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Invocation of Pledged Shares and the Impact of Covid-19

Suppose, you are the promoter of a company, and your company needs to raise some finance. For that, you decide to take a loan of say INR 1,00,000/- from a bank. Now you would also need to pledge some sort of collateral to the bank for the advancement of this sum of money. So you decide to pledge the shares of your company as the collateral (as the shares are also considered to be assets).

The market value of these shares needs to be higher than the amount of loan advanced (i.e. INR 1 Lac in the present case). This is because the banks maintain a margin amount. The Share Pledge Agreement usually provides for a minimum collateral value.

The market value of the shares keeps fluctuating, and therefore, in case the market value of these pledged shares declines below the minimum collateral value as agreed upon in the Share Pledge Agreement, then the company would need to furnish more collateral, cash, or simply more shares. But in case of non-compliance, the Bank could be forced to invoke the pledged shares.

Meaning
As discussed above, the shares of a company can be pledged with a lender as collateral against the issuance of loan amount. But what happens when the market value of these shares fall below the level agreed upon by lenders and the promoters in the Share Pledge Agreement?

In such cases, the lenders have the right to sell the shares which are pledged with them in case the promoters of the company fail to come up with additional collateral within a stipulated time period. This process of selling the pledged shares by the lenders, is called invocation of pledged shares.

Who Can Pledge The Shares?

Promoter(s)
Shareholders

Who Can Lend Against Pledged Shares?

Banks
NBFCs (Non-banking Finance Companies)

Circumstances Under Which The Pledged Shares Can Be Invoked?

As discussed above, when the prices of the pledged shares fall, the lenders seek additional margin in terms of more shares, cash, or other form of collateral, and in the event the companies are unable to provide for this additional margin, it leads to non-compliance, and the lenders may be forced to invoke the pledge.

(However, the Invocation of pledged shares need not take place only due to fall in market price. It can also happen due to violation of any other provision in the Share Pledge Agreement.)

Factors Affecting The Market Value Of Shares

The Marketplace
The marketplace determines share prices. While seller supply and buyer demand meet in the market, there is no perfect equation that lets investors know exactly how share prices will behave.

Demand and Supply
Demand and supply in the market affect the prices of shares. When demand for shares exceeds supply, which means the buyers are more than sellers, the prices increase. When demand is less than supply, meaning that buyers are less than sellers, the prices decrease.

Interest Rates
In case of lower interest rates, demand for funds is higher and the subsequent demand for shares rises. On the other hand, high interest lowers the demand for funds and the demand for shares is lower.

Investors
Market players have an impact on share prices. With more bulls than bears, the prices increase. With more bears than bulls, share prices decline.

Dividends
Dividends indicate the movement of share prices. When companies make dividend announcements, the share prices of such companies are likely to increase. It is important to note that if the dividend rate announced is lower than the investors' expectations, share prices decline while if they are up to more than expected, share prices increase.

Management
Management profile has a significant effect on company success and stock prices. If management consists of experienced professionals with a proven track record, share prices are likely to be higher. If the management that takes over a company lacks integrity, share prices tend to fall.

Economy
Fluctuations in the economy feature what are commonly referred to as booms and depressions. Under favorable conditions share prices are at their peak and their lowest point is experienced during depressions. Share prices gradually rise during recovery and fall during recessions.

Political Climate
Political factors that range from relations with other nations to government policies can also affect the share prices.

Market Sentiments
It is widely believed that market sentiment and technical factors are overwhelming on a short-term basis but fundamentals ultimately set share prices in the long run. Since conventional theories are not sufficient for explaining all the things that go on in the market, behavioral finance or market sentiment will always be a keen area of interest.

What Are The Effect Of Invocation?

When the lenders invoke the pledged shares, it is not a good outcome for the company as inter-alia, the following would be the implications:
  • Shareholding pattern makes a shift
  • Promoter's Shareholding reduces
  • Promoter's Control over the company also reduces
  • Value of the Shares falls

How Can One Prevent Invocation Of Pledged Shares?

