SEBI extends disclosure related exemption to eligible NBFCs & HFCs

-Amends Reg. 29 (4) of SAST Regulations, 2011 dealing with disclosures relating to pledge

By Simran Jalan (simran@vinodkothari.com)

SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (SAST Regulations) provides requirement in relation to manner of acquisition, takeover, disclosure requirements, acquisitions triggering open offer etc. It is a common phenomenon to pledge the shares of a listed entity as a security for availing of loan from Banks, financial institutions.

In line with the approval granted by SEBI in its Board meeting held on December 12, 2018[1] SEBI issued SEBI (Substantial Acquisition of Shares and Takeovers) (Third Amendment) Regulations, 2018[2] on December 28, 2018 (‘Amendment Regulations’) exempting certain class of NBFCs and HFCs from the requirement of disclosing acquisition (resulting from encumbrance) and disposal (resulting from release of encumbrance). This article discusses the impact of the said amendment.

The Amendment Regulations are effective from December 31, 2018.

Meaning of Pledge

A Pledge is a form of security interest wherein the pledgee acquires the possession of the pledged goods. It may be considered as transfer of specific interest in property.

The term “Pledge” has been defined in Section 172 of the Indian Contract Act, 1872 as:

172. “Pledge” “pawnor”, and “pawnee” defined. – The bailment of goods as security for payment of a debt or performance of a promise is called “pledge”. The bailor is in this case called the “pawnor”. The bailee is called the “pawnee”.

Further, Section 176 of the Indian Contract Act, 1872 states the pawnee’s rights in case of default made by the pawnor. It states that the pawnee has the right to make a sale of the pledged article when the pawnor makes the default. Therefore, in case of pledge there is a right of sale. [3]

Pledge under SAST Regulations

To analyse the applicability of SAST Regulations in case of creation or invocation of pledge, one need to look into the terms of creation of pledge as pledge can be created with or without voting rights attached to it. If the terms of the agreement, denote that the pawnee is entitled to the voting rights or the pawnor has to vote on the directions of the pawnee, then it may be construed that pledge is created with voting rights.

Further, if the terms only oblige the pawnor to inform the pawnee about the votes casted, then it may be said that pledge is created without voting rights.

Under SAST Regulations, the acquirer is required to make an open offer on acquisition of voting rights beyond the prescribed thresholds. Therefore, the acquirer is not required to make a public announcement if the same was created without voting rights. In case of invocation of pledge, the pawnee is entitled to voting rights and depending on the percentage of acquisition, open offer requirement gets triggered.

Requirement under Regulation 29

Regulation 29 (1) mandates initial disclosure in case of acquisition of 5% or more of shares or voting rights in the target company, by the acquirer along with persons acting in concert.

Regulation 29 (2) mandates continual disclosure in case of further acquisition or disposal of shares or voting rights by acquirer along with persons acting in concert, resulting in the change exceeding 2% of the total shareholding or voting rights in the said target company.

Regulation 29 (3) provides the timeline for making the disclosure i.e. within 2 working days of intimation of allotment of shares or acquisition or disposal of shares or voting rights in the target company, to the stock exchange and the target company.

Regulation 29 (4) clarified that disclosure in case of pledge would trigger on creation of encumbrance on the shares which will be equivalent to acquisition and on release of encumbrance which will be equivalent to disposal.

Impact of Amendment Regulations

Since, accepting shares under pledge is a common affair for banks and financial institutions, such a requirement to disclose every encumbrance and on release of the same, beyond the prescribed threshold, would have been practically difficult.

Therefore, the proviso to Regulation 29 (4) formerly, exempted only a scheduled commercial  bank  or  public  financial  institution  as  pledgee, from the disclosure requirement in  connection  with  a pledge of shares for securing indebtedness in the ordinary course of business.

By virtue of the Amendment Regulations, the aforesaid exemption has been extended to i) deposit taking HFCs or HFCs of asset size of Rs.500 cr or more, registered with National Housing Bank and ii) Systemically Important Non-banking Financial Companies(NBFCs)[4] on the basis of similar rationale.

Accordingly, the aforesaid entities will no longer be required to submit disclosures under Regulation 29 (1) or Regulation 29 (2).

Pending exemption under Reg. 10 (1) (b) (viii)

Regulation 10 (1) (b) provides for exemption from the requirement to make an open offer in case of acquisition in the ordinary course of business. Clause (viii) exempts acquisition by virtue of invocation of pledge by Scheduled Commercial Banks or Public Financial Institutions as a pledgee as absence of such exemption will turn out to be a deterrent for the banks and financial institution accepting shares as collateral. Therefore, para 10(b)(viii) was introduced.

However, with the advent of time, other classes of financial institutions like NBFCs and HFCs also lend against security of shares and it would be very logical to extend similar relaxation to such entities for the acquisition made in the ordinary course of business by invocation of pledge to recover the amount due from borrower by subsequently causing a sale of the shares invoked. The pledgee is only interested in recovering the amount and not acquiring any control through such acquisition.

An exception in this regard may be inserted, with the condition that the acquirer (pledgee) in this case, shall dispose of the shares so acquired within a given period, say 6 months. This will ensure that the relaxation is only limited to those who invoked the pledge, purely for recovery of money.

[1] https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/dec-2018/1544618318217.pdf#page=3&zoom=auto,-23,468

[2] http://egazette.nic.in/WriteReadData/2018/194779.pdf

[3] You can also refer our article on Pledges in context of insider trading regulations

[4] means a non-banking financial company registered with the Reserve Bank of India and recognised as systemically important non-banking financial company by the Reserve Bank of India