Delhi High Court puts a quietus to the uncertainty prevailing on account of absence of a suitable procedure in the Depositories Act, 1996 or the SEBI (Depositories and Participant) Regulations, 2018 concerning substitution of the name of an erstwhile Pledgee with a new Pledgee

1. In an important judgment relating to the scope and ambit of Section 5 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”), the Hon’ble Delhi High Court has ruled that an Asset Reconstruction Company (“ARC”), acquiring a non-performing asset from a bank, is deemed to be the lender and gets all the rights of the bank. (See Judgment and Order dated 6 December 2022 in the case of UV Asset Reconstruction Company Ltd. vs. UOI & Ors, WP (C) No. 15395 of 2022).

Facts

2. In the case at hand, Burnpur Cements Limited (“BCL”) had availed term loans from a consortium of lenders where State Bank of India (“SBI”) was the lead bank. To secure the loan facilities extended to it, BCL (as the Pledgor) had pledged certain shares in favour of SBI (i.e. the Pledgee). The Managing Director of BCL was also one of the pledgors. BCL and SBI were recorded as Pledgor and Pledgee in the records of the Depository. As BCL did not repay the loans, its account was declared as a non-performing asset (“NPA”) by SBI.

3. Subsequently, pursuant to a Debt Assignment Agreement, an ARC acquired BCL’s account from SBI along with all the underlying securities. This Debt Assignment Agreement was entered into in accordance with Section 5 of the SARFAESI Act.

4. When BCL and SBI were recorded as Pledgor and Pledgee in the records of the Depository, the same was done after following the procedure prescribed in the SEBI (Depositories and Participants) Regulations, 2018 (dealing with manner of creating pledge or hypothecation). However, both the Depositories Act, 1996 and the above regulations are silent on the procedure to be followed if the name of the Pledgee has to be substituted with a new Pledgee. They also do not provide any guidance in situations where the Pledgor has objected to the substitution, and whether in such a situation, his consent or no-objection is necessary.

5. In the above background, when the ARC requested the Depository to update its records, the Depository intimated the Pledgor, who objected to the request for substitution. As such, the substitution could not be given effect to. Feeling aggrieved, the ARC filed the writ petition seeking a clarification that once an ARC has acquired the financial assets of any bank or financial institution (including the right to be the Pledgee in relation to pledged shares), its name must be recorded in the records of the Depository without there being any need to call for a non-objection from the original Pledgor.

Findings

6. The Hon’ble High Court has ruled that:

• SARFAESI Act envisages acquisition of financial assets of any bank or financial institution by an ARC;
• If a bank or a financial institution is a lender in relation to any financial assets that are acquired by an ARC from such bank or financial institution, then the ARC will be deemed to be the lender and all the rights of the bank or financial institution will vest in the ARC in relation to such financial assets;
• If an ARC has acquired an NPA of a borrower from a lender, alongwith all assets, including shares which the borrower (i.e. Pledgor) had pledged in favour of the lender (i.e. Pledgee), then the ARC becomes the new Pledgee – which must be recognized by all statutory authorities.

7. Pertinently, the Hon’ble High Court has noted that the present regime , the Depositories Act, 1996 and the SEBI (Depositories and Participant) Regulations, 2018 do not lay down any procedure pursuant to which the Depository can substitute the name of the erstwhile Pledgee with the new Pledgee. Having noted that, the Hon’ble High Court has, however, held that since all rights of the bank or financial institution already stand vested in the ARC (in view of Sections 5(2) and 5(3) of the SARFAESI Act), the Depository must incorporate such changes in its records; and such incorporation can be done even if the Pledgor objects to such substitution.

8. This is a significant decision in that it has given effect to the wide amplitude of the language employed in Section 5 of the SARFAESI Act. At the same time, it has put a quietus to the uncertainty which prevailed on account of absence of a suitable procedure in the Depositories Act, 1996 and the SEBI (Depositories and Participant) Regulations, 2018 governing substitution of the name of an erstwhile Pledgee with a new Pledgee.

JSA team represented the Depository – National Securities Depository Limited.

JSA Dispute Team Comprised Partner – Sidharth Sethi, Associate – Avinash Das, and Junior Associate – Rishabh Yadav.