Close on the heels of the Supreme Court’s verdict in the now-famous ‘PTC Financial’ case, the Bombay High Court has said, in World Crest Advisors LLP Vs Yes Bank, that if a financial company transfers to itself shares pledged by a creditor, the financial company indeed becomes the beneficial owner of the shares.  

In the World Crest vs Yes Bank case, a division bench of the Bombay High Court, headed by Justice GS Patel, allowed Yes Bank to vote in the Dish TV AGM, overruling the objections of World Crest. 

These two cases relating to pledge shares have an interesting echo—in the Insolvency and Bankruptcy Code.

But first, the World Crest vs Yes Bank case.  

World Crest vs Yes Bank

World Crest pledged its shares in Dish TV to Catalyst Trusteeship, which is the security trustee of Yes Bank. The pledge was to secure borrowings of several companies of the Essel group. A default occurred and Catalyst enforced the pledge and transferred 24.19 per cent of the pledged shares to Yes Bank, making the bank. This meant that Yes Bank had all the rights of a beneficial owner of such shares, including voting rights, because Yes Bank’s name was recorded as the ‘beneficial owner’ of the pledged shares under Regulation 58(8) of SEBI’s Depositories Regulations.  

World Crest objected to Yes Bank’s voting rights. Its argument was that the bank had no voting rights because the pledged shares were yet to be sold to a third party under Section 176 of the Contract Act. This argument was rejected by the Bombay High Court, which ruled that the Depositories Regulations do not provide for any restricted rights to a pledgee. 

Here, it is pertinent to recall the Supreme Court’s judgment in the PTC Financial case. In that case, the apex court had held that while PTC Financial was the beneficial owner of pledged shares (of NSL Energy Ventures), but the transfer of the pledged shares to itself was not an actual sale (emphasis added). 

Till the actual sale

Writing in Mondaq, Vaibhav Singh of Shardul Amarchand Mangaldas notes that the actual sale meant the sale of the invoked shares to a third party and not to itself (PTC Financial). “Till such time as such actual sale does not take place, the pledgor’s right of redemption of the shares as per the Contract Act remains alive.” 

Thus, reading the two judgments together reveals that a bank or a finance company may transfer to itself pledged shares when the borrower defaults, it is a beneficial owner and can vote in an AGM, but the transfer of the shares is not a ‘sale’ of shares. 

It is here that an interesting twist occurs.  Under Section 21 of the IBC, a financial creditor who is a related party of a corporate debtor loses its right of representation, participation or voting in the Committee of Creditors.  

But who is a ‘related party?’ It is one who controls more than 20 per cent voting rights in the corporate debtor (borrower). That makes the Yes Bank, with 24.91 per cent voting rights in Dish TV, a ‘related party’— which means it has no say in the Committee of Creditors! Experts at ZBA, a specialist law firm based in Mumbai, point out that “An insolvency professional may take a view that banks/financial institutions exercise voting rights attached to the pledged shares and consequently, are “related parties”, although this should not be the case.” 

Financial creditors at disadvantage

The Bombay High Court judgment in the case of World Crest Vs Yes Bank seems to put financial creditors at a disadvantage. To protect their lending they must transfer any pledged shares to themselves, but if they do, they become ‘related party’ and can’t be a part of Committee of Creditors, should the borrower go into insolvency.