SEBI regards maintenance of ‘cover ratio’ & ‘borrowing cap’ as ‘encumbrance’

Penalises promoter entities for non-disclosure under SAST

Ambika Mehrotra & Smriti Wadhera


The term ‘encumbrance’ as referred to in various court rulings is not a novel term used in law. Although defined in various rulings, in its generic sense, encumbrance means to specify any burden, obstruction, or impediment on an asset, that lessens its value or makes it less marketable. The Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (SAST Regulations) prior to the amendment introduced vide SEBI (Substantial Acquisition of Shares and Takeovers) (Second Amendment) Regulations, 2019, w.e.f. 29-07-2019[1], defined encumbrance under Regulation 28(3) as

“a pledge, lien or any such transaction, by whatever name called

However, SEBI had further widened the scope of encumbrance vide the said regulation. Though, the earlier interpretation as was clear enough to say that the definition was an inclusive explanation and not an exhaustive one. In order to provide a simplistic explanation/clarification of terms/concepts related to SAST Regulations, SEBI has also come with its FAQs on SAST Regulations[2] to setting various interpretational issues in this regard. The above regulations provide that the shares taken by way of an encumbrance shall be treated as an acquisition and its release shall be treated as disposal under the said Regulations. Accordingly, the disclosures w.r.t acquisition or disposal of shares in any manner, as such, shall mutatis mutandis apply in the case of such transactions. Having said that SEBI has also clarified this requirement in its recent order dated March 31, 2020[3].

In this article, we intend to cover various points of law discussed by SEBI while clarifying the ambit of encumbrance.

Facts of the case

The arguments herein were primarily with respect to the interpretation of the term ‘encumbrance’ on the shares as provided in Regulation 28(3) of the SAST Regulations. Two promoter entities of the Company (i.e. Yes Bank in the present case) issued unlisted unsecured zero coupon Non-Convertible Debentures (ZCNCD) to third parties and executed debenture trust deed (DTD) in this regard. Notably, a DTD is meant to safeguard the interest of the debenture- holders. However, the clauses of the deed in the given matter were drafted in a manner which according to SEBI gave the colour of having an encumbrance on the shares held by the issuer. The DTD executed included certain clauses w.r.t the cover ratio and borrowing cap to be maintained at all times until the redemption date, which provided a negative restriction on the issuers thereby providing the protection/ cushion to the debenture holders. The first promoter was required to maintain a cover ratio of 3.3X (cover of equity shares over borrowing) till 12 months and 3 X thereafter. On the other hand, the second promoter was required to maintain ratio of 0.5X (borrowing over the value of the shares) i.e. a borrowing cap of 0.5X. In case of a breach of the cover, they had to transfer to itself such number of listed shares or purchase such additional listed shares so as to maintain the required cover. If the same is not cured within the specified period, then it would be treated as an event of default.

Considering the above, SEBI was of the view that although there was no direct creation of security but the clauses in the deed lead to an indirect encumbrance on the shares, which required disclosure under Regulation 31 of SAST Regulations. Thus SEBI imposed a monetary penalty of total Rs. 50,00,000 on each of the promoter(s) separately under section 15A (b) of the SEBI Act for their respective violation of not making requisite disclosures of encumbrance under Regulations 31 of the SAST Regulations at the relevant time.

Construction of covenants and its implications

As mentioned above, the decision of SEBI was based on the obstructive clauses in the DTD which gave a taste of encumbrance created on the shares held by the promoter entities. The promoter entities or issuer companies were bestowed with the obligation to maintain cover ratio and borrowing cap respectively. In case of breach of the ratio, the promoter entities were required to either purchase or transfer shares so as to maintain the ratio. However, if the breach continued, it was treated as an event of default and the promoter entities were required to redeem the ZCNCDs but with prior approval of the ZCNCD holders.

Arguably, the covenants did not directly restrict the ability of the company to dispose of the said shares, however, requiring such an asset cover through the period of debentures, indirectly works as collateral for the securing ZCNCDs. Further, the restrictive clauses extended to the mandatory creation of exclusive pledge in case of subsequent borrowings which suggests that the DTD created an indirect security. Now, the question of law does not surround around the fact that whether the ZCNCDs were secured or unsecured. As in case of unsecured NCD which is not supposed to have security on the assets of the issuing company may still have covenants which creates lien etc. However, here the point of focus is that whether the covenants w.r.t to such issuance, restricts the rights of promoters on their shares including restriction on the transfer of shares. In latter case, it is considered to be an encumbrance.

