Aloan against shares (especially shares of listed companies) is a mechanism routinely adopted by lenders to provide financing. However, the adverse market conditions and falling stock prices that have prevailed since early 2008 have led some lenders to invoke their pledges. This has triggered sales, including distressed sales, which in turn have accentuated the fall in share prices.
The markets have reacted strongly, as apart from promoters’ stakes being diluted, minority shareholders have suffered severe wealth erosion. Investors claim to have been cheated because the fact that promoters run the risk of losing a significant part of their shareholding when pledges are invoked is not in the public domain.
However, it is not entirely correct to state that this information is not in the public domain. The Securities and Exchange Board of India (SEBI) Substantial Acquisition of Shares and Takeovers Regulations, 1997, mandates any acquirer of shares or voting rights in a listed company (which, pursuant to an amendment to the regulations in 2002, includes a pledgee) to disclose any acquisitions beyond specified thresholds (starting as low as 5%) to the company and the stock exchanges.
It is interesting to note that SEBI has excluded pledgees, which are banks, from the ambit of the term “acquirer”. Though the regulations do not specifically state so, SEBI has clarified that only banks in India (and not offshore branches of foreign banks) are covered by this exemption. As a reaction to public outrage, and to protect the investors of listed companies, SEBI amended the regulations by making it mandatory from 28 January onwards for promoters to disclose to the company the details of the pledge created on its shares, and for the company in turn to make certain disclosures to the stock exchanges.
The issue that emerges is whether banks, in their capacity as lenders/pledgees, have any onus to take corrective action if they are aware that inaccurate disclosures have been made by companies or promoters as regards the status of promoter holdings. (Inaccurate disclosures might reflect an intention to mislead investors, or to access financing that would not be made available if accurate disclosures were made.)
An interesting case in point is that of Gujarat Heavy Chemical (GHCL). Disclosures made by GHCL, pursuant to the latest amendments, revealed that earlier disclosures GHCL made to the stock exchanges had reported promoter shareholding to be approximately 38-40%, whereas the actual promoter holding was 18-20%.
In this context, under contract conditions or common law, lenders would normally be subject to confidentiality obligations (except in the case of disclosure being permitted or required by law, as in the current situation), and would thus be precluded from divulging information. A Reserve Bank of India (RBI) master circular of 3 November 2008, on customer service, permitted banks to divulge confidential information if there is a “duty to the public to disclose”, or where “the interest of the bank requires disclosure”.
However, even if this were to constitute a mandatory obligation for banks to disclose any such information, banks would probably be reluctant to divulge such information in the absence of clarity as to what constitutes “duty to the public”, and as to the extent of the duty of care (if any) that banks owe to investors and other creditors.
In cases of consortium lending, the RBI requires that banks disclose wilful defaults to other members of the consortium. There is also an obligation on banks to disclose to the RBI details of wilful defaults exceeding Rs2.5 million (US$52,000).
It is also relevant to ask whether the regulatory framework in India contains any uniform requirement for lenders to place information on pledges created on shares of listed companies in the public domain. Unlike the compulsory registration of charge on immoveable property under the Transfer of Property Act, 1882, and the Companies Act, 1956, there is no compulsion to register a pledge of moveable assets of a company, including shares (apart from the disclosure requirements under the regulations, from which banks in India are exempted).
Though the depository contains a record on the shares of listed companies which have been pledged or which are subject to lock-in, depositories do not operate as central registries and thus this information is not publicly available. Chapter IV (yet to be notified) of the Securitization and Asset Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, mandates registration by the secured creditor of all “security interest” created by a company in its favour; but even this would not cover pledges created by individual promoters over shares of listed companies. Such information is also not required to be shared with the stock exchanges.
Given that pledgors are now required to make disclosures as regards creation and enforcement of pledges in favour of lenders (including banks), SEBI would do well to re-evaluate whether there is any merit in retaining the exemption from disclosure presently existing in favour of banks as pledgees.
Vandana Sekhri is a partner and Prachi Loona is an associate at Juris Corp. The firm is a full-service law firm based in Mumbai and specializes in financial transactions including capital markets and securities, banking, corporate restructuring and derivatives.
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