Friday, September 11, 2015

Pledges in the Context of Insider Trading Regulations – Part 1

[The following guest post is contributed by Vinod Kothari and Abhirup Ghosh of Vinod Kothari & Co.]

There are several lurking questions in context of insider trading regulations. The Securities and Exchange Board of India (“SEBI”) on 24 August 2015 issued a Guidance Note on the SEBI (Prohibition of Insider Trading) Regulations, 2015 (“Guidance Note”) in which some questions pertaining to pledges were also answered. However, there was no generic clarity on matters pertaining to pledges. This post seeks to examine pledges in context of SEBI (Prohibition of Insider Trading) Regulations, 2015 (“Regulations”) and particularly to address questions as to the compliances required in respect of each stage of a pledge.

There are four aspects of a pledge in respect of which the question as to whether there is a “trade”, the meaning of which as construed from the definition of “trading” as per Para 2(l) of the Regulations, may be considered. These are: (a) creation of a pledge; (b) invocation of a pledge; (c) sale of pledged property by the pawnee; (d) release of a pledge.

Meaning of “trading”

The term “trading” has been defined in Para 2(l) of the Regulations, in the following manner:

(l) "trading" means and includes subscribing, buying, selling, dealing, or agreeing to subscribe, buy, sell, deal in any securities, and "trade" shall be construed accordingly;

The definition carries elements of an exhaustive definition, which is apparent from the use of the expression “means” – therefore, it is unclear if the definition can be extended to cover what is not explicitly covered in it.

The definition may be analysed as follows: trading means –

(a)        Either of these:
(i)        Buying;
(ii)       Selling;
(iii)      Dealing, or
(b)       Agreeing to either of these:
(i)        Buying;
(ii)       Selling;
(iii)      Dealing.

The words “buying” and “selling” are generally clear and unambiguous. In case of “sale”, there is a transfer of property, along with other features. According to Benjamin,[1] to constitute a valid “sale”, there must be a concurrence of the following elements –

1.   Parties competent to contract;
2.   Mutual assent;
3.   A thing, the absolute or general property of which is transferred from the seller to the buyer;
4.   A price in money is paid or promised.

Some of the other authoritative text books define “sale” in the following manner:  

- Blackstone[2] defines sale as –

"sale or exchange is a transmutation of property from one man to another, in consideration of some price or recompense in value."

- Halsbury's Laws of England[3] defines sale as –

"Sale is the transfer of the ownership of a thing from one person to another for a money price. Where       the consideration for the transfer consists of other goods, or some other valuable consideration, not being money, the transaction is called exchange or barter; but in certain circumstances it may be treated as one of sale. The law relating to contracts of exchange or barter is undeveloped, but the courts seem inclined to follow the maxim of civil law, permutatio vicina est emptioni, and to deal with such contracts as analogous to contracts of sale. It is clear, however, that statutes relating to sale would have no application to transactions by way of barter."

- Williston on Sales[4] defines "sale of goods" as –

"an agreement whereby the seller transfers the property in goods to the buyer for a consideration called the price."

As is evident from the definition of the “sale” contained in the various authoritative books quoted above, a sale involves – (i) transfer of property; and (ii) consideration in money.

“Buying” on the other hand is the reciprocal of “selling” – hence, the meaning of “buying” has each of the elements of sale discussed above.

It is the word “deal” which is broad, and may stretch itself across different dimensions based on requirements. The meaning of “deal” as per Black’s Law Dictionary[5] is as follows:

To traffic; to transact business; to trade.

Therefore, the word “deal” may include any form of a transaction which parties may conduct in course of trade practices. Thus, the expression “deal” obtains a contemporaneous meaning, including within its sweep each of the different types of ways in which parties may, in course of trade, “deal” with a particular object. For example, the context in the present case is securities. So, securities may be sold, pledged, mortgaged, or may be the subject matter of a securities lending transaction, or securities ready-forward trade, etc.

Meaning of a pledge:

The term “pledge” has been defined in Section 172 of the Indian Contract Act, 1872 in the following manner –

172. "Pledge" "pawnor", and "pawnee" defined. - The bailment of goods as security for payment of a debt or performance of a promise is called “pledge”. The bailor is in this case called the "pawnor". The bailee is called the "pawnee".

A pledge is certainly a form of security interest; however, unlike mere lien, a pledge carries possessory interest as well. That is, the pledgee acquires the bailment of goods. Further, under Section 176 of the Indian Contract Act, 1872, the pawnee has the right to cause a sale of the pledged article where the pawnor makes a default.

Pledge and mortgage:

A mortgage is defined in Section 58 of the Transfer of Property Act, 1882 to mean the following –

(a)       A mortgage is the transfer of an interest in specific immoveable property for the purpose of securing the payment of money advanced or to be advanced by way of loan, an existing or future debt, or the performance of an engagement which may give rise to a pecuniary liability.

The transferor is called a mortgagor, the transferee a mortgagee; the principal money and interest of which payment is secured for the time being are called the mortgage-money, and the instrument (if any) by which the transfer is effected is called a mortgage-deed.

There is a transfer of specific interest in property in case of a mortgage. The mortgagor is the transferor, and the mortgagee is the transferee. The mortgagor vests specific interest in the property in favour of the mortgagee, thereby making the mortgagee the holder of a specific interest. The specific interest may be limited to (a) such interest, for example, usufructuary interest as may be passed by the mortgagor; (b) right to cause a sale or cause a transfer of property in terms of the mortgage deed; (c) right to become absolute owner by foreclosure of the mortgagor’s right of redemption, etc.

Whereas in case of pledge, there is, no doubt, a right of sale, conferred by Section 176 of the Indian Contracts Act, 1872. There is also a right of possession, as pledge is essentially a possessory interest. Hence, a pledge may be considered transfer of specific interest in property.

[To be continued]

- Vinod Kothari & Abhirup Ghosh



[1] Lease Financing and Hire Purchase, by Vinod Kothari, Chapter – 19, Page 874
[3] Halsbury's Laws of England, Second Edn., Vol. 29, p. 5, Para. I,
[4] Williston on Sales, 1948 Edn

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