SC: Vesting of withheld securities of a defaulting memberdoes not take place in favour of the NSE/NSCCL unless a formal expulsion order is passed

The Hon’ble Supreme Court, on 20th November 2020, in the matter of Rusoday Securities Ltd. v. National Stock Exchange Of India Ltd. & Ors. held that vesting of withheld securities of a defaulting member does not take place in favour of the NSE/NSCCL 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.

The Hon’ble Supreme Court observed that:

The legislature has bestowed upon the Exchange sufficient freedom of action to effectively control and regulate the functioning of stock brokers who use the Exchange as a means to enter into financial relationships with the investors and common public. This freedom of action is guaranteed in the pre­approved Byelaws which enable the Exchange to frame Regulations, instructions, operational parameters, notice etc. and bring them into force without subjecting them to any added condition of prior approval of the Central Government/SEBI. The only limitation on this power of the Exchange is that such Regulations or operational parameters issued under the Byelaws are subject to Securities Contracts (Regulation) Act, 1956 or Securities and Exchange Board of India Act, 1992, as the case may be, including the Rules framed thereunder. (Para 31)

 Indubitably, the Exchange provides a middle ground to the stock brokers and investors dealing with public funds/investments, and considering the nature of activities undertaken in a stock market, it is the bounden duty of the Exchange to fortify the public trust. In doing so, the Exchange is required to prevent and remedy all possible mischief “on a real time basis”. To that end, it may prescribe a set of parameters for fulfilling its objective of “regulating” and “controlling” the stock market, as stated in the Preamble of the Act. Since the Byelaws and Rules of the Exchange are duly approved by the Central Government/SEBI, it can safely be stated that actions taken by the Exchange under the Byelaws or Regulations ­ by prescribing such operational parameters in the form of a circular and in consequence thereof as discussed above – would assume enforceable character. (Para 32)

The contention that the act of adoption of this circular by the Exchange amounts to an indirect amendment of the Byelaws is a tenuous argument. For, if every regulation or instruction concerning any procedural matter for effective regulation and control of the stock market prescribed by the Exchange, in furtherance of its powers coupled with duty under the Byelaws, is to be deemed as an amendment merely because it provides for something in addition to the Byelaws (but not repugnant thereto), it would make various other operational clauses of the Byelaws repugnant. That cannot be countenanced. (Para 34)

The principle of constructive amendment signifies that unless a clear case of repugnancy is made out, the later provisions could not be treated as modification or abrogation, more so when such provisions further the intent of the source provisions. (Para 35)

The relationship between a stock exchange and trading member runs across various levels. Admission to membership, continuation of membership, denial of trading facilities, imposition of fines, calling for additional deposits, suspension of membership and expulsion of membership are various facets of this relationship. Action against members is to be taken only upon violation of conditions and procedures therefor. It is a serious matter and resorted to only upon the fulfilment of conditions specified in the Byelaws, Rules, Regulations or even in operational parameters. Notably, the conditions required for withdrawing the trading facility are distinguishable from the conditions required for suspension/expulsion of membership. Under the relevant provisions, withdrawal could take place upon a standalone violation of certain operational parameters on a given trading day. Whereas, expulsion would take place upon a sustained violation of membership obligations (like failure to maintain the base capital and also for failure to replenish the prescribed amount) within the time frame specified therefor. The two actions vary not only in their texture, but also in their resultant effect. Withdrawal, for instance, does not extinguish the membership. It acts like a halt for indulging in further trading activity. (Para 59)

To say that mere withdrawal of trading facility would ipso facto absolve a trading member from keeping up with other obligations towards the Exchange for continuation of membership would result into an anomalous situation. It would amount to the diffusion of one stage of the relationship with the other, and would become a concocted way to extend benefit for its own wrong to a defaulting member. Such a consequence could not be intended to result from an action of withdrawal of trading facility. For, the withdrawal of trading facility is a temporary or interim action which is taken against an erring member to prevent him from continuing on a mischievous path during the trading hours and to take corrective steps forthwith. The nature of this action is preventive and the provisions governing this action provide for certain remedial acts, like depositing additional sums to increase the exposure limits, the performance of which can help a member in resuming his trading operations. The obligations for continued admission as a member are entirely different and merely because trading has been halted due to a member’s own default, it does not result in a hiatus situation or extricate him from membership obligations. If that were to be the case, there was no need for the Byelaws to provide these actions separately. (Para 60)

