2022 (5) TMI 813 - SC - SEBI

Pledge of shares - Pawnor and the pawnee s right to sue for recovery and sell the pawned goods - Accretion on pawned goods - Pledge or hypothecation of securities held in a depository - legal jurisprudence relating to law of pledge - rights of depository Participant - right of redemption given to the pawnor vide Section 177 of the Contract Act - whether the Depositories Act, 1996 read with the Regulation 58 of the Securities and Exchange Board of India (Depositories and Participants) Regulations, 1996, For short, 1996 Regulations has the legal effect of overwriting the provisions relating to the contracts of pledge under the Indian Contract Act, 1872 - Relevant provisions of the Contract Act - HELD THAT - We do not find any derogation or conflict between Section 176 of the Contract Act and sub-regulations (8) and (9) of Regulation 58. Regulation 58(8) entitles the pawnee to record himself as a beneficial owner in place of the pawnor. This does not result in an actual sale . The pawnee does not receive any money from such registration which he can adjust against the debt due. The pledge creates special rights including the right to sell the pawn to a third party and adjust the sale proceeds towards the debt in terms of Section 176 of the Contract Act. The reasoning that prior notice under Section 176 of the Contract Act would interfere with transparency and certainty in the securities market and render fatal blow to the Depositories Act and the 1996 Regulations is farfetched as it fails to notice that the right of the pawnee is to realise money on sale of the security. The objective of the pledge is not to purchase the security. Purchase by self, as held above, is conversion and does not extinguish the pledge or right of the pawnor to redeem the pledge. Equally, it may be a disincentive for both the pawnor and the pawnee in many cases, if we accept this interpretation and ratio, which would inhibit them from entering into a transaction creating a pledge. Difficulties and disputes regarding price, valuation, right to redemption etc. could invariably arise. There would also be difficulties in case the dematerialised securities are not traded as in the present case. If the case pleaded by MHPL is to be accepted, the entire dues of PIFSL stand paid without in fact a single penny coming to the coffer of PIFSL. Whether or not PIFSL will be able to find a willing buyer and sell the shares is unknown given the fact that the shares are unlisted and MHPL continues to be the holding company of NEVPL. In the context of the present case, the contract of pledge envisages that PIFSL is entitled to get itself recorded as beneficial owner without forfeiting its right in terms of Clause 6.2 to sell the shares. The contention of MHPL that Clauses 6.1 and 6.2 are in the alternative and once PIFSL has exercised option under Clause 6.1, the option under Clause 6.2 is closed must be rejected as absolutely untannable. We do not find any such condition in the two clauses. As noticed above, PIFSL could not have exercised the right under Clause 6.2 unless the pledge shares were registered in its name as beneficial owner . This step was necessary to enable PIFSL to exercise its right and enforce the sale of pledge shares. Whether or not it would be successful in selling the pledge shares is unknown and uncertain even today. The amount of money that would be received is also unknown and uncertain. As per Clause 5.1(m), the pawnor agrees that throughout the continuance of the pledge created pursuant to the pledge deed and until the repayment of the amount outstanding in full under the transaction document, that is, the Bridge Loan Agreement, the pawnor shall remain the beneficial owner of the shares pledged at all times, except on the sale made by the pawnee as the bridge loan lender. Further, vide Clause 5.1(k), the pawnor has irrevocably waived any right it may have under the Depositories Act, the 1996 Regulations, or any other applicable law to the extent it is inconsistent with the provisions of the Pledge Deed. Clause 5.1(k) would only apply if the Depositories Act, the 1996 Regulations, or any other law permits the parties to contract out of the regulations by mutual agreement. It is a settled position of law and as discussed above, a contract cannot be inconsistent with the provisions of any existing law, including regulations, unless the said law permits the parties to enter into a contract inconsistent with the provision. PIFSL by the letter dated 23rd January 2018 had informed MHPL in terms of Clause 6.1 that there has been an occurrence of default, which has continued and, therefore, they, on 16th January 2018, in exercise of its right under Clause 6.1 of the pledge deed, have applied for transfer of the pledged shares in its name. Consequently, all the rights in the pledged shares, including but not limited to the right of attending general body meetings, voting rights, and rights to receive dividends and other distributions, now vests with them as per Clause 2.3(A)(ii)(b), This intimation to MHPL is without prejudice to any rights or remedies PIFSL has in terms of the pledge deed or security documents executed in pursuance of the bridge loan agreement. PIFSL expressly reserved its right to transfer and sell pawned shares for value providing five days notice as required under Clause 6.2 of the pledge deed and Section 176 of the Contract Act. We would, without hesitation, therefore hold that on becoming the beneficial owner in the records of the depository , the pawnee had complied with the procedural requirement of Regulation 58(8) to enforce the right to sell the shares. Thereafter, such a sale should be made according to Sections 176 and 177 of the Contract Act. Violation of the said provisions, if made by PIFSL, would have its consequences as per the law. Pawn has not been sold and there is no violation of the Contract Act or for that matter the Depositories Act and the 1996 Regulations. PIFSL has not overlooked its obligations under Sections 176 and 177 of the Contract Act by relying upon sub-regulation (8) to Regulation 58, which has an entirely different object and purpose. Recording change in the register of the depository , whereby PIFSL as the pawnee has become the beneficial owner , is only to enable the pawnee to sell and transfer the shares in accordance with the Depositories Act and the 1996 Regulations. The object and purpose of sub-regulation (8) to Regulation 58 is not to nullify the obligation of MHPL i.e., the pawnor, and PIFSL i.e., the pawnee, under the Contract Act but to enable PIFSL to exercise its rights under Section 176. It also follows that MHPL is entitled to redeem the pledge before the sale to a third party is made. As to be held that registration of the pawn, that is the dematerialised shares, in favour of PIFSL as the beneficial owner does not have the effect of sale of shares by the pawnee. The pledge has not been discharged or satisfied either in full or in part. PIFSL is not required to account for any sale proceeds which are to be applied to the debt on the actual sale . The two options available to PIFSL as the pawnee under Section 176 of the Contract Act remain and are not exhausted. For the aforesaid reasons, the present appeal must be allowed and the impugned order passed by the Appellate Authority dated 20th June 2019 upholding the orders of the Adjudicating Authority dated 6th July 2018 and the emails of the IRP dated 19th February 2018 are set aside. It is held that MHPL is not a secured creditor of the Corporate Debtor, namely NNPIL, to the extent of the value of the 31,80,678 shares. PIFSL has rightly made a claim as financial creditor of the Corporate Debtor without accounting for the value of 31,80,678 shares of NEVPL in its claim petition. Insolvency proceedings against the Corporate Debtor, namely NNPIL, will proceed accordingly.

