III. Non-disposal undertaking (NDU) from the off-shore shareholder over its Indian shareholding
Commonly, in a cross-border financing transaction, an NDU is executed by an offshore shareholder (of an Indian company) where it contractually agrees to not dispose of its shareholding until the final settlement of the loan. As a standard market practice, execution of NDUs is typically followed by filing of Form 39 (in case of filings with the National Securities Depository Limited) by such offshore shareholder for creation of a ‘hold’ on the shares of the Indian company with the depository participant (DP) in favour of the lender. Once the relevant filings are completed, the shares are marked by the DP. This operationally means that without obtaining the prior consent of the lender, the shareholder would not be able to transfer such shares to a third-party.
Once there is a freeze over the shares with the DP, the DP shall not facilitate any transfer, and this, in my view, is akin to ‘constructive possession’ (as there is no alternative way of taking possession of dematerialized shares, even in the case of a general lien) and creation of a ‘negative lien’. The term ‘negative lien’ is not formally defined in any Indian legislation, however, as commonly understood, interpreted and judicially acknowledged, a negative lien restricts a person from creating any kind of encumbrance over its assets or otherwise disposing them without the prior consent of the lender. In other words, the lender does not take actual possession of the property on which the lien has been obtained. However, the right to deal with (or transfer) the assets over which a negative lien is created, would be contingent and conditional upon the lender’s consent. In terms of FEMA, a lien amounts to a “transfer”, as the definition of the term “transfer” is an all-encompassing and includes a “lien“.
Currently, in the finance market, there is lack of legal certainty on this issue and till date there does not exist any RBI circular expressly prohibiting or permitting such an NDU arrangement. However, such a security structuring is always vulnerable to scrutiny by the RBI, where it might consider such NDU arrangement akin to creation of a security interest. Hence, it is recommended to take a conservative view, and apply for prior RBI approval for creation of security by way of NDUs (which is to be followed by filing of FORM 39).