SEBI
Topic34 Fungibility Free Transferability Sec9A 9B
Fungibility & Free Transferability of Securities
Topic 34 — Depositories Act Section 9A & Section 9B: Fungibility, Free Transferability & Investor Rights | SEBI Law Officer
Fungibility (Section 9A) and free transferability (Section 9B) are two related but distinct innovations of the depository system. Fungibility ensures that all identical securities are interchangeable — there is no 'specific' share with a unique identity. Free transferability ensures that the right to transfer securities cannot be restricted by the issuer or any agreement — enabling efficient secondary market trading. Together, these provisions underpin the liquidity and efficiency of India's capital markets.
1. Section 9A — Fungibility of Securities
Section 9A: Securities held in a depository shall be fungible and shall not be identified by distinctive numbers. |
Fungibility is the property that makes each unit of a security identical and interchangeable with every other unit of the same class. Section 9A's two components:
- 'Securities held in a depository shall be fungible': Once held in demat form, securities become fungible — 100 Infosys shares in Account A are identical to 100 Infosys shares in Account B. No share is 'better' or 'worse' than another.
- 'Shall not be identified by distinctive numbers': Physical certificates had certificate numbers, folio numbers, and distinctive share numbers. Demat securities have no such identifying numbers. They are held as a bulk quantity against each ISIN.
2. ISIN — International Securities Identification Number
In the demat system, securities are identified by their ISIN (International Securities Identification Number) — a 12-character alphanumeric code assigned to each class of securities by NSE/BSE on behalf of SEBI:
ISIN Component | Meaning |
|---|---|
First 2 characters (Country code) | 'IN' for India |
Next 9 characters (National number) | Unique identifier for the specific security — assigned by the exchange |
Last character (Check digit) | Calculated check digit for validation |
Example: ISIN INE002A01018 identifies Reliance Industries Limited's equity shares of ₹10 face value. Every demat account's holdings are recorded as quantities against specific ISINs — not as specific certificate numbers.
3. Practical Implications of Fungibility
Implication | Explanation |
|---|---|
Seamless settlement | Any 100 TCS shares can settle a trade for 100 TCS shares — no 'specific' certificate required. |
No bad delivery | Since all shares of a class are identical, there is no concept of 'bad delivery' in the demat system. |
Efficient short selling | A seller can deliver any available shares of the same ISIN — not required to deliver the specific shares originally purchased. |
Securities Lending | Fungibility enables Securities Lending and Borrowing (SLB) — any equivalent securities can be returned. |
No odd lots | Holdings of any quantity (even 1 share) are fully tradable — no minimum lot size restriction. |
Pooling of assets | Clearing corporations can pool securities from multiple accounts for settlement — efficiency benefit. |
4. Section 9B — Free Transferability of Securities
Section 9B: Notwithstanding anything contained in any other law for the time being in force or in any contract, agreement, or instrument, securities held with a depository shall be freely transferable. |
Section 9B is the free transferability provision — it overrides ANY restriction on the transfer of dematerialised securities. The 'notwithstanding' clause is of paramount importance:
- Overrides contractual restrictions: Transfer restrictions in shareholder agreements, Articles of Association, or other instruments cannot prevent the transfer of demat securities.
- Overrides statutory restrictions: Restrictions in 'any other law' — including Companies Act provisions on pre-emptive rights, lock-in periods etc. — are overridden for demat securities.
- 'Notwithstanding anything in any other law': This is the broadest possible override clause — Section 9B has precedence over all competing provisions.
5. Exceptions and Limits to Free Transferability
Section 9B's free transferability is subject to important qualifications:
- SEBI-imposed lock-ins: SEBI (ICDR) Regulations mandate promoter lock-in periods after IPOs — these lock-ins are enforced through the depository system (demat accounts are frozen for lock-in quantities).
- Court orders/regulatory freeze: SEBI or courts can direct the depository to freeze specific accounts — overriding free transferability for enforcement purposes.
- Pledge block: Pledged securities cannot be transferred by the pledgor until the pledge is released.
