Casually Freezing DEMAT Accounts Is Draconian, Violates Article 300A: Bombay High Court Imposes ₹80 Lakh Costs On BSE, NSE, SEBI

The Bombay High Court has awarded a compensation of Rs. 30 lakhs and Rs. 50 lakhs to two individuals whose Demat accounts were frozen at the behest of the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE), following the directives of the Securities and Exchange Board of India (SEBI).Justice G. S. Kulkarni and Justice Firdosh P. Pooniwalla observed that the arbitrary freezing of demat accounts by the authorities violated the right to property under Article 300A of the Constitution. The Court remarked “…we are of the clear opinion that BSE/NSE as also SEBI has clearly failed to discharge their duties and to act in accordance with law so as to deprive the petitioner of his shares in the demat account held by him which certainly, in our opinion, is an infringement of petitioner's right guaranteed under Articles 14, 21 and 300A of the Constitution. Any casual approach to such infringement certainly would not be an acceptable approach and in fact would strengthen the hands of these authorities to repeat such illegalities.”The petitioners, Dr. Pradeep Mehta and Neil Pradeep Mehta challenged the actions of the BSE and the NSE under the directives of SEBI, to freeze their Demat accounts. Dr. Pradeep Mehta is a practising doctor. He had invested in a company named Shrenuj & Company Limited. Shrenuj was promoted in 1989 by his father-in-law. His son, Neil Pradeep Mehta also had investments in Shrenuj. In 2017, BSE issued a letter to Shrenju regarding non-compliance with the SEBI (LODR) Regulations and imposed a fine on it. The freezing of the petitioners' demat accounts was done based on SEBI circulars that placed liability on promoters of the company to pay fines and penalties for non-compliance of regulatory requirements by the company. The respondent authorities not only froze the petitioners' shareholding in Shrenuj but also their shares in ITC Limited. Dr. Pradeep Mehta contends that he was classified as a 'promoter' of Shrenuj even after the formation of the company. He contended that he was never part of the management of Shrenuj and had no control over its affairs, thus it was incorrect to consider him as the promoter.Promoter's role in the company The Court stated that a promoter is a person who initiates the scheme for the formation of a company, gets memorandum and articles prepared and executed, and finds the first directors of the company among other things. It observed that a person's status as a promoter is contingent upon his actual involvement in the formation of the company which is a question of fact. It noted that the relationship between promoter and company is fiduciary and this would stand discontinued once the Board of Directors start managing the affairs of the company. The Court noted that there needs to be robust evidence regarding the role of the promoter. It noted that consideration needs to be given to whether the promoter has an active role in the company. “This would necessarily involve robust evidence to be available and considered in regard to the role of the promoter not only qua the company but also whether any active role of the promoter exists qua the shareholders at large and whether the fiduciary capacity in which the promoter is required to discharge his role in formation of a company, would still bind him for various compliances, under the SEBI Regulations or it would be the liability of the company managed by the Board of Directors for achieving all the compliances, which are necessary to protect the interest of the investors who subscribe to the shares of a company.” It remarked that if no such consideration is given, it would lead to serious prejudice, thus rendering any action of penalty or freezing of any Demat account of a promoter to be illegal. In the present case, the Court noted that the petitioner, who is a practising gynaecologist, did not exceed his professional position to take an interest in the formation of Shrenuj or to manage its day-to-day affairs. It stated that after the incorporation of the company and the constitution of its Board of Directors, the status and role of the petitioner as a promoter came to an end. It thus held that the non-compliance with SEBI (LODR) Regulations could not have been imposed on the petitioner. Freezing shares from non-defaulting company illegal The Court observed that there are no explicit provisions which provide that SEBI has the power to attach the securities of a promoter, which is held in a company other than the one of which he is a promoter. It noted that the SEBI Act does not confer any authority to freeze the demat account of the promoter with respect to shares held by him in a company other than the defaulting company of which he is a promoter. It stated that no provisions provide for “...such drastic order to be passed against the promoter which is in the nature of a penalty without even a notice being furnished to him.” It observed that under Regulation 98(1) of SEBI (LODR) Regulations, the action of...

Casually Freezing DEMAT Accounts Is Draconian, Violates Article 300A: Bombay High Court Imposes ₹80 Lakh Costs On BSE, NSE, SEBI

Sanjana Dadmi

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