2022 (6) TMI 1188 - HC - Companies Law

Transfer of pledge shares - right of pledgee - whether Catalyst can transfer these shares to its name but only for the limited purpose of holding them safely until they are redeemed sold (after notice to World Crest) or for the purposes of Catalyst s recovery suit? - Sections 176 and 177 of the Contract Act - HELD THAT - When there is a default by the pledgor i.e. the pledgor does not fulfil his promise to pay the debt the pledgee has the right (but not an obligation) to sue on the date and to continue retention of the pledged goods as a collateral security and also the right to sell the goods but after reasonable notice of the proposed sale to the pledgor. Once sold the pledgor s right of redemption is extinguished and forever lost. Until the sale actually occurs the pledgor is entitled to his right of redemption again on payment of debt. What happens when a pledgee brings suit for recovery of the debt? Although the pledgee is entitled to retain the goods he must return them on payment of the debt (and expenses). The Supreme Court in PTC INDIA FINANCIAL SERVICES LIMITED VERSUS VENKATESWARLU KARI AND ANOTHER 2022 (5) TMI 813 - SUPREME COURT also reaffirmed that a pledgee has only special property in the pledge but the general property remains with the pledgor. It is said to be a right in the pledged goods higher than the mere right of detention but less than the general property right. This is explained the pledgee has a right to transfer the general property rights in the pledged items i.e. to pass title so long as the pledge is not redeemed. This is also said to be a conditional general property interest . i.e. subject to the condition that the general property can be passed to a third party if the pledged goods are brought to sale. This means that a pledgee can validly pass full tile in the pledged goods i.e. plenary ownership and general property rights to a third party on sale. The pledgee cannot validly acquire these rights by a sale to itself. Until that sale to a third party happens or takes place the pledgor has a right to redeem and this redemption means that the pledgor gets back the entirety of the general property rights in the pledged goods. The right of ownership of a demat security (share) vests in what is known as the beneficial owner . Every person or entity who or which is recorded as a beneficial owner can transact and deal in securities but must do so through a DP. Section 12 of the Depositories Act permits the pledge and hypothecation of securities held in a depository. In PTC India This Section was held not to be inconsistent with the Contract Act. We believe on a careful consideration that Mr Khambata is correct on two very broad issues. First whether on this presentation on behalf of World Crest it can be said that it has made out so overwhelming a prima facie case that an order in its favour had to be made in the impugned order; and since it was not whether we must do so. As the learned single Judge said there are contentious issues. There is the historical background. We are being asked to infer that the recording of Catalyst s name under Regulation 58(8) as the beneficial owner results in it having some severely curtailed rights as a beneficial owner - Second we are being asked to presume that the conferment of voting rights in Clause 2.1(b) amounts or equates to the general property in the shares and the contract or pledge document could not so provide. We are shown no clear interdiction but are being asked to read it into PTC India and the law relating to pledges. Clause 2.1 says that it preserves all rights under Section 176. Therefore the parties knew exactly what they were about when they entered into the contract. PTC India restates long-standing law on pledges; it does not re-write it. An interesting thought experiment might be to consider the situation as its stood before the era of the dematerialization at a time of physical securities when they were accompanied with blank transfer forms. If there was a power of such transfer Mr Khambata argues and it was effected surely it could not be suggested that the transferee would be rendered such an emasculated member of the company. Appeal dismissed.

Summary

Issues Involved:
1. Whether the appellate court can interfere with the discretion exercised by the Single Judge in refusing ad-interim relief.
2. Application of Sections 176 and 177 of the Indian Contract Act, 1872 concerning pledges.
3. Interpretation of Regulation 58 of the SEBI (Depositories and Participants) Regulations, 1996.
4. The legality of Catalyst transferring pledged shares to itself and subsequently to YBL.
5. Whether YBL, as a nominee or transferee, can exercise voting rights over the pledged shares.
6. The contractual terms of the Pledge Deed and their enforceability.

Detailed Analysis:

1. Appellate Court's Interference with Single Judge's Discretion:
The court emphasized the principle laid down in *Wander Limited v. Antox India Private Limited* and reaffirmed in *Mohd Mehtab Khan v. Khushnuma Ibrahim Khan*, which restricts appellate courts from interfering with the discretion exercised by a Single Judge unless it is shown to be arbitrary, capricious, or perverse. The appellate court should not substitute its discretion for that of the trial court if the trial court's decision was reasonably possible based on the material before it.

2. Application of Sections 176 and 177 of the Indian Contract Act, 1872:
The court discussed the law relating to pledges, highlighting that a pledgee has a "special property" in the pledged goods, while the general property remains with the pledgor. The pledgee has the right to retain possession until the debt is paid or the promise is performed and can sell the pledged goods after giving reasonable notice. The pledgor retains the right of redemption until the actual sale of the pledged goods. The court noted that a sale-to-self by the pledgee is forbidden as it would amount to conversion.

3. Interpretation of Regulation 58 of the SEBI (Depositories and Participants) Regulations, 1996:
The court analyzed Regulation 58 in the context of the Depositories Act, 1996, which requires the pledgee to be recorded as the "beneficial owner" before selling the pledged securities. This regulation does not override the Contract Act but ensures procedural compliance for the sale of dematerialized securities. The court emphasized that the recording of the pledgee as the beneficial owner is a mandatory procedural step to facilitate the sale and does not confer unrestricted ownership rights on the pledgee.

4. Legality of Catalyst's Transfer of Pledged Shares:
Catalyst, as the pledgee, transferred the pledged shares to itself and subsequently to YBL. The court examined whether this transfer was permissible under the law of pledges and the terms of the Pledge Deed. The court noted that the transfer to Catalyst as the beneficial owner was permissible under Regulation 58(8) but questioned whether Catalyst could further transfer these shares to YBL.

5. YBL's Voting Rights as Nominee or Transferee:
The court considered whether YBL, as a nominee or transferee of Catalyst, could exercise voting rights over the pledged shares. The court noted that under the Companies Act and the Depositories Act, only the beneficial owner can exercise such rights. The court discussed whether Catalyst's transfer of voting rights to YBL was consistent with the law and the terms of the Pledge Deed.

6. Contractual Terms of the Pledge Deed:
The court examined the terms of the Pledge Deed, particularly Clauses 2.1, 5, 7.1(c), and 7.1(g), which dealt with the rights of the pledgor and pledgee before and after an event of default. The court noted that the Pledge Deed allowed Catalyst to transfer the pledged shares to itself or its nominee and exercise voting rights upon an event of default. The court questioned whether these contractual terms were enforceable and consistent with the law of pledges.

Conclusion:
The court found that the Single Judge's decision to refuse ad-interim relief was not arbitrary, capricious, or perverse and was a plausible view based on the material presented. The court emphasized the importance of the pledgor's right of redemption and the procedural requirements for the sale of pledged securities under Regulation 58. The court concluded that the contractual terms of the Pledge Deed, including the transfer of voting rights to Catalyst and YBL, were subject to the constraints of the law of pledges and the requirements of the Depositories Act and SEBI Regulations. The appeal was dismissed, and the Single Judge's order was upheld.