In this blog post, Shubhanan Chaturvedi, a student at University of Petroleum and Energy Studies and pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, describes the different methods of restructuring corporate bonds.  

Every Listed Company is under an obligation to file Shareholding Pattern under Clause 35 of Listing Agreement within 21 days of close of each quarter to the Stock Exchanges where their shares are listed. The principal objective of filing of Shareholding Pattern with the Stock Exchanges is to disseminate information to the common public as well as prospective (potential) investors to know the category/ class of shareholders who/which are controlling the company or at least have interest in the Company at the end of each quarter. 

SEBI vide its circular no. SEBI/CFD/DIL/LA/2009/3/2 dated February 3, 2009 has amended the reporting format of Clause 35 and included the disclosure related to status of pledge or encumbrances created on the shares held by the promoters or promoter group. 

The above amendment in Clause 35 is, in fact, the consequential effect of amendment taken place in SEBI (Substantial Acquisition of Shares and Takeover) Regulations 1997 (hereinafter referred as Takeover Regulations) in January 28, 2009. SEBI vied its notification No. LAD-NRO/GN/2008-2009/33/15022 has inserted Regulation 8A in SEBI Takeover Regulations and directed that a promoter or every person forming part of promoter group shall disclose the details of shares pledged or details of invocation of pledge to the Company within 7 working days of creation of pledge or invocation thereof and Company is an under obligation to disclose the same to the stock exchanges, within 7 working days of receipt of information from the promoters or promoter group. 

On January 28, 2009, by inserting a new Regulation 8A in SEBI (SAST) Regulation, SEBI decided that Promoter and Promoter group shall disclose the details of pledge of shares held by them in listed entities promoted by them. At first stage, promoter and promoter group entities were required to disclose details of shares pledged by them, within 7 working days of commencement of amended regulation i.e. on or before Friday February 6, 2009 (i.e. transitional disclosure). SEBI has further provided that subsequent disclosure must be made within 7 working days of creation of pledge or invocation of pledge, to the Listed Company and thereafter, Listed Company must disclose the information received to the Stock Exchanges within 7 working days of receipt of such information from Promoter and Promoter group entities. All the disclosures either made by Promoters entities to the Company or by the Company to the Stock Exchanges must be in the prescribed format. 

Clause 35 was amended vide circular dated February 3, 2009 and stated that “The format for reporting the shareholding pattern contains six parts. The first two parts viz. Part I(a) and I(b) contains  disclosures of shareholding  of promoter and promoters group.  Part I(a)  and I(b)  of the format are required to be amended  to include details of shares pledged  by promoters and promoter group entities as specified in the annexure. 

 It is important to note that though the Circular refers only to the disclosure regarding “details of shares pledged” by promoters and promoter group entities but the annexure to the aforesaid SEBI Circular No dated February 3, 2009 in the relevant column states “Shares pledged or otherwise encumbered”.   The above two instances i.e. Regulation 8A and circular related to Clause 35, are primarily focused on disclosures related to pledge of shares. Whereas format pertaining to Clause 35 has includes a category “otherwise encumbered” besides the information related to “Pledge” of shares.  The pertinent question arise whether a format (i.e. Annexure) prescribed in terms of Circular should not restrict itself to the provisions of Circular and cannot overreach beyond the express terms of the Circular. Keeping in view to the amendment taken place in Takeover Regulations and Listing Agreement, we may say that the genus of the Annexure related to Clause 35 is a Circular dated February 3, 2009 and Circular is a consequential impact of Regulation 8A inserted on January 28, 2009. 

Case: 1. Assuming P (Promoter of a Listed Company) has executed an agreement on March 15, 2011 in which it is agreed to pledge say 300,000 shares of the equity held by P in Listed Company towards a security of a loan taken by P.  There could be three situations. 

(1)   P can hold his entire 3 lacs shares in Physical form

(2)   P can hold entire 3 lacs shares in Dmat form

(3)   P can hold part of its holding say 1 lac in physical and 2 lacs Dmat mode both 

Question arises at what point of time pledge is deemed to be created or actually created in case of aforementioned situations and at what point of time it will amount to “encumbered”.  The following circumstances may arise while dealing with the above situations. 

(a)    The date on which agreement is executed.

(b)   The date on which pledge slip is submitted to the Depository Participant but does not marked as pledge in Dmat account. 

(c)    The date on which pledge has been marked by the Depository i.e. NSDL / CDSL and appeared in Register of Members maintained by the RTA.

(d)   The date on which physical share certificate is handover by P to the Lender along with blank transfer deed but not submitted by the lender to RTA for creation of pledge on Physical shares. 

(e)    The date on which RTA has earmarked physical shares as pledge shares in the respective folio of P and updated register of members.

