil Code provides a principle that the secured obligation may be a future obligation. Article 8a of Decree 163 further indicates that “in case a security interest is created to secure a future obligation, the parties are not required to reach a specific agreement on the scope of the secured obligation or on the deadline for performing the secured obligation, unless there is some other agreement between them or unless the law otherwise stipulates. When the obligation is formed, the parties are not required to register changes to the registered items of the secured transaction”. This is very favorable for secured creditors. For example, when the value of the shares is much greater than the amount of the secured obligation, the security agreement may state that “the shares are mortgaged to secure the whole loan X and all other loans or financial obligations of the mortgagor generating in the future relationship between the bank and the mortgagor”.

Validity and enforceability

Article 343 of the Civil Code requires that the share mortgage be in writing. However, the mortgage does not need to be notarized.

The mortgage is enforceable against the parties from the date of its execution unless otherwise provided by the parties (Article 10.1 of Decree 163). It is enforceable against third parties from the date of its registration with the National Centre for Registration of Transactions and Assets (NRAST) under the Department of Security Registration of the Ministry of Justice[7] (Articles 323.3 and 325 of the Civil Code, Article 11.1 of Decree 163 and Article 3.7 of Circular No. 05/2011/TT-BTP of the Ministry of Justice on registration of security with NRAST dated 16 February 2011).

Transfer of ownership over shares as security

In practice, it is quite common that the debtor transfers ownership of the shares it holds in a company as security in favor of its creditor. Is that security valid and enforceable under Vietnamese law?

Pursuant to Article 318 of the Civil Code, security measures include pledge of assets, mortgage of assets, security deposit, deposit securing the return of leased property, escrow deposit, guarantee and reputation-based security. The first five security types constitute asset-based security whereas guarantee and reputation-based security involve mere personal undertakings to perform. The types of asset-based security that are mentioned in the Civil Code confer mere rights over the secured assets, while the ownership of the secured assets remains with the securing party. Therefore, Vietnamese law does not recognize the transfer of ownership over shares in favor of a secured lender as security for a loan.

The Supreme People’s Court of Vietnam has invalidated contracts for the transfer of ownership over real property as security for loans by re-characterizing such contracts as mere mortgages[8] or by ruling that that they constitute false contracts.[9] Even if the assets which are the subject of the security measures are immovable assets, we understand that the Supreme People’s Court of Vietnam has established the principle that the transfer of ownership of an asset cannot be used as a means of security and that such transfer of ownership by way of security is not valid or enforceable.

Dividends, communications and voting rights

As the share mortgage does not entail transfer of the ownership over the shares to the secured creditor, the mortgagor remains the owner of the shares until enforcement. As a registered member or shareholder of the company, the mortgagor is still entitled to receive all dividends and communications sent to members or shareholders and to exercise all voting rights.

Enforcement of a mortgage over shares

Overview

Under Article 56 of Decree 163, a creditor may enforce its security in the following circumstances:

 The debtor fails to perform or performs incorrectly the secured obligation when it falls due;

 The debtor has to perform the secured obligation early because of its breach of that obligation pursuant to an agreement or as provided by law[10];

 The law requires that the secured asset be realized in order for the securing party to perform other obligations[11];

 Other cases as agreed by the parties or provided by law.

Before enforcing a security interest, the secured party must give notice of the enforcement[12] to the securing party and the other registered secured creditors (if the asset has been secured in favor of more than one creditor) or register the notice of enforcement with the relevant registrar of security (Articles 61 and 62 of Decree 163). The secured party can only enforce the security upon the expiry of a waiting period, which may be agreed by the parties. Absent such agreed-on waiting period, the time for realization which will not be earlier than 7 days as from the date of the notice of enforcement (Article 62 of Decree 163).

Enforcement on corporate insolvency proceedings

As from the date on which a court accepts jurisdiction over a petition to commence insolvency proceedings, realization of the secured shares of the insolvent mortgagor is suspended. Such enforcement may be authorized by a court if the following conditions are concurrently met: (i) the secured debt has matured; (ii) the enforcement does not materially affect the business of the mortgagor and (iii) the secured creditor provides in writing legitimate reasons for such enforcement and the necessity of it (Article 27 of the Law No. 21/2004/QH11 on Bankruptcy dated 15 June 2004 (the Law on Bankruptcy) and item 2, section II of the Supreme People’s Court’s Resolution 03/2005/NQ-HDTP dated 28 April 2005 guiding implementation of certain articles of the Law on Bankruptcy). In other words, the court will consider how the enforcement of the share security would impinge upon the rescue of the insolvent mortgagor in order to decide whether or not to authorize the enforcement. Moreover, on liquidation of the insolvent mortgagor, the mortgagee ranks in priority to all preferential creditors (e.g., insolvency expenses, claims of employees against the company or tax claims) and unsecured creditors (Articles 35, 36 and 37 of the Law on Bankruptcy).

