Creation of a pledge over shares, especially over the shareholding of the promoter group in the borrower entity or a related entity controlled by the promoter group is one of the common mechanisms for security creation in commercial lending transactions. It is widely believed that lenders typically prefer security in the form of pledged shares owing to the ease of enforcement by way of disposal, particularly in the case of shares of listed entities. Additionally, the prospect of the lender enforcing its pledge rights and selling such shares in the market also results in the promoter group’s own control over the relevant entity being diluted, which usually ensures better compliance and discipline on part of borrowers in honoring their repayment obligations.

While the jurisprudence on this has evolved, the process of enforcing a pledge continues to be governed by the provisions of Sections 176 and 177 of the Indian Contract Act, 1872. Section 176 provides the pledgee with following remedies upon default by the pledgor, namely, suing the pledgor for the secured debt, retaining the security as collateral, or selling the pledged security upon giving the pledgor reasonable notice of sale.

This article was originally published in Legal Era on 30 November 2022 Co-written by: Veena Sivaramakrishnan, Partner; Parth Gokhale, Partner. Click here for original article

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