In order to prevent the lender from invoking the pledged shares, following shall be ensured by the promoter:
  • Maintain the value of collateral,
  • Pledge additional collateral (i.e. additional shares/cash/other assets) in case the value of the pledged shares decline, and
  • Abide by the other terms of the Share Pledge Agreement

Can Companies Revoke The Invocation?

No, once the lender successfully sells the pledged shares of the company, in the open market, companies cannot do anything to revoke that transaction.

However, the companies can approach the court seeking an injunction order before the pledged shares have been invoked by the lender. Following case would be a nice example:

Recently, the Bombay High Court, in the case of Rural Fairprice Wholesale Limited & Anr. v. IDBI Trusteeship Services Limited & Ors, the shares of Future Retail Limited were pledged against the debenture issue and the respondents had the right to invoke pledge in case of fall in margin coverage. As per the applicants, the fall was because of stock market collapse triggered by COVID-19, and HC issued an ad-interim injunction to restrain lenders from exercising their rights to invoke the pledge on the shares of Future Retail Limited, which operates the hypermarket Big Bazaar.


Covid 19 Impact:

The lockdown imposed due to the Covid19 situation has impacted almost every business in each sector, due to which the stock prices of various companies have taken a beating. Therefore, for the companies, whose promoters have pledged their shares with the lenders as collateral against the loan availed for personal/business purpose, there is a high possibility that these pledged shares would be liquidated, or invoked and sold in the open market if the slide in these stocks continues.

In order to escape such a situation, the promoters of such companies are making sure to pledge additional collateral to maintain the minimum collateral value.

Following are the examples of the measures taken by some of the companies recently:
  1. On March 5, HDFC invoked 3.2 million shares of Eveready Industries pledged by promoters Williamson Magor & Co. Lenders have also invoked shares of companies such as Asian Hotels (North), JustDial, Mandhana Retail and Arcotech.

  2. Billionaire industrialist Gautam Adani and his family brought in additional shares worth Rs 11,000 crore as collateral, according to a Bloomberg analysis of regulatory filings for four of his group's companies - Adani Port, Adani Enterprises, Adani Transmission and Adani Green Energy.

  3. The promoters of Emami provided 838,000 shares to IndusInd Bank as topup collateral on March 20.

  4. The promoters of Motherson Sumi increased their pledge by 24.5 million shares in favour of Kotak Mahindra Investment. Similarly, promoters of Jindal Steel & Power increased their pledge by 1.13 million shares in favour of IDBI Trusteeship on March 23.

Recent Case Study:
Yes Bank acquires stake in Dish TV by way of Invocation of Share Pledges:

Private sector lender Yes Bank has acquired 24.19 per cent in Dish TV, and became second-largest shareholder in the direct-to-home (DTH) company.

The Dish TV had pledged shares with Yes Bank and thereby Yes Bank moved to pick up a stake in Dish TV, by invocation of pledged shares to the tune of INR 445.3 million.

The Dist TV's promoters who held 54.36 per cent stake in the company, after the invocation by Yes Bank, now hold just 30.37 per cent.

This is the sixth such transaction by YES Bank in a year in various companies. Last year, YES Bank had invoked pledged shares of CG Power, Cox & Kings, and Reliance Infrastructure. While earlier this year, it had invoked pledged shares of Reliance Power and Sical Logistics.

Conclusion
Given the situation of falling value of the shares in the market due to the Covid19 scenario, the promoters of the companies who have availed the loans by pledging their shares as collateral to the lenders such as banks and NBFCs, would be worried to compensate the falling collateral value by either pledging more shares, or by giving cash, or pledging some other asset. Otherwise they too would fear the invocation of their pledged shares, which would not only lead to the dilution of promoter's stake and control in the company, but which also decrease the further value of the shares of such company in the market.

References:
  1. https://www.barandbench.com/columns/policy-columns/invocation-of-pledged-shares-amid-covid-19-can-force-majeure-save-promoters-in-distress
  2. https://economictimes.indiatimes.com/markets/stocks/news/many-promoters-lose-pledged-shares-after-market-mayhem/articleshow/74839048.cms?from=mdr
  3. https://www.business-standard.com/article/companies/yes-bank-acquires-24-19-stake-in-dish-tv-through-pledged-shares-120053100023_1.html

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