October 7, 2015
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The Stock Exchange, Bombay …….Appellant
V.S. Kandalgaonkar & Ors. ..….Respondents1. BACKGROUND OF THE CASE: The case pertains to the Income Tax Authorities’ right to recover its dues from the defaulting members of the Stock Exchange, by claiming over the amount realized by the stock exchange through auction of the membership card of such defaulter. 2. APPELLANT’S CONTENTIONS: That the membership card is only a personal privilege granted to a member and is inalienable. It cannot be attached by the Income Tax Department at any stage. The moment a member is declared as a defaulter all rights attached to the membership card of the member cease and even the right of nomination vests in the stock exchange. As per Rules 38 read with 44 of the rules made by the Stock Exchange all securities in the form of shares that are given by a member shall be transferred and held either in the name of the trustees of the stock exchange or in the name of a bank which is 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 has to be “transferred” either to him or as he shall direct or in the absence of such direction to his legal representatives. Further by virtue of Rule 43, the Stock Exchange has 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. 3. RESPONDENT’S CONTENTIONS The rules made by the Stock Exchange make it 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. The counsel of the Respondent further argued 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. 4. RELEVANT RULES OF THE STOCK EXCHANGE REFERRED TO HEREIN: a. Rule 5. Membership a personal privilege- The membership shall constitute a personal permission from the Exchange to exercise the rights and privileges attached thereto subject to the Rules, Bye-laws and Regulations of the Exchange. b. Rule 7. Right of nomination- Subject to the provisions of these Rules a member shall have the right of nomination, which shall be personal and non-transferable. c. Rule 9. Right of nomination of deceased or defaulter member- On the death or default of a member his right of nomination shall cease and vest in the exchange. d. Rule 10. Forfeited or lapsed right of membership- When a right of membership is forfeited to or vests in the exchange under any rule, bye-law or regulation of the exchange for the time being in force it shall belong absolutely to the exchange free of all rights, claims or interest of such member or any person claiming through such member and the governing board shall be entitled to deal with or dispose of such right of membership as it may think fit. e. Rule 16. Allocation in order of priority- When as provided in these rules the governing board has exercised the right of nomination in respect of a membership vesting in the exchange the consideration received therefore shall be applied to the following purposes and in the following order of priority namely – (i) dues of exchange and clearing house, (ii) liabilities relating to contracts and (iii) the payment of the surplus if any to the funds of the exchange: provided that the exchange in general meeting may at its absolute discretion direct that such surplus be disposed of or applied in such other manner as it may deem fit. f. Rule 37. Form of security- The security to be furnished by a member shall be provided either by a deposit of cash or it may be provided in the form of a deposit receipt of a bank approved by the governing board or in Securities approved by the Governing Board subject to such terms and conditions as the governing board may from time to time impose. g. Rule 38. Security how held- Deposits of cash shall be lodged in a bank approved by the governing board and bank deposit receipts and securities shall be transferred to and held either in the names of the trustees of the exchange or in the name of a Bank approved by the governing board and lodged with a bank approved by the governing board. Such deposit shall be entirely at the risk of the member providing the security but it shall be held by the bank solely for and on account of the exchange at the absolute discretion of the exchange without any right whatever on the part of such member or those in his right to call in question, the exercise of such discretion. h. Rule 41. Change of Security- A member may withdraw any security provided by him if he first provides in lieu thereof other security of sufficient value to the satisfaction of the Governing Board. i. Rule 43. Lien on Security- The security provided by a member shall be subject to a first and paramount lien for any sum due to the exchange or to the clearing house by him or by the partnership of which he may be a member and for the due fulfillment of his engagements, obligations and liabilities or of the partnership of which he may be a member arising out of or incidental to any bargains, dealings, transactions and contracts made subject to the rules, bye-laws and regulations of the exchange or anything done in pursuance thereof. j. Rule 44. Return of Security- On the termination of his membership or on his ceasing to carry on business on the exchange or on his working as a representative member or on his death all security not applied under the rules, bye-laws and regulations of the exchange shall at the cost of the member be repaid and transferred either to him or as he shall direct or in the absence of such direction to his legal representatives. 5. ISSUES & THEIR JUDGMENTS A. Whether the membership card is a privilege or a right for the defaulting member. The Court held that as per Rules 5 and 9 leads to the conclusion that a membership card is only a personal permission from the Stock Exchange to exercise rights and privileges, which can be taken away along with the right of nomination from the defaulting member. The Court, relied on the Ahmedabad Stock Exchange case, where it was held that the membership under the above mentioned rules is merely a personal privilege granted to a member and is non- transferrable and incapable of alienation by the member and concluded that once a right of nomination vests in the Stock Exchange under the rules, that right belongs to the stock exchange absolutely. b. Whether the phrase ‘membership security’, means “securities shall be transferred to and held” The Court construed the expression “securities shall be transferred to and held” so as to be providing only for transfer by delivery of security to the Stock Exchange, while the ownership still remains with the member. It was noted that the expression “transferred” must take colour from the expression “lodged”. So, when understood in this sense, transfer only means delivery for the purposes of holding such shares as securities. Thus, making it clear that such member continues to be the owner of the said shares by way of security for otherwise they cannot possibly be at the member’s risk. c. Whether the Stock Exchange has a first and paramount lien for any sum due to it 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. 6. CONCLUSION: The Stock Exchange’s appeal was allowed and the impugned judgment passed by the Division Bench of the Bombay High Court was set aside.