Therefore, the underlying fact is that it is not only the ‘encumbrances’ which entail a risk of the promoters’ shares being appropriated or sold by a third party, directly or indirectly but all kinds of undertaking including those which encumbers, obstructs or restricts the right of promoters on the shares held by them should be disclosed to the stock exchanges. Hence, for the purpose of understanding whether any transaction is attracting the provision of encumbrance or not, one will have to resort to the manner of construction of the instrument supporting the security. Accordingly, it not a plain reading of the provisions but a clear understanding between the lines, which has to be referred to while drawing any conclusions.

In view of the same, while providing the annual disclosures, that promoters need to give to target company under Regulation 31(4) of the SAST Regulations, stating that apart from the ones disclosed during the financial year, they have not made any other encumbrances on the shares of the target company, the promoters will have to go through all similar covenants in DTD and other agreements with the third parties entered in order to ensure the same.

Analysis of the points of law covered

SAST – a welfare legislation

The term ‘welfare regulation’ has also been discussed by various courts. Recently, the Allahabad High Court in the matter of M/s Vasu Infrastructure Private Ltd. vs State Of U.P. and Ors.[4] on 23 September, 2019 stated that-

“In construing a social welfare legislation, the court should adopt a beneficent rule of construction; and if a section is capable of two constructions, that construction should be preferred which fulfils the policy of the Act, and is more beneficial to the persons in whose interest the Act has been passed…”

Thus, it is a well-known standard of construction that when a court is called upon to interpret the provisions of any social welfare legislation the supreme responsibility of the Court shall be to adopt such an interpretation which is in line with the purposes of law and if possible, avoid the one which goes against the actual intent. In this regard, the Securities Appellate Tribunal in the matter of Pitti Electrical Equipment Pvt. Ltd v/s SEBI[5] on 31st October, 2013, mentioned that even the SEBI ACT is certainly a social welfare legislation.

Considerably, the SAST Regulations in its overall perspective, deal with matters relating to transfer and holding of securities as an incidence of acquisition or their disposal and the disclosures required in this regard. The intent of the regulations is not only to ensure best corporate governance but also enable the stock exchanges and regulators to monitor such transactions of the promoters. The overall purpose is to bring about transparency in the transactions, in order to assist the stakeholders in having an informed decision making. Thus, the regulations on the whole serve as a social welfare regulation.

Genesis of the disclosure obligations

Broad intent behind mandating disclosures

As discussed, the fact that purpose of SAST Regulations is to extend the social welfare, more so for benefit of the stakeholders at large, it becomes more pertinent to understand the actual intent behind the disclosure requirements under Regulation 31. The disclosure obligations particularly those of the promoters of the listed companies have fairly critical and an important component of the legal regime. SEBI has laid such disclosure requirements not only for the benefit of the target company but for the investors at large. This apart, it also enables the stock exchanges and regulators to monitor such transactions of the promoters. This has therefore been a result of the continues discussions and recommendations held in the backdrop. SEBI in it the above-mentioned order also refers to report of Justice P.N. Bhagwati Committee[6] in the year 2002 recognised that disclosures should be ensured whenever shares were acquired by way of pledge by persons at the point of time when the pledge was created. This was noted while considering review of such obligations under Takeover Regulations of 1997[7].

Initially, the origin of the obligation to make the relevant disclosures arose in 2009 after the Satyam scandal where promoters’ shares were pledged to financial institutional without being known to the remaining shareholders. Thereafter, it was re-emphasized that the promoters will be required to disclose their acquisition as well as encumbrance by whatever name called on periodic as well as transaction specific basis to the Stock Exchange and the target company.

The PMAC also noticed some instances have come to light where private companies (controlled by the promoter(s) of a listed company) issued NCDs backed by the promoter(s) either in the form of pledge of securities (including shares) of a group company  or  through  other  forms  of  encumbrances  such  as  covenants,  NDUs, etc. which are very complex in nature. Accordingly, there was a need to further clarify the scope of encumbrance and make it more specific for the purpose of disclosure requirements which led to the introduction of SEBI (Substantial Acquisition of Shares and Takeovers) (Second Amendment) Regulations, 2019.

