Invocation of pledged shares amid COVID-19: Can Force Majeure save promoters in distress?

A loan against collateral is perceived to be relatively risk-free for lenders, as the pledged asset can be liquidated in case of the borrower’s default. Liquidity of the asset is the main criteria for granting such loans by the lenders. Collateral, therefore, serves as security against borrower’s default.

Typically, the amount lent is less than the market value of the asset pledged, the difference being the margin which the lenders retain as security. The collateral can be immovable property, vehicles, machinery, securities etc.

Considering that a substantial amount of the promoter’s wealth is tied up in the form of shares, share pledging agreements help them to raise funds to fuel other business ventures while retaining their holdings. However, when the prices fall, the lenders seeks additional margin and in the event of non-compliance, the lenders may be forced to invoke the pledge.

Recently, the Bombay High Court, in the case of Rural Fairprice Wholesale Limited & Anr. v. IDBI Trusteeship Services Limited & Ors, issued an ad-interim injunction to restrain lenders from exercising their rights to invoke the pledge on the shares of Future Retail Limited, which operates the hypermarket Big Bazaar.

In the present case, it is understood that shares of Future Retail Limited were pledged against the debenture issue and the respondents had the right to invoke pledge in case of fall in margin coverage. As per the applicants, the fall is because of stock market collapse triggered by COVID-19.

On the other hand, the respondents averred that an amount of more than Rs. 610 crore is recoverable and the present value of pledged shares is not more than Rs. 350 crore. Thus, they have the right to invoke pledge due to fall in margin coverage.

The aforesaid order appears reasonable in the context of present circumstances, but it raises a bigger question of a lender’s right to invoke the pledge on collateral security and the defence of force majeure condition attributable to COVID-19 against it.

First, in absence of any force majeure provision, a party cannot use it as a shield under common law contracts. The basic principle of common law is that contracts need to be strictly enforced.

The Supreme Court in Nabha Power Limited (NPL) v. Punjab State Power Corporation Limited (PSPCL) & Anr. extended a word of caution and observed that

“It should certainly not be an endeavour of commercial courts to look to implied terms of contract. In the current day and age, making of contracts is a matter of high technical expertise with legal brains from all sides involved in the process of drafting a contract. It is even preceded by opportunities of seeking clarifications and doubts so that the parties know what they are getting into. Thus, normally a contract should be read as it reads, as per its express terms”

Second, it must be kept in mind that the decision to invoke pledge is a matter of commercial wisdom of the lenders, which includes business prospects of the borrower and its ability to repay. In case of publicly listed shares, if it is not invoked while there is enough liquidity to offload the entire stake, the recovery of public money would further get impacted.

The lenders, being answerable to the stakeholders, are rather duty bound to invoke the pledge to avoid corporate governance issues as well. The principle finds relevance in the recent decision in K Sashidhar v. Indian Overseas Bank, where the Supreme Court, while deciding the scope of judicial scrutiny of the commercial decisions taken by Committee of Creditors (‘COC’) during the Corporate Insolvency Resolution Process under the Insolvency and Bankruptcy Code, 2016 held that commercial wisdom of COC, which comprises of lenders, is not open to judicial review.

Although the decision of the Apex Court does not squarely covers the lenders here, the correlation between the lenders and the COC can be argued.

On the other hand, where the force majeure provision is not part of the contract, Section 32 and Section 56 of the Indian Contract Act, 1872 can be pressed into defence.

Reiterating its earlier decision in Satyabrata Ghosh v. Mugneeram Bangur & Co, the Supreme Court in Energy Watchdog vs Central Electricity Regulatory Commission & ors, held,

"...the word “impossible” has not been used in the Section 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 of the parties...

...It was further held that where the Court finds that the contract itself either impliedly or expressly contains a term, according to which performance would stand discharged under certain circumstances, the dissolution of the contract would take place under the terms of the contract itself and such cases would be dealt with under Section 32 of the Act. If, however, frustration is to take place de hors the contract, it will be governed by Section 56”.

Further, it would be difficult for the borrower to seek cover even on the basis of COVID-19-induced volatility, resulting into a slump in share prices, since it is undisputed that the share prices are highly volatile and tend to discount the value of future prospects of businesses. Therefore, uncertainty and volatility are inherently present in the share prices.

Although the present ad-interim order provides relief to the defaulting borrowers purely from standpoint of commercial and financial propriety, the same was much needed, as barring essential services, economic activity has virtually come to a halt.

But, if the lenders are restrained by the courts from invoking the pledge, it could make lending against securities unattractive for the lender if the pledge cannot be invoked in case of a default which would eventually restrict the funding for the promoters going ahead.

Thus, under the share pledge agreements wherein parties entered into contracts with their respective commercial wisdom and understanding of likely risks of volatility in the share price, the borrowers may find it difficult to seek shelter under the force majeure condition.

More such instances of lenders invoking the pledge due to sharp slump in prices are expected going ahead. As such, the decision of the Bombay High Court may be relied upon as a precedent by such borrowers.

The Reserve Bank of India circular of March 27, which grants moratorium of three months for all term loans instalments, is conspicuously silent on invocation of pledge in case of loans against securities.

Therefore, it would be more appropriate if relaxations and forbearances are granted by the government and regulators to safeguard the interests of such borrowers, as the possible impact of such invocation would be promoters losing control of the business, causing further cascading effects.

The author is an Advocate.