Pledge of Shares, FDI

In recent times Government/RBI has made several attempts to liberalize, rationalize and simplify the processes associated with FDI flows to India and reduce the transaction time. In furtherance of this, the RBI vide a circular dated May 2, 2011 has delegated its powers to AD Category-I banks to allow non resident investors to pledge their shares held in an Indian Company, subject to certain conditions. The conditions prescribed are as follows:

In case shares are pledged in favour of an Indian bank the following conditions are applicable:

1. In case of invocation of pledge, the transfer of shares should be in accordance with the FDI Policy existing at the time of creation of pledge.
2. A declaration from the statutory auditor that the loan proceeds would be applied for the declared bona fide  business purpose.
3. The Indian company whose shares are pledged will have to comply with the SEBI disclosure norms. In other words the Indian Company would have to comply with Regulation 8A of the Takeover Code and Clause 35/41 of the Listing Agreement.  
4. The lender bank will have to comply with the provisions of S. 19 of the Banking Regulation act, 1949. In other words the lender bank cannot hold shares as a pledge of an amount exceeding thirty percent paid up share capital of that company or thirty percent of its own paid up share capital and reserves, whichever is less.

In case shares are pledged in favour of an overseas bank the following conditions are applicable:

1. Loan is utilized for genuine business purpose overseas and not for any investments either directly or indirectly in India.
2. Overseas investment should not result in any capital inflow into India.
3. In case of invocation of pledge, the transfer of shares should be in accordance with the FDI Policy existing at the time of creation of pledge.
4. A declaration from the statutory auditor that the loan proceeds would be applied for the declared bona fide business purpose.

A VCCIRCLE article analyzes the effect of the circular in detail. On a parting note though, the circular comes at a time when pledging of shares may not be commercially viable due to the prevailing market prices of these shares.