Private Credit: Supreme Court holds that ownership of pledged shares remains with pledgor despite transfer to pledgee 

In a landmark ruling, Supreme Court has clarified the law surrounding pledge of demat shares. Until this ruling, courts had held that a transfer of shares to the pledgee upon invocation would amount to an ‘actual sale’ and that the pledgee becomes the owner of the pledged shares due to the way the framework for demat shares operated.

The SC has now overruled a series of prior rulings and held that the term ‘actual sale’ must mean the sale to a third party by the pledgee, and mere transfer of shares to the pledgee upon invocation does not transfer the ‘ownership’ in the shares to the pledgee. The SC has also differentiated between mortgage and pledge and held that while ‘general ownership’ remains with the pledgor, the pledgee gets a ‘special right’ to dispose off the shares to recover outstanding dues.

The SC has also acknowledged that the findings of the court will now require a holistic review of how the takeover code and other securities laws will operate with respect to invoked shares. This is because upon invocation, while the beneficial owner in depository records changes to the pledgee, ownership continues to remain with the pledgor. The decision is likely to create significant practical and administrative challenges with respect to regulatory compliances.

Key Takeaways:
  • SC overrules a series of prior rulings which held that pledgee becomes the ownerof pledged shares upon invocation.
  • SC holds that even though pledgee is recorded as beneficial owner upon invocation, pledgee only receives ‘special rights’ and not ‘ownership’ over pledged shares.
  • The term ‘actual sale’ means sale to a third party, not to the pledge.
  • Takeover Code and other legislations may need a ‘holistic review’ in view of thisruling.
  • Approach to regulatory filings and compliances will need to be reassessed – whoholds the ownership and voting rights?

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