Options for enforcement

The enforcement of the security is conducted in accordance with the methods of enforcement that the parties have agreed on in the security agreement. Absent an agreed-on method of enforcement, the secured asset will be auctioned (Article 58.1 of Decree 163).

There are two main consensual enforcement routes which are available to the holder of a mortgage over shares: sale to a third party and appropriation.

Pursuant to Article 439 of the Civil Code, “ownership with respect to property for sale passes to the purchaser from the time when the property is delivered, unless otherwise agreed by the parties or unless otherwise provided by law. Where the law requires that ownership with respect to property, which is the subject matter of a contract for sale, must be registered, such ownership shall pass to the purchaser upon completion of the procedures for registration of the ownership with respect to such property”. More specifically, under Article 449.3 of the Civil Code, “the time when ownership rights with respect to property rights are transferred is the time when a purchaser receives documents evidencing the ownership rights with respect to the property rights, or the time when the transfer of the ownership rights is registered if so provided by law”. It should be noted that the law does not require registration of ownership over shares with a competent State authority.

Under Article 26 of the Law on Enterprises, any amendment to the registered contents of the Business Registration Certificate will be re-registered with the Provincial Department of Planning and Investment (DPI) within ten (10) days from the date of the change. Failure by the company to register the purchaser or mortgagee as its new founding shareholder or late registration is subject to a fine between VND 3,000,000 and VND 5,000,000 in accordance with Article 34 of Decree No. 53/2007/ND-CP dated 4 April 2007 on administrative sanctions on the fields of planning and investment, as amended in 2010.

Pursuant to Article 87.5 of the Law on Enterprises, the seller of shares will remain the owner of the shares until the name of the purchaser is registered in the register of shareholders. As such, the time of transfer of ownership over shares in a shareholding company is the time of registration of the purchaser in the register of shareholders. In case of a mortgage over shares, in compliance with this principle, the purchaser or the mortgagee will become the owner of the shares upon its registration in the register of shareholders of the company in which the shares have been mortgaged.

It should be noted that the law does not set out such principle in case of transfer of share of a limited liability company. Therefore, two interpretations are possible:

 Ownership over the shares is passed to the purchaser or mortgagee upon registration of it in the register of members of the company.

 Ownership over the shares is passed to the purchaser or mortgagee upon registration with the DPI.

As the law remains unclear, it is in the interest of the purchaser or mortgagee to request the company and the mortgagor to procure both registrations in order to give effect to the share transfer.

Finally, pursuant to Article 63.1 of Decree 163, on enforcement of the security, the person who currently retains the secured asset must hand it over to the secured party. It is not clear how such hand-over could be effected in relation to shares, but presumably this would entail the director of the company cooperating to register a transfer of the shares into the name of the purchaser or mortgagee.

Restrictions on share transfer

The law does not deal specifically with the requirement for approval of the new member or shareholder, being the purchaser or mortgagee of the shares, by the other members or shareholders of the company. Indeed, the Law on Enterprises addresses only the transfer of shares by way of sale and the payment of a debt by means of shares. In case of a limited liability company, the proposed transferor must first offer to sell its shares to other members of the company (Article 44.2 of the Law on Enterprises). Likewise, the creditor receiving the shares of a member in the company in lieu and in place of payment of a debt owed to him by that member will become a member of the company only upon approval of other members (Article 45.6 of the Law on Enterprises). In case of a shareholding company, within three years as from the date of issuance of the business registration certificate to it, a founding shareholder may transfer its ordinary shares to the other founding shareholders but the transfer to a third party is subject to the approval of the General Meeting of Shareholders (Article 84.5 of the Law on Enterprises)[13]. As such, the spirit of the Law on Enterprises is to prevent the transfer of shares to third parties which would allow them to participate in the Members’ Council or the Board of Directors of the company, unless such transfer is approved by the other members or shareholders. In order to avoid subsequent conflicts, the mortgagee may seek prior approval of the other members or shareholders of the company when entering into the share mortgage.

Furthermore, existing caps on foreign ownership in Vietnamese companies may significantly affect the enforcement of security over shares in case the purchaser or the mortgagee is a foreign entity[14].