Case 2:  There may be a situation, where Lender had not insisted for creation of pledge as per Regulation 58 of SEBI (Depositories and Participant) Regulations 1996. Subsequent on arise of dispute between Promoter and Lender, and on the sole initiative of Lender, Arbitrator had passed ex-parte order in favor of Lender. The interim relief may be granted by Arbitrator to protect the interest of Lender such as “restraining, prohibiting or alienating promoters from dealing in disputed shares until further order”  

The pertinent question is whether at this stage, due to the Arbitration Award, the shares which are of a subject matter of arbitration proceedings, would amount to a “pledged shares or encumbrance shares” although, there is no pledge marked on the shares as per Regulation 58 of SEBI (Depositories and Participant) Regulations 1996 and also no specific demarcation in Register of Members maintained by RTA. 

The term “pledge” is not defined in Takeover Regulations 1992 and also in Listing Agreement. However, now in SEBI (Substantial Acquisition of Shares and Takeover) Regulations 2011 under “Regulation  28(3) defines the term “encumbrance”. According to Regulation 28(3) the term “encumbrance”   shall  include  a pledge , lien  or any such  transaction  by whatever name called.   Further, Section 172 of the Indian Contract Act defines a “pledge” as the bailment of goods as security for the payment of a debt or 2011 performance of a promise. Securities Appellate Tribunal (SAT) has applied definition of “pledge” as defined in Section 172 of the Indian Contract Act while passing order related to Takeover Regulation. In case of Lallan Prasad Vs Rahmat Ali (1967) 2 SCR 233 it was stated that delivery of goods is an essential feature of a pledge. When shares are held in physical form, delivery may take place by depositing the share certificates with the pledgee. However, when shares are held in dematerialized form, they are fungible in nature, and they are represented only by entries on the electronic ledger of the depository. Hence in this situation, delivery of shares would not be possible. Since the basic feature of “delivery of shares” would not be possible in case of shares held in dematerialized form, it was decided in the matter of JRY Investments Pvt. Ltd Vs Deccan Leafine Services Ltd (2004) 121 Comp Cas 12 (Bom) that a dematerialized share cannot be pledged under Section 172 of the Indian Contract Act. 

The term “encumbrance” is not defined in Takeover Regulation and Clause 35 of Listing Agreement. In common understanding, “encumbrance” means a claim or liability that is attached to property or some other right and that may lessen its value such as a lien or mortgage.  The “encumbrances” are not confined to the law of property, but pertain to the law of obligations also. (John Salmond, Jurisprudence) 

Pledge of shares held in dematerialized form:

The SEBI (Depositories and Participants) Regulations 1996 create a mechanism for pledging shares held in dematerialized form which dispenses with the requirement of delivery as stipulated in Section 172 of the Indian Contract Act in case of shares held in physical form. In many instances, SEBI and SAT have refused to treat a transaction as a pledge if it doesn’t not follow the process of the SEBI (Depositories and Participants) Regulations 1996 (refer NE Electronics Ltd Vs SEBI (Manu/SB/0129/2008, Eonour Technologies Ltd Vs SEBI (2008) 83 SCL 7 (SAT), Classic Credit Ltd Vs SEBI (SAT order dated December 8, 2006, Appeals Nos 68-73/2003). Regulation 58(3) provides that the concerned depository would make a “note of the pledge” in its record. So long, as the entry of a pledge remains, the depository will not permit a transfer of shares without consent of pledgee. Further. The entry may be cancelled by the depository only with the prior concurrence of the pledgee. In case of default, pledgee has all the rights to invoke the pledge in accordance with pledge document, the depository would record the pledgee as the beneficial owner of the shares as per the provisions of Regulation 58(8) of SEBI (Depositories and Participants) Regulations 1996. 

Pledge of shares held in physical form:  When physical shares are pledged, the pledgee may choose to not become the owner of those shares when the pledgor defaults on the underlying debt. When the pledgee invokes the pledge and sells the pledged goods to a third party, he sells them not as a full owner but by virtue of an implied authority from the pawnor to do so. On the other hand, since the depository records the pledgee as the beneficial owner of the shares upon an invocation of the pledge, the pledgee of the de-materialized shares has no option but to become their beneficial owner if he wishes to invoke the pledge. 

A pledgee who holds physical share certificates (with or without blank share transfer forms) as security but who is not registered with the Company in respect of those shares, he cannot enjoy voting rights although he has liberty to get the shares registered in his name and become real owner of those shares. The shares, although, in the possession of the Lender but not “earmarked” as pledge in the register of members of the Company cannot be treated as “pledge” however, it may be treated as “encumbered” at the level of Promoter (i.e. borrower). So far, Company is concerned unless there is a specific communication from the Lender or Borrower, Company cannot record as “pledged” or “encumbered” in its register of members and while filing Shareholding Pattern will disclose these shares as “free shares” in absence of express information pertaining to “pledge or otherwise encumbered”. This was the peculiar situation till October 2011 which was required to be clarified by the SEBI to put the rest of controversy between Listed Company and Regulator.  After many years SEBI felt it necessary to  remove ambiguity and finally defined the word “encumbrance” under Regulation 28(3) as discussed above. 

