Encumbrance
Also written Encumbrances · Encumbered securities
Any charge or restriction over securities in favour of another party - a pledge, lien, non-disposal undertaking or similar - which the depository records and which stops the securities being freely transferred.
In plain language
Securities in a demat account are either free - the holder can sell or transfer them at will - or encumbered, meaning someone else has a claim or restriction over them. A pledge to a lender is the most familiar encumbrance; a lien or a non-disposal undertaking are others.
Encumbrances matter in two directions. For the holder, encumbered securities cannot simply be sold, transferred on death, or moved when an account is closed. For the market, encumbrances on promoter shares are a warning sign investors are entitled to see, which is why SEBI's takeover regulations require their disclosure and the depositories record them.
How it works
From Chapters 4, 6, 8 and 9:
Recording (Chapter 9, section 9.3). The SAST Regulations, 2011 require promoters to disclose encumbered shares, including NDUs. SEBI's circular of July 24, 2020 advised depositories to record all types of encumbrances specified under Regulation 28(3) of those regulations. In CDSL, those other than NDU and lien are recorded as "Other Encumbrances"; the PAN of the ultimate lender and the reason are compulsory.
Kinds of encumbrance described in the workbook:
| Encumbrance | Key feature |
|---|---|
| Pledge | Pledgee can appropriate securities unilaterally on default |
| Hypothecation (NSDL) | Lender needs borrower's concurrence to appropriate |
| Lien | Creditor in possession may retain until the debt is repaid |
| Non Disposal Undertaking | Negative lien - promise not to transfer or alienate |
| Margin pledge / re-pledge | Client's securities pledged to TM/CM, re-pledged to CC |
| CUSPA pledge ("unpaid") | Auto-pledge on shares the client has not paid for |
Effects.
- Transmission (Chapter 6): encumbered securities (pledged, earmarked etc.) are not transferred out of a deceased BO's account; they remain until the encumbrance is released or the obligation met.
- Account closure (Chapter 4): if an account cannot be closed because of open pledges, the DP freezes it ("suspended for debit and credit"); in the transfer-of-holdings module, pledge balances and unconfirmed pledges are rejected and stay in the source account.
- Unpaid securities (Chapter 8): if the CUSPA pledge is neither invoked nor released within the stated period, it is auto-released and the securities become free "without encumbrance".
- Corporate benefits: pledged securities still earn dividends for the pledgor; bonus/split shares are credited to the pledgor with pledge marked, provided a pledge exists for at least one share on the execution date.
A worked example
Illustrative. Late Mr Joshi's demat account held:
| Holding | Status |
|---|---|
| 3,000 shares of Company P | Free |
| 1,200 shares of Company Q | Pledged to a bank |
| 600 shares of Company R | Free, but ISIN frozen for debit pending listing |
His son, the nominee, applies for transmission.
- 3,000 P shares transmit to the son's account.
- 1,200 Q shares are encumbered - they stay in the deceased's account until the bank's pledge is released (the loan is repaid) or invoked.
- 600 R shares also stay, because the ISIN is frozen.
The DP cannot close Mr Joshi's account while the pledge is open, so it freezes the account - suspended for debit and credit (in CDSL, the account moves to "To be closed").
Separately: before his death, Mr Joshi was a promoter of Company Q. The bank had also taken an NDU on 5,000 other Q shares. That NDU is recorded in the depository with the bank's PAN and reason "NDU", and Company Q's promoter disclosures treat those 5,000 shares as encumbered under the SAST Regulations.
Why NISM asks about it
Encumbrance runs through Chapter 9 (Pledge and Hypothecation, 10% weightage; section 9.3 on NDUs and all encumbrances), Chapter 6 (Transmission and Nomination - encumbered securities are not transmitted), Chapter 4 (account closure and freezing with open pledges) and Chapter 8 (unpaid-securities pledges). Questions test what counts as an encumbrance, the July 24, 2020 requirement to record all Regulation 28(3) encumbrances, and what happens to encumbered securities on transmission or closure.
Common exam traps
- Encumbered securities are not transmitted until the encumbrance is released or the obligation met.
- An account with open pledges cannot be closed - it is frozen for debit and credit (NSDL) or marked "To be closed" (CDSL).
- NDU is an encumbrance even though nothing is pledged.
- All Regulation 28(3) SAST encumbrances are recorded (SEBI, July 24, 2020); CDSL groups the rest as "Other Encumbrances".
- Pledged shares still earn corporate benefits for the pledgor; bonus shares are credited with the pledge marked.
- Workbook inconsistency on unpaid-securities pledges: Chapter 8 says the TM/CM sells unpaid securities within five trading days of pay-out, but that an un-invoked, unreleased pledge is auto-released after seven trading days. Know both figures as stated.
