The Supreme Court’s recent decision in the Tata v. Mistry case celebrates the victory of the salt to software conglomerate in the most hyped corporate feud. Importantly, the Court set aside NCLAT’s finding regarding oppression of minority shareholders and mismanagement. However, the struggle isn’t over yet. The Apex Court dismissed all the interim applications, including the one filed by the Tata Group seeking restraint on the Shapoorji Pallonji Group (‘SP Group’) from raising capital against the security of their shareholding in Tata Sons, with a direction to take fresh legal recourse upon this.
Interestingly, this application was moved by the Tata Group just a day after the SP Group entered into a deal with a Marquee Global Investors to raise ₹3,750 Crores against the pledge of its 18.4 percent stake in Tata Sons. While the debt-ridden SP Group considered this investment to be the elixir amidst the pandemic, the Tatas have sought to restrict the creation of any direct and indirect pledge on its shares. The Tatas argue that the pledge of shares would amount to a transfer of shares and the Articles of Association (AoA) of the company, under Article 75, provide a right of first refusal to the Board members; to buy at fair value, the shares of the member who is seeking to sell his shares.
The whole controversy then boils down to the question as to whether the pledge of shares amounts to a transfer of shares under the AoA. The case of Nippon India Mutual Fund and Anr. v. IRDAI (‘Nippon’) too failed to conclusively settle this issue.
Exploring the Interpretation of ‘Transfer’
The Sales of Goods Act, 1930 deals with the transfer of ownership of goods, including shares via their sale. However, the said Act via its savings clause talks about its non-application to any transaction operating by the way of mortgage, pledge, charge, or any other security. Therefore, reliance must be placed upon Section 5 of the Transfer of Property Act, 1882, which defines transfer to be an act of conveyance, through which the transferor creates new interests or titles in favor of the transferee which he did not have prior to such an act. This Act unlike the Sale of Goods Act, 1930, extends to the transfer of interests like ownership (Sale or gift), security (Mortgage) and possession (Lease). Therefore, the term ‘transfer’ acquires different meanings under different statutes.
a. Pledge is a Charge
‘Transfer’ acquires a restricted meaning under the Companies Act, 2013, limiting itself to the transfer or transmission of ownership and not security interests or possessory interests. The latter of these interests, usually tantamount to creation of a charge. Charge can be described as an interest or lien created on the assets of the company as security, including a mortgage. However, it does not mention pledge within its ambit. Pledge which itself is a bailment of goods for payment of a debt, seems to be absent from the scope of Section 56 and Section 2(16) of the Companies Act, 2013.
However, a clue with respect to pledge being considered as a charge can be located in Section 77 which requires registration of all kinds of charge, including pledge. The rationale behind such an inclusion is that despite pledge not creating any interest or a lien, it ends up in establishing a possessory security interest which then amounts to charge. With pledge being a charge, and a charge being a mere right of payment, not amounting to transfer of property to the transferee, it can be reasonably concluded that pledge of shares does not amount to transfer of shares.
b. Pledge is a special property
There is an old saying that a mortgagee is a transferee, but a pledgee is not. The pledgee has a special interest in the property as a holder of security, who may sell the property pledged if the condition of non-payment is left unfulfilled. However, unlike mortgage, which transfers mortgagor’s interest to the mortgagee, a pledge is known to lack this feature. The very expression “special property” seems to exclude the notion of that general property which is the badge of ownership. It is only restricted to a legal proprietary interest but not a legal title. This is evident from the case of Mohini Mohan Chakravartty v. Mohanlal Thalia, wherein the pawnee of the shares was disallowed from being treated as a holder of shares or entitled to dividends because it was the pawnor who continued being the owner of the shares.
Therefore, pledge of shares cannot amount to a transfer of shares as per the sources quoted above. Hence, in round two, Tatas seem to be losing the mark by unnecessarily restricting the SP Group from exercising their rights in Tata shares. However, the pawnee despite not having any general property in the shares pledged, continues to have a right to sell the shares in the event of pawnor’s default upon the production of reasonable notice to sell.
