Wednesday, July 19, 2017

Reprimand or Warning Orders by NCLT

[Guest post by Rohit Sharma, Executive at Vinod Kothari & Co.]

Background

UW International Training & Education Centre for Health Private Limited voluntarily filed an application before the National Company Law Tribunal (‘NCLT’) with respect to a matter pertaining to section 56(2)(a) of the Companies Act, 2013 (the ‘Act’) for transfer and transmission of securities.

In this regard, section 56(4)(a) of the Act states as follows:

Every Company shall, unless prohibited by any provisions of law or any order of Court, Tribunal or other authority , deliver the certificates of all securities allotted, transferred or transmitted-

within a period of two months form the date of incorporation, in the case of subscribers of the memorandum; 

Hence, the company should have delivered the certificates of all securities allotted, transferred or transmitted, to the subscribers of the memorandum of association (MoA) of the company within a period of 2 months from the date of incorporation, in case there are subscribers to the MoA of the Company.

However, in the case of UW International, although the company was incorporated in New Delhi on 15 October 2015, due to numerous procedural requirements the bank accounts of the company were opened only on 26 April 2016. Accordingly, the company received the subscription money on 27 April 2016 and 6 May 2016 from the subscribers to the MoA of the company.

Since UW International was incorporated on 15 October 2015, the share certificates should have been issued to the subscribers of the MoA by 15 December 2015. Nevertheless, as stated above, due to the delay in opening of the bank account of the company to deposit the subscription money, the certificate was not issued within the prescribed time limit under the provisions of the Act.

Penalty prescribed for the aforesaid matter

The penalty for default in compliance with section 56(4)(a) of the Act has been prescribed in section 56(6) of the Act, which states as follows:

Where any default is made in complying with the provisions of sub-sections (1) to (5), the company shall be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees and every officer of the company who is in default shall be punishable with fine which shall not be less than ten thousand rupees but which may extend to one lakh rupees.

[Emphasis provided]

Pursuant to section 441 of the Act, the following offences are considered for compounding:

(a)        Offence punishable with fine only;

(b)       Offence punishable with imprisonment or fine; or

(c)        Offence punishable with both.

Therefore, the aforementioned penalty happens to be a compounding offence.

Order of the NCLT

In the instant case, pursuant to the aforesaid provisions of the Act, the minimum penalty on UW International should have been Rs. 25,000, while for the defaulting officers it should have been Rs. 10,000. Moreover, the maximum penalty on company should be Rs. 5,00,000, while on the defaulting officers it should be Rs. 1,00,000. However, the NCLT held that the concept of minimum fine on compounding matters is not mandatory, and the NCLT may even consider reprimanding the defaulter or issuing a warning as part of compounding of an offence. Therefore, considering the fact that the delay in issuing the share certificates to the subscribers as mentioned in the MoA was not within the control of UW International, the NCLT imposed a minimum fine of Rs. 10,000 on UW International and each of the defaulting officers.  The NCLT also ordered that the fine imposed on the defaulting officer shall be paid out of their personal accounts.

Conclusion

This case is an example that brings out the actual intention behind imposing minimum penalty on the defaulter(s). It is not necessary that fine imposed on the defaulter shall be solely in monetary terms. The consequences may also be imposed by way of reprimanding the defaulter or by giving an appropriate warning to the defaulter. The entire rationale behind imposing a fine implies a warning to the defaulter or as a deterrent. This case suggests that there might be other means to achieve the objective of the legislation.

- Rohit Sharma

Thursday, July 13, 2017

Supreme Court on Hardship vis-à-vis Frustration and Force Majeure

[This is a guest post contributed by Rishabh Raheja, a third year student at NALSAR University of Law, Hyderabad.]

The Supreme Court was presented with the perfect opportunity to clarify the relationship between frustration, force majeure and hardship or commercial impracticability in its decision in Energy Watchdog v. Central Electricity Regulatory Authority. While it has already been argued on this blog that the Supreme Court’s approach has further obfuscated the doctrine of frustration, and undermined the Party’s autonomy in stipulating for force majeure, this post will deal with the implications of this decision on a party’s position in the face of onerous performance or hardship.

