The Stock Exchange v. V.S. Kandalgaonkar [Full Bench]
Background of the Case
The case pertains to the Income Tax Authorities’ right to recover its dues from an assessee (defaulter declared by the Stock Exchange) by having a first claim over the amount realized by the Stock Exchange at the auction of the Membership Card of such defaulter.
I. Contentions
Ø Appellant’s Contentions
§ That the membership card is only a personal privilege granted to a member that cannot be attached by the Income Tax Department at any stage. The moment a member is declared a defaulter all rights qua the membership card of the member cease and even his right of nomination vests in the Stock Exchange.
§ That a conjoint reading of Rules 38 with 44 of the Rules made by the Stock Exchange shows that the security in form of shares that are given by a member is transferred and held either in the name of the trustees of the Stock Exchange or in the name of a Bank which is approved by the Governing Board. Therefore, the member is no longer an owner, consequently the Income Tax Department cannot lay hands on these shares or its sale proceeds as the member ceases to have ownership rights of these shares.
§ That by virtue of Rule 43, the Stock Exchange has a first and paramount lien for any sum due to it, and that this made it a secured creditor so that in any case income tax dues would not to be given preference over dues to secured creditors.
Ø Respondent’s Contentions
§ That the High Court’s reasoning is correct where it had held that though a defaulting member had no interest in a membership card and that the Income Tax Department was not right in attaching the sale proceeds of such card, still money which is likely to come in the hands of the garnishee, that is the Bombay Stock Exchange, for and on behalf of the Assessee is attachable because the requisite condition is the subsistence of an ascertained debt in the hands of the garnishee which is due to the Assessee, or the existence of a contractual relationship between the Assessee and the Stock Exchange consequent upon which money is likely to come in the hands of the garnishee for and on behalf of the Assessee
§ That a conjoint reading of rules made by the Stock Exchange makes it clear the expression “transferred” would not refer to transfer of ownership but would refer only to the delivery made of shares for the purpose of realization in case a member defaults.
§ That the mere fact that a lien was provided in the Rules did not make such lien a statutory lien and that therefore Government dues would have a first preference over all the dues of the Stock Exchange.
II. Relevant Provisions
Ø Income Tax Act
§ Section 226 3 (i) The assessing officer or tax recovery officer may, at any time or from time to time, by notice in writing require any person from whom money is due or may become due to the Assessee or any person who holds or may subsequently hold money for or on account of the Assessee, to pay the assessing officer or tax recovery officer either forthwith upon the money becoming due or being held or at or within the time specified in the notice (not being before the money becomes due or is held) so much of the money as is sufficient to pay the amount due by the Assessee in respect of arrears or the whole of the money when it is equal to or less than that amount:
§ Rule 26 of Schedule II of the Income Tax Act then provides Debts and Shares, etc. - (1) In case of
(a) a debt not secured by a negotiable instrument… c) other movable property not in the possession of the defaulter…the attachment shall be made by a written order prohibiting, (i) in the case of the debt - the creditor from recovering the debt and the debtor from making payment thereof until the further order of the tax recovery officer…(iii) in the case of the other movable property (except as aforesaid) - the person in possession of the same from giving it over to the defaulter.
Ø Securities Regulation Act, 1956
§ Section 9. Power of recognised stock exchanges to make bye-law- (1) Any recognised stock exchange may, subject to the previous approval of the Securities and Exchange Board of India, make bye-laws for the Regulation and control of contracts.
Ø Rules made by the Stock Exchange
§ Rule 5. Membership a Personal Privilege- The membership shall constitute a personal permission from the Exchange to exercise the rights and privileges attached thereto subject to the Rules, Bye-laws and Regulations of the Exchange.
§ Rule 7. Right of Nomination- Subject to the provisions of these Rules a member shall have the right of nomination, which shall be personal and non-transferable.
§ Rule 9. Right of Nomination of Deceased or Defaulter Member- On the death or default of a member his right of nomination shall cease and vest in the Exchange.
§ Rule 10. Forfeited or Lapsed Right of Membership- When a right of membership is forfeited to or vests in the Exchange under any Rule, Bye-law or Regulation of the Exchange for the time being in force it shall belong absolutely to the Exchange free of all rights, claims or interest of such member or any person claiming through such member and the Governing Board shall be entitled to deal with or dispose of such right of membership as it may think fit.