Finally, the company’s charter may prohibit the creation of any security interest over shares. Therefore, careful reading of the company’s charter is needed to determine if any such prohibition exists. If the charter contains an express prohibition on the creation of security interests over shares, the mortgage will not be enforceable. In this case, the secured creditor should insist on the members or shareholders altering the charter so that shares are freely transferable to it and, following enforcement of the security, by it to a purchaser. To protect against a future change to the charter removing the freedom of transfer, the mortgagee should, where necessary, obtain undertakings from other members or shareholders not to vote on a resolution to alter the charter[15]. Such undertakings would be legally binding on the members or shareholders.

Sale

The holder of a mortgage over shares may sell the shares on a default without the need to apply to court if this method of enforcement is contained in the security agreement (Article 59.1 of Decree 163). The sale must be effected in compliance with Article 428 and seq of the Civil Code relating to contracts for sale of property, especially with provisions governing the sale of property rights[16]. The parties may reach an agreement on the value of the secured shares or must appoint a property valuation entity to fix the selling price of the secured shares (Article 64a.2 (a) of Decree 163).

Under Article 198 of the Civil Code, a person who is not the owner of an asset is allowed to dispose of this property only under a power of attorney or by operation of law. It seems from the reading of Article 64a.2 (b) of Decree 163[17] that the secured creditor has the right to proceed with the sale of the secured shares without having to obtain a power of attorney to do so from the securing party[18]. However, if the mortgagee wishes to sell the shares itself, this option should be clearly stated in the mortgage agreement to prevent subsequent conflicts.

The law is silent on the duties that the mortgagee owes to the mortgagor on a sale. But the mortgagee should have a duty to act in good faith and take reasonable steps to obtain the best price reflecting full market value for the shares. Furthermore, if the mortgagee sells the shares to a company in which it has an interest, the mortgagee and the purchaser must demonstrate that the mortgagee took reasonable precautions to get the best price reasonably obtainable at the time[19].

If the sale proceeds received by the secured creditor exceed the amount secured, the secured creditor must return the balance to the securing party unless there is some other agreement (Articles 355 and 338 of the Civil Code and Article 64a.2 (b) of Decree 163). This is because of the secondary nature of a security interest and the application of the principle of return of the property in case of unjust enrichment as provided in Article 256 of the Civil Code: the security enforcement must not give the secured creditor more than the normal performance of the secured obligation would bring to him. The securing party thus retains a proprietary interest in the secured shares.

After the sale, the mortgagor and the mortgagee must cooperate to carry out the procedures for registering the transfer of the shares into the name of the purchaser (Article 64a.2 (c)).

Appropriation

On enforcement, it is possible for the secured creditor to take over the secured property in lieu and in place of performance of the secured obligation by the securing party[20] without the need for court intervention (Article 59.2 of Decree 163). In order for the secured creditor to exercise that power, the security agreement must contain an express power for the mortgagee to appropriate the shares.

The parties may reach an agreement on the value of the secured shares or must appoint a property valuation entity to fix such value (Article 64b.1 of Decree 163). Furthermore, the secured creditor is under an obligation to remit the balance to the securing party unless there is some other agreement (Article 64b.2 of Decree 163).

Investment procedures

Under Article 11 of Decree No. 160/2006/ND-CP dated 28 December 2006 and Article 11 of Ordinance No. 28/2005/PL-UBTVQH11 dated 13 December 2005 on foreign exchange control as amended in 2013[21], an enterprise with foreign direct invested capital must open a direct investment capital account at an authorized credit institution. If the enforcement of the mortgage results in the Vietnamese company becoming a foreign invested company, in principle, it will have to open such investment capital account.

Furthermore, pursuant to Article 11 of Decree No. 102/2010/ND-CP dated 1 October 2010 providing detailed guidelines for the implementation of the Law on Enterprises, any acquisition by a foreign investor of an interest of more than 49% in a Vietnamese company will require the issuance of an Investment Certificate, even though, in practice, the DPI may also request the issuance of an Investment Certificate for acquisition of an interest of less than 49%.

It is apparent that there are still material gaps in the law relating to security over shares and enforcing a share mortgage is by no means a straightforward process. It appears that the cooperation and good faith of the mortgagor, the company itself and possibly other members/shareholders are very important to ensure a smooth process (especially if the mortgagee is a foreign invested company), which is not likely to happen in the context of a dispute. The parties to a share mortgage may fill in legal gaps by their agreement. However, reform of the law is needed[22] in order to ease the taking of security over that special kind of property to support access to credit in a market that is sorely in need of investment funding.-