BACKGROUND

The concepts of frustration, force majeure and hardship are varied manifestations of the universal principle of rebus sic stantibus, or changed circumstances, an exception to the tenet of pacta sunt servanda, or the sanctity of contractual promises.[1] It is crucial to note that the similar origin of these doctrines does not imply that they are the same; in fact, they have differing thresholds and different implications for the parties.[2]

The contract being considered in Energy Watchdog involved an extremely detailed set of force majeure clauses, and the dispute concerned a situation of hardship to one of the parties, in the form of a drastic and unprecedented rise in the cost of raw material, yet the Court focused not on force majeure or on hardship, but on frustration.The Court did correctly note that the risk allocation between the parties, and their explicit exclusion of increasing costs as a force majeure event would mean that this hardship would not attract the relief of the force majeure clauses. However, it did this almost as an afterthought, leading with an elaborate exposition on how this situation would be treated under the doctrine of frustration. Analysing this situation in the context of frustrationwhen the concerned party was not even seeking to frustrate the contract, and what’s more, when there was an explicit provision on exemption in the contract, was certainly unnecessary, and even harmful, as I shall demonstrate. Ironically enough, the Court both began and ended its discussion on the issue in full recognition of the above point that the doctrine of frustration embodied in Section 56 could not be invoked where there was an express stipulation of force majeure:


Having once held that clause 12.4 applies as a result of which rise in the price of fuel cannot be regarded as a force majeure event contractually, it is difficult to appreciate a submission that in the alternative Section 56 will apply… When a contract contains a force majeure clause which on construction by the Court is held attracted to the facts of the case, Section 56 can have no application.”


IMPACT ON FRUSTRATION AND FORCE MAJEURE:

The potential harms of the Supreme Court’s overreaching approach include an extension of an already nebulous doctrine of frustration to situations where the parties have decided to leave the allocation of risk not to the default rule under Section 56, but rather to their own determination. Further, this decision did not avail of the opportunity to strengthen a largely underdeveloped jurisprudence on force majeure clauses.

In fact, while the force majeure provisions in the contract did explicitly exclude changes in price in the general, it still carved out an exception for such a price rise to the extent that it was a consequence of an event of force majeure. Pursuant to these provisions, while a price rise resulting from market fluctuations would be excluded from the relief of force majeure, the same may not as easily be said about a price rise resulting from an unprecedented foreign regulation implemented several years after the contract was concluded, as occurred in this case. In fact, the non-exhaustive ‘Non Natural Force Majeure Events’ clause in the contract did include several references to governmental interference, embargoes and the like, and so this regulation was definitely a pertinent question for the Court to consider.

While the extremely clear allocation of risk between the parties would have probably still led the Court to the same conclusion- especially since such an event was not express and at best analogous to those specified- the Court should have still taken these clauses into account, as it was, after all, faced with a direct question of contractual interpretation. If at all the Court was interested in considering concomitant issues, examining the role of rules such as expression uniusest exclusion alterius and ejusdsem generis in this force majeure clause would have been much more preferable to delving into the completely inapplicable doctrine of frustration. In fact, the position with respect to foreign regulations implemented after the contract’s conclusion is a present controversy in global force majeure jurisprudence[3], and is distinguishable from plain and simple ‘onerousness’ that the Court emphatically rejected. However, the Court glossed over all of these considerations, choosing instead to devote most of its reasoning to the (non-)issue of frustration.

IMPACT ON HARDSHIP VIS-À-VIS FRUSTRATION:
It was the Court’s emphatic and outright rejection of onerousness as a ground for relief that is perhaps the most concerning aspect of this decision[4]. While rejecting onerousness as a defence based on the specific force majeure provisions of this dispute would have been entirely reasonable, the Court did not stop, or technically even begin there. It began by citing a plethora of English authorities as per which onerousness or hardship is not considered as grounds for frustration. Not only was the Court incorrect in doing this as it was not even dealing with frustration, but this is also potentially inconsistent with the Indian jurisprudence on frustration, which has long since freed itself of English influence[5]. The threshold laid down in SatyabrataGhose v. MugneeramBangur[6], relied on in this judgment for being a ‘seminal’ decision on frustration, seems to suggest that impracticability is grounds for frustration:

“This much is clear that the word ‘impossible’ (in Section 56) has not been used here in the sense of physical or literal impossibility. The performance of an act may not be literally impossible but it may be impracticable and useless from the point of view of the object and purpose which the parties had in view and if an untoward event or change of circumstances totally upset the very foundation upon which the parties rested their bargain, it can very well be said that the promisor found it impossible to do the act which he promised to do.”

