By JAYANT M. THAKUR
Chartered Accountant
In the ongoing Covid-19 crisis,
where the world is reeling and stock markets are crashing three times and then
recovering once, a recent SEBI order on disclosure of encumbered shares could
have widespread repercussions on promoters. Increasingly, over the years, the
regulatory outlook of SEBI has been one of disclosures and self-education
rather than close monitoring and micro-management. Material events relating to
a company should be disclosed at the earliest so that the public can educate
itself and take an informed decision. In this context, an order levying a
fairly stiff penalty in a complex case of encumbrance of shares held by a
promoter company makes interesting reading (Adjudication Order in respect of
two entities in the matter of Yes Bank Ltd. Ref No.: EAD-2/SS/SK/89/252-253
/2019-20, dated 31st March, 2020).
BRIEF
BACKGROUND
Disclosure of holding of shares
in listed companies by promoters and certain other persons (substantial
shareholders, etc.), is an important feature of the securities laws in India.
Promoters typically have large holdings of shares, they control the company and
their continued involvement in it as substantial shareholders is an aspect
considered by the public as relevant in investment decision-making. Being
insiders with control of the company, their dealings in shares are also closely
monitored. Thus, movements in shareholding of shares are required to be
disclosed by several provisions of the securities laws. These disclosures are
event-based and also periodical. Quarterly / annual disclosures are mandated.
So are disclosures based on certain types of transactions or crossing of
certain values / quantities / percentage of movement in the shares held.
Interestingly, and this is the
topic of this article, disclosure of encumbrance in the shares of promoters and
their release is also a requirement under the provisions of SEBI (Substantial
Acquisition of Shares and Takeovers) Regulations, 2011 (‘the Takeover
Regulations’). Regulation 31 of the Takeover Regulations requires disclosure by
the promoters of the creation, release or invocation of any encumbrance on
their shares.
The definition of what constitutes
‘encumbrance’ has undergone changes over the years and the present case relates
to a matter before the recent amendment made in July, 2019, though the
principle would apply even now. The earlier definition was short – ‘“encumbrance”
shall include a pledge, lien or any such transaction, by whatever name called’.
It is of particular interest to
shareholders whether and to what extent the shareholding of promoters is
encumbered. The Satyam case is often referred to in this regard.
COMPLEXITY
OF ENCUMBRANCES
Pledging and hypothecation of
shares are the classic and most familiar of encumbrances on shares. A
shareholder may, for example, transfer his shares to a lender who would hold
them till the loan is repaid. If there is a default, the lender may simply sell
the shares in the market and realise his dues. But now that shares are held
digitally in demat accounts, a special process has been made to enable pledge /
hypothecation of shares. The shares are not transferred to the lender but a
record is made of the pledge / hypothecation in the demat account.
However, encumbrance, as the
definition shows, is a wider term rather than mere pledge / hypothecation. The
definition is inclusive and also has a residuary clause that says such
transactions ‘by whatever name called’ are also covered. As we will see later,
the parties in the present case, however, claimed that encumbrances should be
limited to pledge / hypothecation.
A question arises whether
restrictions placed on the disposal or other transactions in respect of shares
amounts to encumbrance as so envisaged. The classic case is of giving a
Non-Disposal Undertaking, popularly referred to as an NDU, in respect of the
shares. This means an undertaking is given that the shares held shall not be
disposed of till certain conditions (say, loans / interest are repaid) are met.
Even if a plain vanilla NDU is held to be an encumbrance, there are actually
many variants of an NDU or similar encumbrances as the present case shows. The
question is whether the definition should be treated as a generic catch-all
definition or whether it should be given a restrictive meaning. This has been
the core question addressed in this decision. Let us consider the specific
facts.
FACTS
OF THE CASE
The matter concerns two promoter
companies of Yes Bank Limited. Broadly summarised, the essential facts (though
there is some variation in details) are as follows: Both took loans by way of
differently structured non-convertible debentures from entities. The total
amount of loans taken was Rs. 1,580 crores. The shares held and which were the
subject matter of the alleged encumbrance, constituted 6.30% of the share
capital of Yes Bank. The debenture documents / terms placed certain
restrictions on the promoter entities. They were required to maintain a certain
cover ratio / borrowing cap. If such limits were violated, there were certain
consequences, principally that the promoter entity could be held to have
defaulted. There was, however, some flexibility. The promoter entities could
make certain variations after the approval of debenture holders in a specified
manner or after complying with certain conditions.