Summary

Issues Involved:
1. Whether the Depositories Act, 1996, and Regulation 58 of the Securities and Exchange Board of India (Depositories and Participants) Regulations, 1996, override the provisions relating to the contracts of pledge under the Indian Contract Act, 1872.
2. The legal difference between ownership, pledge, and mortgage.
3. The pawnee's rights in the pledged property.
4. The effect of accretion on pawned goods.
5. The requirement of notice of sale by the pawnee.
6. The legality of the sale of pledged goods by the pawnee to self.
7. The effect and purpose of the Depositories Act, 1996, and its regulations on pledges under the Contract Act.
8. Analysis of relevant case laws and their applicability to the facts of the case.
9. Application of the law of pledge to the specific facts of the case.

Detailed Analysis:

1. Overriding Effect of the Depositories Act and Regulation 58:
The primary legal issue is whether the Depositories Act, 1996, and Regulation 58 of the Securities and Exchange Board of India (Depositories and Participants) Regulations, 1996, override the provisions of the Indian Contract Act, 1872, concerning contracts of pledge. The judgment concludes that the Depositories Act and Regulation 58 do not override but rather complement the Contract Act. The Depositories Act introduces a new regime for the dematerialization and transfer of securities but does not nullify the fundamental principles of the law of pledge under the Contract Act.

2. Legal Difference Between Ownership, Pledge, and Mortgage:
The judgment distinguishes between ownership, pledge, and mortgage. A pledge creates a special property right in the pawnee, while the general property remains with the pawnor. A mortgage, on the other hand, transfers the right of property by way of security. The pawnee has the right to retain possession until the debt is paid or the promise is performed, and the right to sell after reasonable notice.

3. Pawnee's Rights in the Pledged Property:
The pawnee has a special property in the pledged goods but not general ownership. The pawnee's rights include retaining the goods as collateral security and selling the goods after giving reasonable notice to the pawnor. The judgment emphasizes that the pawnee's right to sell does not extinguish the pawnor's right to redeem the pledged goods until the actual sale.

4. Accretion on Pawned Goods:
The judgment states that any increase or profit from the pledged goods, such as dividends or bonuses, also forms part of the pledge. The pawnee's right to retain and sell the pledged goods extends to any accretions and additions.

5. Requirement of Notice of Sale by the Pawnee:
The judgment reiterates the necessity of giving reasonable notice to the pawnor before the pawnee can sell the pledged goods. This requirement is mandatory and cannot be waived by contract. The purpose of the notice is to give the pawnor an opportunity to redeem the pledged goods before the sale.

6. Legality of Sale of Pledged Goods by the Pawnee to Self:
The judgment holds that the sale of pledged goods by the pawnee to himself is not valid and amounts to conversion. Such a sale does not extinguish the pawnor's right to redeem the pledged goods. The pawnee must sell the goods to a third party to extinguish the pawnor's right of redemption.

7. Effect and Purpose of the Depositories Act and Its Regulations:
The Depositories Act and Regulation 58 aim to facilitate the dematerialization and transfer of securities, ensuring transparency and reducing risks associated with physical securities. The judgment clarifies that while the Depositories Act introduces new procedures, it does not negate the requirements of the Contract Act concerning pledges. The pawnee must comply with both the Depositories Act and the Contract Act.

8. Analysis of Relevant Case Laws:
The judgment analyzes various case laws to highlight the principles of the law of pledge. It distinguishes between different forms of security interests, such as pledge, mortgage, and hypothecation, and emphasizes the necessity of complying with statutory requirements for each.

9. Application of the Law of Pledge to the Specific Facts of the Case:
The judgment applies the principles of the law of pledge to the specific facts of the case, concluding that the registration of the pledged shares in the name of the pawnee (PIFSL) as the beneficial owner does not constitute an actual sale. The pledge has not been discharged, and the pawnee retains the right to sell the pledged shares after giving reasonable notice to the pawnor. The judgment sets aside the orders of the Adjudicating Authority and the Appellate Authority, holding that MHPL is not a secured creditor of the Corporate Debtor to the extent of the value of the pledged shares.

Conclusion:
The appeal is allowed, and the impugned orders are set aside. The judgment clarifies that the Depositories Act and Regulation 58 do not override the Contract Act but must be read harmoniously. The pawnee retains the right to sell the pledged goods after giving reasonable notice, and the pawnor retains the right to redeem the pledged goods until the actual sale.