Non-Disposal Undertaking and its Reporting in the Indian Securities Market

[Guest post by Divyajyot Verma, a student at the
Jindal Global Law School]
Non-Disposal Undertakings
(or agreements) (“NDUs”) are signed usually by the debtor in favour of the
lender in relation to any loan obligation undertaken by the debtor. An NDU helps
in ensuring that the debtor does not transfer the shares held by it in a
company by way of outside arrangements such that the creditor is left without
access to significant assets of the debtor. Usually, the usage of an NDU is
prevalent in the stock market as shareholders, predominantly promoters, tend to
undertake a loan against their shares in the company and with an understanding with
the creditor that they will not alienate or create any other form of
encumbrance upon the shares, therefore, creating a negative lien upon them. Typically,
the shares are transferred to a new escrow demat account for the purposes of
this arrangement, but the beneficial ownership over the shares does not change (remaining
with the debtor) and the creditor is also not able to dispose them off to clear
off the dues (unlike a pledgee).
In the banking
sector, such NDUs are coupled with a power of attorney (“PoA”) thereby
appointing a security trustee. The combination of the NDU along with a PoA
ensures that there is a positive as well as a negative covenant in the
arrangement such that if the debtor (being the shareholder) fails to keep up
with its dues against the creditor, the security trustee can exercise his
powers under the PoA to alienate the shares in favour of the creditor (or any
other person). The alienation of the shares by the debtor is safeguarded by the
presence of the PoA and the escrow account under which such shares are held.[1]
Such an arrangement has been intentionally designed to avoid the framework of a
pledge to ensure that banks do not hold more than 30% of the shareholding of
the total paid-up share capital in the company as mandated under section 19(2)
of the Banking Regulation Act, 1949[2].
The complex legal arrangement has been formulated to avoid the compliance
required under section 19(1) of the Banking Regulation Act as the holding of
shares in an arrangement of pledge has a possibility of the bank becoming a
shareholder (in case of non-payment of dues) resulting in the company whose
shares are so pledged/encumbered to become its subsidiary.
Irrespective of the
structure of an NDU, there is no doubt that it creates an limitation of some
sort upon the shares of the promoters (especially when it is coupled with a
PoA) and it is vital that such information is disseminated adequately in the
public sphere. Previously, the Securities Board of India (“SEBI”) had amended
its formats under the SEBI (Substantial
Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Regulations”)
to ensure that appropriate disclosures are made with respect to NDUs within the
scope of “encumbrances” to help investors in taking an informed decision.[3] However,
these disclosures were seemingly restricted only to public listed companies and
their acquisitions under the Takeover Regulations.
Lately, it has also been noticed that companies are indulging in creating
special purpose vehicles for transferring shares through NDUs to avoid
compliance with the disclosures requirement as set through in the circular
issued on August 5, 2015
. The format so provided fell short as there was no
way in determining whether the shares of the promoters are encumbered until and
unless the promoters themselves declare it so. Despite there being a format in
place, NDUs still went unnoticed as they were dependent upon voluntary
declaration.
Therefore, through a more
recent circular dated June 14, 2017
, SEBI has mandated depositories to
develop a separate module/transaction type in their system to record NDUs. As a
result, a new procedural requirement has been introduced in the depository system
whereby depositories are required to electronically display/mandate disclosure
of NDU or similar arrangements upon the individual demat accounts of the shareholders.
As these agreements are individually entered into between the shareholder/promoter
and creditor (and generally through a written agreement), there was never any
means to ensure that they are appropriately reflected in the records of the
depository system.
Following are some of the guidelines issued in this regard:
– Both parties to the
NDU shall have a demat account with the same depository and be KYC compliant.
– Pursuant to
entering the NDU, the beneficial owner (BO) along with the other party shall
make an application through the participant (where the BO holds his securities)
to the depository, for the purpose of recording the NDU transaction.
– The entity in whose
favour NDU is entered shall also authorize the participant of the BO holding
the shares to access the signatures as recorded in that entity’s demat account.
– The participant,
after being satisfied that the securities are available for NDU, shall record
the NDU and freeze for debit the requisite quantity of securities under NDU in
the depository system.
– Upon creation of a freeze
in the depository system, the depository/ participant of the BO holding shares
shall inform both parties of the NDU regarding creation of freeze under NDU.
– The depositories
shall make suitable provisions for capturing the details of company/ promoters
if they are part of the NDU.
– In case the
participant does not create the NDU, it shall intimate the same to the parties
of the NDU along with the reasons thereof.
– Once the freeze for
debits is created under the NDU for a particular quantity of shares, the
depository shall not facilitate or effect any transfer, pledge, hypothecation,
lending, re-materialisation or in any manner alienate or otherwise allow dealing
in the shares held under NDU till receipt of instructions from both parties for
the cancellation of NDU
Despite the issuance
of such guidelines, SEBI could face several challenges, especially in terms of
enforcing the disclosure requirements if parties opt not to make the
appropriate disclosure of NDUs through the depository system as now required.
– Divyajyot Verma



[1] Ishaan Chhaya,
Non-Disposal Undertaking-Power of Attorney: A Grey Area Surrounding Investments
in Non-Banking Companies by Banks. Available at
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2056194
[2] Section
19(2) of the Banking Regulation Act, 1949: “Save as provided in
sub-section (1), no banking company shall hold shares in any company, whether
as pledgee, mortgagee or absolute owner, of an amount exceeding thirty per cent
of the paid-up share capital of that company or thirty per cent of its own
paid-up share capital and reserves, whichever is less:
PROVIDED that any
banking company which is on the date of the commencement of this Act holding
any shares in contravention of the provisions of this sub-section shall not be
liable to any penalty therefor if it reports the matter without delay to the
Reserve Bank and if it brings its holding of shares into conformity with the
said provisions within such period, not exceeding two years, as the Reserve
Bank may think fit to allow.”

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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