The language in the above paragraph contains several invocations of the doctrine of hardship. In fact, the use of the word ‘impracticable’ itself indicates a possible practical and commercial colouring, such as in the Uniform Civil Code in the US, where ‘commercial impracticability’ is listed as an excuse for performance for a rise in cost caused, inter alia, by an unforeseen governmental action.[7] Similarly, this paragraph is at least comparable to the definition of hardship under the UNIDROIT Principles- a transnational instrument of contract law:

“There is hardship where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of a party’s performance has increased or because the value of the performance a party receives has diminished…[8]

Thus, as per the test laid down by SatyabrataGhose, it could even be argued (not in the present case, as the risk allocation was clear) that the purpose of the contract, i.e., profit, was eroded due to the completely unanticipated change in circumstances, through the enactment of an unprecedented law leading to an astronomical rise in costs. Such a position may still be arguable under the doctrine of frustration in future if Courts are willing to view Energy Watchdog’s findings on frustration and hardship as obiter, since they were completely irrelevant to the real matter at hand- the force majeure clauses.
IMPACT ON HARDSHIP VIS-À-VIS FORCE MAJEURE:
The Supreme Court’s rejection of hardship as a ground for frustration may— in a climate where force majeure clauses are viewed through the unitary lens of frustration— even percolate down to force majeure clauses, where hardship, even when resulting from another event, is rejected. This is counter to the current trend in transnational law, where unforeseen and insuperable hardship is increasingly being viewed as a force majeure event. The CISG Advisory Council has found that Article 79— which is near identical to the force majeure model clause of the ICC— should also be seen to cover onerous performance and hardship, and this has been the approach taken on the provision by a recent Belgian Court decision. Even in the Common Law tradition, the 2002 Uniform Civil Code’s addition of ‘commercial impracticability’ as an excuse for performance indicates a potential shift in stance with respect to hardship and force majeure.
As force majeure is largely if not solely a question of construction of the Parties’ intent through contractual clauses, a blanket rejection of hardship as a force majeure event should not become the prospective influence of the decision in Energy Watchdog. Whether Indian law will want to take the CISG and US approach remains to be seen, but an overzealous obiter in a case with a special allocation of risk should not play a role in this decision.




[1] Peter J. Mazzacano, Force Majeure, Impossibility, Frustration & the Like:
Excuses for Non-Performance; the Historical Origins and Development of an Autonomous Commercial Norm in the CISG, Nord. J. Comm. Law, 1 (2011).
[2] A.H. Puelinckx, Frustration, Hardship, Force Majeure, Imprévision, Wegfall der Geschäftsgrundlage, Unmöglichkeit, Changed Circumstances, 3(2)J.Int'l Arb.,47 (1986).
[3]2012 UNCITRAL Digest of case law on the United Nations Convention on the International Sale of Goods, Digest of Article 79 case law, ¶ 17; JoernRimike, Force majeure and hardship: Application in international trade practice with specific regard to the CISG and the UNIDROIT Principles of International Commercial Contracts, Pace Rev. CISG, 216 (1999-2000).
[4]See paragraphs 35-39 of the judgment, where the Court relies on several judgments and commentaries to reject onerousness, stating in paragraph 38, “It is clear that a more onerous method of performance by itself would not amount to an frustrating event.
[5]Naihati Jute Mills Ltd. v. KhyaliramJagannath, A.I.R. 1968 S.C. 522; DhruvDev v. Harmohinder Singh, A.I.R. 1968 S.C. 1024.
[6]A.I.R. 1954 S.C. 44.
[7]Uniform Civil Code, § 2-615. Excuse by Failure of Presupposed Conditions (note 4).
[8]UNIDROIT Principles, Article 6.2.2.

Wednesday, July 12, 2017

Bombay High Court on the Permissibility of Shareholder Representative Suits

Bar & Bench yesterday reported that the Bombay High Court denied leave to certain shareholders of various Tata group companies to bring a representative suit that made certain legal claims in the aftermath of the ouster of Mr. Cyrus Mistry from the board of Tata Sons as well as other Tata group companies. The order of the court in Pramod Premchand Shah v. Rata Tata is now available.

Facts and Ruling

Various shareholders of Tata group companies brought a representative suit under Order 1 Rule 8 of the Code of Civil Procedure, 1908 (the “CPC”) against Tata Sons, its directors and various Tata group companies. The plaintiff shareholders’ claim was that Mr. Mistry was wrongfully ousted as the chairman of Tata Sons, which then led to his removal from the boards of various Tata group companies. These led to a massive decline in the share value of the Tata group companies. As a result, the plaintiff shareholders sought relief from the court to nullify Mr. Mistry’s removal and they also claimed damages in the sum of about Rs. 41,832 crores. The plaintiffs assert their rights as a representative of all “non-promoter shareholders” of the Tata group companies.