Check yourself
1.The creation of pledge and hypothecation against securities held in demat mode is permitted under which provision?
- a)Section 12 of the Depositories Act, 1996
- b)Section 176 of the Indian Contract Act, 1872
- c)Regulation 28(3) of the SEBI (SAST) Regulations, 2011
- d)Rule 5(7) of the Indian Stamp Rules, 2019
Show the answer
Answer: (a) Section 12 of the Depositories Act, 1996
The creation of pledge and hypothecation against securities which are held in demat mode is permitted under Section 12 of the Depositories Act, 1996. The same section, read with Regulation 79 of the SEBI (Depositories and Participants) Regulations, 2018, is also the basis for the margin pledge framework.
The other three options are all real provisions from this chapter, used for different things — which is what makes them good distractors:
- Sections 176 and 177 of the Indian Contract Act, 1872 are what the pledgee undertakes to comply with when giving reasonable notice to the pledgor
- Regulation 28(3) of the SEBI (SAST) Regulations, 2011 specifies the types of encumbrances the depositories must record
- Rule 5(7) of the Indian Stamp Rules, 2019 is the stamp duty provision for invocation of pledge
2.By its circular dated July 24, 2020, what did SEBI advise the depositories to record?
- a)Only pledges created against bank loans
- b)Only Non Disposal Undertakings given by promoters
- c)Margin pledges created in favour of trading members
- d)All types of encumbrances specified under Regulation 28(3) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011
Show the answer
Answer: (d) All types of encumbrances specified under Regulation 28(3) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011
The workbook: "SEBI vide its circular dated July 24, 2020 advised the Depositories to record all types of encumbrances, which are specified under Regulation 28(3) of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011."
The context: the SAST Regulations, 2011 require promoters to disclose details of their encumbered shares, including NDUs, which fall within the scope of "Encumbrances".
- A and B are too narrow. The depositories were separately permitted to offer a system for recording NDUs, but the July 2020 circular covers all types of encumbrances under Regulation 28(3).
- C is a different circular. Margin pledge came from SEBI's circular dated February 25, 2020, effective August 1, 2020.
In CDSL, all other encumbrances are treated as "Other Encumbrances".
3.What charge applies to the DP of a client on whose securities a hold is created for a Non Disposal Undertaking?
- a)0.01 percent of the value of securities, subject to a minimum of ₹25
- b)0.1 percent of the value of securities, subject to a minimum of ₹100
- c)A flat fee of ₹25 irrespective of value
- d)No charge, as an NDU involves no movement of securities
Show the answer
Answer: (a) 0.01 percent of the value of securities, subject to a minimum of ₹25
DPs of clients on whose securities a hold is created for NDU shall be charged @ 0.01 percent of the value of securities upon creation of hold, subject to a minimum of ₹25.
Option C is tempting because the ₹25 is real — but it is a floor, not the charge itself. On securities worth ₹50 lakh the charge is 0.01% = ₹500, not ₹25.
Option D reasons from the nature of an NDU, and the reasoning is sound but the conclusion is wrong. It is quite true that NDUs are undertakings given by a shareholder not to transfer or otherwise alienate the securities, in the nature of a negative lien — nothing moves. But the depository still records a hold, and recording is chargeable.
Two further NDU requirements are commonly tested alongside: the PAN of the ultimate lender is required to be mentioned on the form, and the NDU / lien / encumbrance reason is compulsory.
Where this is taught
Free preparation for NISM Series VIRelated terms
- Margin pledgeThe only permitted way for a client to give securities as margin — a special pledge created in the depository system that leaves the shares in the client's own demat account instead of transferring them to the broker.
- LienA creditor's right to keep possession of a debtor's goods or securities until the debt is repaid, unless a contract says otherwise; in the depository, liens are recorded as encumbrances.
- PledgeA charge created over demat securities in favour of a lender who may appropriate them unilaterally on default — created by book entry under section 12 of the Depositories Act, not by handing over anything.
- HypothecationA charge over demat securities where the lender needs the borrower's concurrence to appropriate them — the same book entries as a pledge, with one extra confirmation, and a term used only in NSDL.
- Non Disposal UndertakingAn undertaking, typically by a promoter to a lender, not to transfer or alienate specified shares - a negative lien that can be recorded in the depository system as an encumbrance.
- Mass shifting facilityThe depository facility that lets a DP move a whole group of client accounts from one DP module or location to another in one go - for example when it opens a new centre - without clients re-opening accounts.
- Deletion of nameRemoving a deceased joint holder's name from a demat account so the surviving holders can continue the same account, instead of opening a new one, provided the request reaches the DP within 365 days of death.