Despite the temporary action of withdrawal of trading facility, a member continues to be a member of the Exchange with all corresponding rights and obligations intact on both sides. A member can always resign from the membership of the Exchange and move out of all fiscal obligations after settling his dues, but as long as he opts to retain his membership of the Exchange, there is nothing in the governing provisions to support the view that withdrawal of trading would automatically extricate the defaulting member from his obligation regarding annual charges and margin requirements, as the case may be. The timely fulfilment of these requirements has been envisaged in the Byelaws as a pre­-condition for admission or continued admission in the Exchange. The continuation of membership and fulfilment of capital adequacy norms run co-­terminously with each other, and failure to comply with the latter would automatically put the former in jeopardy. (Para 61)

As per the general scheme of regulation of a trading/clearing member, it is settled position that a member whose membership has been terminated or who has been expelled is not absolved from fulfilling his contractual or other obligations in any manner. (Para 81)

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, the same principle is not absolute and the cases in which the statutory/contractual scheme itself provides for such sale/realisation fall outside its purview. It is settled that 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. Therefore, if provisions provide for realisation of such lien property, the same may be given effect to in accordance with the provisions.(Para 84)

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 – first, to persuade the defaulting member to fulfil its obligations during the continuation of membership if it so wishes and second, 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. (Para 97)

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 pre­condition for realisation. (Para 98)

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 usage of the word “shall” before the word “dealt” is conscious and instructive here, and its vigour cannot be toned down in a light manner. In other words, 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. The raison d’etre underlying this duty is to protect the interests of a member and to prevent any undue damage to its interests as a crucial element of the market. No doubt, such dealing could be in any of the manners specified in the Regulation or even in any other unspecified manner, but to say that the Exchange could sit idle on the withheld securities of an amount exceeding the amount owed by the defaulting member, without protecting them from being exploited by third parties in any manner, would be akin to permitting a free abuse of this provision. (Para 105)

The role of the Exchange is broadly premised on the principle analogous to fiduciary relationship. Propriety guides that when one party holds some property on behalf of the other, even for the fulfilment of any liability, it must treat the property in a manner in which a prudent person would. It is so because the property is not directly in dispute between the parties, rather, what is in dispute is an outstanding liability for the discharge of which the property is being held as a mere security. Ordinarily, the sanctity of such security needs to be preserved. An implied element of trust is involved in any action of withholding, which is the basic foundation of a fiduciary relationship. (Para 106)

We are conscious of the fact that traditionally speaking, the relationship of Member­Exchange may not be regarded as a fiduciary one. But we are not examining the nature of this relationship as a generalised enquiry. Our concern is limited to the dynamics of this relationship qua the withheld securities in light of the regulatory scheme. Therefore, it is only for the purpose of performance of functions that a fiduciary character is recognised in this relationship. (Para 106)

Constructive trust arises by operation of law in specific factual scenarios and not by any statute or contract. However, such trust, and rights and obligations under it would depend strictly upon the prevailing set of facts and governing provisions. (Para 106)

The principles of constructive trust and fiduciary relationships are equitable principles, and equity never operates in an absolute manner or in a vacuum. In fact, the very basis of the law of equity is its flexibility to take care of mutual concerns of the parties. Equity is about balancing the competing interests – by preventing the erosion of interests of one party while ensuring a free exercise of legally enshrined discretionary powers to the other. No doubt, specific fiduciary duties could definitely be recognised in the specific facts of the case but the manner of performance of such duties cannot be dictated in regulatory matters. Legal recognition of the role of a trustee and fixing actual obligations to be performed under such role are two separate matters. The latter is dependent on the nature of discretion and on the diligence of other party. (Para 108)

The duties of a trustee can be broadly classified into mandatory duties and discretionary duties. The court is always circumspect in enforcement of discretionary duties. (Para 109)

It is the fundamental principle of an equitable examination that “the one who seeks equity must do equity”. (Para 110)

Upon withholding, it becomes the duty of the stock broker to raise a request for the registration of securities and to comply with the payment shortfall and other requirements. (Para 110)

Copy of judgment: Judgement_20-Nov-2020

-Adv. Tushar Kaushik

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