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Priority of Lien = Stock Exchange Lien over the Defaulter account – Rights of Income Tax department for charging the account of Defaulter for his income tax arrears – Apex court held that since the lien possessed by the Stock Exchange makes it a secured creditor and as such the lien 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. as it is settled law that no Government holds better right than the secured creditor over the pledged property of defaulter = CIVIL APPEAL NO.4354 of 2003 The Stock Exchange, Bombay …….Appellant Versus V.S. Kandalgaonkar & Ors. ..….Respondents = 2014 – Sept.Month – http://judis.nic.in/supremecourt/imgst.aspx?filename=41963

Priority of Lien = Stock Exchange Lien over the Defaulter account – Rights of Income Tax department for charging the account of Defaulter for his income tax arrears – Apex court held that since  the  lien possessed by the Stock Exchange makes it a secured creditor and as such the lien 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. as it is settled law that no Government holds better right than the secured creditor over the pledged property of defaulter =

a  member  of  a  Stock

Exchange being declared a defaulter. The Income Tax Department  claims  that it has priority over all debts owed by the  defaulter  member,  whereas  the Stock Exchange, Bombay claims otherwise.=

      By a notice dated 29th June 1994, the Stock Exchange, Bombay  declared

Shri Suresh Damji Shah as a  defaulter  with  immediate  effect  as  he  had

failed to meet his obligations and discharge his liabilities.  By  a  notice

dated 5th October 1995 issued under Section 226 (3) of the Income  Tax  Act,

the Income Tax Department wrote to the Stock Exchange  and  told  them  that

Shri Shah’s membership  card  being  liable  to  be  auctioned,  the  amount

realized at  such  auction  should  be  paid  towards  Income  Tax  dues  of

Assessment Year 1989-90 and 1990-91 amounting to Rs.25.43 Lakhs.  The  Stock

Exchange, Bombay by its letter dated 11th October 1995 replied to  the  said

notice and stated that under Rules  5  and  6  of  the  Stock  Exchange  the

membership right is a  personal  privilege  and  is  inalienable.   Further,

under Rule 9 on death or default of a member his right of  nomination  shall

cease and vest in the Exchange and accordingly the membership right of  Shri

Shah has vested with the Exchange on his being declared a  defaulter.   This

being the case, since the Exchange is now and has always been the  owner  of

the membership card, no amount of tax arrears of Shri Shah  are  payable  by

it.  By a prohibitory order dated 10th May 1996, the Income  Tax  Department

prohibited and  restrained  the  Stock  Exchange  from  making  any  payment

relating to Shri Shah to any person whomsoever otherwise than to the  Income

Tax Department.  The amount claimed in the prohibitory order was  stated  to

be Rs. 37.48 Lakh plus interest.  On 18th July 1996, the Solicitors  of  the

Stock Exchange, Bombay wrote to the Income Tax Department calling upon  them

to withdraw the prohibitory order dated 10th May 1996 in view  of  the  fact

that the membership right of the Exchange is a  personal  privilege  and  is

inalienable.  By a letter dated  27th  December  1996,  the  Tax  Department

wrote back to the Bombay Stock Exchange refusing to recall  its  prohibitory

order.  Meanwhile,  Shri  Shah  applied  to  be  re-admitted  to  the  Stock

Exchange which application was  rejected  by  the  Stock  Exchange  on  13th

February, 1997.=

 

 It is no doubt true that the Supreme Court  held  that  the  statutory

lien of a Harbour  authority  over  a  vessel  is  a  paramount  lien  which

overrides the claim of all  other  creditors  including  secured  creditors.

The question, however, in  the  present  case  is  somewhat  different.  The

question is whether the lien exercised under Rule 43 by the  Stock  Exchange

can be said to be a superior right to  income  tax  dues  which  may  become

payable by virtue of the Stock Exchange being a secured creditor.

23.   It  was  argued  that  Black’s  Law  Dictionary  5th  Edition  defines

“statutory lien” as follows:

      “Statutory lien: A lien  arising  solely  by  force  of  statute  upon

specified circumstances  or  conditions,  but  does  not  include  any  lien

provided by or dependent upon an agreement to give security, whether or  not

such lien is also provided by or is also dependent upon statute and  whether

or not the agreement or lien is made fully effective by Statute.”

      Based on this it was further argued that such lien would  not  include

any lien provided by or dependent on an agreement to give security,  whether

or not such lien is also provided by or dependent upon statute, and  whether

or not such lien is made fully effective by statute.

