CASE ANALYSIS: 20201BBL0016

PTC INDIAN FINANCIAL SERVICE LIMITED VS. VENKATESWARLU KARI

AND ANOTHER;

FACTS:

The appellant (PILSL) is an existing company under the Companies Act, 2013. The
appellant (PTC India Financial Service limited) earlier let NSL Nagapatnam Power and Infra
tech limited to borrow a loan of Rupees. 125 crs. On 10 th March 2014, a Bridge Loan
Agreement was made as per sub clause (6) of clause 3.1.1 which later on was secured and
executed by subsidiary of Mandava Holdings Private Limited (MHPL), a Pledge Deed which
was in favour of PTC financial service limited. The corporate debtor filed a petition before
the National Company Law Tribunal in Hyderabad on November 17, 2017, citing Section 10
of the Insolvency and Bankruptcy Code, 2016, to start the corporate insolvency resolution
process. On January 18, 2018, the petition was granted under IBC Section 10(4). As the
Interim Resolution Professional, Mr.Venkateswarlu Kari, Respondent No. 1, was chosen.
PIFSL sent a notice to MHPL on 28th Dec 2017, under the Pledge Deed informing it of the
corporate debtor's defaults and stating that if the debt was not discharged within 7
days PIFSL would use its rights under the Pledge Deed. Later, on January 16, 2018, PIFSL
wrote to the Depository Participant, exercising its entitlement under the Pledge Deed, as long
as the debt was not settled. The Depository Participant granted PIFSL the title of "beneficial
owner" of the pledged shares of NEVPL in response to the request. PIFSL had challenged the
orders where the Adjudicating Authority had accepted with MHPL that it is a financial
creditor of the Corporate Debtor to the value of the shares and the date on which the pledge
was invoked by PIFSL will be the deciding factor to determine which PIFSL AND MHPL
are the creditors of the corporate debtor. PIFSL presented its financial justification before the
IRP for the sum that NNPIL owes and is obligated to pay. MHPL also made a claim before
the IRP, claiming, among other things, that since PIFSL was given the title of "beneficial
owner" of the pledged shares, MHPL no longer had any ownership interest in those shares
and that MHPL now had a claim against NNPIL (and not PIFSL). PIFSL could recover its
obligations in full or in part by selling and transferring the pledged shares in accordance with
the law because it was now the only owner of them. PIFSL cannot use Section 176 of the
Contract Act to "reclaim" the debt after exercising its right to become the owner of the shares.
The IRP is not permitted to consider Section 176 of the Contract Act when compiling
PIFSL's financial claim under Section 18 of the IBC. PIFSL challenged these decisions
before the Supreme Court.

ISSUE RAISED:

I. Whether the lender can retain the benefits accrued to the pledged shares?
II. Will the lender have any special rights apart from general rights in the pledged
property?
III. Whether the notice of sale and the duty of the lender to sell be applicable in case of
pledged property? Whether one can sell a pledged property to self?
IV. Whether there is any requirement of the effect of DP Act on the provisions of the
Contract Act?

ANALYSIS:

The current ruling is a positive step toward resolving many of the issues that have complicated the
enforcement of the demat share pledge. It is now evident that neither the debt nor the borrower's right
to redeem the pledged shares would be wiped out by the simple act of invoking the pledge under the
DP Regulations. Only the actual sale to a third party would trigger this. However, there are still a
number of considerations that lenders should make when making loans in exchange for pledged
shares. The issues like can the lender exercise voting rights on mere shares would eventually be
governed by the pledge agreement and its terms. As a result, if the pledge agreement permits it, the
lender may exercise voting privileges over the shares while holding them in its demat account. Here
the Court also summarized that not only does the pledge create a special interest when it came to the
transfer of property in case of any default. The general right in the pledged property is not recognized
by the law of pledge. Therefore, it is unclear on what grounds the judgment indicates that the lender
could exercise the voting rights on the shares if the pledge agreement so provided (which is akin to
exercising ownership rights, i.e., something more than just the mere right to sell). The right of
shareholders to contractually agree on voting issues is allowed under a shareholders' agreement. The
shareholder, however, votes in accordance with the terms of the agreement as a result of such a voting
agreement. This is distinct from using your voting rights as the share's beneficial owner. As the
beneficial owner, the lender is entitled to a direct vote. And a lender may exercise the rights when it
comes to protecting a pledged property or the value of security. And the second issue other than that is
that of the initiation of insolvency constituting of assets of any corporate debtor and no sale to be
made by the lender this is due to the reason The corporate debtor may have pledged the shares, which
is not the case in this instance, and a CIRP may be admitted against it after the pledge has been
invoked. It is unclear whether or not the unsold pledged shares are included in the corporate debtor's
assets after the filing for bankruptcy. Without taking into account the value of the shares holding up in
the lender's account, the present judgement approved the lender's claim in the insolvency proceedings.
As a result, even though the lender's claim is still valid, the resolution specialist does not have control
over the unsold shares due to the lender's earlier invocation.

