Background
St James Bank & Trust Company Ltd (Bank) loaned US$2,047,396.50 to Mr Rajiv Shukla (Borrower) secured by 1,800,000 shares in Humacyte, Inc. (Shares). The arrangement was documented by an agreement dated 5 October 2023 (Agreement).
The Agreement contained loan and security language commonly seen in secured lending transactions, with repayment obligations and events of default. However, it also contained a clause which provided that, upon the occurrence of an event of default which had not been cured within the relevant cure period, the Borrower’s equity of redemption (i.e. the right to recover the assets subject to security on full repayment of the secured debt) would be forfeited. In addition, various clauses of the Agreement restricted the Borrower’s ability to redeem the Shares.
Following the occurrence of certain events of default the Borrower attempted to repay the loan. The Bank refused to cooperate with the Borrower’s attempts to repay and asserted that, as an event of default had occurred, the Borrower's equity of redemption had been forfeited.
The Borrower commenced proceedings against the Bank and claimed damages of approximately US$15m, which largely arose due to the fall in value of the Shares.
Legal issue: Could the Borrower benefit from the equity of redemption?
The Borrower argued that the Agreement constituted a secured loan agreement and that the provisions that sought to prevent or restrict the Borrower from redeeming the Shares were void as clogs on the equity of redemption. Consequently, the Borrower remained entitled to redeem the Shares.
The Bank argued that there was no secured loan agreement: its position was that, in substance, the loan agreement was actually an agreement for the sale of the Shares to the Bank with a buy-back option. Therefore, the Borrower could not benefit from the equity of redemption.
Consequently, the Court had to consider was whether the Agreement constituted a secured loan agreement.
The Court's decision
The Court found in favour of the Borrower and held that the clause in the Agreement purporting to extinguish the equity of redemption on the occurrence of an event of default was void. This also applied to certain other clauses in the Agreement namely a clause that allowed the Bank to secure the Shares in favour of third parties and a clause limiting the Borrower's remedies for any breach by the Bank to damages only.
The Court also held that the Bank had an implied duty to co-operate with the Borrower's proposed repayment which included providing redemption figures and account details.
Practical takeaways
Substance over form
An agreement can constitute a secured loan agreement even if it contains certain provisions that are not entirely consistent with a 'typical' loan agreement. Lenders should remain alive to the risk that a court will look behind any creative drafting to determine whether an agreement creates a security interest by substance or effect and therefore whether a borrower will benefit from the equity of redemption. This is important in structured or publicly tradeable share-backed transactions, especially where a party expects to benefit from a speculative increase in value of the assets in question (the increase of which might benefit a borrower rather than a lender).
The courts will protect a borrower's right to redeem
The courts have demonstrated a consistent willingness to protect the equity of redemption. Any attempts to exclude a borrower’s right to redeem security are likely to be deemed void, even in a negotiated deal between sophisticated parties. Lenders who refuse to provide details to enable a borrower to repay a loan could breach a duty to co-operate with that borrower.
Contributing author: Claire Dowle
