Tuesday, July 30, 2013

‘Marketable Securities’ and ‘Spot Delivery Contracts’: The Supreme Court’s Analysis of the SCRA

In its recent judgment in Bhagwati Developers v Peerless General Finance, the Supreme Court has considered some important questions relating to the interpretation of the Securities Contract (Regulation) Act, 1956 [“SCRA”]. There were principally two questions before the Court: (i) the applicability of the SCRA to public unlisted companies and (ii) the construction of a settlement agreement to ascertain whether a prior agreement was a ‘spot delivery contract’ as defined in section 2(i) of the SCRA. With respect, it appears that the answer the Supreme Court gave to the second question is clearly incorrect. The answer it gave to the first is correct as a matter of precedent but, as Professor Umakanth has powerfully argued, the reasoning in those cases highlights the need for a Bench of appropriate strength to review this area of the law.

The facts are of some importance and must be analysed with care. In July 1986, Bhagwati Developers Pvt Ltd [“BDPL”] advanced a sum of Rs. 38 lakhs to Mr Tuhin Kanti Ghosh [“TKG”] to be used by him to acquire 3,530 equity shares of Peerless General Finance and Investment Co [“Peerless”]. TKG bought the shares and was to repay the loan by December 1991. On October 30, 1987, TKG—for what reason it is not stated—agreed to transfer this block of 3,530 shares to BDPL in full repayment of the loan. He handed over the transfer deeds (which, it was later alleged, were not properly executed) and stated in a letter of even date that all dividends, bonus shares and other benefits attached to the block of 3,530 shares would be payable to BDPL. Soon after, Peerless declared an issue of bonus shares in the ratio 1:1. As the registered holder, TKG got a further 3,530 shares. BDPL wrote to him in December 1987 asking for fresh transfer deeds for the block of (now) 7,060 shares. TKG did not do so. In 1991, a further bonus issue in the same proportion was announced, and TKG now had 14,120 shares.

In May 1991, BDPL instituted a suit in the Civil Court in Allahabad to restrain TKG from claiming any right in the 14,120 shares and obtained an interim injunction. On 21.11.1994, the parties arrived at a settlement, under which TKG recognised that he had sold the 3,530 shares to BDPL in October 1987 but, in consideration of not contesting the suit, was to be paid a further sum of Rs. 10 lakhs, and allowed to retain the amounts received by way of dividend until October 1989. For his part, TKG gave up his claim to the 14,120 shares, which BDPL now sought to register with Peerless. Peerless refused registration on the ground (inter alia) that the transfer of shares from TKG to BDPL was not a ‘spot delivery contract’ as defined in section 2(i) and therefore a nullity. The Company Law Board agreed, and dismissed BDPL’s petition challenging the refusal. A single judge of the Calcutta High Court dismissed the appeal, which was challenged in the Supreme Court.

The first issue was whether the SCRA applies to public, unlisted companies. This depends on whether the shares of such a company can be described as “…other marketable securities of a like nature…” for the purposes of s 2(h) of the SCRA. The correct view (although not the view accepted by the courts) is that it cannot. The reasons are set out persuasively in Professor Umakanth’s article and I will here summarise the two that seem to me to be the most powerful: (i) the legislative history of the SCRA—notably the Bombay Securities Contract Control Act, the Gorwalla Committee Report and the speech of Finance Minister CD Deshmukh on November 28, 1955 establish clearly that the object of the SCRA is to curb speculation, which presupposes the existence of a market price; and (ii) ‘Stock exchange’ is defined in s 2(j) as a body constituted for the purpose of… “dealing in securities. Since the word ‘securities’ in that section must be given the meaning assigned to it in s 2(h), it would be most surprising if a public unlisted company is part of s 2(h)—for it would follow that its shares (without the company being listed) should be dealt with in a stock exchange. However, the courts, with a few exceptions, have rejected this analysis, and generally equated ‘marketable’ with ‘freely transferable’, heavily influenced by the definition of ‘marketable’ that appears in the Oxford Dictionary and Black’s Law. In Bhagwati v Peerless, the Supreme Court has endorsed this: “the size of the market is of no consequence… the number of persons willing to purchase such shares would not be decisive”. To the Court, the only reason the shares of a private company are not marketable (for there are persons willing to purchase those shares too) is that they are not ‘freely transferable’. In other words, any security that is ‘freely transferable’ is ‘marketable’. The Court goes on to say:

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    
It is not quite clear from where the Court derived the proposition that restrictions must be ‘onerous’. Quite apart from that, it is also not clear why the shares of a public company are freely transferable, if the Bombay High Court is right that private agreements are outside the ambit of s 111A (which, we have argued it is, although not for the reasons it gave). The Supreme Court also observes that section 13 may apply even if s 2(h) does not (at p 16). In the ultimate analysis, the conclusion that the SCRA applies to public unlisted companies is consistent with existing law: indeed, it is surprising that Sahara was not cited.  

