We have in our recent post discussed the clarifications issued by the Insurance Regulatory and Development Authority of India (“IRDAI”) in relation to Transfer of Shares of an insurance company. These clarifications were notified pursuant to the circular issued to all CMDs and CEOs of insurance and re-insurance companies on July 22, 2020 (“Circular”). However, the Circular also discussed certain critical issues relating to creation of pledge over shares of an insurance company.
Below is a summary of these clarifications provided by the Circular in relation to pledge of shares of an insurance company:
Does “transfer” include creation of an encumbrance
The term “transfer of shares”, as used in connection with shares of insurance companies, has been ascribed a wide definition under the IRDAI (Transfer of Equity Shares of Insurance Companies) Regulations, 2015 (“Transfer Regulations”). The definition is as follows: ““Transfer of Shares” includes transfer of shares from existing shareholder to another person and includes transmission and fresh issuance of the equity shares which lead to change in the shareholding pattern of an insurance company”. Even though this is an inclusive definition, neither the Insurance Act, 1938 (“Insurance Act”), nor the Transfer Regulations provided for adequate clarity on whether the term covered an encumbrance over shares of an insurance company in the form of a pledge. A pledge in itself does not result in any change in shareholding in the insurance company, but simply allows the pledgee to sell the pledged shares on the pledgor, failing to meet its obligations in connection with which the security was created. Of course, industry participants and stakeholders have been aware that pledging requires prior IRDAI approval. However, there was always lack of clarity on whether this approval should be taken at the time the pledge was created or at the time of exercising the pledge.
The regulators view in relation to this matter eventually came to be tested when, in 2019, the IRDAI called into question a pledge created over the shares of Reliance General Insurance Company Limited (“RGICL”) by its promoter and 100% shareholder, Reliance Capital Limited (“RCL”).
How the matter came up to the IRDAI
RCL had pledged its entire shareholding in RGICL in favour of IDBI Trusteeship Services Limited (“IDBI TSL”) as security against certain borrowings incurred by RCL and its group companies (“RCL Group”). In October 2019, upon the RCL Group defaulting, IDBI TSL invoked the pledge on shares of RGICL and RGICL informed the IRDAI about the invocation of pledge. To this, the IRDAI, by way of certain orders passed in December 2019 (“IRDAI December Orders”), decided that the invocation of the pledge, followed by the transfer of RGICL’s shares to IDBI TSL was in violation of Section 6A(4)(b)(iii) of the Insurance Act and hence “null and void ab initio”.
IDBI TSL along with the financiers appealed against the orders passed by the IRDAI before the Securities Appellate Tribunal (“SAT”). In their submissions before SAT, the appellants contended that IDBI TSL, as a debenture trustee, had only taken possession of the shares of RGICL as a consequence of invocation of the pledge and that there was no actual transfer of shares of RGICL. It was further contended that the exercise of the pledge did not allow IDBI TSL to exercise rights as a 100% shareholder of RGICL and IDBI TSL also did not intend to exercise control/ voting rights in RGICL, or make any changes or have a say in the management or decision making process of RGICL. The appellants also clarified that IDBI TSL would take prior approval of IRDAI before transferring the pledged shares of RGICL to any third party. IDBI TSL had also furnished an undertaking to this effect before the IRDAI at the time of the personal hearings before the IRDAI (a similar undertaking was also furnished by IDBI TSL to SAT).
Based on the undertaking furnished by IDBI TSL to IRDAI at the time of personal hearing, the IRDAI passed an order dated February 4, 2020, acknowledging that IDBI TSL was holding the shares of RGICL as a trustee only and the said shares had not been transferred to IDBI TSL. The order passed by the IRDAI further clarified that IDBI TSL would be required to take IRDAI’s approval prior to transferring RGICL’s shares to any third party.
The SAT’s order
On February 27, 2020, the SAT, after considering IRDAI’s order of February 4, 2020, and the submissions made by the appellants, set aside the portion of IRDAI’s finding that the transfer or pledge of the shares in question are “null and void ab initio” (“SAT February Order”). SAT further directed IDBI TSL to make an application before the IRDAI for taking its approval for transferring the pledged shares to a third-party buyer. SAT made it clear that as long as IDBI TSL is holding shares in the capacity of a trustee or custodian, it will not be allowed to exercise any control over RGICL. However, in passing the aforementioned directions, the SAT clarified in its order that it was not ruling on whether “the word “transfer” as depicted as per the provisions of Section 6A(4)(b)(iii) of the Insurance Act would also include any form of transfer of shares including a pledge”.
It is to be noted that the SAT February Order is restricted only to the point relating to violation of Section 6A(4)(b)(iii) of the Insurance. 
Clarity brought about by the July 22 Circular
The question whether pledge constitutes “transfer of shares” under Section 6A of the Insurance Act and the Transfer Regulations has now been settled by the IRDAI by way of the Circular. The Circular has clarified that provisions relating to transfer of shares as contained in Section 6A(4)(b) of the Insurance Act and the Transfer Regulations shall apply mutatis-mutandis to the creation of pledge or any other kind of encumbrance over shares of an insurance company, by its promoters. This signifies that a pledge or encumbrance on shares by the promoters of an insurance company will now require prior IRDAI approval if the pledge is created over shares in excess of thresholds prescribed in Section 6A(4)(b) of the Insurance Act. It is pertinent to note that prior IRDAI approval will not be required if a non-promoter shareholder proposes to create an encumbrance/pledge over the shares of an insurance company.
Some unanswered questions and the road ahead
The Circular leaves a few questions unanswered in relation to pledge of shares. For example, whether the subsequent invocation of the pledged shares by the pledgee will require a separate IRDAI approval? Particularly in instances where, upon invocation of the pledge (and prior to enforcement), the pledgee proposes to exercise voting rights in the insurance company or have a say in the management or decision-making process of the insurance company? Another open question is whether a non-promoter shareholder would be required to take approval of the IRDAI at the time of invocation of the pledge or will the IRDAI simply rely on the requirement of approval at the time of enforcement, given that typically non-promoters are those with shareholding of less than 10%. It also appears to be unclear as to how a pledge of a listed insurance company will be treated in light of the relaxations granted for transferring shares of listed insurance companies.
That said, the Circular has settled and given clarity in relation to a question that has been unanswered for a long time, i.e. whether creation of pledge over shares of an insurance company requires IRDAI approval. Up until the Circular, lenders had to rely on representations made by the borrower that no prior IRDAI approval was required for pledging the shares of an insurance company as a security and were always at a risk of being prohibited under law from enforcing the pledge. The risk became even more imminent after the IRDAI December Orders wherein the IRDAI declared the creation of pledge ‘null and void’. Now, with the clarifications provided, it is clear that shares of an insurance company can be provided as pledge by the promoters and also the procedure to be followed to accept shares of an insurance company as security. This should generally have a positive impact on the Indian financial market.
 Nippon India Mutual Fund and Anr. v. IRDAI and Ors., Case No. Misc. Application No. 6 of 2020 and IRDAI Appeal No. 4 of 2020 (accessible at: http://sat.gov.in/english/pdf/E2020_IR20204.PDF), para. 4, 5, 6 and 7.
 Ibid, para. 8
 Ibid, para. 14
 The Supreme Court by its final order dated November 5, 2020 held that the SAT February Order is restricted only to the point relating to violation of Section 6A(4)(b)(iii) of the Insurance Act