      24.   The first 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 (supra) held that Government  dues  only  have

priority over unsecured debts and in so holding  the  Court  referred  to  a

judgment in Giles vs. Grover (1832) (131) English Reports 563  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.  In  fact,

in Collector of Aurangabad and Anr. vs. Central Bank of India and Anr.  1967

(3) SCR 855  after referring to various authorities held that the  claim  of

the Government to priority for  arrears of income tax dues  stems  from  the

English common law doctrine of priority of  Crown debts and has  been  given

judicial recognition in British India prior to 1950 and was  therefore  “law

in force” in  the  territory  of  India  before  the  Constitution  and  was

continued by Article 372 of the Constitution (at page 861, 862).

      25.   In  the  present  case,  as  has  been  noted  above,  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.

26.   The three issues are answered as above.  The Stock  Exchange’s  appeal

is allowed and the impugned judgment passed by the  Division  Bench  of  the

Bombay High Court is set aside.

2014 – Sept.Month – http://judis.nic.in/supremecourt/imgst.aspx?filename=41963

REPORTABLE

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO.4354 of 2003

The Stock Exchange, Bombay …….Appellant

Versus

V.S. Kandalgaonkar & Ors.
..….Respondents

J U D G M E N T

R.F.Nariman, J.

1. The present matter arises as the result of a member of a Stock
Exchange being declared a defaulter. The Income Tax Department claims that
it has priority over all debts owed by the defaulter member, whereas the
Stock Exchange, Bombay claims otherwise.

2. The facts necessary to appreciate the controversy are as follows:

By a notice dated 29th June 1994, the Stock Exchange, Bombay declared
Shri Suresh Damji Shah as a defaulter with immediate effect as he had
failed to meet his obligations and discharge his liabilities. By a notice
dated 5th October 1995 issued under Section 226 (3) of the Income Tax Act,
the Income Tax Department wrote to the Stock Exchange and told them that
Shri Shah’s membership card being liable to be auctioned, the amount
realized at such auction should be paid towards Income Tax dues of
Assessment Year 1989-90 and 1990-91 amounting to Rs.25.43 Lakhs. The Stock
Exchange, Bombay by its letter dated 11th October 1995 replied to the said
notice and stated that under Rules 5 and 6 of the Stock Exchange the
membership right is a personal privilege and is inalienable. Further,
under Rule 9 on death or default of a member his right of nomination shall
cease and vest in the Exchange and accordingly the membership right of Shri
Shah has vested with the Exchange on his being declared a defaulter. This
being the case, since the Exchange is now and has always been the owner of
the membership card, no amount of tax arrears of Shri Shah are payable by
it. By a prohibitory order dated 10th May 1996, the Income Tax Department
prohibited and restrained the Stock Exchange from making any payment
relating to Shri Shah to any person whomsoever otherwise than to the Income
Tax Department. The amount claimed in the prohibitory order was stated to
be Rs. 37.48 Lakh plus interest. On 18th July 1996, the Solicitors of the
Stock Exchange, Bombay wrote to the Income Tax Department calling upon them
to withdraw the prohibitory order dated 10th May 1996 in view of the fact
that the membership right of the Exchange is a personal privilege and is
inalienable. By a letter dated 27th December 1996, the Tax Department
wrote back to the Bombay Stock Exchange refusing to recall its prohibitory
order. Meanwhile, Shri Shah applied to be re-admitted to the Stock
Exchange which application was rejected by the Stock Exchange on 13th
February, 1997.

3. The Stock Exchange then filed a Writ Petition being Writ Petition
No.220 of 1997 dated 24th December 1996 in which the following reliefs were
claimed:

that this Hon’ble Court may be pleased to issue a writ of certiorari or a
writ in the nature of certiorari or any other appropriate writ, order or
direction under Article 226 of the Constitution of India calling for the
records in relation to the recovery proceedings initiated by the
Respondents against Mr. Suresh D. Shah and after going through the same and
examining the legality and validity thereof to quash and set aside the
impugned notice dated 5th October, 1995 and the impugned order dated 10th
May 1996, Impugned Notice/ letter dated 27th December 1996 being Exhibits
“D”, “F” and “H” hereto;

that this Hon’ble Court may be pleased to issue a writ of mandamus or any
other appropriate writ, order or direction under Article 226 of the
Constitution of India ordering and directing the Respondents to withdraw
forthwith the recovery proceedings initiated against in respect of the dues
of Mr Suresh D. Shah and ordering and directing the Respondents to withdraw
forthwith the impugned notice dated 5th October, 1995 and the impugned
notice dated 5th October, 1995 and the impugned prohibitory Order dated
10th May, 1996, Impugned Notice/letter dated 27th December 1996 being
Exhibits “D”, “F” and “H” hereto;

that this Hon’ble Court be pleased to permit the Petitioner to exercise the
right of nomination in respect of the membership right of Suresh D. Shah in
favour of such person as the petitioner may decide and to apply the
consideration received therefore and also appropriate all other securities
placed with the Petitioner by Suresh d. Shah and which have vested in the
Petitioner in accordance with the Rules, Bye-laws and regulations of the
Petitioner;

4. The Writ Petition was finally heard and by a judgment dated 27th
March 2003, most of the contentions of the Stock Exchange were rejected and
the Writ Petition was dismissed.

