Contract Act Does Not Recognize Sale Of Pledged Goods By Pawnee To Self : Supreme Court

The Supreme Court has held that the Indian Contract Act 1872 does not recognize the sale of the pledged goods by a pawnee to himself in the event of default of payment by the pawnor.The Court noted that as per Section 176 of the Contract Act, in the event of default by the pawnor, the pawnee may bring a suit or sell the pledged items on giving the pawnor reasonable notice of the sale.As per Section 177, the pawnor has right to redeem the pledged goods before the actual sale of them. The Court further noted that a pawnee has only special rights over the pledged goods - to retain them as security for the debt- and no general rights over them.Referring to various precedents, and analyzing the differences between "ownership", "pledge" and "mortgage", a bench comprising Justices MR Shah and Sanjiv Khanna observed that the law does not recognize the pawnee's sale to self. Sale to self is regarded as a case of "conversion" and not "actual sale" in terms of Section 177."Several other High Courts have similarly opined and we agree that the Contract Act does not conceive of sale of the pawn to self and consequently, the pawnor's right to redemption in terms of Section 177 of the Contract Act survives till 'actual sale'", the bench observed.The bench also overruled the solitary judgment of the single judge of the Punjab and Haryana High Court Dhani Ram and Sons v. The Frontier Bank Ltd. and Another AIR 1962 P&H 321 which held that the sale of the pawned goods by the pawnee to himself is not void, and the pawnee was held to be the legal owner of the pledged shares. The bench said that this decision proceeds on the incorrect understanding of precedents and is to be overruled.The bench made these observations in the case PTC India Financial Services Ltd versus Venkateswarlu Kari and another, in which it was considering the interplay between the Contract Act and the Depositories Act, 1996 in relation to the pledge of shares.One company(MHPL) had pledged its shares with the appellant PTC India Financial Services Ltd (PIFSL) company as guarantee for a loan. After the pledge, those shares were registered with the depository with the appellant as the "beneficial owner". The issue was whether such registration as "beneficial owner" of shares would amount to sale of shares. This question arose in the insolvency proceedings of the debtor company. When PIFSL raised a claim as a financial debtor, MHPL(the guarantor company which pledged the shares) objected.MHPL argued that the PIFSL has sold the pledged shares and has thereby realized its debts and therefore, it is MHPL which will step into the shoes of the financial creditor.It is in this context that the bench examined the issue if sale to self by the pawnee is recognized by the Contract Act.Depositories Act permits pledgeThe Court noted that Section 12 of the Depositories Act permits pledge and hypothecation of securities held by a depository."Clearly, Section 12 of the Depositories Act is not ex-facie inconsistent with pawnee and pawnor's contractual rights and obligations under the Contract Act and the common law", the judgment authored by Justice Khanna stated.On an analysis of the provisions of the Depositories Act, it was held that they "do not in any manner contradict or lay down a rule which is contrary to the provisions of Sections 176 and 177 of the Contract Act"."These sections(176 and 177), given the objective and purpose behind them, would still apply to any pledge deed and do not get diluted or overridden by the provisions or requirements of the Depositories Act", the judgment added.Sections 176 and 177 apply to pawned dematerialised securities as they apply to other pawned goods"Given the nature and requirements under Section 12 or Regulation 58 of the SEBI (Depositories & Participants) Regulations 1996, do not by implication or due to conflict over-write and undo the legislative mandate of Sections 176 and 177 of the Contract Act. We do not read any legislative intent in the Depositories Act and the 1996 Regulations to change the law of pledge requiring issue of reasonable notice; or as allowing sale to self, or abolishing the right of the pawnor to redeem the pledged goods till 'actual sale'. Sections 176 and 177 are not obliterated, in so far as they would equally apply to pawned dematerialised securities as they apply to other pawned goods".Recording of pawnee as beneficial owner in depository is not "actual sale"The Court held that action on the part of the 'depository' recording the pawnee as the 'beneficial owner' is not 'actual sale' for the purposes of Section 177. The right of redemption would cease on the 'actual sale', that is, when the 'beneficial owner' sells the dematerialised securities to a third person."In The Official Assignee versus Madholal Sindhu AIR 1947 Bom 217 and several other decisions, the expression 'actual sale' in Section 177 of the Contract Act has been interpreted to mean lawful sale to a third person and not conversion or...

Contract Act Does Not Recognize Sale Of Pledged Goods By Pawnee To Self : Supreme Court

Manu Sebastian

The same principle applies to the pledge of shares under the Depositories Act, the Court held.

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