[Previous parts of the Series are available here]
While the previous blogpost left off at the 1969 notification issued by the Central Government under Section 16 of the Securities Contracts (Regulation) Act, 1956 (“SCRA”), this one chronologically navigates the judicial pronouncements that dealt with the definition of the term ‘securities’. The High Courts of Bombay and Calcutta each had somewhat parallelly interpreted the definition under the SCRA until the Supreme Court’s conclusive ruling much later. For better direction, this blogpost draws attention to key judgments on this issue, including those pronounced much later than in 1970s, steering the timeline forward only in the next blogpost.
For ease of reference, Section 2(h)(i) as it originally stood is reproduced hereinbelow:
““securities”- include
(i) Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company”
1978 - Norman J Hamilton & Anr. v. Umedbhai S Patel[1]
In this case, the Bombay High Court determined whether a contract for sale of certain shares of a private limited company had contravened the provisions of SCRA, where the consideration for sale was paid in instalments. The suit was filed to recover the amounts due to the plaintiff after sale and delivery of the shares. Among other things, the defendant had pleaded that the said contract was illegal and unenforceable under the SCRA as it had been signed in Bombay in December 1996 between parties who were not members of stock exchange at a time when doing so was illegal on account of Bombay being a notified area under Section 13. It is this argument that is of relevance for us.
The court noted that the term ‘marketable’ in the definition of ‘securities’ essentially meant something that can be offered for sale in a market and be readily sold. It observed that a private limited company by definition restricts the right to transfer shares and hence its shares cannot be construed to be readily sold in the market. Further, it noted that a reading of the definitions of “Security” and “stock exchange” together clarified the purpose of SCRA, viz. to control securities which are normally dealt with on the exchanges, i.e., shares of public limited companies.
The court applied the maxim noscitur a sociis (meaning of a word to be judged by the company it keeps) to note that the words ‘other marketable securities of a like nature’ are words of a general character which apply to all the preceding words, viz. “shares, scrips, stocks, bonds and debentures”. It thus observed that the term ‘shares’ has to be construed to be limited to ‘marketable securities’, excluding shares that are not marketable, such as those of private limited companies. It noted that the latter are by their very nature not freely transferable and though it may be possible to transfer them after complying with the conditions provided under the articles of the company concerned, they cannot be considered as marketable securities as intended under the SCRA.
The Court thus opined that a security was required to be marketable for it to fall within the scope of the SCRA. Upon examination of the historical background of the law it concluded that the SCRA was undoubtedly not meant to apply to shares of private limited companies. The Court observed as follows in this regard:
“Since there is no question of any speculation in the shares of a private limited company, there could be no question of preventing undesirable transactions in such shares. Secondly, the Act does not provide any machinery for regulating the business of dealing in shares of a private limited company. The machinery that is provided under the Act of regulating dealings in securities is the machinery of the stock exchanges…no such provision is made in the Act, because it was never contemplated that such shares would be covered by the Act.”
1980 - B.K. Holdings (P) Ltd v. Prem Chand Jute Mills Ltd & Ors.[2]
This case involved a purchase of shares of an unlisted company by the petitioner in Calcutta. Upon the concerned company’s rejection for registering the petitioner’s name as the owner, an application was filed for rectification of the share register of said company. The company defended its refusal pleading that the transaction was illegal for violating Section 13 (Calcutta being a notified area) and Section 16 of the SCRA read with the notification issued thereunder.
It was argued that the prohibition under Sections 13 and 16 applied only to securities quoted in the stock exchange per Section 2(h) of the SCRA. The Court observed that reading the definition to infer its applicability only on listed securities would ascribe too narrow a meaning to the expression ‘marketable securities’. It thus equated the expression ‘marketable’ with ‘saleable’, i.e., what is capable of being bought and sold in a market.
This court distinguished the aforementioned ruling of Bombay High Court in Norman Hamilton, noting that the case before itself concerned shares of a public limited company which stands as a class apart from those of a private limited company.