SEBI’S
ALLEGATION
SEBI held that the cover ratio /
borrowing cap effectively amounted to an encumbrance on the shares and thus
required disclosures under the Takeover Regulations. It alleged that the
entities would effectively face a restriction on the sale of their shares
because if they sold the shares, the ratios / caps would get exceeded and hence
the terms of the debentures could get violated. It was an admitted fact that no
disclosure of this alleged encumbrance was made as required under the
Regulations. Thus, there was a violation of the Regulations and SEBI issued a
show cause notice as to why penalty should not be levied.
CONTENTIONS
OF THE PROMOTER ENTITIES
The promoters gave several
detailed technical and substantive arguments to support their view that there
was no violation and hence no penalty could be levied. Technical arguments like
inordinate delay in initiating the proceedings were given. It was also argued
that since then the structure had undergone substantial changes, and
particularly on revision of terms, disclosure was required and was duly made.
It was argued that the definition
of encumbrance effectively limited it to things like pledge, hypothecation,
etc. The principle of ejusdem generis applied for the words used ‘by any
other name called’ considering that they were preceded by the words ‘such
transaction’.
Some of the other major arguments
were as follows: It was argued that the structure and terms of debentures did
not amount to encumbrance as understood in law. The caps on borrowings, etc.
were of financial prudence. There were many alternatives for the entities to
sell the shares if they wanted to do so within the terms of the debentures
themselves. References were made to FAQs and press releases where some
clarifications were given about encumbrances. It was argued that examples were
given of the type of encumbrances that were envisaged to be given and the
present facts did not fit those examples.
Incidentally, the parties had
earlier applied for settlement of the alleged violations but the application
was returned due to expiry of the stipulated time under the relevant settlement
regulations.
REPLY
AND DECISION OF SEBI
SEBI rejected all the arguments.
The debenture documents were made in late 2017 / early 2018 and thus SEBI held
that there was no inordinate delay in initiating the proceedings. The mere fact
that the structure was changed later and the disclosures duly made did not
affect the fact that no disclosure was made originally when the alleged
encumbrance was made.
It also rejected the core
argument that ‘encumbrance’ should be given a limited meaning more or less
restricting it to cases like pledge and hypothecation or the like. SEBI pointed
out that the definition was inclusive and even more descriptive than limiting.
The use of the words ‘by any other name called’ could not be restricted to
examples given of pledge / hypothecation. The principle of ejusdem generis
did not apply.
SEBI also traced the history of
the regulations and explained the dilemma that was faced regarding identifying
the many types of encumbrances. It was accepted that encumbrances on shares of
promoters needed disclosure in the interest of the securities markets.
Considering the varied and often sophisticated nature of encumbrances, the
definition was made descriptive / inclusive and not exhaustive. It was well
settled, SEBI argued, that securities laws being welfare regulations, needed
wider beneficial interpretation.
Although the definition was
modified recently whereby some specific instances were further added, it did
not mean that the earlier definition should be construed narrowly.
SEBI noted that the effect of the
conditions regarding limits was that the shares of the entities could not be
sold. This amounted to an encumbrance on shares and hence non-disclosure
amounted to violation of the Regulations.
SEBI thus levied a penalty of Rs.
50 lakhs on each of the two entities.
CONCLUSION
It goes without saying that
disclosure of encumbrances matters at any stage. Indeed, SEBI has required,
over a period, more and more information relating to encumbrances including,
most recently, the purpose for which the encumbrances were made.
However, their effect would be
seen particularly when the encumbrances end up being given effect to with
shares being sold in the market on invoking of the encumbrances, to take an
example. This may particularly happen when the price of the shares goes down
sharply, resulting in a vicious circle. The coverage / margin required by the
encumbrance documents gets violated and there is need to provide more shares as
encumbrance or sale of shares (and) which results in further lowering of price.
This would again affect the interests of shareholders. We are seeing now a huge
crash in share prices. It is possible that there may be many such similar
encumbrances and they may come to light because of the impact of share sale or
other transactions. There may be more cases in which SEBI may have to act.
This decision is relevant even
under the amended regulations. It lays down the principles and intent of the
regulations relating to encumbrances. Thus, unless reversed on appeal, it would
matter particularly (if and) for any fresh encumbrance as understood in a broad
manner in the SEBI order is undertaken. Such encumbrances then would advisably
be disclosed duly in accordance within the time limits and manner prescribed.
There
may be entities that have not disclosed the encumbrances till now, taking a
stand similar to that taken by the entities in the present case. They may need
to revisit their stand and documents and see whether due disclosures need to be
made, even if belatedly, but voluntarily. Better late than never.
