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Security interests and regulated entities

Louise Hill GrahamNatalie Bell
Generally speaking, the British Virgin Islands (BVI) is an extremely flexible jurisdiction in relation to the granting and registering of security interests. One of the strengths of the BVI as an offshore jurisdiction is that it provides a stable platform for companies to provide collateral as security for debt finance and for the secured lenders to register and protect the priority of their interest.

However, the largely unfettered right of business entities formed in the BVI to grant and register security interests is subject to one particular footnote which is easily overlooked. In the BVI, business entities are required to hold licences in order to conduct certain types of regulated business "in or from within" the Territory (meaning either through a BVI entity, or through a foreign entity physically operating within the jurisdiction). These licences are issued by the BVI Financial Services Commission (FSC) and regulate certain types of financial services activity. The principal types of regulated activity include banking business, trust business, insurance, investment business and company management business.

When such a regulated entity seeks secured financing or is part of a group that seeks such finance there are certain specific provisions which the parties need to be aware of.

If a transaction involves security being taken over the shares issued by various companies within a corporate group and one of those companies is regulated in the BVI there are additional complications.

For example, in relation to licensed banks and trust companies, section 14(1) of the Banks and Trust Companies Act, 1990 (BTCA) provides (emphasis added) that:

14(1) A person owning or holding a significant interest or controlling interest in a licensee shall not sell, transfer, charge or otherwise dispose of his interest in the licensee, or any part of his interest, unless the prior written approval of the [FSC] has been obtained.

Almost identical provisions appear in section 11(1) of the Securities and Investment Business Act, 2010 (Siba) (relating to investment business) and section 21(1) of the Insurance Act, 2008 (relating to insurance business). The meaning of a significant interest is quite involved but is broadly 10% or more of the shares in a company.

In practice, nothing in these provisions prohibits the granting of security over the relevant shares, and traditionally the FSC has usually been very accommodating in relation to granting consent for bona fide arm's-length financing. Section 14(1) of the BTCA and equivalent provisions in other statutes are ensuring, quite rightly, that the regulator has full knowledge of the parties operating and controlling a licensed entity within the BVI, and that any such party meets the strict criteria for holding such a licence as set out in the BTCA, together with the fit and proper criterion set out therein.

As with all things involving a regulator, however, the main consideration is often timing. So long as all the parties are aware of the need to obtain prior regulatory consent, they can plan accordingly.

But where parties overlook the need for consent, this can lead to delays, or worse, the parties may close on the transaction and grant the security without consent. This will often result in a double penalty – failure to obtain consent will almost inevitably constitute an event of default under the relevant financing documents (before the funding is even drawn); secondly, there is the small matter of breaching the relevant statutory provisions, for which there is potentially a $10,000 fine (although such a penalty has never, to the authors' knowledge, been imposed). The FSC also has the power to require the chargor to rescind or reverse the charge, modify the charge in such manner as the FSC directs, or suspend or rescind any activity that is contingent on the charge (although whether the charge documentation will be rescindable or variable will depend on the circumstances).

Conversely, with one exception, the relevant legislation does not create any requirement for a licensee itself to obtain the prior approval of the FSC before granting a security interest over its own assets. The principal exception to this is in relation to insurance business. Section 14(1)(b) of the Insurance Act specifically prohibits licensed insurers granting security over their assets (among other things) without prior regulatory approval. There is no equivalent of that section in either the BTCA or Siba, however.

That seems slightly curious – regulated entities cannot have their shares charged without approval, but they can charge their entire business and undertaking without any need to give notice. On the other hand, it is eminently logical. The relevant section (and equivalent sections in other legislation) seeks to limit the possibility of a change of control occurring without the involvement of the FSC.

It is also worth noting that the FSC has separate powers to monitor the financial circumstances of a licensee (irrespective of whether security interests are granted or not) where this is relevant to its regulatory function. Various types of licensed entities have capital maintenance requirements of their own under the Regulatory Code, 2009 (although that primarily refers to equity capital rather than debt capital) and almost all types of licensed entities are required to provide accounts to the FSC for review, and in some circumstances are under a positive duty to report financial distress (see for example section 7(2) of Siba, section 72(2) and Schedule 3 of the Regulatory Code, 2009 and sections 9(2) and 12(5) of the Insurance Act). Similarly, the enforcement of (or any threat of enforcement of) any security over a licensee's assets would trigger a requirement to disclose under section 70 of the Regulatory Code, 2009, which requires licensees to disclose to the FSC any matters which might reasonably be expected to have a significant regulatory impact. Accordingly, the regulator has a wide array of tools to guard against potential impropriety in relation to improper leveraging of assets.

Given the current financial strain that many businesses are operating under, many of them are seeking additional finance, or refinancing the terms of existing debt. BVI-regulated entities are no different from any others in this regard. But they do need to be aware of the relevant provisions under BVI law so they do not inadvertently create difficulties for themselves.

Louise Graham and Natalie Bell

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