1982 – Dahiben Umedbhai Patel & Ors. v. Norman James Hamilton[3]
In an appeal against the aforementioned decision in Norman Hamilton, the Bombay High Court affirmed its stance in the impugned decision. It observed that a reading of the inclusive part of the definition demonstrated that the legislature has enumerated different kinds of securities of a like nature. It observed that “The use of these words was clearly intended to mean that the earlier categories of securities had to be marketable and any other securities of "like nature", that is to say, like those which were categorised or enumerated earlier were also to be marketable before they could be held to fall within the definition of "securities".”
Keeping this in view, the Court also acknowledged that shares of private companies do not possess the character of liquidity for them to be considered marketable and thus held that they cannot be said to fall within the definition of ‘securities’. Notably, one of its observations was to the effect that the definition would only encompass shares of a public limited company notwithstanding the use of terms ‘any incorporated company or other body corporate’ in the definition.
1985 - East Indian Produce Ltd. v. Naresh Acharya Bhaduri & Ors.[4]
Calcutta High Court in this case affirmed its aforementioned decision in BK Holdings by observing that the scope of SCRA is not limited to transactions relating to listed securities. It held that the transaction in consideration before it (was an option in securities per Section 2(d) of the SCRA and that it) was hit by prohibition under Sections 16 and 20 of the SCRA, and was thereby illegal.
1991 - Brooke Bond India Ltd. v. U.B. Ltd. & Ors. [5]
In this case it was argued that the SCRA is inapplicable to the agreement for transfer of shares of an unlisted public limited company. Despite noting the aforementioned Calcutta High Court decisions in BK Holdings and East Indian Produce, the Bombay High Court relied on its aforementioned decisions in Norman Hamilton and Dahiben to hold that SCRA was not intended to regulate private transactions in shares of an unlisted public limited company.
2004 - Mysore Fruit Products Ltd. v. The Custodian [6]
While dealing with a forward sale of shares of an unlisted company, the Bombay High Court determined the applicability of SCRA thereto in light of the ban on forward contracts. The Court noted that the question before it had not been considered in Norman Hamilton or in Dahiben, which dealt with private limited companies. It also noted that the previously discussed ruling of single judge in Brooke Bond, decided Notice of Motion and the view expressed therein was a prima facie view.
The Court observed that the provisions and scheme of SCRA make it clear that it cannot be restrictively read and that it relates not only to listed securities but also to those that may be unlisted, so long as there is marketability. It noted that any unlisted security cannot be assumed to not be marketable and that the expression ‘marketable’ has been previously interpreted to imply ease of selling. On account of this, it noted that all bonds of government companies and shares of public limited companies are marketable as they are also freely transferable.
The Court noted that the definition of ‘securities’ under Section 2(h) is inclusive and wide, thereby including all securities which are marketable and having a high degree of liquidity and/or are capable of being sold in the market. In effect it observed that forward contracts in shares of unlisted public limited companies are encompassed within the SCRA and prohibited thereunder. The transaction in consideration was thus found contrary to the provisions of the SCRA.
2010 - Naresh K Aggarwala & Co. v. Canbank Financial Services Ltd. & Anr. [7]
In this case, the Supreme Court considered the term ‘securities’ as defined under Section 2(h) of the SCRA with reference to the notification issued under Section 16 and held that the definition does not make any distinction between listed and unlisted securities. It noted that This judgment broadly concluded that the ban on forward contracts under the 1969 Notification was also applicable to contract in unlisted public companies to which the SCRA applies.
2013 - Bhagwati Developers Pvt. Ltd. v. Peerless General Finance & Investment Company Ltd. & Anr. [8]
In this case, the Supreme Court had the opportunity to interpret the definition of the term ‘securities’ under the SCRA while dealing with the determination of legality of a transfer of securities wherein consideration became payable at a point in time later than the sale. The Appellant Bhagwati Developers (“Bhagwati”) had loaned a sum to a party for purchase of shares of Peerless General Finance (“Peerless”) in 1986 whereby the said party had agreed to transfer Peerless’ shares to Bhagwati by way of repayment of the loan. However, later the other party did not transfer the said shares as promised and also retained the dividends and bonus shares received.
A suit filed by Bhagwati in civil judge’s court resulted in an ad interim injunction against the other party from claiming any right, title or interest in the shares. However, during the pendency of this suit, parties entered into an out-of-court settlement in November 1994 whereby the other party acknowledged the entitlement. The trial court decreed the suit in terms of the compromise in November 1994. As per the compromise decree, the other party was to retain absolute ownership over the dividend on the shares up to 1989-90 as consideration for settlement and a further sum of Rs 10 lakh was paid by Bhagwati in terms thereof.
