Supreme Court: In an elaborate judgment running into over 90 pages, the bench of AM Khanwilkar* and Dinesh Maheshwari, JJ has discussed the mode of dealing with withheld securities of a defaulting member by National Stock Exchange of India/National Securities Clearing Corporation Limited, consequent to his expulsion.
The Court explained the law came in the backdrop of a case where the trading facilities of Rusoday Securities Ltd. were withheld on 13.10.1997, followed by withholding of various securities by the Exchange.
Here are the highlights from the judgment extensively discusses the Byelaws, Rules, Regulations and other instructions of the National Stock Exchange:
Realisation of security deposits
As per clause (11) of Chapter XII of the NSE Byelaws titled “Default”, the Exchange is vested with the power to realise the assets of a defaulter member in due course. It provides for realisation of three categories of assets:
- security deposits, margin moneys and other deposits;
- securities which have been deposited by the defaulter member; and
- moneys, securities and other assets due, payable or deliverable to the defaulter by any other Trading Member and recovered by the Exchange.
Out of these three categories, security deposits can be called in and realised per se without any additional condition. There is no requirement of vesting with respect to such deposits neither in the language of clause (11) nor in the overall scheme as the Exchange enjoys a statutory lien over such deposits by way of clause (24) of Chapter IX – “Transactions and Settlements”, NSE Byelaws. It, however, does not include forfeited/withheld assets because the property in the deposited assets may vest in the Exchange by operation of membership obligations, whereas such is not the case with withheld securities.
“It is true that mere existence of lien may not entitle the lienee to sell off the property for satisfaction of debt without a court order. However, when lien itself is a creation of Byelaws, Rules or Regulations etc., the scope, extent and operation of such lien would also be governed by the same scheme.”
The phrase “shall call in and realise” in Clause (11) signifies that realisation is warranted as an imminent action upon declaration of defaulter in case the security deposits are insufficient. Hence, once a trading member has been declared a defaulter, the Exchange is duty bound to realise the security deposits retained by it to satisfy its obligations and return the remaining deposits, if any. If the Exchange fails to do so, it may become liable to make good the loss of interest to the defaulter on any amount over and above the monetary obligation.
Withheld securities
Unlike the money deposits, no legal requirement of forthwith realisation is envisaged in the case of withheld securities.
Introductory securities
A member is termed as an introducing member when it introduces some securities to be transferred to the buyers in a sale transaction, subject to the securities being free from any objections.
Receiving securities
A member is termed as a receiving member when it is supposed to receive the securities for orders placed by it in a purchase transaction, subject to complete settlement and payment.
Unlike money deposits, the “receiving securities” withheld or recovered by the Exchange require legal vesting before they could be realised for the satisfaction of dues. There can be no action, be it of sale or registration, against a property unless the property vests in the entity.
Expulsion or declaration of defaulter is a pre-condition for realisation
Vesting does not take place in favour of the Exchange unless a formal expulsion order is passed. The relevant point of time, therefore, is the date of expulsion. Without such legal vesting, the Exchange only sits upon the withheld assets as a custodian. There is no question of realisation.
Such withholding is done to serve two purposes –
- to persuade the defaulting member to fulfil its obligations during the continuation of membership if it so wishes and
- to secure the liability at the earliest available opportunity as a preventive measure. If liabilities continue to be unfulfilled, expulsion becomes an inevitable consequence and the withheld assets vest in the Exchange.
Hence, realisation cannot be done unless vesting is complete and there is no obligation on the Exchange/Corporation to forthwith realise the securities upon withholding. Expulsion or declaration of defaulter, as the case may be, is a pre-condition for realisation.
“Even on applying rule of prudence, such forthwith realisation would not be appropriate as such action would deprive the defaulting member from an opportunity to correct its mistake by settling liabilities within due course of time without giving up membership.”
Role of Exchange
The primary role of the Exchange is manifested in the phrase “shall be dealt with by the relevant authority at such times and in such manner” under Regulation 9.10, NSCCL Regulations (Regulation 9.12, NSE Regulations). That takes within its ambit a power coupled with a duty.
“The power of the Exchange to deal with the withheld securities in the manner of its choice runs parallel with its duty to mandatorily “deal” with such securities as a prudent person would after coming in possession of securities.”
The Regulation requires the Exchange not to sit idle on the withheld securities and instead, obliges it “to deal” with them in an appropriate manner. This requirement is a manifestation of the basic “duty of care” implicit in regulatory relationships where one member is in a position to control the functionality of the other.
However, the manner of dealing with the withheld securities is not circumscribed under strict parameters. The Exchange is bestowed with a discretion to choose amongst the available options and the appellant holds no control over such choice.
“To this limited extent, the role of the Exchange as regards the withheld assets is of a fiduciary character, obligating it to choose the just course of action out of the available options.”
Registration mandatory or discretionary?
As per Regulation 9.12 of NSE (Capital Market) Regulations, the measure of registration is not provided as an exclusive one, rather, it is in addition to other residuary steps that an Exchange is entitled to take. Therefore, there is no express statutory or contractual requirement of mandatory registration in the applicable law. A clear element of discretion is involved in the manner of dealing.
“It is true that such discretion cannot be exercised in a legally perverse manner, but it is equally true that a discretion cannot be converted into a mandatory obligation, more so when such discretion is provided expressly by a statutory provision.”
Role of defaulting member
It is the fundamental principle of an equitable examination that “the one who seeks equity must do equity”.
Registration of securities or any property for that matter is done in favour of an entity only upon fulfilment of certain allied conditions, including but not limited to the supply of consideration. Without such consideration, contract itself becomes void, let aside entertaining a demand for registration. Upon withholding, it becomes the duty of the stockbroker to raise a request for the registration of securities and to comply with the payment shortfall and other requirements.
The role of the defaulting member is of an enabler and unless the Exchange is placed in a position to register, it cannot its discretion to register. Further,
“… permitting the Exchange to register forthwith as a matter of obligation would also be counterproductive to the interests of the defaulting member. For, such a blanket action would have the effect of converting a limited right of lien into that of absolute ownership over the withheld assets without giving the defaulter sufficient time to get his assets released much less before a declaration of being a defaulter or an order of expulsion. Such can never be the purpose of withholding.”
Hence, registration can only be done on fulfilment of the following conditions:
- request by the defaulting member;
- request to be preceded by fulfilment of conditions relating to payment;
- request to be accompanied with undertaking that any such registration in the name of the Exchange would be subject to final outcome of the case.
[Rusoday Securities Ltd. v. National Stock Exchange of India Ltd., 2020 SCC OnLine SC 948, decided on 20.11.2020]
*Justice AM Khanwilkar has penned this judgment
For appellants: Senior Advocate Siddhartha Mitra and Advocates-on-record Ashok Mathur and Devashish Bharuka
For Respondent(s): Senior Advocate Shyam Divan and Adocates-on-Record. S. S. Shroff, Rabin Majumder, Bhargava V. Desai