SEBI Board Meeting and Recommendations of PMAC

SEBI in its Board meeting held on June 27th, 2019[8] had approved the amendments in the SAST Regulations wrt the disclosures pertaining to encumbrances. This was done in line with the recommendations made by Primary Market Advisory Committee (PMAC)[9].

A snapshot of the pre and post amended definition is as follows:-

Pre-Amendment Recommendation of PMAC Post-Amendment 
(3) For the purposes of this Chapter, the term “encumbrance” shall include a pledge, lien or any such transaction, by whatever name called. “encumbrance” shall mean any fetter on the free and marketable title to the shares whether by way of pledge, lien, negative lien, non disposal undertaking or any other covenant, transaction, condition or arrangement, by whatever name called, executed directly or indirectly.” “(3) For the purposes of this Chapter, the term “encumbrance” shall include,- a) any restriction on the free and marketable title to shares, by whatever name called, whether executed directly or indirectly; b) pledge, lien, negative lien, non-disposal undertaking; or c) any covenant, transaction, condition or arrangement in the nature of encumbrance, by whatever name called, whether executed directly or indirectly.

The objective behind this recommendation was that all stakeholders, including the minority should be aware of the detailed reasons for pledging of shares by the promoters. Particularly for situations where promoters are holding a significant stake and have pledged their shares. In case of defaults, the shares of promoters could be invoked and sold by the lenders in large quantities which may lead to distress sale and fall in prices, affecting other investors, including minority shareholders.

The proactive steps taken by SEBI in this regard required the promoters along with PACs to even specify the reasons for encumbrance in the formats specified. In this regard SEBI also issued circular dated 07th August, 2019[10] which provided the amended format of disclosure, in addition to the disclosure format provided in its erstwhile circular dated August 05, 2015[11].

SEBI FAQs on encumbrance

SEBI by way of its FAQs[12] had already clarified the following points:-

a. As per Regulation 28(3), the term “encumbrance” shall include a pledge, lien or any such transaction, by whatever name called.” The promoters have to understand the nature of encumbrance and those encumbrances which entail a risk of the shares held by promoters being appropriated or sold by a third party, directly or indirectly, are required to be disclosed to the stock exchanges in terms of the Regulations

b. All types of Non-Disposal Undertaking (NDU) by promoters to the lenders would be covered will be covered under the scope of disclosures of ‘encumbrances’ under the Takeover Regulations.

Referring the above clarifications, the PMAC held that it was required that the scope of ‘encumbrance’ may be further clarified in the Regulations in   order   to   retain   the   inclusive   nature   of   the   definition and consequential changes may be carried out in the FAQs.

Meaning of the term ‘encumbrance’

Going by its generic interpretation, the term ‘encumbrance’ as defined above is any right or interest that exists in any person other than the owner of the property or asset wherein such right restricts or impairs any transfer of the property or asset. As regards the definition provided in Regulation 28(3) of the erstwhile SAST Regulations (prior to the amendment dated 27th July, 2019), SEBI has time and again pressed upon the inclusive nature of this definition. Now, in order to interpret the said definition, one may understand the three terms used in the above-mentioned provision in separation. So the definition provides:-

“encumbranceshall include a pledge, lien or any such transaction, by whatever name called.” 

Now, every term as highlighted above requires a clear interpretation.

Accordingly, it is both direct and indirect encumbrance which shall trigger the disclosure obligations. Thus, is to be noted that it may not be material whether the instrument in question, was secured or unsecured, in order to determine whether it creates an “encumbrance” or not. For the given instance, as regards the unsecured non- convertible debenture (NCD), thus is an instrument that may not have security on the assets of the issuing company. However, such issuance can always have such covenants which can create a lien over the assets on the company. The point to focus here is that, if the covenants wrt to such issuance, restrict the rights of the promoters on their shares i.e. restriction on the transfer of shares, etc, then such covenants would indirectly create an “encumbrance” over such shares even though the fact of any creation of security is not directly provided in the covenants.

Pledge or hypothecation as per the Depositories Act, 1996- will it be encumbrance?

Section 12 of the Depositories Act provides the manner of creation of pledge and hypothecation of securities in the depository system. However, this Act, although being the principal regulation governing the creation of encumbrances in the depository system, does not recognize the creation of a non- disclosure undertaking or requires any disclosures wrt the same. In this regard, it is pertinent to note that the said Act only enables pledge or hypothecation of securities which are held in dematerialized form with a depository and provides for entry of pledge or hypothecation on such securities in the records of the depository.