Invocation of Pledge Amounts to Transfer
One might conclude that it is not the pledge, but the invocation of the pledge that amounts to a transfer of shares, when such shares are sold by the pawnee to the buyer in the satisfaction of the debt. The author tries to plead this assertion by a two-fold argument. Firstly, the provisions of Depositories Act, 1996 and the SEBI Regulations support this assertion and secondly, if not expressly, then impliedly the rationale of the Court in Nippon affirms such a conclusion.
It was in the cases like Tendril Financial Services Pvt Ltd. v. Namedi Leasing and Finance Ltd and Ors.. and many others, that the Court concluded that shares in the dematerialized forms cannot be pledged in accordance with the provisions of Section 176 of the Indian Contract Act, 1872, since it requires the delivery of physical possession of goods. With the compulsorily holding of shares only in dematerialized forms, such shares become intangible and invisible, thus incapable of being delivered. This renders the said provision redundant as far as the present analysis is concerned.
Therefore, Section 10 of the Depositories Act, 1996 and Regulation 58 of Depository Participant Regulations, 1996 attempt to enforce a share pledge. Under these provisions, a pawnee becomes the beneficial owner of the shares upon the invocation of pledged shares. In light of this, Securities Appellate Tribunal (‘SAT’), in the case of Liquid Pvt. Ltd. v. SEBI, held that upon the invocation of pledge and subsequent transfer of shares from the pledgor to the pledgee, the pledgee acquires beneficial ownership in the shares.
Therefore, the pledgee on becoming the beneficial owner has the authority to sell the shares to a third person for the satisfaction of the debt and the buyer in such a case, gets recorded as the holder of the shares, and it is this act of conveyance that amounts to transfer of shares.
Secondly, the SAT in Nippon seems to have adopted an approach which tries to re-establish the above-mentioned conclusion. The case principally revolved around recording IRDAI’s approval before the transfer of the shares, but whether pledge of shares amounted to a transfer of shares, became the Rubicon knot to resolve. The tribunal divided the entire transaction into three stages-(i) creation of pledge; (ii) enforcing the pledge to takeover security and (iii) transfer of shares to the buyer after invocation. While the tribunal failed to rule on the main question, its decision suggested that IRDAI’s approval was required at the third stage and not for the first two stages (so long as the pledgee does not exercise control rights in the interim). It ends up in implicitly proving that transfer of shares happens when there is a change of the substantial shareholding of the shares and not on the mere creation of security interest. This clears the clouds on the point that a mere creation of pledge cannot act as a transfer of shares.
Tatas cannot restrict SP Group from raising money against the pledge of their shares by subjecting them to the restrictions of AoA, as those restrictions are meant to apply at a later stage i.e. transfer of shares to the buyer upon the invocation of pledge by the pawnee.
Subjugation to AoA.
Rights of shareholders to transfer their shares are always subject to the provisions of AoA. However, SP Group should ponder about the consequences which may crop up during the invocation of the pledge. Tatas, being a private company, can then force their compliance with AoA. Article 75 of the AoA already grants the Board Members, the power of first refusal.
Technically, the AoA are specific in nature and empower the Board via a resolution, to exercise refusal of registration of transfer of shares to an outsider if any member of the company is willing to purchase the shares at a fair value, within a stipulated time. Finding a member in the company is no big deal for Tatas.
However, such exercise of power should be bonafide and not malafide as there is no blanket authority available to a company to refuse registration of transfer, even if the articles provide absolute discretion. However, even on the bona-fide exercise of power, SP Group may have an easy sail initially but might end up being caught in a conundrum in the event of its failure to discharge the debt against the pledged shares, because Tatas appear to be adamant over its exercise of power of first refusal.
Complications don’t seem to be ending for the SP Group because even if an iota of chance exists for it to wriggle out of the Tata web, the Courts in the light of pandemic are hesitant to allow the lenders to exercise their rights to invoke the pledge on the shares in order to prevent the market from collapsing. However, this is expected to be a temporary measure.
The aforementioned analysis makes it clear that the SP Group might have an initial victory while pledging the shares to raise capital, however, in the long term, there is almost a win-win situation for the Tata Group in round two. SP Group is in dire need of raising capital, but it may fail due to the statutory provisions. While the petition is still pending before the Bombay High Court, it is expected that the Court would at least dismiss Tata’s petition to seek injunction against the pledging of the shares, since it does not amount to a transfer of the shares.