- Minimum public shareholding: SEBI regulations on minimum public float are enforced through depository records — promoters cannot transfer beyond their permissible limit.
6. Section 9A and Section 9B — Relationship with Other Laws
Law | Provision | Effect of Section 9A/9B |
|---|---|---|
Companies Act, 2013 | Section 56 — restrictions on transfer in AoA; pre-emptive rights | Section 9B overrides AoA restrictions for demat transfers — AoA transfer restrictions apply only to physical certificates |
Companies Act, 2013 | Section 58 — company's refusal to register transfer | Company cannot refuse transfer of demat securities — transfer is effected through depository without company's intervention |
SEBI (ICDR) Regulations | Promoter lock-in provisions | SEBI lock-ins enforced through depository (freeze) — Section 9B does not override SEBI-imposed lock-ins |
Shareholder Agreements | Transfer restrictions (right of first refusal, drag-along) | Section 9B overrides contractual transfer restrictions for demat securities — though such agreements may still be enforceable inter partes |
7. Landmark Cases
📖 Bhagwati Developers Pvt. Ltd. v. Peerless General Finance & Investment Co. Ltd. (2013) 9 SCC 584 Facts: Dispute about the transferability of pledged demat securities — the pledgor argued that the pledge agreement restricted the pledgee from transferring securities, and these contractual restrictions overrode Section 9B. Held: The Supreme Court upheld the free transferability of dematerialised securities under Section 9B. Contractual restrictions in the pledge agreement could not override Section 9B's 'notwithstanding any contract' provision. The pledgee, on invocation, had free right to transfer/sell the securities. Ratio: Section 9B's 'notwithstanding any contract' provision is absolute — no contractual restriction can prevent transfer of demat securities. This affirms the supremacy of the Depositories Act framework over private contractual arrangements. |
📖 In re: Venture Capital Funds (SEBI Order) SEBI Informal Guidance, 2008 Facts: Whether AIF/VC fund restrictions on transfer of portfolio company shares could be enforced against transfers through the depository — seeking protection from hostile secondary market buying. Held: SEBI held that Section 9B's free transferability applies to all demat securities. However, where shares are validly placed under SEBI-mandated lock-in or regulatory freeze, the restriction is enforceable through the depository. Contractual transfer restrictions in shareholders' agreements do not bind the depository. Ratio: Regulatory lock-ins (SEBI-mandated) are enforceable through the depository system. Private contractual transfer restrictions (shareholders' agreements) are NOT enforceable through the depository — they can only be enforced inter partes in courts. |
8. Model Examination Questions
Q1. Explain the concept of fungibility of securities under Section 9A and free transferability under Section 9B of the Depositories Act. What is the effect of Section 9B on transfer restrictions in Articles of Association?
Fungibility (Section 9A) & Free Transferability (Section 9B) Model Answer — FUNGIBILITY (Section 9A): 'Securities held in a depository shall be fungible and shall not be identified by distinctive numbers.' Fungibility means all securities of the same class are identical and interchangeable — there is no 'specific' share. Physical certificates had certificate numbers; demat securities are identified only by ISIN and quantity. Implications: no bad delivery; efficient settlement; any equivalent securities can settle a trade; securities lending and borrowing enabled. FREE TRANSFERABILITY (Section 9B): 'Notwithstanding anything contained in any other law or in any contract, agreement, or instrument, securities held with a depository shall be freely transferable.' The broad 'notwithstanding' clause overrides: (i) Companies Act Section 56 (transfer restrictions in AoA); (ii) Companies Act Section 58 (company's right to refuse transfer); (iii) contractual restrictions in shareholder agreements (right of first refusal, drag-along clauses). In Bhagwati Developers v. Peerless (2013 SC), the Court upheld Section 9B — no contractual restriction can prevent transfer of demat securities. EXCEPTIONS: SEBI-mandated lock-ins (e.g., promoter lock-in after IPO) are enforceable through the depository system; court/SEBI freeze orders; pledge blocks. AoA transfer restrictions do not bind the depository — though they may be enforceable inter partes between shareholders through courts. |
🎯 EXAM POINTERS — Topic 34: Fungibility & Free Transferability
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