The concept of encumbrance was cursorily adopted in the Securities and Exchange Board of India (SEBI) (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (takeover regulations). The takeover regulations defined an encumbrance in connection with the disclosures that must be made pursuant to the creation, invocation and release of encumbrances on the equity shares of a listed company by its promoters, along with persons acting in concert (PACs).
The definition of encumbrance was vague. It included a pledge, lien or any such transaction, by whatever name called. This left scope for interpretation of the expression and disclosures that should follow. The specific ambiguity created was whether it included an encumbrance on the shares of the holding company of a company (holdco level encumbrance). Logical analysis would lead to the conclusion that such encumbrances, by virtue of their possible impact on the company upon invocation, that is a potential change in control indirectly, should be disclosed to shareholders of the company.
Perhaps for these reasons, the FAQs on the takeover regulations (prior to the amendment dated 3 September 2019) clarified that the details of a holdco level encumbrance must be disclosed as an encumbrance.
Development of grey area
Against the backdrop of ever increasing complexity in the nature of encumbrances created by promoters of listed companies while raising funds from mutual funds and non-banking financial companies, the SEBI amended the takeover regulations to define encumbrances more comprehensively. Pursuant to the SEBI (Substantial Acquisition of Shares and Takeovers) (Second Amendment) Regulations, 2019, encumbrance now includes:
- Any restriction on the free and marketable title to shares, by whatever name called, whether executed directly or indirectly;
- A pledge, lien, negative lien, non-disposal undertaking; or
- Any covenant, transaction, condition or arrangement in the nature of encumbrance, by whatever name called, whether executed directly or indirectly.
The FAQs on the takeover regulations were also amended to give effect to the broader meaning of encumbrance. However, by such an amendment, the earlier clarification on inclusion of holdco level encumbrances within the meaning of encumbrance was deleted. This gives rise to the question of whether one still needs to disclose a holdco level encumbrance under the takeover regulations?
The answer to this question will also clarify whether the reasons for requiring such holdco level encumbrances to be disclosed under the SEBI circular dated 7 August 2019 and effective from 1 October 2019 (additional disclosure circular). Under this circular, the SEBI requires that an additional disclosure be made by promoters for the reasons for encumbering shares, if the combined encumbrance by the promoter (along with PACs) equals or exceeds either 50% of their shareholding in the company or 20% of the total share capital of the company.
Encumbrances under revised definition
Despite the widening of the definition of encumbrance, the deletion of the FAQ in relation to the holdco level encumbrance has created a grey area. While the expanded definition can be interpreted to include a holdco level encumbrance, many may deem such interpretation to be a conservative one, if not largely incorrect. They may take the view that the creation of an encumbrance such as a pledge, on the shares of the holding company of the company may not necessarily constitute a “restriction on the free and marketable title to the shares of the company”, as the restriction is created at a level above the company.
However, another interpretation of the amended meaning of encumbrance, and a more appropriate one, would be to continue interpreting a holdco level encumbrance as an encumbrance under the takeover regulations despite the deletion of the FAQ. This would be in line with the object of the takeover regulations, which apply to the direct and indirect acquisition of shares or voting rights in, or control over, a target company. It would also give a clearer and more accurate picture of the shareholding structure to the minority holders of the company, on an ongoing basis. The failure to disclose such information would be likely to result in a significant market reaction, if the omission to disclose came to light at a later date.
In view of the above, although there is scope to interpret the new meaning of encumbrance in a limited way, a better view is that such holdco level encumbrances should continue to be regarded as encumbrances under the takeover regulations, and that those benefitting from them should make the disclosure, including the reasons for creating them.
Yogesh Chande is a partner and Preeti Kapany is an associate at Shardul Amarchand Mangaldas & Co.
Shardul Amarchand Mangaldas & Co
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New Delhi – 110 020
Executive Chairman: Shardul Shroff
Managing Partner: Pallavi Shroff & Akshay Chudasama
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