The plaintiff shareholders experienced temporary victory when on December 9, 2016 a judge of the Bombay High Court granted leave under Order 1 Rule 8 enabling them to pursue the suit on behalf of all interested persons. This is generally considered to be significant as the decision to grant leave in a representative suit is an important hurdle for plaintiffs to cross in such suits. This victory was short-lived as another judge of the Bombay High Court by way of the present order under discussion revoked the leave earlier granted to the plaintiff shareholders, thereby putting an end to the current set of claims.

The Court was largely concerned with the interpretation of Order 1 Rule 8, and whether all the shareholders of the various Tata group companies enjoyed the same interest. For this purpose, it would be useful to briefly set out the relevant text of Order 1 Rule 8, which is as follows:

One person may sue or defend on behalf of all in same interest.

(1) Where there are numerous persons having the same interest in one suit,--

(a) one or more of such persons may, with the permission of the Court, sue or be sued, or may defend such suit, on behalf of, or for the benefit of, all persons so interested;

The Court sought to analyse the background and the reason for the enactment of Order 1 Rule 8:

This scheme is an exception to the general rule that all persons interested in the suit must be made parties to it. The object of this exception is clearly to facilitate the redressal of grievances in which a large body of persons are interested, but where several practical difficulties would arise if every individual so interested were to either join in one suit or file a separate suit under the general rule. …

The Court placed considerable emphasis on the terminology used in the legislative provisions, which is “same interest in one suit”, and discussed relevant English case law at some length. Thereafter, it applied the principles to the facts of the present case.

At the outset, a distinction was sought to be made between rights and interest. All shareholders enjoyed the same rights in the form of proprietary interest in the shares they held in the various Tata group companies. However, when it came to interests, the shareholders were found not to enjoy the same level of commonality. The Court relied substantially on the perception that individual shareholders held not only on the events that transpired on the board of Tata Sons and other group companies, but also regarding the views of individual shareholders regarding the acceptability of the consequent decline in the market value of Tata group company shares. For instance, it was mentioned that long-term shareholders may not necessarily view the temporary decline in share values of the companies unfavourably. On this point, the Court concluded:

In short, each of the non-promoter shareholders in the present case may have the same type of proprietary right in the share and thereby, the same interest in protecting its value, but so far as the complaint of prejudice to that interest is concerned, other non-promoter shareholders may not have a common cause with the Plaintiffs. It is this prejudice or accrual of liability arising therefrom, which forms the subject matter of ‘interest in the suit’ and not the proprietary right per so or the interest in protecting its value. …

Similarly, the Court found a lack of commonality of interests in the two reliefs sought (as discussed above). For these reasons, it concluded that the requirements of Order 1 Rule 8 did not stand satisfied, and revoked the leave granted to the plaintiff shareholders.

Some Thoughts

At the outset, this decision calls into question several considerations that arise when some shareholders bring a collective suit to assuage the concerns of fellow shareholders with whom they share a similar interest. Usually, this also depends upon the type of suit or claim involved. Company law recognises specific types of shareholder suits. The first is an action for oppression or mismanagement that is brought directly by shareholders for their own benefit. It is uncommon for such actions to be brought on behalf of shareholders other than those who brought them. These rights are well-recognised under the Companies Act, 2013. The second is a derivative action, which is brought by some shareholders, but on behalf of the company. Such a claim is not codified in the Companies Act, 2013, and is still premised upon Order 1 Rule 8. As a co-author and I have argued in this paper, the representative suit under Order 1 Rule 8 is available for some shareholders (or other interest holders) to bring suits on behalf of others similarly situated, while a derivative action is brought on behalf of the company instead. Despite these incongruities, there seems to be no legislative momentum to codify derivative actions in India. Minority shareholders may instead derive some solace by the presence of the third type of action statutorily provided in the Companies Act, 2013, namely the shareholder class action. This is a direct action that shareholders can bring on behalf of the entire class, and the mechanism for the same has been elaborately set out in section 245.

