The Delhi High Court (“Delhi HC”), in its judgement dated April 2, 2024, in the matter of STCI Finance Limited v. Sukhmani Technologies Private Limited [O.M.P. (COMM) 340/2017], has held that mere registration of shares in favour of the pledgee as the ‘beneficial owner’ does not amount to sale of shares, and that the pledgee is not required to account for any sale proceeds until such shares are actually sold to a third party.

Facts

STCI Finance Limited (“Petitioner”), a systematically important non-deposit taking non-banking financial company registered with the Reserve Bank of India, upon a request of Sukhmani Technologies Private Limited (“Respondent”), agreed to sanction a loan facility of INR 50 crores to the Respondent vide a letter of intent dated February 8, 2012 (“LOI”), against the pledge of shares of Tulip Telecom Limited (“Tulip Telecom”). In terms of the LOI, Cedar Infonet Private Limited (“Cedar Infonet”) acknowledged to assist the Respondent in raising funds to the tune of INR 50 crores by providing security in the form of pledge of equity shares of Tulip Telecom, owned by it in favour of the Petitioner.

Pursuant to the LOI, the Petitioner and the Respondent entered into and executed several loan/security documents, all dated February 10, 2012, including a facility agreement (“Loan Facility Agreement”), irrevocable power of attorneys, and declarations along with post-dated cheques, to secure the loan being granted to the Respondent. In order to secure the loan facility granted by the Petitioner under the Loan Facility Agreement, Cedar Infonet and the Respondent (being the pledgers) executed a share pledge agreement dated February 10, 2012 (“Share Pledge Agreement”) with the Petitioner (the pledgee). Under the terms of this Share Pledge Agreement, it was agreed that shares equivalent to 200% of the loan amount would be pledged. Mr. H.S. Bedi, the director of the Respondent, and Mrs. Maninder Singh Bedi (“Personal Guarantors”) executed a personal deed of guarantee dated February 10, 2012, in favour of the Petitioner, thereby unconditionally guaranteeing to repay any outstanding amount within a period of 3 days of a demand notice being served in writing by the Petitioner. Accordingly, the Personal Guarantors and Cedar Infonet pledged 1,37,13,000 equity shares of Tulip Telecom (“Pledged Shares”) in favour of the Petitioner to secure the loan amount granted to the Respondent.

On September 2012, due to a steep fall in the share price of the Pledged Shares, the Personal Guarantors offered the Petitioner an additional security by way of mortgage over their immoveable properties as well as a revised payment schedule to regularise the interest payment. However, as a consequence of such steep fall in the share price of the Pledged Shares and a failure on part of the Personal Guarantors to provide the requisite security margin, the Petitioner invoked 1,01,50,000 shares out of the Pledged Shares in terms of the Loan Facility Agreement and the Share Pledge Agreement, and managed to sell only 1,69,099 shares, thereby recovering only a part of the outstanding amount, which was duly credited and reflected in the account statement of the Respondent, maintained by the Petitioner.

Thereafter, the Petitioner agreed to renew the loan facility on two occasions upon the request of the Respondent, however, despite several demands by the Petitioner, the Respondent failed to make payments and regularise its loan account. Consequently, the Petitioner issued a letter dated May 19, 2014 demanding the Respondent to clear its entire dues of approximately INR 52 crores as on April 1, 2014. A loan recall notice dated September 2, 2014 was also served upon the Respondent, to which the Respondent filed a reply objecting to the credit of the proceeds of sale of the Pledged Shares in its account. Another legal notice dated September 15, 2014 was served upon the Personal Guarantors, demanding them to make the payment of the dues to the Petitioner. In view of the dispute that had arisen, the Petitioner issued a notice dated February 12, 2016 invoking the arbitration clause contained in the Loan Facility Agreement. During the arbitration proceedings, the Petitioner sought the recovery of a sum of approximately INR 70 crores along with interest at the rate of 18% per annum. However, the Respondent contested the claims of the Petitioner.

Pursuant to the above, the sole arbitrator passed a ‘Nil Award’ dated August 11, 2017 (“Impugned Award”), observing that immediately upon the invocation of the Pledged Shares by the Petitioner, it became the beneficial owner of such Pledged Shares, and would be entitled to the credit of the value of such Pledged Shares. The sole arbitrator further opined that if the invoked portion of the Pledged Shares had promptly been sold by the Petitioner at the time of such invocation, the Petitioner could have recovered its outstanding dues from the Respondent.