It is in its resolution of the second issue that the Court, with respect, erred. A ‘spot delivery contract’ is defined in s 2(i) as a “contract which provides for actual delivery of securities and the payment of price either on the same day as the contract or on the next day”. Peerless’ case was that the sum of Rs. 10 lakhs paid by BDPL to TKG in November 1994 as consideration for settling the suit was actually the price paid for the shares transferred by TKG to BDPL in October 1987; since some seven years elapsed between the contract and payment, it was not a spot delivery contract. It is, with respect, extraordinary that this contention was successful before the Company Law Board, the Calcutta High Court and the Supreme Court. There are three fundamental objections to it:

(1)   Unless TKG and BDPL were clairvoyant, neither could have known in 1987 that a dispute would arise and that BDPL would pay TKG Rs. 10 lakhs some seven years later. Yet, both plainly intended to transfer the shares in October 1987, for which the consideration was that the loan would be discharged. The discharge of a debt in kind (through shares, rather than money) is not open to the objection in Pinnel’s case, for that rule does not apply to payment in kind, and was in any event specifically abolished in Indian law (see ss 41 and 63 and Kapur Chand Godha’s case). It is axiomatic that there can be no consideration for a contract that is already concluded: in the famous case of Roscorla v Thomas (1842) 114 ER 496, a warranty given by a seller of a horse was held to be void for want of consideration because he had already sold the horse (for consideration—the price). Likewise here—nothing BDPL promised or paid after October 1987 could possibly have been consideration for the sale of shares because that was concluded, and BDPL had acquired title: it could not have paid TKG anything to sell something he had already sold, and which it had already bought. This should have led to the conclusion that Rs. 10 lakhs was consideration for a separate agreement—to settle the suit.

(2)  The Supreme Court appears to have been influenced by the fact that the settlement agreement stated that Rs. 10 lakhs was paid as consideration for the shares. Even if it did, it is irrelevant because it cannot furnish consideration for a contract concluded in 1987. In any case, the Settlement Agreement did not. The text of the Settlement Agreement is reproduced in in the judgment of the High Court under appeal, reported in 128 CompCas 444 and records that: (i)TKG has lawfully sold the original shares…on 30th October 1987…and thereupon TKG ceased to have any beneficial interest”; (ii) TKG shall co-operate with BDPL in having BDPL registered, by executing fresh transfer deeds if necessary, and relinquish all its right, title and interest, for which Rs. 10 lakhs is paid. It is apparent that Rs. 10 lakhs is consideration for the fresh agreement to settle TKG’s claims (ie, his defences to the suit instituted by BDPL).

(3)   It may be asked what the purpose of paying Rs. 10 lakhs was. The answer is that a compromise agreement generates its own consideration, provided the parties believe bona fide that they have a claim (even if the belief is subsequently shown to be mistaken) (see Treitel on Contract, Chapter 3 and Wade v Simeon (1846) 2 CB 548). Here both parties plainly did: BDPL instituted the suit, and TKG presumably defended it. Rs. 10 lakhs (and the agreement to allow TKG to retain the amount received as dividend) was consideration for the settlement, not the transfer of shares. It was, therefore, a spot delivery contract.

Ironically, while this judgment will be cited for its conclusion that the SCRA applies to public unlisted companies, it is the analysis of the second that is likely to be more controversial. It is not just a matter of construction of this particular agreement: it is difficult to see how any agreement to settle a suit filed for a declaration of title to the shares of a public unlisted company will not be governed by this judgment. Indeed, the somewhat odd result is this: a contract for the sale of shares is a spot delivery contract if it is performed in accordance with its terms, but is not a spot delivery contract if one of the parties is in breach, and the buyer settles the dispute by paying the seller a fresh sum of money.


Anonymous said...


Great post. Sorry for this query unrelated to the post- how does one keep a tab on the latest landmark judgments of the Supreme Court and the High Court on commercial law? Thank you.

Anonymous said...

The link to prof Umakanth's article published in nujs law review seems to be dead. Any way you can upload the same elsewhere?

Umakanth Varottil said...

@Anonymous. The article published in the NUJS Law Review can be accessed at https://ssrn.com/abstract=1912436.