By TIOL News Service

NEW DELHI, SEPT 25, 2014: THE issues before the Bench are - Whether when a Member of the BSE defaults, the stock exchange gets lien over member's securities and such lien will have precedence over income tax dues; Whether rules made by stock exchanges in exercise of powers conferred by the Securities Act are subordinate legislation and Whether the lien of the stock exchange by Rule 43 is conferred by Rules under the statute - Whether the provisions of Income tax Act provides for any paramountancy of dues. And the verdict goes against the Revenue.

Facts of the case

The appellant, the Bombay Stock Exchange (BSE), by a notice declared one of its member Mr. Suresh Damji Shah as "defaulter" upon his failure to meet his obligations and discharge his liabilities. Consequently, the Income Tax Department issued notice u/s 226(3) asking the Appellant for auctioning of Mr. Shah's membership card as the sum realized from such auction was to meet income tax dues of Mr. Shah amounting to Rs. 25.43 lakhs. In reply of the said notice, the Appellant stated that the membership right was a personal privilege and inalienable; and upon death or default of a member, his right of nomination would cease and vest in the Exchange and accordingly the membership right of Mr. Shah had vested with the Exchange on him being declared a defaulter. The Appellant also stated that since the Exchange was the actual owner of the membership card, no amount of tax arrears of Mr. Shah were payable by it. However, rejecting the reply of the Appellant, the Department passed a prohibitory order restraining the Stock Exchange from making any payment relating to Mr. Shah to any person whomsoever otherwise than to the Department. The Appellant requested the Department for withdrawal of the same, but the Department refused to recall its prohibitory order. Accordingly, the Appellant filed writ before the High Court, however, it was rejected.

In an appeal before the Supreme Court, the Counsel for the appellant submitted that the sale proceeds of a membership card and the membership card itself being only a personal privilege granted to a member could not be attached by the Department at any stage. The moment a member was declared a defaulter, all rights qua the membership card of the member would cease and his right of nomination would also vest in the Stock Exchange. The counsel on a conjoint reading of Rule 38 and 44, submitted that all securities in the form of shares that were given by a member would be transferred and held either in the name of the trustees of the Stock Exchange or in the name of a Bank which was approved by the Governing Board. By operation of Rule 44, on termination of the membership of a broker, whatever remains by way of security after clearing all debts had to be "transferred" either to him or upon his direction or in the absence of such direction to his legal representatives. It was further submitted that what was contemplated was a transfer of these shares by virtue of which the member ceases to be owner of these shares for the period that they were "transferred" and this being so, the Tax Department could not lay their hands on these shares or the sale proceeds thereof as the member ceases to have ownership rights of these shares. The counsel also submitted that by virtue of Rule 43, the Stock Exchange had a first and paramount lien for any sum due to it, and that this made it a secured creditor so that in any case income tax dues would not to be given preference over dues to secured creditors.

However, counsel for Revenue contended that on a conjoint reading of the Rules and the Bye-Laws, a membership card might be said that it was not directly attachable, but there were indirect ways of attaching the same. Further, on a conjoint reading of the various Rules relating to member’s security, it was clear that the expression "transferred" would not refer to transfer of ownership but would refer only to the delivery made of shares for the purpose of realization in case a member defaults. He further contended that the mere fact that a lien was provided in the Rules did not make such lien a statutory lien and that therefore Government dues would have a first preference over all the dues of the Stock Exchange.

Having heard the parties, the Supreme Court held that,

++ a reading of Rules 5 and 9 lead to the conclusion that a membership card is only a personal permission from the Stock Exchange to exercise the rights and privileges that may be given subject to Rules, Bye-Laws and Regulations of the Exchange. Further, the moment a member is declared a defaulter, his right of nomination shall cease and vest in the Exchange because even the personal privilege given is at that point taken away from the defaulting member. The matter is thus no longer res integra. This Court in case of Isha Valimohamad and Anr. vs. Haji Gulam Mohamad & Haji Dada Trust, held that no accrued right to property was ever vested in the defaulting member. it is seen that Rule 38 of the Exchange Rules provides how securities are to be "held' which is clear from the marginal note appended to it. What falls for construction is the expression "securities shall be transferred to and held'. It is clear therefore that the expression "transfer" can depending upon its context mean transfer of ownership or transfer of possession. It is clear that what is transferred is only possession as the member only "deposits" these securities. Further, as has been held by this Court in case of Vasudev Ramchandra Shelat vs. Pranlal Jayanand Thakur & Ors., a share transfer can be accomplished by physically transferring or delivering a share certificate together with a blank transfer form signed by the transferor. The transfer of shares in favour of the Stock Exchange is only for the purposes of easy liquidity in the event of default. Therefore, the expression "transferred' must take colour from the expression "lodged" in Rule 38 when it comes to deposits of cash. Understood in this sense, transfer only means delivery for the purposes of holding such shares as securities. This is also clear from the language of Rule 38 when it says "such deposit shall be entirely at the risk of the member providing the security”. Therefore, when Rule 44 speaks of repayment and transfer, it has to be understood in the above sense as the security is being given back to the member under the circumstances mentioned in the Rule;

++ it is a settled law that Government debts have precedence only over unsecured creditors as this was held in Dena Bank v. Bhikabhai Prabhudas Parekh Company. Therefore, we find force in the submission of the Stock Exchange that the moment the Stock Exchange has a lien over the member's securities, it would have precedence over income tax dues. In the present case, the first and paramount lien given to the Stock Exchange is by Rule 43 u/s 8 of the Securities Contract Act. Sections 7A, 8 and 30 of the said Act deal with the power of recognized Stock Exchanges making rules restricting voting rights; rules relating to Stock Exchanges generally including membership thereof; and rules to carry out the purposes of the Act respectively. Whereas, the rules made u/s 7A and 8 are made by recognized Stock Exchanges with the approval of the Central Government and published in the Official Gazette, rules made u/s 30 are made by the Central Government itself for purposes of carrying into effect the objects of the Securities Act. It is seen that whether a rule is made u/s 7A, 8 or 30, all rules made under the Act are to be laid before Parliament, making it clear thereby that rules made under each of these provisions are statutory in nature. It is thus clear that Stock Exchanges who make rules in exercise of powers conferred by the Securities Act are equally "Rules" and therefore subordinate legislation. This makes it amply clear that the lien spoken of by Rule 43 is a lien, conferred by Rules under a statute;

++ the main thing to be noticed is that the Income Tax Act does not provide for any paramountcy of dues by way of income tax. This is why the Court in Dena Bank's case has held that Government dues only have priority over unsecured debts and in so holding the Court referred to a judgment in Giles vs. Grover, in which it has been held that the Crown has no precedence over a pledgee of goods. In the present case, the common law of England qua Crown debts became applicable by virtue of Article 372 of the Constitution which states that all laws in force in the territory of India immediately before the commencement of the Constitution shall continue in force until altered or repealed by a competent legislature or other competent authority. Therefore, in the instant case, the lien possessed by the Stock Exchange makes it a secured creditor. That being the case, it is clear that whether the lien under Rule 43 is a statutory lien or is a lien arising out of agreement does not make much of a difference as the Stock Exchange, being a secured creditor, would have priority over Government dues.

(See 2014-TIOL-81-SC-IT-LB)