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Invocation of Pledged Shares

According to Section 172 of the Indian Contract Act, 1872. A pledge is a type of bailment in which a debtor conveys custody of a commodity to a creditor as a security until the debt is paid off or the promise is fulfilled.

The firm XYZ Ltd needs to raise funds, according to the promoter. It chooses to borrow INR 1,00,000/- from a bank for this purpose. For the bank to advance you this amount of money, you'll need to put up some type of collateral. As a result, you decide to use your company's stock as security.

Since the market value of the shares fluctuates, if the market value of the pledged shares falls below the minimum collateral value set forth in the Share Pledge Agreement, the company will be required to provide additional collateral, cash, or simply more shares. In the event of non-compliance, however, the Bank may be required to use the pledged shares.

Meaning
The shares of a company can be pledged to a lender as collateral against the issuing of a loan amount, and the lenders have the right to sell the pledged shares if the firm's promoters fail to provide additional security within a certain time period. The practice of lenders selling pledged shares is known as an invocation of pledged shares.

  • The shares can be pledged by the promoters and shareholders.
  • Banks and non-bank financial companies (NBFCs) lend against pledged securities.


Invocation of pledged shares

  • When the pawnor fails to pay his loan, the pawnee has certain rights. Section 176 of the Indian Contract Act, 1872, is the key provision that applies in this case. After giving the pawnor due notice, the pawnee has the option to sue the pawnor, (ii) keep the pledged items, or (iii) sell them.
  • Regulation 79 (8) of the SEBI (Depositories and Participants) Regulations, 1996, is the relevant SEBI regulation that governs the invocation of a promise. However, this legislation does not specify that the pawnor must be served with any kind of notice before the pledge can be used. All it says is that everything should be done according to the pledge document.


Under what circumstances can the pledged shares be invoked?

  • When the value of the pledged shares drops, the lenders want extra margin in the form of new shares, cash, or another kind of collateral. If the firms are unable to offer this additional margin, non-compliance occurs, and the lenders may be obliged to activate the pledge.
  • However, the revocation of pledged shares is not required to occur just because of a decrease in market value. It might also occur as a result of a breach of any other condition of the Share Pledge Agreement.
  • Companies are unable to withdraw the invocation because after the lender has successfully sold the pledged shares of the firm on the open market, they are unable to do so.


Implications of the pledged being invoked by the pleader:

  • The shareholding pattern changes;
  • the promoter's shareholding decreases;
  • the promoter's control over the firm decreases;
  • and the value of the shares decrease


Sebi regulations related to the pledging of shares

  • The promoters of a public business must hold at least 20% of the shares for a three-year lock-in term under Regulation 36 of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009. The promoters, on the other hand, can pledge shares in excess of 20% for any purpose under Regulation 39 of the same set of laws. That 20% can only be pledged for financing operations that would assist the firm in meeting its goals. This implies that if a freshly listed company's promoter wants to take out a loan for personal purposes, their entitlement to pledge under the ICA is subject to SEBI's other rules.
     
  • The word "encumbrance" is defined under Regulation 28 (3) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011 to cover all sorts of pledges and liens. This is especially important since, under Regulation 31(1) of the same set of laws, all promoters must declare any creation, invocation, or release of encumbrance to the public. This demonstrates that pledging shares of a publicly-traded firm as a promoter are far more regulated than pledging shares like a regular investor.

Case Law:

  • 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 a pledge in case of a fall in margin coverage. As per the applicants, the fall was because of the stock market collapse triggered by COVID-19, and the High Court 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.
  • JRY Investments Pvt. Ltd. v. Deccan Leafing Services Ltd held that there was no duty upon the pawnee to serve a notice to the pawnor when pledged Demat shares were being enforced. It was also stated that the pledge of Demat shares can only be created under the Depositories Act, 1996, and not the ICA. The ICA could only regulate pledges relating to physical shares as in the context of Demat shares, no physical delivery of goods takes place.
  • GTL Limited v. IFCI Ltd. & Others held that reasonable notice for selling Demat securities under Section 176 of the ICA is mandatory. Otherwise, the contract would be illegal as the pawnor would not have the opportunity to redeem the pledged shares. Further, it was held that the requirement of notice only comes when the pawnee plans on selling the share and not when they plan on invoking the pledge and transferring the securities into their own Demat account.
  • Tendril Financial Services Pvt. Ltd. and Ors. v. Namedi Leasing & Finance Ltd. and Ors. declined its previous ruling of the GTL Limited v. IFCI Ltd. & Others case and held that a notice was not required. The Delhi HC stated that the provisions of the Depositories Act, 1996 were not taken into account in the previous judgment.

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