The pledge is defined as security for the fulfillment of a contract or the payment of debt and is liable to forfeiture in the event of failure. The main motive for pledging the shares is to raise loans by keeping shares as security. The person who is the owner and wants a loan against them is a pledger and to whom it is lent is pledgee. Share pledging is a new way of accessing funds from the company. Sometimes person pledges their shares for their personal needs as well.

How Does A Share Pledge Agreement Work?

A share pledge agreement is between three parties:

1. Lender;
2. Borrower;
3. Promoter.

The main agreement is signed between the lender which is usually a bank or a Non-Banking Financial Company (NBFC) and the borrower which is a company, whereas, a collateral contract is signed between the promoter and the borrower. The collateral contract contains the details of the collateral/shares pledged in the main agreement. This is done so that there is absolutely no confusion regarding the ownership and quantum of securities pledged

After the borrower agrees to the share pledge agreement, the agreement comes into effect. The promoter negotiates for a loan from the lender on behalf of the company as its agent and also in his own personal capacity. This means that the promoter is not only speaking for the company but also in his own capacity as a natural person in the eyes of the law.

What Are The Risks Associated With This Agreement?

The risks associated with this agreement are as follows:

1. Risks faced by promoters:
   The shares are traded on the stock exchange and their prices fluctuate and keep on changing. If the price of a share decreases, the value of collateral also decreases. To make up for the decreased value the promoter has to pledge additional shares, this is known as a marginal call. If the promoter fails to meet the margin call then the lender usually invokes the pledge by selling the pledged shares in the market and realizes his money.
    
2. Risks faced by investors:
   Companies with a high proportion of promoter pledging are viewed as risky by the market because it raises questions about promoters falling short of money in their personal capacity or facing debt problems in other ventures. When the lenders sell off the pledged shares in the open market, the price of shares falls further. Selling of shares by lenders in the open market also alters the shareholding pattern of the company.
   
   In most cases, even the promoters lose their stake and have no or less voting power in crucial matters of the company. Investors, therefore, need to keep a close eye on promoter pledging, as companies with high pledging can witness major fluctuations in their stock prices. As an investor, one must do their research and gather necessary information on pledged shares on the websites of the stock exchanges.

Regulations Involved In A Share Pledge Agreement

Before SEBI was established, the two regulations that governed pledge agreements were the Indian Contract Act, 1872 and the Banking Regulation Act, 1949. In 1992, SEBI was established.

SEBI is a statutory body established by the government in 1992 to regulate the capital and securities market in the country. As regulator of securities, SEBI ensures that the interest of the investors is protected by making regulations issuing guidelines, frequently. In 2011, SEBI introduced the SEBI (Substantial Acquisitions of Shares and Takeover) Regulations, 2011, (SAST Regulations). The Regulation were mainly added to regulate the acquisition of shares and voting rights in public listed companies in India. It contains the disclosure requirements of the pledgor and pledgee with respect to the pledged shares.

The two main Regulations under the SAST Regulations that contain disclosure requirements are:

1. Regulation 29:
   It deals with the disclosure requirements of the lender. The regulation states that on any acquisition or disposal of shares or voting rights by the lender or any person acting jointly with him, of the company aggregating to 5% or more, shall disclose their voting right and/or their total shareholding in such company within 10 working days of acquisition of such share or voting rights. The disclosure shall be made:
   1. to every stock exchange where the shares of the company are listed;
   2. to the company at its registered office.
   The disclosure shall also be made if there is a change in shareholding or voting rights. The disclosure is to be made even if the total shareholding or voting rights fall below 5% or if there is an increase in total shareholding or voting rights above 29%.
   
   This Regulation shall not be applicable to scheduled commercial banks or public financial institutions as a pledge in connection with the pledge of shares for securing the debts in the normal course of its business.
    
2. Regulation 30:
   It deals with the disclosure requirements of the promoters. It states that the promoter of the company has to disclose all the details of shares encumbered, or any details of invocation of such encumbrances or release of such encumbrances by him or by persons acting in concert with him in the company.The disclosure should be made within 7 working days from the creation, invocation or release of encumbrance, as the case maybe, to:
   1. Every stock exchange where the shares of the company are listed;
   2. The target company at its registered office.

Recently, SEBI exempted the below mentioned companies from disclosure requirements under the SAST Regulations:

1. Deposit taking Housing Finance Companies (HFCS) or HFCs of asset size of at least Rs.500 crores, registered with the National Housing Bank (NHB)
2. Systematically important NBFCs i.e whose assets are worth 500 cr or more.

Pledging Of Shares For Non-Residents

The regulatory change brought about by the RBI in its Circular 57 permits non-resident shareholders of the Indian companies to avail of loans from Indian and overseas banks. They can pledge their shares using their shareholding in Indian companies as collateral after obtaining the no-objection certificate (NOC) from the relevant authorized dealers (AD).

Accordingly, the requirement to obtain prior approval of the RBI for pledging the Indian shares held by non-residents is dispensed with subject to fulfillment of the conditions prescribed. ADs in respect of foreign direct investment (FDI), such as private banks, public sector banks and multinational banks can act as an AD in the matters relating to pledge of shares.