FACTS
The facts of the case are, PTC India Financial Services Ltd. (PIFSL), is a Non-Banking Financial Company which entered in a bridge loan agreement with NSL Nagapatnam Power and Infratech ltd. the agreement was to lend money to the latter. Mandava Holdings Private. Ltd. is promoter of the borrower company and NSL Energy Private Ltd. (NEVPL)is the sister company. The promoters pledged the shares of NEVPL as collateral for the agreement. On 3rd June 2016, NSL Nagapatnam Power and Infratech ltd. defaulted in the repayment of loan. Subsequently, the pledge was invoked and PIFSL was recognised as beneficial owner by the Depository Participant. Meanwhile, the borrower or the corporate debtor filed an application for Corporate Insolvency Resolution Process under Indian Bankruptcy Code, 2016.
ISSUES RAISED
The issue raised in the court of law was that if MHPL is a financial creditor to the extent of pledged shares for the resolution process and whether the invocation of pledge would result in transfer of ownership of the pledged goods (shares) or only gives a right to pledgee to sell those goods under section 176 of The Indian Contract Act, 1827.
CONTENTION
The respondent, Mandava Holdings Private Ltd. contended that since the appellant is registered as beneficial owner in Depository and therefore, should be considered as the financial creditor for the purposes of resolution process. It contended that it has stepped in the shoes of PIFSL. However, the other side argued that the borrower owes the money for the repayment of loan and the pledged shares are not sold so the debt should include the amount equal to the value of pledged shares.
RATIONALE
The matter was taken to the National Company Law Tribunal that ruled in favour of MHPL. The reason of its judgement was that after invocation of pledge, the shareholding in NEVPL was reduced and thus MHPL became the financial creditor. On appeal filed in National Company Appellate Tribunal which dismissed it on the grounds that the contention of appellant that the sale of shares did not take place is irrelevant. The present appeal in Supreme Court was filed which was allowed for the following reasons:
Rights accrued on pledged property in comparison to mortgaged property:
The court held that in case of an agreement of mortgage the right of mortgagee or property is general in nature and similar to that of owner. However, in case of pledge it nis not like so. The pledgee only has special right on the property. He only has the right to retain property is discharged and either has the right to file a suit or right to sell the pledged good upon non- repayment under Indian Contract Act, 1872.
Notice of sale of property:
The Indian Contract Act, states that the validity of right of pledgee to sell the goods upon non-repayment is conditional upon notice is given to the pledgor prior to such sale. The precedents were taken under consideration and it was determined that though the notice of sale is mandatory, the time period after notice to authorise sale is not determined. The court stated that it depends upon case-to-case basis. Therefore, in case of shares 24 hours could also be appropriate time.
Effect of SEBI (Depositories Participants) Act, 1996 and Regulations read with Indian Contract Act:
As per the DP Act and DP Regulations, the court held that the right to sell shares is only that of ‘beneficial owner’ registered under DP. Such registration is not sufficient to consider it as ‘actual sale’, it only gives a right to sell. The term ‘actual sale’ is not sale to self. The right to redeem pledged shares of pledgor under section 177 of Indian Contract Act is lost when sale is made to third person but is present upon mere registration as beneficial owner.
The conclusion was that the Contract Act and Depository Act and Regulations can be read harmoniously. There is no need of alteration. There is one exception, The court ruled that under the Contract Act, a borrower’s right to redeem pledged shares due to notice that is not reasonable under Section 176 does not apply to dematerialized securities transferred according to the DP Act and Regulations. This exception was made because adherence to DP Act procedures ensures transaction certainty for listed demat securities. The DP Act mandates notification to both borrower and pledgor after pledge invocation, thereby fulfilling the intent of Sections 176 and 177 of the Contract Act without conflicting with DP Act provisions.
On application of this view of the court on the present case, it was concluded that there are different stages to such sale. The registration of lender as beneficial owner fulfils the condition under Regulation 58(8) to initiate right to sell. However, the pledge remains intact and the debt owed, is not discharged at this stage. Furthermore, the Court underscored that the options available to the pledgee under Section 176 of the Contract Act, such as suing for recovery of debt while retaining the pledged property or selling the property after giving due notice, remain viable and should be followed in compliance with the law.
The court rules in favour of PIFL (appellant) thereby overruling the decision of NCLT and NCLAT.
DEFECTS IN LAW
In my opinion the judgement does not have any defects as it does not cause any unnecessary alteration and provides an interpretation of law that elucidates the true purpose behind the laws. The decision ensures strict adherence to the legal provisions and precedents. It clarifies the practical implication of law and generates awareness among parties of pledge. It provides legal certainty by presenting a predictable outcome of written laws.
INFERENCE
Firstly, the judgment underscores the distinction between ownership rights and the special property rights that a lender (or pledgee) holds over pledged shares. When PIFSL invoked the pledge on shares held by Mandava Holdings Private Limited (MHPL), it gained possession and control of those shares but did not acquire full ownership. This distinction is crucial because it dictates the extent of control and entitlements the lender has over the pledged assets until the debt is fully discharged.
Secondly, the court reaffirmed that benefits arising from pledged shares, such as dividends or bonus shares, are considered part of the security for the debt. This principle ensures that any accruing benefits from the pledged shares are preserved and should be returned to the borrower upon redemption of the pledge. This protection of benefits serves to maintain the integrity of the security provided by the borrower.
The requirement for a reasonable notice before the sale of pledged shares was also highlighted. Section 176 of the Indian Contract Act mandates that the lender must give the borrower adequate notice before proceeding with the sale. The court clarified that while specific details like the date, time, and place of sale need not be stipulated in the notice, it must afford the borrower a fair opportunity to settle the debt and redeem the pledged shares. This procedural safeguard ensures fairness and transparency in the enforcement of pledges.
Moreover, the court’s stance on the sale of pledged property is pivotal. It explicitly stated that the lender cannot sell the pledged property to itself. Such an action would constitute conversion and does not terminate the pledge legally. Instead, the pledge is extinguished only upon a lawful sale to a third party, thereby protecting the borrower’s rights until such a transaction occurs.
The interplay between the Contract Act and the Depositories Act and Regulations was another critical aspect of the judgment. The court harmonized these statutes, emphasizing that while becoming the “beneficial owner” under depository laws is a necessary step for a lender, it does not equate to an actual sale under the Contract Act. This distinction ensures that the borrower retains the right to redeem the pledged shares until they are lawfully sold to a third party, maintaining the integrity of the pledge mechanism.
In conclusion, the judgment provides clarity on the rights and responsibilities of both lenders and borrowers in cases involving pledges of shares. It upholds the principles of fairness, transparency, and legal clarity in enforcing pledges under Indian law. By delineating the limits of a lender’s rights and the procedural safeguards to be followed, the court’s decision reinforces confidence in the legal framework governing financial transactions involving pledged assets. This case serves as a significant precedent for future disputes concerning pledges and underscores the importance of adherence to statutory requirements in such matters.
DIYA MOGRA
O. P. Jindal University, Sonipat.