Accordingly, the provisions of Section 12 above do not per-se limit the nature and kind of ‘encumbrance’ on securities to pledge or hypothecation as sub- specie of pledge. In the securities market, there are numerous other covenants apart from pledge/hypothecation which may be possible. Thus, if any of such covenants restrict the right of issuers, it shall surely be considered within the ambit of encumbrance. Further, the Depositories Act in itself states the provisions laid therein are in addition to and not in derogation of any other law. Thus, the inclusivity of regulation 28(3) cannot be read in a manner to limit the ‘encumbrances’ only to pledge or hypothecation listed in section 12 of the Depositories Act, 1996.

Principle of ‘ejusdem generis”

“ejusdem generis” is a Latin expression which means “of the same kind or nature”. The principle has time and again been referred to while interpreting loosely written statutes. It provides that in cases where a law lists specific classes of persons or things and then refers to them in general, the general statements only apply to the same kind of persons or things specifically listed. In line with the same, the Hon’ble Supreme Court has defined the said norm in the matter of Maharashtra University of Health Sciences and Ors. v. Satchikitsa Prasarak Mandal and Ors.(2010)[13]. Now, arguably, while discussing the definition of ‘encumbrance’, one may resort to the widely used principle of ‘ejusdem generis” in determining the ambit of the phrase ‘any such transactions’ appearing in Regulation 28 (3) of the SAST Regulations.

In this regard it is to be noted that, besides the above-mentioned proposition, it is also a well-known fact that the principle of ejusdem generis is not a universal application. If the particular words in a phrase exhaust the whole genus, the general word following these particular words is construed as embracing a larger genus in its correct perspective so as to fructify the legislative intent and provision, so that real objective of any such enactment is not frustrated. Moreover, as upheld by the Hon’ble Supreme Court in SEBI Vs Ajay Agarwal[14] vide its judgment and order dated February 25, 2010.

‘It is a well -known canon of construction that when Court is called upon to interpret provisions of a social welfare legislation the paramount duty of the Court is to adopt such an interpretation as to further the purposes of law and if possible eschew the one which frustrates it.’

As discussed above, SAST being a social welfare regulation, which aims to provide investor protection, should not be narrowed to read the same as a loosely written statute. This infact, should be interpreted with the perspective favouring the securities market and investors. In addition to the same, the Hon’ble Supreme Court in the matter of Lilavati Bai v. Bombay State[15] provided that-

‘while applying the rule of ejusdem generis a restricted meaning has to be given to words of general import only where the context of the whole scheme of legislation requires it. But where the context and the object and mischief of the enactment do not require such restricted meaning be attached to words of general import, it becomes the duty of the courts to give those words their plain and ordinary meaning.’ 

Thus, in the given case the interpretation of ‘any such transaction’ in the regulation has to be read as an addition to the prior terms ‘pledge’ and ‘lien’ used in the definition, keeping in mind the inclusivity of the provision which takes into its ambit all kinds of restrictions on transferability of shares. Also, it is interesting to note the fact as pointed out by SEBI in the instant case that if the intent of regulation was only to limit the scope of ‘encumbrance’ to pledge, lien and similar transactions only, then the words “by whatever name called” would not be necessary in regulation 28(3).


Although, it has been held by the regulatory bodies time and again that one may resort to the precedents laid by various courts in order to derive inferences. However, the same cannot be resorted to where the law itself has provided its clarity on the provisions. The law is always required to be interpreted in the manner which may not prejudice the interest of those associated with the same. Therefore, as mentioned above, initially, the origin of the obligation to disclose “encumbrances” arose in 2009 after the Satyam scandal where promoters’ shares were pledged to financial institutional without being known to the remaining shareholders. Thereafter, it was re-emphasized that the promoters will be required to disclose their acquisition as well as encumbrance by whatever name called on periodic as well as transaction specific basis to the Stock Exchange and the target company. So as to enable the investors and other stakeholders to be informed about the steps taken by the promoters. SEBI has time and again clarified and broadened the term to include almost every transaction into its purview. Hence, this order can be a eye opener for companies avoiding disclosures to stock exchange.


[2] simplistic explanation/clarification of terms/concepts related to














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