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YOUR PERFECTED PLEDGE MAY NOT BE PERFECT, HERE’S WHY

As a lender, you can take security over a borrower’s inventory stored in South Africa by way of a pledge, but the pledge must first be perfected before you can enforce it. Perfection of the pledge is not enough. There are a few more boxes that would need to be ticked to make sure that your pledge can be enforced without delay or complication when needed.

A pledge is perfected when the entity granting the pledge is dispossessed of the inventory and the inventory is delivered to you or your agent. Many lenders appoint collateral managers or stock monitoring companies as custodians to hold the inventory on their behalf. For such an arrangement to work and not negate the pledge, it is important that this custodian expressly agrees that it will act as your agent and hold the inventory on your behalf to perfect the pledge.

It is also important that the inventory be stored separately and is clearly marked as pledged in your favour. This is particularly so where the inventory is stored in a warehouse together with the inventory of a third party or where it can easily be commingled with other inventory not subject to the pledge.

Make sure the custodian gets paid

Under South African law, a collateral manager or storer will have a lien over the inventory in their custody which they can enforce to recoup unpaid fees. The borrower would typically be liable to pay these fees. If the borrower fails to pay these fees, the lien may be enforced and the collateral manager or storer can sell the inventory to recover the unpaid fees, leaving you with less or no security. This risk can be mitigated by obtaining a waiver of lien from the collateral manager or storer. Alternatively you, as the lender, can assume the responsibility to pay arrear fees and request the borrower to reimburse you for that payment. All of this can be recorded in a tripartite agreement between the lender the custodian and the borrower.

A special resolution may be needed from shareholders

If the pledge is being granted by a South African company as security for the debts of another company within the same group of companies, it will qualify as financial assistance under the Companies Act. If this is the case, the prior approval of the shareholders of the pledging company by way of a special resolution will be required. If the special resolution is not passed prior to the pledge agreement being signed, the transaction will be void and incapable of being ratified.

Exchange control approval may be needed

If you are a non-resident lender and the pledge is being granted by a South African resident, exchange control approval from the Financial Surveillance Department of the South African Reserve Bank may be needed. Such an application must be processed through an “authorised dealer” which includes local banks and branches of foreign banks which are approved by the South African Reserve Bank as authorised dealers in foreign currency.

Ideally, this approval should be obtain prior to the pledge taking effect. The Reserve Bank may impose certain conditions or decline the application altogether. If the application is declined, the proceeds realised from any sale of the inventory on enforcing the pledge cannot be repatriated.

Prepared by:
Jessica Lewis | Consultant | Banking and Finance Law

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)