JUDGMENT:

The Court had held that when there is a case like this a lender does not have the right of ownership,
but rather just a limited right to retain possession until the debt is paid off, whereas the owner enjoys
the rights of ownership, enjoyment, and disposition. Additionally, in the event of default, the Lender
may (a) file a lawsuit to collect the debt and keep the pledged property as security, or (b) sell the
pledged property after providing the borrower adequate notice of the sale. Thus, the only particular
property right in the pledged goods that belongs to the lender. The pledged products' unique property
rights are superior to the bare right of detention but inferior to general property rights. The Court also
took into the observation that in the second issue that the pledge includes accretions and additions; as
a result, when the lender returns the pledged goods, it must also repay any accretions or additions. The
Court upheld earlier rulings in the context of share pledges that stated benefits like dividends, bonus
or rights shares issued on pledged shares, or any other kind of benefits received from pledged shares
also constituted a security for the debt and had to be paid back to the borrower upon redemption.
Taking the third issue into consideration the Court held that that in the event of a default, the lender
could choose to sell the property that was pledged after providing the borrower adequate notice. The
notice need not include information about the sale's time, place, and date. The facts of each case
would determine whether the notice required by Section 176 of the Contract Act was reasonable.
Even 24 hours could be considered a reasonable notice in the case of listed shares. However, giving
notice prior to a transaction is necessary and cannot be excused. This is due to the fact that the
borrower should be given every chance to cancel the loan and reclaim the pledged assets. Even after
the notice of sale has been issued, the lender cannot be forced to sell the pledged property. And also
elaborated about the sale of pledged property to self with section 177 of the Indian Contract Act gives
the pledger the right to redeem the pledged shares up until the sale itself. As a result, the Contract Act
does not support the idea of a lender selling pledged property to itself. The High Court's earlier
rulings, as well as the Contract Act's provisions, were cited by the Court in holding that a lender's sale
of a pledged asset to itself constitutes a conversion and does not terminate the pledge. The court ruled
that the pledge only expires and the borrower loses the right to retrieve the pledged property after it is
sold to a third party. In light of this, the Court reversed the High Court's earlier ruling that the lender's
sale to himself was not void. In consideration of the DP Act, the Court held that, the DP Act,
Regulations, and Contract Act's organizational structures are in harmony with one another and can all
be read as one without invalidating or changing one another. However, the Court noted that there was
one exception to this. Because the pledger did not receive reasonable notice as required by Section
176, the borrower is allowed by the Contract Act to redeem the pledged shares. The Court determined
that this could materially affect the certainty of transactions in listed demat securities if it were
applied to de-mat securities that had been transferred in accordance with the DP Act and DP
Regulations. And that when it comes to the borrower’s right to redeem any pledged shares especially
on the grounds of failure in providing any prior notice under section 176 will apply in the case of de-
mat shares which were initially transferred according to the DP Act and Regulations. In fact,
notification to both the borrower and the pledger following the invocation is already provided for by
the DP Act and DP Regulation's scheme. Thus, the DP Act and DP Regulations' overall scheme  are
not hampered by the Contract Act's Sections 176 and 177, barring this exception. The Court
overturned several decisions of the High Courts by making the aforementioned comments, which took
the position that the provisions of the DP Act and DP Regulation are in derogation of the Contract Act
in the context of the de-mat shares. In its final judgment the Court held that PIFSL did not engage in a
"sale" when it changed possession of the Pledged Shares. In truth, it was a step required to complete
the sale. It was still unclear if PIFSL would be able to find a willing buyer for the pledged shares.
PIFSL could not account for the pledged shares prior to selling them to a third party and receiving the
proceeds of the sale. Therefore, it was determined that neither a partial discharge of the debt nor a full
discharge had taken place. It was concluded that MHPL was not a secured creditor of the borrower as
a result. And allowed the appeal of PIFSL.

CONCUSION: Apparently, there is need for clarity on issues related to this judgment whether it will
trigger once the invocation of pledge or the actual sale of the pledged shares by the pledgee. It also
protects the interests of lenders by allowing them to claim their debts instead of accounting for the
value of pledged shares and restricting the rights of leaders having security to those shares to giving
the third parties an actual sale.