The Securities and Exchange Board of India (“SEBI”) has on March 23, 2020 issued two circulars (“Circulars”), to prescribe regimes for sponsors of Infrastructure Investment Trusts (“InvITs”) and Real Estate Investment Trusts (“REITs”) (together “Sponsors”) to create ‘encumbrances’ on units held by them in InvITs or REITs (“Sponsor Units”).
Prior to the Circulars being notified, the SEBI (Infrastructure Investments Trusts) Regulations, 2014 (“InvIT Regulations”) and the SEBI (Real Estate Investments Trusts) Regulations, 2014 (“REIT Regulations”) did not expressly permit Sponsors to create ‘encumbrances’ on Sponsor Units. Absent any prescription or prohibition in this regard, some Sponsors in the market have been (to address liquidity needs) encumbering Sponsor Units in favour of lenders (and lenders have been taking a punt on the legal enforceability of such arrangements).
The Circulars seek to grant legal sanctity to such arrangements and SEBI has vide the Circulars, sought to regulate such transactions. Going forward, such encumbrances can be created by Sponsors on Sponsor Units, subject to compliance with the terms of the Circulars.
II. Framework for creation of encumbrances on Units
1. Under the InvIT Regulations, Sponsors are (subject to certain conditions) required to hold (after an initial offer of units, on a post-issue basis): (i) at least 15% of the units of an InvIT, for a period of at least 3 years from the date of the listing of units; and (ii) units exceeding 15% on a post issue basis, for a period of at least 1 year from the date of listing of the units. Under the REIT Regulations, the 3 year lock in period applies on at least 25% of the units of REITs. Additionally, the REIT Regulations require the Sponsors to hold at least 15% of the units of a REIT, at all times (together the “Locked-In Units”).
2. Creation of Encumbrance:
The Circulars allow Sponsors to create ‘encumbrance’ on the Locked-In Units during the mandatory holding periods prescribed in the InvIT Regulations and the REIT Regulations. “Encumbrance” includes “pledge, lien, negative lien, non-disposal undertaking etc. or any other covenant, transaction, condition or arrangement in the nature of encumbrance”. The definition covers all kinds of encumbrances (in addition to plain vanilla pledge), as is used in the context of SEBI regulations governing listed companies.
3. Agreement for Creation of Encumbrance:
Sponsor(s) are allowed to create encumbrance on the Locked-In Units, subject to the agreements executed in relation to creation of such encumbrance, containing terms that are in compliance with the requirements prescribed in the Circulars. Accordingly, the beneficiaries of such encumbrances (i.e. persons for whose benefit the encumbrances are created), will need to be comfortable with the conditions set out in the Circulars (and bespoke conditions that such beneficiaries may otherwise have been accustomed to (e.g. standard terms and conditions that lenders are typically used to), may have to be tailored to comply with the terms of the Circulars).
The Circulars prohibit invocation of encumbrances on the Locked-In Units during the mandatory holding periods prescribed in the InvIT Regulations and REIT Regulations. Accordingly, the benefit of the Circulars may not be available for borrowing short term loans (whose tenures are less than 3 years from the date of listing of the units).
Additionally, for REITs, given that at least 15% of the units need to be held by Sponsors at all times, the Circulars prescribe that encumbrances on the Locked-In Units maybe invoked only by other Sponsor(s) of the REIT. If the beneficiary of the encumbrance is not a Sponsor, such person needs to be re-designated as a Sponsor (which re-designation process is subject to consent of at least 75% of the unitholders of the REIT or the dissenting unitholders need to be given an exit), before such encumbrance can be invoked. Such a restriction may result in the Circulars being more commonly used for lending arrangements involving InvITs and their Sponsors (as opposed to for REITs).
5. Disclosures relating to the Encumbrance:
Details of any encumbrance created on Sponsor Units will have to be disclosed: (i) by the Sponsor, to the investment manager of the InvIT or REIT (within 2 working days from the date of creation of such encumbrance); and (ii) by the InvIT or REIT to the stock exchanges, within 2 working days of the receipt of such intimation from a Sponsor.
Such disclosures need to inter alia include details of the Sponsor Units being encumbered, the beneficiary of the encumbrance and the purpose of borrowing.
Such disclosure requirements will promote transparency in relation to encumbrances that maybe created by Sponsors on the Sponsor Units, and have been included to ensure that all information in relation to such transactions are available to the market (and public unitholders).
The Circulars helpfully set out the parameters within which, Sponsors can create encumbrances on the Locked-In Units, during the mandatory holding period. The regime was long due, as certain Sponsors have been encumbering their Units to secure their (and the InvITs’ / REITs’) borrowings (though from a regulatory perspective, such transactions were in the ‘grey zone’ of permissibility). The Circulars will streamline such transactions and ensure that they are effected in a transparent manner.
Such a move by SEBI, at a time when liquidity is scarce, will increase the ability of Sponsors to source funding (for themselves and for the InvITs / REITs), by offering the Sponsor Units as collateral under the legally recognized framework of the Circulars. For the lenders on the other hand, the Circulars grant legal sanctity to their enforcement rights vis-à-vis encumbrances created on Sponsor Units, which prior to the notification of the Circulars, were questionable. SEBI’s move to notify the Circulars is thus a welcome move that should (to an extent) ease fund raising and address liquidity needs of Sponsors, and of InvITs and REITs, going forward.
Atreya Bhattacharya, Partner
Raina Upadhyay, Senior Associate
 Circulars SEBI/HO/DDHS/DDHS/CIR/P/2020/43; and SEBI/HO/DDHS/DDHS/CIR/P/2020/44