Dilemma for the Listed Company and its Company Secretary: 

Based on the depository’s note, register of members maintained with the RTA would reflect the position of shares as “pledged” or “invoked” and accordingly, Company disclose the correct fact while filing Shareholding Pattern under Clause 35 of Listing Agreement. In absence of “any mark” as stipulated in Regulation 58, Company as such would not be in a position to know any “pledge” creation on the shares held in demat form and accordingly would not be able to disclose the shares under the category of “pledge or otherwise encumbrance” in spite of the fact that there is an understanding between Promoter and Lender (at their private level), in respect of shares held in demat form.  

In the above, circumstances, where there is no mechanism available to the Company to know the private understanding between Promoter and its Lender and creation of pledge in respect of such borrowing, Company is duty bound to disclose the facts based on the information as provided by RTA and file the Shareholding Pattern with the Stock Exchanges. The filing of Shareholding Pattern is the responsibility of the Listed Company and not the Promoters of the Company. Whereas providing of information related to “creation of pledge or invocation or revocation” is the responsibility of the Promoters under Takeover Regulations. 

Observations on case studies as mentioned above:

Case-1: The date on which agreement is executed between Promoter and Lender, would not amount to a date on which pledge is created. Pledge deemed to be created only upon adherence  of mechanism as provided in Regulation 58 of SEBI (Depositories and Participant) Regulations 1996 in case of shares held in demat mode. Whereas in case of physical shares, promoter would require to inform the Registrar and Transfer Agent (RTA) of the Company to “earmark” the physical shares as “pledge” in favour of Lender. Upon such “earmarking” the Physical shares will be treated as “pledge” and Listed Company is duty bound to disclose these shares as “pledge” while filing Shareholding Pattern. Keeping in view to the above discussion, the queries may be answered as follows:   

(a)    The date on which agreement is executed or the date on which pledge slip is submitted to the Depository Participant but does not marked as pledge in Dmat account.  At this stage this will not amount to a creation of “pledge” however, it may be treated as “encumbered” at the level of Promoter and the Lender but not at the level of a Listed Company.

(b)   The date on which pledge has been marked by the Depository i.e. NSDL / CDSL and appeared in Register of Members maintained by the RTA. At this stage this will amount to a creation of “pledge” at the end of promoter as well as listed company and this need to be reported while filing Shareholding Pattern under Clause 35 of Listing Agreement. 

(c)    The date on which physical share certificate is handover by P to the Lender along with blank transfer deed but not submitted by the Lender to RTA for creation of pledge on Physical shares. At this stage this will not amount to a creation of “pledge” however, it may be treated as “encumbered” at the level of Promoter and Lender but not at the level of Listed Company.

(d)   The date on which RTA has earmarked physical shares as pledge shares in the respective folio of P and updated register of members. At this stage this will amount to a creation of “pledge” at the end of Promoter as well as Listed Company and this need to be reported while filing Shareholding Pattern under Clause 35 of Listing Agreement

Case 2:  Whether ex-parte arbitration award passed by the sole arbitrator restraining promoter from selling, transferring, or dealing in such shares which are subject matter of Arbitration proceeding, will amount to kind of “pledge” or “encumbrance”. As explained hereinabove, in the given circumstances, arbitration award is putting restriction on promoters and providing interim relief to the lender. Keeping in view to the provisions of Regulation 58 of SEBI (Depositories and Participant) Regulations 1996, (in case of shares held in Dmat form) and Section 172 of Indian Contract Act, we may say that by virtue of Arbitration Award, such shares are amount to be “encumbered”. However, since no intimation is required to be furnished by the Promoter or Promoter Group in respect of “encumbrance created on shares” under Takeover Regulation, hence, Listed Company would not be able to access these information and consequently would not be able to file the disclosure as required in Clause 35 of Listing Agreement and to that extent anomaly between the actual position and reported position would emerged.

In strict interpretation of the term “pledge or encumbrance” and various judicial precedent, it appears that the act of voluntary initiative by the promoter, is an essence to create a pledge or encumbrance on the shares held in physical or demat mode. In an arbitration proceeding, there is a lack of voluntary initiative and hence by virtue of Arbitration Award, shares (although) “reserved” specifically for lender but cannot be qualified to be treated as “Pledge” or “encumbered”. If Listed Company disclose these shares as free shares as per the record of RTA, to that extent Company’s disclosure is in line with the requirement of Clause 35 of Listing agreement and Regulator cannot held responsible to the Company for not disclosing these shares as “Pledged shares or encumbered shares”.