TaxTMI 
TaxTMI 
2022 (2) TMI 1523
X X X X Extracts X X X X
X X X X Extracts X X X X
.... October, 2019 and has further directed the appellant to deposit a sum of Rs.158.68 crores alongwith interest at the rate of 7% in an escrow account till the issue of settlement of clients' securities are reconciled. 2. The facts leading to the filing to the present appeal is, that the appellant is a banking company incorporated and registered under the Companies Act, 1956 and is carrying on the business of banking under the Banking Regulation Act, 1949. The appellant extended loan facility to M/s. BRH Wealth Kreators Ltd. (hereinafter referred to as 'BRH') who was a trading member/ broker on the National Stock Exchange of India Ltd. (hereinafter referred to as 'NSE'). These loan facilities was granted pursuant to a loan agreement dated 7th October, 2005, 10th August, 2007 and 21st June, 2014 which was extended/renewed from time to time. Under this agreement the loan extended was secured by pledge of shares given by BRH. 3. At the time of availing the loan facilities, BRH made an express declaration in the overdraft request letters that securities pledged by BRH to the appellants were held by BRH in their own name as an absolute owner and not in any other ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ale of the pledged securities BRH continues to owe a sum of Rs. 26.70/- crores. 6. In the meanwhile, on 30th September, 2019, NSE passed an order suspending BRH with effect from 1st October, 2019 for noncompliance of regulatory provisions of the exchange and, on 7th October, 2019 SEBI passed an ex-parte ad-interim order restraining BRH and seven other related parties to BRH from accessing the securities market and further restraining them from dealing with their assets. The ex-parte ad- interim directions issued by the WTM against BRH and seven related entities are extracted hereunder: "9. Under the above circumstances, I, in exercise of powers conferred upon me under Sections 11(1), 11(4), 11B and 11D read with Section 19 of the SEBI Act, 1992 and Regulation 35 of SEBI (Intermediaries) Regulations, 2008, by way of this ex parte ad interim order, hereby issue the following directions: (i) BRH Wealth Kreators Limited (formely BMA Wealth Creators Limited), Shiv Kumar Damani, Anubhav Bhatter, Murgesh Devashrayi, BRH Commodities Private Ltd. (formerly BMA Commodities Pvt. Ltd.), Prosperous Vyapaar Private Limited, Polo-Setco Tie Up Private Limited and Parton Commer....
X X X X Extracts X X X X
X X X X Extracts X X X X
....xchanges'/ clearing members'/clearing corporations', obligations; and (x) The above directions are without prejudice to the right of SEBI to take any other action that may be initiated in respect of aforesaid entities/persons." 7. The aforesaid directions were issued against BRH and seven other entities as on a scrutiny it was found that there was a shortfall of clients' securities and that BRH had misappropriated the clients' securities and transferred it to the seven entities. The WTM prima facie observed that BRH failed to segregate clients' securities and violated SEBI circular dated 18th November, 1993, 26th September, 2016, the Securities and Exchange Board of India (Stock Brokers and Sub-Brokers) Regulations, 1992 and the Securities Contracts (Regulation) Rules, 1957 and further failed to unpledge the securities as per the circular dated 20th June, 2019. Subsequently, the interim order was confirmed on 2nd January, 2020. 8. On 19th March, 2020, a show cause notice was issued to the appellant to show cause why appropriate directions should not be issued for not complying with ex-parte ad interim direction dated 7th October, 2019 and for ....
X X X X Extracts X X X X
X X X X Extracts X X X X
...., the matter is sub judice. It was contended that the securities pledged by BRH were in its own name and were shown as beneficial owner in the records of the CDSL i.e. depository and, thus, on that basis, the appellant were fully entitled to accept a pledge of such shares which showed BRH as the beneficial owner under Section 10 and 12 of the Depositories Act. It was also contended that the pledge was created in accordance with the Depositories Act and the Regulations framed therein. It was also urged that in any case the bank has a general lien under Section 171 of the Contract Act in all forms of securities presented to it. 10. The WTM after considering the material evidence on record held that the assets of BRH as per para 9(v) of the ex-parte ad-interim order dated 7th October, 2019 includes securities which are pledged to the bank and, therefore, once an order has been passed by the WTM it was not open to the appellant to invoke the pledged security. The WTM further held that even though the appellant was not a party to the ex-parte ad- interim order dated 7th October, 2019, nonetheless, the interim order partakes the character of an "order in rem" and binds all constituent....
