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Pledge of shares by promoter entities

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– concerns involved, regulatory framework and need for additional disclosures

– Anushka Vohra, Manager | corplaw@vinodkothari.com

Background

It is common for promoter / promoter companies (HoldCo) to raise funds by way of pledging their shares held in operating companies (OpCo). This is known as loan against securities (LAS). LAS enables borrowers to raise funds from banks / NBFCs by keeping shares, mutual funds or life insurance policies as collateral. There are specific regulations issued by RBI with respect to LAS.

As on March 6, 2023[1], there are 239 companies that have reported promoter pledge on BSE.  Pledging of shares by promoter companies held in operating companies does not raise a red flag per-se, however one has to know, (i) the percentage of shareholding pledged by promoters / promoter companies viz-a-viz the paid up share capital held, that is to say the unencumbered shares, (ii) leverage at the group level; (iii) impact of default.

In this article, the author tries to highlight the concerns arising from pledging of shares held in OpCo by HoldCo, the disclosure provisions currently prevailing w.r.t. the pledged shares, and the need for additional disclosures.

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Broken Pledge? Apex Court reviews the law on pledges

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By Vinod Kothari, Managing Partner, Sikha Bansal, Partner and Shraddha Shivani, Executive | corplaw@vinodkothari.com

The Supreme Court ruling in  PTC India Financial Services Limited v. Venkateshwar Kari and Another is significant in many ways – not that it categorically rewrites the law of pledges which is settled with 150 years of the statute[1] and even longer history of rulings, but it surely refreshes one of the predicaments of a pledge. Importantly, since most of the pledges of securities currently are in the dematerialised format, it brings out a very important distinction between the meaning of ‘beneficial owner’ under the Depository law, and the right of the pledgee (a.k.a. pawnee or security interest holder) to cause the sale in terms of the rights arising under the pledge. Also, very importantly, the SC dwells upon the essential principle of equity of redemption in pledges and renders void any provision in the pledge agreement which allows the pledgee to make a sale of the pledged article without notice to the pledgor, or to forfeit the pledged article and convert the same as pledgee’s own property. There are also observations in the ruling that seem to give an indefinite time to the pledgee for the sale of the pledged property – this is a point that this article discusses at some length.

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Utilisation of accumulated surplus by section 8 companies

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-Can surrogate means be used to relegate funds or benefits to shareholders

Pammy Jaiswal | Partner | Vinod Kothari and Company

Shraddha Shivani | Executive | Vinod Kothari and Company

corplaw@vinodkothari.com

Background

Section 8 of the Companies Act, 2013 (‘CA’) provides for the formation of companies with specific objects. Since the section revolves around incorporation of companies with charitable or some other specified welfare objectives, it gives an impression that these companies do not work to earn financial gains for their shareholders. This impression becomes evident since Section 8 companies are commonly referred to as ‘not-for-profit’ companies which further substantiates this understanding and adds to the confusion. They may make profits, as indeed, they very often do; however, the profit necessarily gets redeployed to carry the very same objects for which the company was formed, and cannot be relegated to the shareholders.

 In fact, earning profits is not just permitted but is also essential for their continued existence and organic growth of its affairs. Most such companies do not borrow; hence, they carry their activities either through corpus contributions or through retained profits. Thus, the restrictions under CA are not on earning profits but on the distribution of the same to its shareholders. 

The most common way for a company to distribute profits to its shareholders is by way of payment of dividend. This is explicitly barred in case of a Section 8 company. Having said that, these companies may also come across a situation where they do not foresee any immediate application of their accumulated profits and therefore, may look out for ways to utilise it for some other purpose. The management running these companies, potentially representing shareholders, may not be necessarily driven by avarice when they intend to use the funds other than for the purpose for which the company was formed.

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