In In re Karcredit SARL [1], the United States Bankruptcy Court for the Western District of Louisiana faced two lenders who claimed an original share certificate as collateral. On June 1, the court ruled that the company that issued the double pledged shares was liable to the first lender under section 8 of the Uniform Commercial Code (UCC), as enacted in Louisiana, as a protected buyer and for violating the terms of its merger agreement and the express provisions of its share certificate.

An insider of a debtor pledged the original certificate as security for its obligations secured under a loan to an affiliated entity. After the replacement certificate was issued, the insider pledged the replacement certificate to another lender to secure a separate loan to the debtor. The court noted that although the debtor is at fault for initiating the double pledge, the issuer of the shares must also be held responsible because he knew that both lenders held security in the same shares.

The double pledge program

In 2006, Ronnie Ward guaranteed a loan of $ 683,825.00 from Caldwell Bank & Trust Company to an entity owned by Ward. To secure the loan, Ward pledged shares to Caldwell Bank in Homeland Bancshares, Inc., represented by Certificate 253. Under Section 9 of the UCC, a secured party may perfect a security interest in real property. investment by filing a UCC-1 financing statement, which is generally sufficient for the realization of a security right, or by control, for example by possessing the certificate of origin. Only one secured creditor at a time can upgrade through possession of an original share certificate. Caldwell Bank took possession of Certificate 253, thus completing its security interest in the shares.

Homeland Bancshares, Inc. subsequently merged with Homeland Interim Company. The merger agreement required the cancellation of all existing shares of Homeland Bancshares, Inc. and the reissue of the shares of the combined entity Homeland. The merger agreement expressly provided that only the holder of the existing Homeland Bancshares, Inc. share certificates could deliver the certificates for replacement shares. Ward signed an affidavit of lost shares, falsely claiming that he had lost certificate 253 and requested a replacement share certificate. Homeland canceled the certificate and issued Ward with a replacement certificate: Certificate 495. Caldwell Bank, unaware of the cancellation of Certificate 253, made additional loans secured by Certificate 253. As of at least July 11, 2016, Homeland knew Ward had pledged his shares in Homeland. to Caldwell Bank as collateral for a loan.

While dealing with Caldwell Bank, Ward also guaranteed loans made by Cross Keys Bank to Karcredit LLC and other companies owned by him. In 2019, the Homeland chairman sent the chairman of Caldwell Bank an email providing the value of the shares so that Caldwell Bank could appraise the shares Ward pledged as loan collateral. The very next day, the president of Homeland emailed Cross Keys Bank for the same reason. In 2019, Ward signed a security agreement granting Cross Keys Bank a security interest in the shares represented by the 495 certificate and returned possession of the 495 certificate to Cross Keys Bank. Ward had now pledged the same shares to two different lenders. The situation fell apart when Karcredit LLC defaulted and Cross Keys Bank called the loan.

Cross Keys Bank has taken legal action against Karcredit and its guarantors to recover a promissory note and enforce commercial guarantees. Caldwell Bank intervened in the action against Cross Keys Bank, asserting a higher priority over Cross Keys Bank in the collateral. Due to the double pledge, Caldwell Bank lost its first class security interest in the shares when the certificate of origin was canceled and the new certificate was turned over to Cross Keys Bank, as only one secured party can have control of the shares. shares by possession of an original certificate at a time. Additionally, since Caldwell Bank did not file a UCC-1 Funding Statement, it went from being fully secured to fully unsecured.

Result

The court found that Homeland Bancshares, Inc. had violated the Merger Agreement and the express provisions of Certificate 253. Under the Merger Agreement, only the “holders” of the shares of Homeland Bancshares, Inc. could surrender the certificate. Homeland Bancshares, Inc. breached its obligations to Caldwell Bank by issuing Certificate 495 to Ward, a non-holder of Certificate 253. Likewise, Certificate 253 states that it was “transferable only in the books of the company by the holder hereof in person or by agent upon delivery of the duly endorsed certificate. Homeland Bancshares, Inc. violated the express provisions of Certificate 253 by issuing Certificate 495 to Ward without requiring Ward or Caldwell Bank to deliver Certificate 253.

The court also found Homeland Bancshares, Inc. liable under the UCC. Both Caldwell Bank and Cross Keys Bank were protected buyers – a buyer of certified or uncertified security who:

  • gives value,

  • has not been notified of any adverse warranty claim, and

  • gets certified or uncertified title control.

Section 8 of the UCC governs the replacement of lost, destroyed or mistakenly taken security certificates, and in cases like this where both security certificates have been promised to protected buyers, Homeland Bancshares, Inc. is obliged to honor and register both certificates, unless an over-issue results. If this results in an over-issue, the UCC provides that “a person authorized to issue or validate may recover from the issuer the price of the person or of the last buyer for the value paid with interest at the request of the no one “. Accordingly, Homeland Bancshares, Inc. was indebted to Caldwell Bank for the amount owed to Caldwell Bank by Ronnie Ward.

Takeaway Troutman

For issuers:

  • Be aware of third party collateral transactions, where the issuer’s shares are used as collateral by others; and

  • Comply with all contractual and statutory obligations regarding the issue and pledge of shares.

For lenders:

  • Notify issuers that the lender is a secured creditor with respect to the shares of the issuer and obtain recognition from the issuer; and

  • Perfect a security interest in an investment property by depositing in addition to control, so that the lender’s position is not totally unsecured if control of a physical certificate is lost.


[1] Banker. WD La. June 1, 2021


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