X X X X Extracts X X X X
X X X X Extracts X X X X
....rem' but an 'order in personam'. It was urged that the direction in the interim order is against BRH and its related parties and in the absence of any direction being issued against the appellant the contention that a holistic approach should be taken or that the order should be read as 'order in rem' was patently erroneous and is not based on any sound principles of law. 14. It was also urged that the allegation that the securities which were pledged by BRH belonged to the clients of BRH was erroneous and cannot be accepted in as much as the Pledge Master Report of the depository (CDSL) indicates that the securities were of BRH as it was shown as the beneficial owner. It was submitted that when the securities were pledged the appellants carried out due diligence and only accepted the securities when they saw the name of BRH as the beneficial owner in the records of the depository. 15. On the other hand, the stand of SEBI is the same as taken in the impugned order contending that the assets of BRH would also include the pledge created by BRH and that the impugned order is required to be read holistically as an order in rem. 16. Before we deal with the r....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ener has no locus to intervene nor is a necessary or an interested party. The intervention application is accordingly rejected. 19. The gist of the allegations levelled in the show cause notice is summarised as under :- (a) Non-compliance of the directions contained in the interim order by wrongly invoking the pledged securities. (b) Failure to exercise due diligence while extending credit facilities to BRH. (c) Violation of Clause 2.5 of SEBI circular dated 26th September, 2016 read with Clause 2(c) of SEBI circular dated 22nd June, 2017 and (d) Violation of Clauses 4.8 and 4.9 of SEBI circular dated 20th June, 2019 by invoking the pledge of securities without giving the requisite notice of five days to the clients of BRH thereby depriving them a fair opportunity of claiming back their securities. 20. We find that the directions contained in the ex-parte ad-interim order was against BRH and its related entities. Further, directions were issued to the stock exchange and depositories to ensure compliance. The directions contained in the interim order is an order in personam and does not take the character of an order in rem nor does this ord....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ed by clients and uncleared cheques issued to clients." Clause 2(c) of the circular dated 22nd June, 2017 "2. SEBI has received further representations from the market participants regarding certain provisions of the aforesaid circular. Based on the discussions with different stakeholders, following clarifications are made: (a) ......... (b) ........... (c) Clause 2.5 stand modified as follows: "As per existing norms, a stock broker is entitled to have a lien on client's securities to the extent of the client's indebtedness to the stock broker and the stock broker may pledge those securities. Pledge of such securities is permitted, only if, the same is done through Depository system in compliance with Regulation 58 of the SEBI (Depositories and Participants) Regulations, 1996. To strengthen the existing mechanism, the stock brokers shall ensure the following." Clauses 4.8 and 4.9 of SEBI's circular dated 20th June, 2019 "4.8 Further, the client's securities already pledged in terms of clause 2.5 of SEBI Circular SEBI/HO/ MIRSD/MIRSD2/CIR/P/2016/95 dated September 26, 2016 and clause 2(c) of SEBI circular....
