Appropriation of Financial Collateral: The Remedy and Its Practical Demands

Appropriation is among the more powerful enforcement remedies available to a secured creditor under English law, and among the least well understood. Introduced by the Financial Collateral Arrangements (No. 2) Regulations 2003 (the “FCARs”), it permits a collateral taker, on enforcement, to take charged financial collateral as its own and apply its value against the secured obligations without a court order, a receiver, or a sale to a third party. For lenders, debt funds and the security agents who hold collateral on their behalf, it requires careful understanding, both for what it offers and for the conditions it imposes.

The statutory remedy

The FCARs implemented the EU Financial Collateral Directive into UK law. They apply to a “financial collateral arrangement”, i.e. a security financial collateral arrangement: security granted over financial collateral (cash, financial instruments such as shares and bonds, or certain credit claims) where the collateral taker has possession or control of that collateral.

Where the arrangement qualifies and the security document expressly confers the power, Regulation 17 permits the collateral taker to appropriate the collateral on enforcement. Regulation 18 governs valuation: the collateral must be valued in accordance with the terms of the arrangement and, in any event, in a commercially reasonable manner. The collateral taker applies that value in discharge of the secured obligations, remains entitled to pursue any shortfall, and must account to the collateral provider for any surplus.

Appropriation is not automatic. As confirmed in Cukurova Finance International Ltd v Alfa Telecom Turkey Ltd, the remedy is effected by an overt act evidencing the intention to exercise the power, communicated to the collateral provider, together with a proper valuation. It is a deliberate, documented step, not a silent change of ownership.

The conditions that must be satisfied for an Appropriation

Two requirements do most of the analytical work.

The first is possession or control. The collateral, or the collateral taker’s interest in it, must be held so as to be in the possession or under the control of the collateral taker or a person acting on its behalf. In Gray v G-T-P Group Ltd, the court held that practical or administrative control is insufficient; what is required is legal control, the right to prevent the collateral provider from dealing with the collateral, closer to the control associated with a fixed charge. An uncrystallised floating charge that leaves the chargor free to deal with the assets will not, without more, satisfy the test.

The second is an express power and an agreed valuation basis. The arrangement must confer the power to appropriate and must provide a method of valuation. A power that is absent, or a valuation mechanic that is vague, undermines the remedy before enforcement is ever contemplated.

The valuation standard after ABT Auto

The most significant recent guidance comes from ABT Auto Investments Ltd v Aapico Investment Pte Ltd [2022] EWHC 2839 (Comm), the first occasion on which the English court examined the Regulation 18 valuation duty in any depth. A collateral taker had appropriated charged shares in a joint venture company, ascribing a value based on a third-party valuation; the collateral provider challenged both the validity of the appropriation and the value attributed, contending the shares were worth substantially more.

The court upheld the appropriation. Several points of practical importance emerge. “Commercially reasonable” is an objective, fact-sensitive standard, assessed by reference to the methodology and conduct of the valuation rather than to hindsight about outcome. A welcome precision is that the collateral taker’s duties do not extend to fiduciary or wider equitable good-faith obligations of the kind owed in some other enforcement contexts; they are confined to the Regulation 18 standard. For the security agent, the decision illustrates that a valuation that is independently instructed, properly reasoned and documented contemporaneously is hard to dislodge. And non-compliance with Regulation 18 does not, of itself, invalidate an appropriation: the court may instead set aside the valuation, substitute its own, or award damages.

Appropriation among the enforcement options

Set against the conventional routes, appropriation occupies a distinct position. A power of sale depends on a willing buyer and carries the timing risk of realising into a falling or illiquid market; appropriation does not. The appointment of a receiver introduces cost, delay and procedural overhead; appropriation, as a self-help remedy, does not. Foreclosure requires a court application; appropriation does not.

The corollary is that the analytical burden shifts to valuation and to the integrity of the documentation. Appropriation also carries consequences that a sale does not: the asset is taken onto the collateral taker’s own balance sheet, with related commercial, tax and reputational considerations. It is a precise instrument suited to particular circumstances, not a default.

Relevance in a restructuring

The FCARs do something most enforcement remedies cannot: they disapply or modify a number of provisions of UK insolvency law that would otherwise impede enforcement, and remove the usual registration and perfection formalities. In a distressed scenario, this means appropriation can generally be exercised notwithstanding processes that would frustrate a conventional enforcement against the counterparty. That feature is what gives the remedy real weight in a restructuring rather than confining it to theory.

Practical considerations for a security agent

For a security agent, the work that makes appropriation available is done long before any default.

The documentation must establish a qualifying security financial collateral arrangement, confer an express power of appropriation, and set out a commercially reasonable valuation method tailored to the nature of the collateral. Control must be real and not merely nominal: holding share certificates and signed transfer forms, controlling the relevant accounts, and restricting the chargor’s ability to deal with the collateral. On enforcement, the agent should confirm its authority and instructions, effect appropriation by a clear overt act and notice, obtain and document a valuation that meets the Regulation 18 standard, and account for any surplus promptly.

Reform on the horizon

Under the Financial Services and Markets Act 2023, the FCARs are expected to be repealed and replaced in due course with broadly similar provisions. The remedy is unlikely to disappear, but its detail will change, and the replacement regime warrants close attention as it develops.

Appropriation rewards preparation. By the time enforcement is contemplated, the decisive question is simply whether the documentation and control arrangements were put in place with that day in mind.