§ Rule 16. Allocation in Order of Priority- When as provided in these Rules the Governing Board has exercised the right of nomination in respect of a membership vesting in the Exchange the consideration received therefore shall be applied to the following purposes and in the following order of priority namely-…(iii) the payment of the surplus if any to the funds of the Exchange: provided that the Exchange in general meeting may at its absolute discretion direct that such surplus be disposed of or applied in such other manner as it may deem fit.
§ Rule 37. Form of Security- The security to be furnished by a member shall be provided either by a deposit of cash or it may be provided in the form of a Deposit Receipt of a Bank approved by the Governing Board or in Securities approved by the Governing Board subject to such terms and conditions as the Governing Board may from time to time impose…
§ Rule 38. Security How Held- Deposits of cash shall be lodged in a Bank approved by the Governing Board and Bank Deposit Receipts and securities shall be transferred to and held either in the names of the Trustees of the Exchange or in the name of a Bank approved by the Governing Board and lodged with a Bank approved by the Governing Board. Such deposit shall be entirely at the risk of the member providing the security but it shall be held by the Bank solely for and on account of the Exchange at the absolute discretion of the Exchange without any right whatever on the part of such member or those in his right to call in question, the exercise of such discretion.
§ Rule 41. Change of Security- A member may withdraw any security provided by him if he first provides in lieu thereof other security of sufficient value to the satisfaction of the Governing Board.
§ Rule 43. Lien on Security- The security provided by a member shall be subject to a first and paramount lien for any sum due to the Exchange or to the Clearing House by him or by the partnership of which he may be a member and for the due fulfillment of his engagements, obligations and liabilities or of the partnership of which he may be a member arising out of or incidental to any bargains, dealings, transactions and contracts made subject to the Rules, Bye-laws and Regulations of the Exchange or anything done in pursuance thereof.
§ Rule 44. Return of Security- On the termination of his membership or on his ceasing to carry on business on the Exchange or on his working as a representative member or on his death all security not applied under the Rules, Bye-laws and Regulations of the Exchange shall at the cost of the member be repaid and transferred either to him or as he shall direct or in the absence of such direction to his legal representatives.
Ø Bye- Laws made by the Stock Exchange
§ Rule 326. Defaulter’s Assets- The Defaulters’ Committee shall call in and realise the security and margin money and securities deposited by the defaulter and recover all monies, securities and other assets due, payable or deliverable to the defaulter by any other member in respect of any transaction or dealing made subject to the Rules, Bye-laws and Regulations of the Exchange and such assets shall vest in the Defaulters’ Committee for the benefit and on account of the creditor members.
III. Issues
1. Whether the membership card is a privilege or a right for the defaulting member.
2. Whether in the Chapter entitled ‘Membership Security’, the phrase “securities shall be transferred to and held” in Rule 38, means a mere transfer of possession of security or transfer of ownership of security. In other words, whether the security furnished by the member (in form of shares in the present case), remains in his/her ownership or the ownership rests with the person keeping the ownership.
3. Whether the government debts have precedence over secured creditors.
4. What is the nature of the lien under rule 43, i.e., whether it is a statutory lien or a lien under an agreement of furnishing a security.
5. Whether the lien under Rule 43 makes make the Stock Exchange a secured creditor.
IV. Judgment on the Issues
On Issue 1
The Court held that a conjoint reading of Rules 5 and 9 leads to the conclusion that a membership card is only a personal permission from the Stock Exchange to exercise rights and privileges, which can be taken away along with the right of nomination from the defaulting member. The Court here distinguished between any accrued right to that of any privilege. In its opinion, the member only had a privilege and not an accrued right to property. The Court, by relying on the Ahmedabad Stock Exchange case where it had held that the membership under the above mentioned rules is merely a personal privilege granted to a member and is non- transferrable and incapable of alienation by the member and concluded that once a right of nomination vests in the Stock Exchange under the Rules, that right belongs to the Stock Exchange absolutely.
The Court also noticed that whenever under Rule 16 (iii) the Governing Board exercises the right of nomination in respect of a membership which vests in the Exchange, the ultimate surplus that may remain after the membership card is sold by the Exchange comes only to the Exchange - it does not go to the member. This shows that the member does not have any right to property.