X X X X Extracts X X X X
X X X X Extracts X X X X
....rd to indicate that the funds raised by the broker on such pledged securities exceeded the debit balance in the ledger of that particular client. Further, nothing has come on record to indicate that the securities pledged by the broker did not have the tacit/ explicit authorisation from its clients. 25. Further, Clause 2.5 of the circular dated 26th September, 2016 makes it apparently clear that the pledge was only permitted if the same was done through the depository system in compliance with Regulation 58 of the Depository Regulations, 1996. Nothing has come on record in the impugned order to show that the securities pledged by BRH were not in accordance with Regulation 58 of the Depository Regulations, 1996. 26. Allegation that the appellant has violated Clause 4.8 of the circular dated 20th June, 2019 is per se erroneous. The finding that five days previous notice was required to be given by the appellant to the clients of BRH before invoking the pledge is patently erroneous. Clause 4.8 of the circular dated 20th June, 2019 only directed the broker to unpledge the securities and return it to the clients upon fulfilment of pay in obligation or dispose off after giving five....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... consequently, the subsequent invocation by the appellant was also illegal is totally misplaced. 28. It was alleged that para 9(v) of the ex-parte ad- interim order was violated by the appellants, namely, that the assets of BRH could be utilised only for the purpose of payment of money to the clients of BRH or the investors under the supervision of the depository/ exchange. It was alleged that the appellant has wrongly invoked the pledge and by invoking such pledge has violated Clause 9(v) of the interim order. 29. It was urged before us that the words 'assets of the noticees' includes the securities pledged by the broker and, therefore, such securities pledged could not be utilised by the Bank for its purposes. 30. In this regard, in Harshad Shantilal Mehta v. Custodian and Ors. (1998) 5 SCC 1 the facts were that the property of the notified person was attached by the custodian under Section 3 of the Special Act. The Supreme Court held that where a mortgaged/pledged property of a notified person was already mortgaged/ pledged to the bank on the date of the attachment, then such mortgaged/pledged property could not be attached. Further, the proceeds from which dist....
X X X X Extracts X X X X
X X X X Extracts X X X X
....bilities of the notified person. This would also be the position when the property is already mortgaged or pledged on the date of attachment to a bank or to any third party. This, however, is subject to the right of the Custodian under Section 4 to set aside the transaction of mortgage or pledge. Unless the Custodian exercises his power under Section 4, the right acquired by a third party in the attached property prior to attachment does not get extinguished nor does the property vest in the Custodian whether free from encumbrances or otherwise. The ownership of the property remains as it was." Similar view was again reiterated by the Supreme Court in Standard Chartered Bank v. Custodian and Ors. (2001) 4 SCC 424. 31. In The Bank of Bihar vs. The State of Bihar & Ors. (1972) 3 SCC 196 the underlying facts was that certain merchandise was pledged with the bank. The bank held the goods as security for the advances made. While the goods were in possession with the bank the district magistrate forcibly removed certain number of bags of sugar. No payment was made to the bank. The defence taken by the district magistrate was that the goods were seized pursuant to lawful orders whic....
X X X X Extracts X X X X
X X X X Extracts X X X X
....regard, we need to look into certain provision of the Depositories Act, 1996. For facility Section 2(a), Section 7(1), Section 9, Section 9(1), Section 10, Section 11 and Section 12 are extracted hereunder. Section 2(a) "2. Definitions (1) In this Act, unless the context otherwise requires,- (a) "beneficial owner" means a person whose name is recorded as such with a depository; " Section 7(1) "7. Registration of transfer of securities with depository .- (1) Every depository shall, on receipt of intimation from a participant, register the transfer of security in the name of the transferee." Section 9 "9. Securities in depositories to be in fungible form .- (1) All securities held by a depository shall be dematerialised and shall be in a fungible form. [(2) Nothing contained in sections 153, 153A, 153B, 187B, 187C and 372 of the Companies Act, 1956 (1 of 1956) shall apply to a depository in respect of securities held by it on behalf of the beneficial owners.]" Section 10 "10. Rights of depositories and beneficial owner .- (1) Notwithstanding anything contained....
X X X X Extracts X X X X
X X X X Extracts X X X X
....lf a beneficial owner may with the previous approval of the depository create a pledge in respect of a security owned by him through a depository. Further, any entry in the records of a depository shall be evidence of a pledge. 35. In exercise of the powers conferred by Section 30 of the SEBI Act read with Section 25 of the Depositories Act, SEBI made the regulations known as Securities and Exchange Board of India (Depositories and Participants) Regulations, 2018. One such provision provided under the regulation is clause (d) and (f) which are extracted hereunder: (d) the manner of creating a pledge or hypothecation in respect of security owned by a beneficial owner under sub- section (1) of section 12; (f) the rights and obligations of the depositories, participants and the issuers under sub-section (1) of section 17; 36. Regulation 79 provides the manner of creating a pledge or hypothecation. For Facility, Regulations 58 and 79 are extracted hereunder: Regulation 58 "Agreement by participants 58. Every participant shall enter into an agreement with a beneficial owner before acting as a participant on his behalf, in a manner speci....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... Provided that the depository before registering the hypothecatee as a beneficial owner shall obtain the prior concurrence of the hypothecator. (12) No transfer of security in respect of which a notice or entry of pledge or hypothecation is in force shall be effected by a participant without the concurrence of the pledgee or the hypothecatee, as the case may be." 37. A perusal of sub-clause (8) of Regulation 79 indicates that the pledgee may invoke the pledge and on such invocation the depository shall register the pledgee as beneficial owner of such securities in its record accordingly. 38. Before we proceed further we need to take a look at certain provisions of the Companies Act, 1956. For facility, Section 150, 151 and 152A of the Companies Act are extracted hereunder: "150. Register of members (1) Every company shall keep in one or more books a register of its members, and enter therein the following particulars: - (a) the name and address, and the occupation, if any, of each member; (b) in the case of a company having a share capital, the shares held by each member, [distinguishing each share by its number except where....
