A somewhat peculiar situation came up for consideration of the Securities Appellate Tribunal (SAT) in Liquid Holdings Private Limited v. SEBI, on which SAT passed its order on March 11, 2011.
Liquid Holdings Private Limited (Liquid) was one of the promoters of Blue Coast Hotels Limited (the Target). Morepen Laboratories Limited, a group company of Liquid, obtained loans from two banks, against which Liquid pledged its holding of shares in the Target. The shares were held in dematerialized form, and the pledge was created using the procedures prescribed under the depository system for demat shares. Due to a default on the loans sometime in 2004, the banks enforced the pledge and transferred the shares into their own demat accounts. Appropriate disclosure of the acquisition of the shares was also made at that stage by the one of the banks, Lakshmi Vilas Bank Limited, as required under Reg. 7 of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997. Subsequently, in 2007, Morepen discharged its loan to Lakshmi Vilas Bank and as a result the shares were transferred back to the demat account of Liquid.
The legal question that arose was whether the re-transfer of shares from Lakshmi Vilas Bank to Liquid required Liquid to make an open offer to all shareholders of the Target as the acquisition triggered its obligation under Reg. 11(1) of the SEBI Takeover Regulations.
The adjudicating officer of SEBI found that Liquid (along with some other appellants before SAT) had breached Regs. 7 and 11(1) of the SEBI Takeover Regulations by neither disclosing the acquisition nor making an offer to the other shareholders of the Target. Liquid preferred an appeal to SAT.
SEBI argued that when Morepen defaulted on repayment of its loans, the banks became owners of the shares as they were transferred in their names upon invocation of the pledge. When the loan was subsequently settled, what occurred was a transfer of the shares back to Liquid. However, Liquid argued that the relationship between Liquid and the banks continued to be one of pledgor and pledgee even after the transfer of the shares and that the banks were only holding the shares as collateral security. Based on this argument, it was contended that the provisions of the Takeover Regulations were not attracted. On balance, SAT accepted the position of SEBI rather than Liquid.
First, SAT recognized that a pledge may be created in respect of demat shares through the procedure laid down in Reg. 58 of the SEBI (Depositories and Participants) Regulations, 1996. This act by itself does not constitute a change in beneficial ownership, and therefore the creation of the pledge by Liquid in favour of the banks did not attract the offer requirements under the Takeover Regulations. Second, once the banks invoked the pledge, the records reflected a change in beneficial ownership of the shares with the banks being treated as beneficial owners. All rights that flow with beneficial ownership, including voting rights, were now enjoyable by the banks and Liquid ceased to have any beneficial interest in the shares. Subsequently, when Liquid reacquired the shares upon repayment of the loan by Morepen, Liquid became the beneficial owner thereof as its name was entered in the depository’s records. This required Liquid to make necessary disclosures under Reg. 7 of the Takeover Regulations and to make an offer under Reg. 11, which was not done. Hence, the adjudicating officer’s order was upheld.
SAT’s order reinforces the position that transfer of beneficial ownership in shares, particularly voting rights, puts the acquirer under an obligation to comply with the Takeover Regulations. Although the documentation between the parties inter se may confer a right on the original pledgor to obtain the shares back after the transfer, SEBI will have primary regard to the process followed under the Depositories Regulations for creation and enforcement of the pledge while determining the parties’ obligations under the Takeover Regulations. Hence, where a pledgee invokes the pledge and obtains a transfers of the securities through change in beneficial ownership of the shares through the process prescribed under the Depositories Regulations, that will determine the duties of the parties under the Takeover Regulations even though the parties may have intended in the documentation to allow a subsequent redemption of the transaction through repayment of the loan by the borrower. To that extent, SAT’s judgment provides clarity in structuring the creation and redemption of pledges over shares of listed companies that are held in demat form.