With the recent order of the Securities and Exchange Board of India (SEBI) imposing a fine on the promoter entities of YES Bank, the much contentious issue of the definition of encumbrance has again taken the centre stage. This post aims to analyse the recent order of SEBI in light of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
The SEBI Takeover Regulations, under regulation 28(3), defines ‘encumbrance’ to include a pledge, lien or any other transaction by whatever name called. However, pursuant to an amendment in the Takeover Regulations in 2019, the definition of encumbrance was widened to also include:
- Any restriction on the free and marketable nature of shares, whether directly or indirectly;
- Pledge, lien, negative lien and non-disposal undertaking; or
- Any transaction, covenant, condition or arrangement which is in the nature of an encumbrance and has been executed either directly or indirectly.
In the order dated 31 March 2020, SEBI has imposed a penalty of Rs. 50 lakhs each on two promoter entities, i.e., Morgan Credits Private Limited (MCPL) and Yes Capital India Private Limited (YCPL), for non-disclosure of encumbrances on their shareholding in Yes Bank Limited. Both MCPL and YCPL had raised money from mutual funds through the issue of zero coupon non-convertible debentures. Furthermore, the two entities agreed maintain a cover ratio or borrowing cap as a part of the transaction.
The main issue that came for consideration before SEBI was whether the condition of maintaining the cover ratio or borrowing cap falls under the ambit of the term encumbrance on the shares of Yes Bank. SEBI in its order discussed several issues raised by the promoter entities.
The promoter entities argued that the cover ratio or the borrowing cap is not in the nature of an encumbrance as it does not directly or indirectly affect the tradability of the shares. As a response to the same, SEBI observed that the requirement of a company to maintain an asset cover restricts the company from disposing off the shares without triggering a default of the underlying debt. This is not in the nature of a direct restriction, but it has the same effect as restriction in an indirect manner.
The major contention of the entities was that the transaction does not fall under the definition as laid down in regulation 28(3) by way of application of the principle of ejusdem generis. According to the promoters, the nature of transaction is not similar to a pledge or lien and hence does qualify as any other transaction by whatever named called under regulation 28. While discussing this contention, SEBI clearly laid down that the principle of ejusdem generis is not of universal application and cannot be applied in a manner that defeats the purpose of the law. Furthermore, the application of the rule of ejusdem generis provides for the grant of a restricted meaning to the words of general import only in cases where the context of the whole scheme of legislation requires it. Therefore, the Takeover Regulations, which are essentially a socio -economic regulation with the aim to protect the interests of the investors must be interpreted in the light of its context.
Furthermore, the FAQ as released by SEBI has clearly laid down that non-disposal undertakings fall under the definition of encumbrance. This goes on to depict that the explanation is inclusive and not an exhaustive one. Hence, SEBI held that the transaction falls under the ambit of the definition of encumbrance and disclosures under regulation 31 are required to be made by the promoter entities.
On the contention that the borrowings raised by way of issuance of non-convertible debentures is of unsecured nature and is not in the nature of an encumbrance, SEBI has clarified that the question as to whether the instrument which created the encumbrance on the shares is secured or unsecured is immaterial in nature.
With regards to the contention regarding the applicability of section 12 of the Depositories Act, SEBI has noted that the Depositories Act and the regulations made under it are merely in addition to and supplemental to the SEBI Act and the Takeover Regulations and, hence, the inclusivity of regulation 28(3) cannot be read down so as to limit the definition of encumbrances in accordance with section 12 of the Depositories Act.
Analysis and Conclusion
From the very beginning, the drafters have framed regulation 28 in a manner that the definition of the word encumbrance is construed as inclusive and not exhaustive in nature. Even after the amendment to the Takeover Regulations in 2019, the definition has not been made exhaustive and is flexible enough to include any other transaction or condition which may affect the tradability or marketability of the equity shares of the listed company. Such usage of language by the regulator goes on to depict that the definition of the term encumbrance is accommodative of any complex transactions that may arise in the future that are not predictable now and may have an effect on the marketability of the shares.
Furthermore, the principles of statutory interpretation lay down that the court must interpret a provision in a manner which furthers the object of law and does not frustrate it. The intent of the regulator for making such disclosures compulsory is to protect the interests of the investors. However, if such transactions which are not explicitly included in the definition but jeopardize the interests of the investors, it would lead to entities bypassing the law and would hence defeat the entire purpose of the law. Such an interpretation should be seen as a welcome move, as it would ensure greater transparency and accountability in the system.
– Arushi Gupta