5. A Special Leave Petition was filed against the said judgment being
SLP(Civil) No. 8245 of 2003 in which, by an order dated 7th May 2003, the
operation of the judgment was not stayed to the extent that it specifically
directed the petitioner to make certain payments and handover securities to
the Income Tax Department. However, in so far as the judgment declared law,
the operation of such declaration of law was stayed.

6. As this Civil Appeal raises important questions of law both from the
point of view of the Bombay Stock Exchange and the Income Tax Department,
we are going into the matter in some detail.

7. Section 226 of the Income Tax Act provides for a garnishee notice in
the following terms:

“Section 226 3(i) The assessing officer or tax recovery officer may, at any
time or from time to time, by notice in writing require any person from
whom money is due or may become due to the assessee or any person who holds
or may subsequently hold money for or on account of the asssessee, to pay
the assessing officer or tax recovery officer either forthwith upon the
money becoming due or being held or at or within the time specified in the
notice (not being before the money becomes due or is held) so much of the
money as is sufficient to pay the amount due by the assessee in respect of
arrears or the whole of the money when it is equal to or less than that
amount.”

Under Sub-section (x), if the person to whom a notice is sent fails to make
payment in pursuance thereof he shall be deemed to an assessee in default.
Rule 26 of Schedule II of the Income Tax Act then provides:

“26. Debts and Shares, etc. – (1) In case of—

a debt not secured by a negotiable instrument,
a share in a corporation, or
other movable property not in the possession of the defaulter except
property deposited in, or in the custody of, any court,the attachment shall
be made by a written order prohibiting, —
in the case of the debt – the creditor from recovering the debt and the
debtor from making payment thereof until the further order of the tax
recovery officer;
in the case of the share – the person in whose name the share maybe
standing from transferring the same or receiving any dividend thereon;
in the case of the other movable property (except as aforesaid) – the
person in possession of the same from giving it over to the defaulter.
(2) A copy of such order shall be affixed on some conspicuous part of the
office of the tax recovery officer, and another copy shall be sent, in the
case of the debt, to the debtor, in the case of the share, to proper
officer of the corporation, and in the case of the other movable property
(except as aforesaid), to the person in possession of the same.

(3) A debtor prohibited under clause (i) of sub-rule (1) may pay the amount
of his debt to the tax recovery officer, and such payment shall discharge
him as effectually as payment to the party entitled to receive the same.”

Sections 8 and 9 of the Securities Regulation Act, 1956 deal with
Rules, Regulations and Bye-Laws to be made in respect of Stock Exchanges.
Sections 8 and 9 of the said Act read as follows:

“8. Power of Central Government to direct rules to be made or to make rules-
(1) Where, after consultation with the governing bodies of stock exchanges
generally or with the governing body of any stock exchange in particular,
the Central Government is of opinion that it is necessary or expedient so
to do, it may, by order in writing, together with a statement of the
reasons therefore, direct recognised stock exchanges generally or any
recognised stock exchange in particular, as the case may be, to make any
rules or to amend any rules already made in respect of all or any of the
matters specified in sub-section (2) of section 3 within a period of two
months from the date of the order.

(2) If any recognised stock exchange fails or neglects to comply with any
order made under sub-section (1) within the period specified therein, the
Central Government may make the rules for, or amend the rules made by, the
recognised stock exchange, either in the form proposed in the order or with
such modifications thereof as may be agreed to between the stock exchange
and the Central Government.

(3) Where in pursuance of this section any rules have been made or amended,
the rules so made or amended shall be published in the Gazette of India and
also in the Official Gazette or Gazettes of the State or States in which
the principal office or offices of the recognised stock exchange or
exchanges is or are situate, and, on the publication thereof in the Gazette
of India, the rules so made or amended shall, notwithstanding anything to
the contrary contained in the Companies Act, 1956 (I of 1956), or in any
other law for the time being in force, have effect, as if they had been
made or amended by the recognised stock exchange or stock exchanges, as the
case may be.