X X X X Extracts X X X X
X X X X Extracts X X X X
....wners maintained by the depository under Section 11 of the Depositories Act would be deemed to be an index of members for the purpose of this Act, namely, the Companies Act. 40. In law the contents of the register of members under Section 150 of the Companies Act constitutes a prima facie evidence of the truth of the matter stated in that register, namely, that the name found in the register of members under Section 150 indicates that such member is the owner of the shares of the Company. Section 152A provides that the register maintained under Section 11 of the Depositories Act shall be deemed to be an index of members under the Companies Act meaning thereby the name of a beneficial owner recorded in the register maintained under Section 11 of the Depositories Act would be sufficient proof of the ownership of the shares of that beneficial owner. 41. In JRY Investments P. Ltd. vs. Deccan Leafline Services Ltd. and Ors. (2003) SCC Online Bom 1134 Justice Shri S.A. Bobde, as he then was, while considering the provisions of the Depositories Act and the principles of the Contract Act held: "22. It must be remembered that the shares in question are demated shares, i.e., s....
X X X X Extracts X X X X
X X X X Extracts X X X X
....whole and self-contained procedure for the creation of pledges. In any case, since it is not possible to physically deliver demated shares and therefore pledge them in accordance with the Indian Contract Act, 1872, it must be held that a pledge of such shares can only be validly created in accordance with the provisions of the Depositories Act, 1996," 42. In Ankit Securities And Finance Co vs Birla Investment Services (2004) Bom CR 436 Justice Shri D.Y. Chandrachud, as he then was, explained certain provisions of the Depositories Act especially Section 9 of the Depositories Act which required all shares to be dematerialised and would be in fungible form. For facility para 10 is extracted hereunder: "10. In the context of the present case, it would be instructive to have regard to the relevant provisions of the Depositories Act, 1996. Section 9(1) of the Act provides that all securities held by a depository shall be dematerialised and shall be in a fungible form. The expression "fungible" is defined in Webster's Third New International Dictionary (1993 Edition page 922) as being "of such a kind or nature that one specimen or part may be used in place of another speci....
X X X X Extracts X X X X
X X X X Extracts X X X X
....arely covered in accordance with the provisions of Section 12 of the Depositories Act which provides that a beneficial owner may with the previous approval of the Depository create a pledge in respect of a security owned by him. 44. In the light of the aforesaid, the decisions cited by the intervener is not required to be dealt with and are not applicable as those cases are under the Contract Act wherein the principle that the pledgee cannot get a better title than the pledgor was involved. The decisions cited are Solomon vs. Attenborough [(1912) 1 Ch. 451]; Ram Bharose Sharma vs. Mahant Ram Swaroop & Ors. [(2001) 9 SCC 471] and Shyam Sunder Kejriwal vs. Usha Kejriwal [2010 SCC Online Cal 2091]. 45. In addition to the aforesaid certain other decisions have also been added in the written submissions are also on the issue of trust and trustee which again are not applicable and are also distinguishable. 46. In the light of the aforesaid, we find that a pledge was created by the broker BRH under the Depositories Act in favour of the appellant. Once a pledge is validly created by the broker in favour of the appellant and the appellants is recorded as the beneficial owner in the....