Aggrieved by the Impugned Award, the Petitioner and the Respondent filed separate petitions under Section 34 (Application for setting aside arbitral award) of the Arbitration and Conciliation Act, 1996, challenging the Impugned Award passed by the sole arbitrator, and urged the Delhi HC to set aside the Impugned Award.

Issue

Whether registration of shares in favour of the pledgee as the ‘beneficial owner’ amounts to sale of such pledged shares.

Arguments

Contentions of the Petitioner:

The Petitioner submitted that the Impugned Award was perverse, arbitrary, unsustainable and had prejudiced the rights of the Petitioner in claiming the loan amount extended by it to the Respondent. The Petitioner further contended that the Impugned Award was in conflict with the fundamental policy of Indian law and that the sole arbitrator had committed a serious error of law in not appreciating the law in respect of pledges in India.

The Petitioner submitted that the Impugned Award was based on the incorrect premise that the Petitioner would be entitled to the credit of the total value of the shares invoked/transferred, prevalent as on the date of such invocation/transfer. In order to support its arguments, the Petitioner relied on the judgement of the Hon’ble Supreme Court (“SC”) in the case of PTC India Financial Services Limited v. Venkateswarlu Kari and Another [(2022) 9 SCC 704] (“PTC India Case”), whereunder the SC had held that an exercise of right on the part of a pawnee as the ‘beneficial owner’ is not ‘actual sale’. The pawnor’s right to redemption under Section 177 (Defaulting pawnor’s right to redeem) of the Indian Contract Act, 1872 (“Contract Act”) continues and can be exercised even after the pawnee has been registered and has acquired the status of ‘beneficial owner’. Such right of redemption would cease only on the ‘actual sale’, that is, when the ‘beneficial owner’ sells the securities/ pawned goods to a third person. Once the ‘actual sale’ has been affected by the pawnee, the pawnor forfeits his right under Section 177 of the Contract Act to ask for redemption of the securities/ pawned goods.

Contentions of the Respondent:

The Respondent submitted that the sole arbitrator had erred in passing the Impugned Award and had failed to determine the value of 1,01,50,000 shares of Tulip Telecom invoked by the Petitioner. Despite the Respondent filing a pledge master report, clearly depicting the invocation of 1,01,50,000 shares of Tulip Telecom by the Petitioner, along with all the data pertaining to the share prices of such shares prevalent on different dates, the sole arbitrator had failed to determine the surplus amount realised by the Petitioner after invoking 1,01,50,000 shares of Tulip Telecom. Hence, the Respondent submitted that the Impugned Award was liable to be set aside.

Observations of the Delhi HC

The Delhi HC relied on the PTC India Case wherein the SC had observed that even upon becoming the ‘beneficial owner’ of the pledged shares, the pledgee lender continues to be the financial creditor of the corporate debtor. In the PTC India Case, the SC had emphasized on the concept of actual sale for the purpose of Sections 176 (Pawnee’s right where pawnor makes default) and 177 (Defaulting pawnor’s right to redeem) of the Contract Act, and held that an actual sale means sale of the invoked shares to the third party. Till the time such actual sale does not take place, the pledger’s right of redemption of the shares remains alive.

Decision of the Delhi HC

In furtherance of the position of law propounded by the SC in the PTC India Case, the Delhi HC opined that the Impugned Award was against the fundamental policy of law, and hence, was set aside.

VA View:

The Delhi HC has rightly relied on the PTC India Case and confirmed the position that mere registration of shares in favour of a pledgee as the beneficial owner does not automatically amount to the sale of those shares. The right of a pledgee to recover its debt would subsist till the shares are actually transferred or sold to a third party. Further, the pledger’s right to redeem the shares expires only after the pledged shares are sold to a third party. The mere conferment of the status of ‘beneficial owner’ would not preclude the pledgee from bringing any action to recover the entire debt payable to it by the pledgor.

Through this judgement, the Delhi HC has offered much needed insight regarding the legal position pertaining to pledge over shares.

For any query, please write to Mr. Bomi Daruwala at [email protected]

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