The interesting aspect of the present suit initiated by the shareholders of the Tata group companies is that it falls in none of the well-recognised shareholder remedial mechanisms provided under company law. In other words, it appears to be a sui generis claim. Understandably, it is not structured as a derivative action because the benefits would have enured to the company rather than the shareholders, thereby defeating the purpose of their damages claim. It is not structured as a shareholder class action because that requires the support of at least 100 shareholders or those holding at least 10% of the share capital of the company. In the present case, obtaining the support of shareholders holding at least 10% of the share capital will be a daunting task, while obtaining the numerical support of shareholders may be more likely, if at all. Given the broad scope of claims that can be initiated through the class action mechanism, that may be a more appropriate route to follow in circumstances as the present one. On the other hand, even assuming the hurdle of obtaining leave of the court to bring a representative suit can be crossed, the substantive issues surrounding a sui generis claim could give rise to interesting but challenging legal issues.

On the substance of the Bombay High Court’s decision itself, there remains the issue of whether “perception” of shareholders can be treated as a significant criterion for determining whether they share a common “interest” for purpose of passing the bar set by Order 1 Rule 8. The difficulty with excessive reliance on perceptions is that they are bound to differ when one considers a group of persons such as shareholders. Some might be in favour of legal action, while others may not (and may even accept the circumstances as they are). Hence, caution needs to be exercised while using investor perception as a criterion to determine whether shareholders constitute a common interest group for bringing representative suits.

Saturday, July 8, 2017

A Misturning on section 12(5) of the Arbitration Act?

A few days ago we had highlighted a decision of the Bombay High Court in DBM Geotechnics v. BPCL where the High Court had drawn a distinction between the power to nominate an arbitrator and the choice of the nominee. The arbitration clause allowed an employee of a company to nominate another employee as an arbitrator. The Court held that the power to nominate continued to remain valid even if statutory bars now meant that another employee could not be an arbitrator.

The Supreme Court has now ruled on a similar point in TRF Ltd. v. Energo Engineering Projects (Civil Appeal 5306 of 2016 judgment dated 3 July 2017). The relevant arbitration clause contained in the contract between the parties provided: “Unless otherwise provided, any dispute or difference between the parties in connection with this agreement shall be referred to sole arbitration of the Managing Director of Buyer or his nominee…” The question was whether this clause was valid in view of section 12(5) of the Arbitration & Conciliation Act 1996 as amended in 2016. The appellant argued that the new provisions meant that the Managing Director could not be an arbitrator: if that is so he could not nominate another person as arbitrator either. The Respondent argued that while the Managing Director may be disqualified to act as an arbitrator he is not deprived of his right to nominate an arbitrator (of course the arbitrator actually nominated would have to be sufficiently independent). The answer given by the Court is this:

In such a context, the fulcrum of the controversy would be, can an ineligible arbitrator, like the Managing Director, nominate an arbitrator, who may be otherwise eligible and a respectable person. As stated earlier, we are neither concerned with the objectivity nor the individual respectability. We are only concerned with the authority or the power of the Managing Director. By our analysis, we are obligated to arrive at the conclusion that once the arbitrator has become ineligible by operation of law, he cannot nominate another as an arbitrator. The arbitrator becomes ineligible as per prescription contained in Section 12(5) of the Act. It is inconceivable in law that person who is statutorily ineligible can nominate a person. Needless to say, once the infrastructure collapses, the superstructure is bound to collapse. One cannot have a building without the plinth. Or to put it differently, once the identity of the Managing Director as the sole arbitrator is lost, the power to nominate someone else as an arbitrator is obliterated…

This does not engage with the reasoning of the decision of the Bombay High Court we had highlighted earlier. With respect, that reasoning appears to be clearly more powerful. The formulation adopted by the Supreme Court, that it is “inconceivable in law that a person who is statutorily ineligible can nominate a person”, may give rise to difficulties. For instance, what happens in the case of contracts where one party is given a right to nominate an arbitrator? Are such clauses now to be considered invalid, even if the choice of a nominee is not hit by the bar on the basis of the principle laid down by the Supreme Court?

The Supreme Court referred to the decision in Firm of Pratapchand Nopaji in support of its conclusion. But that was a decision – not on the Arbitration Act at all, incidentally – which only held that that which cannot be done directly cannot be done indirectly either, and that what one does through another is as good as done by oneself. But this is a clearly inappropriate analogy. An arbitrator is never expected to simply adopt the views of the nominating party.

The reasoning of the Court extracted in the paragraph quoted above appears to be a significant departure from the language of section 12(5) and it is hard to find a reasonable argument to support this departure. For now, though, this is the law of the land, laid down by a Bench of three Judges of the Hon’ble Supreme Court of India.


Friday, July 7, 2017

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.”
[3] SEBI circular as issued on August 5, 2015