However, Peerless still refused to register the transfer on the grounds that it was in breach of the SCRA, since the contract was not a spot delivery contract. Aggrieved, Bhagwati approached the Company Law Board which observed that the sale of shares of unlisted public limited companies was within the purview of the SCRA and that the transfer was illegal since the sale of shares was not a spot delivery contract per the definition under Section 2(i). It also construed the sum of 10 Lakh paid in 1994 to be forming part of the consideration of transfer.
In appeal, the high court also affirmed this view also taking into account the fact that in terms of the compromise decree as part of consideration, the other party retained absolute ownership over the dividends on the shares including the bonus shares up to the accounting year 1989-90.
The Supreme Court then noted that the effect of Section 13 of the SCRA is that a contract in relation to securities in notified areas is considered illegal if made otherwise than between members of recognized stock exchanges. It noted firstly that the contract in question was entered into a notified area and not between members of recognized stock exchange; and secondly that the payment of Rs. 10 lakh formed consideration for the transfer, thereby concluding that the concerned transaction was not a spot delivery contract.
The court opined that securities comprised within the definition of ‘securities’ under Section 2(h) of the SCRA, would attract the rigors of Section 13. Accordingly, it decided whether the provisions of SCRA applied to shares of unlisted public limited companies. In doing so, it took note of all of the abovementioned caselaws. It alluded that for shares of such companies to come within the scope of Section 2(h)(i) they would have to satisfy that they are marketable. Further, it noted that the expression has been equated with being ‘saleable’ irrespective of the size of the market, in light of the fact that there may not be any purchaser even for listed shares.
The Court in this case pronounced that what is required is free transferability. In this regard, it opined that shares of public limited company though not listed on stock exchange would come within the definition of the term ‘securities’ while noting as follows:
“Subject to certain limited statutory restrictions, the shareholders possess the right to transfer their shares, when and to whom they desire. It is this right which satisfies the requirement of free transferability. However, when the statute prohibits or limits transfer of shares to a specified category of people with onerous conditions or restrictions, right of shareholders to transfer or the free transferability is jeopardized and in that case those shares with these limitations cannot be said to be marketable.”
The court also took note that East Indian Produce relying on BK Holdings came to the same conclusion which dealt with public limited companies and distinguished Dahiben Umedbhai Shah on account of it dealing with private limited companies.
The SC however noted that the Brooke Bond India followed Dahiben Umedbhai Patel and expressed a prima facie view that the transaction of shares of an unlisted public limited company was not intended to be covered under the SCRA. It noted that the judge in Brooke Bond had referred to the Calcutta High Court decisions in BK Holdings and East India Produce Ltd., but disagreed with the ratio without assigning any reason, finding himself bound to follow Dahiben Umedbhai Patel. The Supreme Court noted that this decision of the Bombay High Court was highly influenced by the fact that SCRA was intended to govern stock exchange transaction, a view it did not endorse.
By affirming its view in Naresh K Aggarwala and holding that shares of unlisted public limited companies are covered within the SCRA, the Supreme Court settled the position on this issue.
[1] (1979) 81 BOM LR 340. Decided by the Bombay High Court on July 24, 1978.
[2] 1983 53 Comp Cas 367. Decided by the Calcutta High Court on July 16, 1980.
[3] (1983) 85 BOM LR 275. Decided by the Bombay High Court on December 08, 1982.
[4] [1988] 64 COMP CAS 259 (CAL). Decided by the Calcutta High Court on August 9, 1985.
[5] 1992 (2) BOM CR 429. Decided by the Bombay High Court on December 05, 1991.
[6] (2005) 107 BOM LR 955. Decided by the Bombay High Court on July 28 2004.
[7] 2010 6 SCC 178. Decided by the Supreme Court of India on May 05, 2010.
[8] Decided by the Supreme Court of India in Civil Appeal No. 7445/2004 on July 15, 2013.
[Any/All views expressed here are personal and belong solely to the author and do not reflect the views of any organization]
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