Encumbrance Over Sponsor Units: InvITs And REITS

The Securities and Exchange Board of India (SEBI) vide circulars dated 23 March 2020 (Encumbrance Circulars) clarified the position of law with respect to creation of encumbrance on the units held by the Sponsors of infrastructure investment trusts (InvITs) and real estate investment trusts (REITs), collectively referred to as Sponsor Units.

The SEBI (InvIT) Regulations 2014 (InvIT Regulations) and SEBI (REIT) Regulations 2014 (REIT Regulations) lay down the following mandatory holding requirements to be maintained by the sponsors for an InvIT and REIT (Sponsor):

While the Sponsor Units of an InvIT amounting to 15% of the total units are locked-in for 3 years, post which they are freely transferable, in case of REITs, 25% of the Sponsor Units are locked-in for a period of 3 years and thereafter 15% of such Sponsor Units would remain locked-in throughout the life of the REIT (Locked-in Sponsor Units).

The Encumbrance Circulars also permit the creation of encumbrance on the Locked-in Sponsor Units during the mandatory holding period and further clarifies that the scope of 'encumbrance' shall include: (i) pledge, (ii) lien, (iii) negative lien, (iv) non-disposal undertaking, or (v) any other covenant, transaction, condition or arrangement in the nature of encumbrance.

Conditions for Invocation

The Encumbrance Circulars also lay down the conditions to be adhered for invocation of Locked-in Sponsor Units that have been encumbered during the mandatory holding period:

• InvIT: The Locked-in Sponsor Units cannot be invoked during the mandatory holding period, i.e., within 3 years from the date of listing of the InvIT units. Further, the agreement via which the encumbrance is created should duly capture this condition.
• REIT: Given that 15% of the total units of a REIT are required to be held by the Sponsor throughout the life of the REIT, any invocation of encumbrance created on up to 25% of the Sponsor Units of a REIT during a period of 3 years from the date of listing of the REIT units or up to 15% of the Sponsor Units throughout the life of the REIT, will be subject to the following:
  • other than in the case of innovation of encumbrance of Locked-in Sponsor Units by a member of the Sponsor Group, any other person invoking the encumbrance in any manner is required to be get itself or its nominee re-designated as the sponsor of the REIT. Such re-designation of Sponsor shall be in accordance with provisions of the REIT Regulations, which inter alia provides for obtaining 75% consent of the unitholders or providing an exit to the dissenting unitholders by buying their units.
  • the person invoking the encumbrance and being re-designated as the sponsor will be required to fulfil the obligations of the sponsor of a REIT.

Further, the above conditions should also be duly captured in the agreement via which the encumbrance on the Locked-in Sponsor Units are created.

Disclosure Requirements

The Sponsor(s) creating any encumbrance on the Locked-in Sponsor Units of an InvIT or REIT is required to provide the details of the encumbrance to the investment manager of the InvIT or REIT, as the case may be, within 2 working days from the date of creation of encumbrance in the format prescribed in the Encumbrance Circulars. The InvIT or REIT, as the case may be, is in turn required to disclose such information regarding the encumbrance to the concerned stock exchanges within the next 2 working days. Thus, the details of any encumbrance created with respect to the Locked-in Sponsor Units of an InvIT or REIT should be disclosed to the stock exchanged within a period of 4 working days from the creation of the encumbrance.

Conclusion

While creation of encumbrance on the Sponsor Units was not explicitly restricted and had resulted in a grey area, the lenders were wary of lending against the locked in Sponsor Units as there was no clarity regarding the legality or their ability to enforce their rights against the Sponsor in case of default. The industry has been seeking clarity on the permissibility of creation of encumbrance on the Sponsor Units of InvITs and REITs during the locked-in period as it would allow Sponsors to create liquidity against the locked in units to either redeploy this capital for acquisition / development of new assets or simply to honour their obligation to participate in any future preferential / rights issue by the REIT or InvIT, as the case may be, to maintain their minimum holding. Even more so, in the current times of the pandemic when liquidity is at a huge premium, this clarification from SEBI should provide the much needed liquidity to the cash strapped promoters / sponsors and may also open up a new avenue for the lenders (both domestic and international) to lend against the Sponsor Units. This may also further facilitate leverage at the REIT or InvIT level, as the case may be, as permissible under their respective regulations.

However, lenders for the REIT Sponsor Units need to bear in mind that their enforceability of the encumbrance created would be conditional upon their ability to find a suitable replacement Sponsor, who not only fulfils the eligibility criteria but also is willing to take on the fiduciary responsibility as laid down under the REIT Regulations.

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