On Issue 2
The Court construed the expression “securities shall be transferred to and held” so as to be providing only for transfer by delivery of security to the Stock Exchange, while the ownership still remains with the member. For that it noted, amongst other reasons, that (i) the expression “transferred” must take colour from the expression “lodged” in Rule 38 when it came to deposits of cash. So, when understood in this sense, transfer only means delivery for the purposes of holding such shares as securities, (ii) the language employed in Rule 38 states “such deposit shall be entirely at the risk of the member providing the security…”, which shows that the deposit of cash or security is entirely at the risk of the member who provides the security. Thus, making it clear that such member continues to be the owner of the said shares by way of security for otherwise they cannot possibly be at the member’s risk, (iii) Rule 41 allows a member to withdraw any security provided by him if he satisfies the conditions of the Rules, (iv) Rule 43 provides for a lien on securities to the Stock Exchange. Such a lien is only compatible with the member being owner of the security, for otherwise no question arises if the Stock exchange (as contended by ld. Counsel for appellants) is the owner of the security.
On Issue 3
The Court while noting that the Income Tax Act itself does not provide for any paramountcy of dues by way of income tax, cited with approval the judgment in the case of Dena Bank v. Bhikabhai Prabhudas Parekh Co, where it was held that the common law of England or the principles of equity and good conscience (as applicable to India) do not accord the Crown a preferential right for recovery of its debts over a mortgagee or pledgee of goods or a secured creditor. Here, Article 372 of the Constitution of India is relevant where the common law of England qua Crown debts becomes applicable to our jurisdiction. In fact, in the case of Collector of Aurangabad and Anr v. Central Bank of India and Anr the Court held that the claim of the Government to priority for arrears of income tax dues stems from the English common law doctrine of priority of Crown debts and has been given judicial recognition in British India prior to 1950 and was therefore “law in force” in the territory of India before the Constitution and was continued by Article 372 of the Constitution. However, such right of priority of Government dues only extends to priority over unsecured debts.
On Issue 4
The Court chose not to address the issue of whether the lien provided under the Rule 43 made by the Stock Exchange is a statutory lien or a lien under an agreement. Therefore, the Contention (iii) of the respondent’s was not relevant. The Court stated that the precedents cited by the respondent’s counsel for the proposition that the statutory lien is a paramount lien only which can override the claims of all other creditors including secured creditors, is not in issue in the present case. Since, to overrule the Income Tax Department’s decision of claiming priority of Government debt over the Stock Exchange’s claims, would only require to prove that the Stock Exchange’s claims make it a secured creditor.
On Issue 5
The Court here referred to the judgment in the case of K.S. Saradambal v. Jagannatham K Brothers, where on a consideration of Section 529 of the Companies Act 1956 read with the relevant provisions of the insolvency law, came to the conclusion that the holder of a statutory lien or the holder of a lien created by contract and registered as required by Section 125 is a secured creditor in the matter of winding up of the insolvent company with regard to, among other things, debts provable in the winding up proceedings.
Explaining the meaning of the term ‘lien’ which is the right to retain possession of a thing until a claim be satisfied which is either particular or general, the Court noted that a secured creditor is one, who has some mortgage, charge or lien on the company’s property. Therefore, a solicitor who holds a lien on documents of a liquidating company for his costs against the company is a secured creditor, and must mention his lien in his proof.
Therefore, the Court concluded that the Stock Exchange being the one holding a lien (irrespective of the fact whether it is a statutory lien or lien by agreement) is a secured creditor and consequently has higher claim over the government’s debts.
V. Conclusion
So, the Court has held that the TRO was not right in attaching the sale proceeds of the nomination rights of the Defaulter-Member’s membership card as the ownership of such nomination rights and the membership card were on default vested in the Stock Exchange and not the defaulter. Since, the membership rights were only a privilege and can be taken away, there was no accrued right to the member. Also, the surplus that may remain after the membership card is sold by
the Exchange comes only to the Exchange and does not go to the member as per Rule 16 (iii).
The Court further held that under Rule 43 the security provided by a member should be subject to the paramount lien for any sum due to the Exchange or to the Clearing House, then, the Income Tax Department can recover its dues.
The Court in that regard rejected the submission of the appellant’s seeking to avoid any recovery by the Income Tax from the security transferred by him to the Stock Exchange on the ground that he had transferred the ownership of thing given in security to the Stock Exchange and the Stock exchange after clearing all debts should transfer back the assets to him or his representative, and consequently concluded that the said security still remained in the member’s ownership.
Stroud's Judicial Dictionary, third edition, at page 1644.
