Pledging mutual fund units? Mark a lien

Investors can pledge their mutual fund units as security to banks or other financial institutions and borrow against them. To do so, a lien has to be marked against the units. Lien refers to the right of the financier to take and hold or sell the property of a debtor as security or payment for a debt. We discuss the process of marking a lien on mutual fund units.

An investor should send a letter to the mutual fund/registrar requesting the fund to mark a lien on the units in favour of the bank. The letter should:

Clearly state the name of the investor which should match with the name in the mutual fund records.

State the folio number, scheme and the number of units for which the lien is to be marked.

Should be signed by the unit holders as per the mode of holding, that is, by all holders if the mode of holding is joint.

Be accompanied by a letter from the financier stating the above.

If the investor is a non-individual entity, board resolution/partnership deed authorising the relevant authorised person for pledging the mutual fund units should also be submitted.

It should be noted that a lien is marked on units and the request to mark lien will be rejected if only an amount is mentioned in the letter. The fund/scheme/ number of units mentioned in the letter from the financier should tally with that of the investor. The number of clear units available for marking lien (that is, the units not locked due to being tax saving schemes) should be equal to or more than the number of units pledged.

The registrar will mark the lien and a letter is sent to the financier with a copy to the investor confirming the marking of a lien on the units.

The financier (lender) can ask for the removal of the lien and send a request letter to the fund. This request should clearly state the name of the investor, fund, folio number, scheme and the number of units for which the lien should be removed.

A financier can also request for a partial removal of lien, in which case, lien on some of the units will be removed and these units are rendered ‘free’ units. This can happen when financiers receive part-payments.

If the financier in his letter of request for marking a lien mentions only the number of units on which the lien is to be marked, it is a normal lien. This would mean that any dividends reinvested or any future accrual in the scheme would be free and not under lien. However, if the request specifically states that future accruals to the existing investments, such as dividend reinvestment, are to be marked under the lien, then it is called dynamic lien.

If the borrower defaults in making payment, the financer can enforce the lien, that is, send a signed request to the mutual fund to redeem the units and the mutual fund will send the proceeds/cheque to the financier.

Contributed by CAMS Viveka, an Investor Education Initiative from CAMS. The views expressed are general practices in the mutual fund industry