Mere act of invoking pledged shares does not discharge debt, rules SC

Top court says debt is not discharged till there has been an actual sale of the pledged items

The Supreme Court has held that mere invocation of a pledge by a creditor does not mean that the debt is discharged.

“A debt is not discharged till there has been an actual sale of the pledged items," the apex court has ruled.

This rule applies even to those creditors registered as beneficial owners as prescribed in Depositories Act, 1996.

This ruling would now enable creditors to be involved in the corporate insolvency resolution process of defaulting borrowers, where such borrowers had pledged demat shares to secure the debt. Also, such borrowers can no longer plead that the debt has been discharged merely because the creditor got itself registered as a beneficial owner.

The SC judgment, made public last week, settled the conundrum between the Depositories Act, 1996 and the Indian Contract Act, 1872, and ruled that the provisions of the Contract Act (dealing with physical shares) will apply equally to pledged demat shares.

The matter pertained to PTC India Financial Services Ltd, a financial creditor that had advanced a loan of Rs 125 crore to the borrower, NSL Nagapatnam Power and Infratech Ltd, in 2014. The transaction was secured by a pledge deed pursuant to which certain demat shares were pledged to PTC India Financial Services Ltd.

When the borrower failed to repay the loan, the financial creditor PTC India invoked its right under the pledge deed, after which the appellant was accorded the status of ‘beneficial owner’ of the pledged shares under the Depositories Act, 1996.

When the matter went before the NCLT and NCLAT, the respondent argued that since the appellant had already been made the beneficial owner, the debt had been paid.

Meanwhile, the appellant argued that merely granting the status of beneficial owner is not enough and there has to be an actual sale of the pledged items for the debt to be paid. The appellant also argued that to sell the pledged shares, Sections 176 of the Indian Contract Act, 1872 has to be complied with.

When the matter came up before the SC, the Court set aside the NCLAT order and observed that Section 176 of the Contract Act empowers pawnees to sell the pledged items after giving reasonable notice of the sale to the pawnor (in this case the borrower). The pawnor, however, can still exercise his/her right to repay the amount till the date of the actual sale, the Court said.

The Court noted, “While the Depositories Act distinguishes between the ‘registered owner’ and the ‘beneficial owner’ (de facto owner), it does not lay down a rule which is contrary to Sections 176 and 177 of the Contract Act. These sections would still apply to any pledge deed and do not get diluted or overridden by the provisions or requirements of the Depositories Act.”

Sidharth Sethi, advocate-on-record and Partner at JSA (representing the appellant), said, “This is a vindication of PFS’s stand. A debt is not discharged till there has been an actual sale of the pledged shares. The SC has clarified and put to rest some key issues concerning law relating to pledge and explained the interplay between the Depositories Act, 1996 and the Contract Act, 1872."

"The judgment will serve as a binding precedent in all those matters where borrowers attempted to evade their liability by asserting that mere invocation of dematerialised pledged shares resulted in discharge of debt. The Court has so aptly held that law of pledge is dynamic and must adapt itself in the context of the current commercial environment," he added.