The pledge is defined as security for the fulfillment of a contract or the
payment of debt and is liable to forfeiture in the event of failure. The main
motive for pledging the shares is to raise loans by keeping shares as security.
The person who is the owner and wants a loan against them is a pledger and to
whom it is lent is pledgee. Share pledging is a new way of accessing funds from
the company. Sometimes person pledges their shares for their personal needs as
How Does A Share Pledge Agreement Work?
A share pledge agreement is between three parties:
The main agreement is signed between the lender which is usually a bank or a
Non-Banking Financial Company (NBFC) and the borrower which is a company,
whereas, a collateral contract is signed between the promoter and the borrower.
The collateral contract contains the details of the collateral/shares pledged in
the main agreement. This is done so that there is absolutely no confusion
regarding the ownership and quantum of securities pledged
After the borrower agrees to the share pledge agreement, the agreement comes
into effect. The promoter negotiates for a loan from the lender on behalf of the
company as its agent and also in his own personal capacity. This means that the
promoter is not only speaking for the company but also in his own capacity as a
natural person in the eyes of the law.
What Are The Risks Associated With This Agreement?
The risks associated with this agreement are as follows:
- Risks faced by promoters:
The shares are traded on the stock exchange and their prices fluctuate and
keep on changing. If the price of a share decreases, the value of collateral
also decreases. To make up for the decreased value the promoter has to
pledge additional shares, this is known as a marginal call. If the promoter
fails to meet the margin call then the lender usually invokes the pledge by
selling the pledged shares in the market and realizes his money.
- Risks faced by investors:
Companies with a high proportion of promoter pledging are viewed as risky by
the market because it raises questions about promoters falling short of
money in their personal capacity or facing debt problems in other ventures.
When the lenders sell off the pledged shares in the open market, the price
of shares falls further. Selling of shares by lenders in the open market
also alters the shareholding pattern of the company.
In most cases, even the promoters lose their stake and have no or less
voting power in crucial matters of the company. Investors, therefore, need
to keep a close eye on promoter pledging, as companies with high pledging
can witness major fluctuations in their stock prices. As an investor, one
must do their research and gather necessary information on pledged shares on
the websites of the stock exchanges.
Regulations Involved In A Share Pledge Agreement
Before SEBI was established, the two regulations that governed pledge agreements
were the Indian Contract Act, 1872 and the Banking Regulation Act, 1949. In
1992, SEBI was established.
SEBI is a statutory body established by the government in 1992 to regulate the
capital and securities market in the country. As regulator of securities, SEBI
ensures that the interest of the investors is protected by making regulations
issuing guidelines, frequently. In 2011, SEBI introduced the SEBI (Substantial
Acquisitions of Shares and Takeover) Regulations, 2011, (SAST Regulations). The
Regulation were mainly added to regulate the acquisition of shares and voting
rights in public listed companies in India. It contains the disclosure
requirements of the pledgor and pledgee with respect to the pledged shares.
The two main Regulations under the SAST Regulations that contain disclosure
- Regulation 29:
It deals with the disclosure requirements of the lender. The regulation
states that on any acquisition or disposal of shares or voting rights by the
lender or any person acting jointly with him, of the company aggregating to
5% or more, shall disclose their voting right and/or their total
shareholding in such company within 10 working days of acquisition of such
share or voting rights. The disclosure shall be made:
The disclosure shall also be made if there is a change in shareholding or
voting rights. The disclosure is to be made even if the total shareholding
or voting rights fall below 5% or if there is an increase in total
shareholding or voting rights above 29%.
- to every stock exchange where the shares of the company are listed;
- to the company at its registered office.
This Regulation shall not be applicable to scheduled commercial banks or
public financial institutions as a pledge in connection with the pledge of
shares for securing the debts in the normal course of its business.
- Regulation 30:
It deals with the disclosure requirements of the promoters. It states that
the promoter of the company has to disclose all the details of shares
encumbered, or any details of invocation of such encumbrances or release of
such encumbrances by him or by persons acting in concert with him in the
company.The disclosure should be made within 7 working days from the
creation, invocation or release of encumbrance, as the case maybe, to:
- Every stock exchange where the shares of the company are listed;
- The target company at its registered office.
Recently, SEBI exempted the below mentioned companies from disclosure
requirements under the SAST Regulations:
- Deposit taking Housing Finance Companies (HFCS) or HFCs of asset size of
at least Rs.500 crores, registered with the National Housing Bank (NHB)
- Systematically important NBFCs i.e whose assets are worth 500 cr or
Pledging Of Shares For Non-Residents
The regulatory change brought about by the RBI in its Circular 57 permits
non-resident shareholders of the Indian companies to avail of loans from Indian
and overseas banks. They can pledge their shares using their shareholding in
Indian companies as collateral after obtaining the no-objection certificate (NOC)
from the relevant authorized dealers (AD).
Accordingly, the requirement to obtain prior approval of the RBI for pledging
the Indian shares held by non-residents is dispensed with subject to fulfillment
of the conditions prescribed. ADs in respect of foreign direct investment (FDI),
such as private banks, public sector banks and multinational banks can act as an
AD in the matters relating to pledge of shares.