To minimise the investment risks, foreign investors invested in Vietnam tend to facilitate a loan rather than immediately acquire shares in an existing company or set up a new enterprise. Over the years, there has been a steady increase in the number of convertible share mortgage agreements under which they provide the creditor an option to convert the loan into shares as a means of enforcement. By doing so, the foreign investor/creditor may have sufficient time to assess the target’s performance during the loan tenure prior to deciding on whether the acquisition should be proceeded or not.
Straightforward it may sound yet troublesome it should be noted. Technically, despite the unclear literature of Vietnamese laws[1], it is acknowledged that shares[2] can legally be used as a mortgaged asset in Vietnam. Be that as it may, it is still questionable whether potential risks to be analysed hereunder may jeopardise the legitimate interests of the creditor. For the ease of reference, this article shall be structured in Q&A format. The scope of this article shall be focused on limited liability company (LLC) and joint-stock company (JSC) which are the most common enterprise form in Vietnam.
The content of this article is only purported to provide readers with an overview picture of how shares can be secured in Vietnam but in no manner constitutes an exhaustive legal opinion. It is highly recommended that professional legal advice should always be carefully sought in prior.
“Mortgage” or “Pledge”: Which type of security to be used?
“Mortgage” (thế chấp) and “Pledge” (cầm cố) are two separate security under the laws of Vietnam[3]. Similar to the UK law, the key element to distinguish these two securities is that pledge allows the pledgee to take possession of the property whereas for mortgage the property remains in the hand of the mortgagor. There have been several academic and practical debates arising out of which terms to be used for security over shares. For private company, mortgage is said to be the most suitable one and for listed company, the laws seemingly fond of pledge[4]. In practice, these terms for security over shares may be used interchangeably without invalidating the security agreement. However, this article opines that the correct term should be used in drafting contract is “mortgage” rather than “pledge”, in particular to non-listed company[5].
What legal procedures needed to be done to give effect to the share mortgage?
Technically, Vietnamese laws provide for either mandatory registration or voluntary registration of security transactions. The former requires a security transaction to be registered in a competent authority for full effect[6]whereby the effectiveness of the latter does not rely upon the registration. As security over share is not listed in the mandatory registration transactions, it can be inferred that no registration needed to be done in order to give effect to a share mortgage. Though not required, it is highly recommended that a share mortgage be registered at the National Registration Agency for Secured Transactions (NRAST) for the sake of the mortgagee, in light of the following reasons:
- Without registration, share mortgage agreement is legally binding on contractual parties but the third party. Therefore, registration shall facilitate the effectiveness of the share mortgage against any third party13cta020T[7].
- If the shares are used to secure several obligations, the mortgagee who has its transaction registered shall be prioritised in the payment order[8].
In addition, no notarisation is obligatorily required for the share mortgage agreement. It can proceed at the sole discretion of the conce,2vDrned parties.
Key issues for enforcement by taking over the shares – What are they?
Taking over the secured asset is one of the three primary means of enforcement provided by the Civil Code[9]. However, it may prove to be troublesome for the foreign investor/mortgagee/creditor (collectively, the “Investor”) in terms of share.
By acquiring shares in a Vietnam-based company, an Investor is subject to specific investment-related requirements, the notable three of which are foreign exchange requirement; limitation on foreign capital ratio, and corporate restrictions on change of ownership.
For foreign exchange, if the acquisition results in foreign investor holding 51% (or above) ownership of the target, the investment (cash flow) must be transferred through a direct investment capital account (DICA) set up by the target[10]. On the other hand, if the ownership is below 51%, the investment may be required to be made through an indirect investment capital account (IICA) set up by the Investor[11]. Long story short, an investment may not be deemed legally valid if the DICA or the IICA, as the case may be, does not record the respective cash flow. Tellingly, it is advised that a loan secured by share at the beginning should be facilitated to the target through the DICA or the IICA or both even if the regulations do not require to do so[12]. This will help to create a safety net for the Investor should the enforcement occur.
Second, several industries remain limited to the foreign investor or even non-committed under the WTO commitment. Under which, subject to the registered business activity of the target, foreign investment can be limited to a certain ratio[13] or even not permitted. For instance, if the target engages in sea transport activities, the foreign investment is capped at 49%[14]. Tellingly, if the enforcement leads to a 60% ownership, it could be the case that 11% out of which is unenforceable.
Third, under the EL Law, for LLC, a shareholder who wishes to transfer its share to a third party must render other shareholders a right of first refusal before offering to a third party[15]; or for JSC, the founding shareholder is not freely allowed to transfer its share to the third party unless with a resolution of the GMS (General Meeting of Shareholders)[16]. To note that further restrictions, though not specified by laws, may be provided in the company’s charter[17]. Given such, if enforcement against one shareholder (as being the mortgagor) occurs, other shareholders may use such restrictions to deter the taking over of the secured shares. As the result, a resolution of the board of members or GMS of the target explicitly permits the enforcement upon its occurrence should be obtained and all shareholders must represent in writing that they consensus vote in favour of the enforcement[18] and facilitate any procedures on the target’s part to complete the enforcement.
Source: <https://www.lawinsider.com/resources/featured/share-as-mortgaged-asset-presumable-risks-for-foreign-mortgagee-under-vietnamese-legal-regime>
[1] The 2014 Law on Enterprise (the “EL Law”) is silent on the possible use of capital contribution/shares in an LLC or a JSC as the mortgaged asset despite allowing the same in partnership (See more: art. 50, art. 114, art. 182.1(e) of the EL Law). However, pursuant to the general principles set out by the 2015 Civil Code (the “Civil Code”), it is widely accepted that shares can be used to secure a loan (See general: Civil Code, art 105.1, art 115 and art. 295.3)
[2] The term “shares” and “shareholder” are respectively referred to (i) capital contribution & contributing member of an LLC and (ii) share & shareholders of a JSC.
[3] Civil Code, art. 292.1 and art. 292.2.
[4] Michel Trochu and Bui Duc Giang, “Taking Security over Shares in Vietnam: Law and Practice” (2014) 2014 Int’l Bus LJ 287, 289.
[5] For the listed company, it may be the case that the laws address the security over share on the basis of share certificate rather than the share itself.
[6] Decree 102/2017/ND-CP (“Decree 102“), art. 4, and art. 5; Decree 163/2006/ND-CP as amended by Decree 11/2012/ND-CP (collectively, “Decree 163”), art. 12.1.
[7] Decree 163, art. 11.1
[8] Civil Code, art. 308.
[9] Civil Code, art. 303.1.
[10] Circular 06/2019/TT-NHNN (“Circular 06”), art. 3.2(b); art. 5.1(a); art 7.1(a)(b); and art. 10.1(b). To note that there may be some certain exceptions provided in art 10.1.
[11] Circular 05/2014/TT-NHNN (as amended by Circular 06), art. 5.1 (as amended by art. 14.2 of Circular 06), art 6.1 and art 7.1(b).
[12] For foreign middle-term and long-term loan, the loan must be funded through the DICA. For short-term loans, DICA or any other account is acceptable at the discretion of the lender and borrower (See: Circular 03/2016/TT-NHNN (as amended by Circular 05/2016/TT-NHNN, art. 24.2; See also: Circular 06, art. 6.1(h)).
[13] See Trochu (n 4) 297.
[14] Decree 163/2017/ND-CP, art. 4.3(a).
[15] EL Law, art. 53.1.
[16] EL Law, art 119.3, and art. 126.
[17] See Trochu (n 4) 297.
[18] ibid.
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