Off-market deals in unlisted firms: NSDL order may be a double-edged sword

The move appears to be aimed at ensuring transparency in unlisted companies and that transactions comply with the AoA and the Companies Act
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National Securities Depository Ltd (NSDL) last month issued an important circular that could impact trading in unlisted shares.

Prior to this circular, any shareholder in a private limited (unlisted) company wishing to transfer their securities could simply submit a Delivery Instruction Slip (DIS) to the depository participant (DP), providing details of the shares to be transferred, the consideration payable, and the transferee’s information.

However, this process will no longer be as simple if the shares are held in demat format with NSDL.

Since this circular is from NSDL, the regulation does not apply to unlisted public limited companies, transactions through CDSL (Central Depository Services Ltd), or any debt instruments.

Prior consent

According to the June 3 circular from NSDL, shareholders must now obtain prior written consent from the unlisted company. This consent must be signed by an authorised official, such as the Company Secretary or Managing Director. The consent letter must include the details of both the transferor and the transferee along with their PANs, the number and class of shares to be transferred, the reason for the transfer, and confirmation that the deal is in compliance with the company’s Articles of Association (AoA) and Section 2(68) of the Companies Act.

The move appears to be aimed at ensuring transparency in unlisted companies and that transactions comply with the AoA and the Companies Act. For unlisted companies, this new compliance requirement gives them more control over their shareholding structure and the authority to reject transfers that are not in line with the AoA or the Companies Act. However, this rule is relaxed in the case of employees or former employees.

The Companies Act already mandates that share transfers must be recorded by the board of directors. However, following the recent dematerialisation of shares in unlisted companies, there have been a growing number of instances where transactions were executed without the board’s consent—merely by submitting delivery instruction slips to DPs.

Though NSDL’s intent is commendable, as it adds another layer of security to off-market transactions, there is concern that the new norms may give undue advantage to the management of unlisted companies. This is especially because there is no specified timeline for giving or refusing consent. Private equity and venture capital investors may find themselves at a disadvantage if the management refuses to transfer shares to less-preferred parties. This could become a major hurdle for them, as PE/VC investors typically expect free transferability and a smooth exit route to liquidate their investments.

A more practical solution could be to prescribe a reasonable timeline for processing such consents, such as a maximum of three months.

Additionally, companies may consider incorporating more safeguards in shareholders’ agreements and the AoA to protect investor rights. These contractual safeguards should be crafted in a way that ensures adherence to the circular, without allowing it to be misused as a tool to obstruct or delay legitimate share transfers—especially when such transfers are not prohibited under existing shareholder agreements.

It may be recalled that earlier this year, Madhabi Puri Buch, SEBI’s former chairperson, had said the capital market regulator was actively considering a platform to allow share allottees in a public issue to trade the security even before formal listing. She was referring to the need to curb the practice of trading in IPO shares ahead of their official listing on stock exchanges.

This mechanism would allow investors to trade during the period between shares being credited to their demat accounts and the actual listing on the stock exchanges.

Depositories, in consultation with exchanges, may want to consider Buch’s proposal seriously and work towards developing platforms that allow transactions in unlisted company securities—with the right checks and balances in place.