9. Power of recognised stock exchanges to make bye-laws.-

(1) Any recognised stock exchange may, subject to the previous approval of
the Securities and Exchange Board of India, make bye-laws for the
regulation and control of contracts.

(2) In particular, and without prejudice to the generality of the foregoing
power, such bye-laws may provide for—

(a) the opening and closing of markets and the regulation of the hours of
trade;

(b) a clearing house for the periodical settlement of contracts and
differences thereunder, the delivery of and payment for securities, the
passing on of delivery orders and the regulation and maintenance of such
clearing house;

(c) the submission to the Securities and Exchange Board of India by the
clearing house as soon as may be after each periodical settlement of all or
any of the following particulars as the Securities and Exchange Board of
India may, from time to time, require, namely;—

(i) the total number of each category of security carried over from one
settlement period to another;

(ii) the total number of each category of security, contracts in respect of
which have been squared up during the course of each settlement period;

(iii) the total number of each category of security actually delivered at
each clearing;

(d) the publication by the clearing house of all or any of the particulars
submitted to the Securities and Exchange Board of India under clause (c)
subject to the directions, if any, issued by the Securities and Exchange
Board of India in this behalf;

(e) the regulation or prohibition of blank transfers;

(f) the number and classes of contracts in respect of which settlements
shall be made or differences paid through the clearing house;

(g) the regulation, or prohibition of bundles or carry-over facilities;

(h) the fixing, altering or postponing of days for settlements;

(i) the determination and declaration of market rates, including the
opening, closing, highest and lowest rates for securities;

(j) the terms, conditions and incidents of contracts, including the
prescription of margin requirements, if any, and conditions relating
thereto, and the forms of contracts in writing;

(k) the regulation of the entering into, making, performance, rescission
and termination, of contracts, including contracts between members or
between a member and his constituent or between a member and a person who
is not a member, and the consequences of default or insolvency on the part
of a seller or buyer or intermediary, the consequences of a breach or
omission by a seller or buyer, and the responsibility of members who are
not parties to such contracts;

(l) the regulation of taravani business including the placing of
limitations thereon;

(m) the listing of securities on the stock exchange, the inclusion of any
security for the purpose of dealings and the suspension or withdrawal of
any such securities, and the suspension or prohibition of trading in any
specified securities;

(n) the method and procedure for the settlement of claims or disputes,
including settlement by arbitration;

(o) the levy and recovery of fees, fines and penalties;

(p) the regulation of the course of business between parties to contracts
in any capacity;

(q) the fixing of a scale of brokerage and other chargers;

(r) the making, comparing, settling and closing of bargains;

(s) the emergencies in trade which may arise, whether as a result of pool
or syndicated operations or cornering or otherwise, and the exercise of
powers in such emergencies, including the power to fix maximum and minimum
prices for securities;

(t) the regulation of dealings by members for their own account;

(u) the separation of the functions of the jobbers and brokers;

(v) the limitations on the volume of trade done by any individual member in
exceptional circumstances;

(w) the obligation of members to supply such information or explanation and
to produce such documents relating to the business as the governing body
may require.

(3) The bye-laws made under this section may—

(a) specify the bye-laws the contravention of which shall make a contract
entered into otherwise than in accordance with the bye-laws void under sub-
section (1) of section 14;

(b) provide that the contravention of any of the bye-laws shall render the
member concerned liable to one or more of the following punishments,
namely:—

(i) fine;

(ii) expulsion from membership;

(iii) suspension from membership for a specified period;

(iv) any other penalty of a like nature not involving the payment of money.

(4) Any bye-laws made under this section shall be subject to such
conditions in regard to previous publication as may be prescribed, and when
approved by the Securities and Exchange Board of India, shall be published
in the Gazette of India and also in the Official Gazette of the State in
which the principal office of the recognised stock exchange is situate, and
shall have effect as from the date of its publication in the Gazette of
India;

Provided that if the Securities and Exchange Board of India is satisfied in
any case that in the interest of the trade or in the public interest any
bye-law should be made immediately, it may, by order in writing specifying
the reasons therefore, dispense with the condition of previous
publication.”

8. As a number of rules of the Stock Exchange have been referred to in
the course of argument, we will set down those which are relevant for the
purposes of the question to be decided.

“Membership a Personal Privilege

5. 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.

Right of Nomination

7. Subject to the provisions of these Rules a member shall have the right
of nomination which shall be personal and non-transferable.

Right of Nomination of Deceased or Defaulter Member

9. On the death or default of a member his right of nomination shall cease
and vest in the Exchange.

Forfeited or Lapsed Right of Membership

10. 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.

Allocation in Order of Priority

16. 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 –

Dues of Exchange and Clearing House

first-the payment of such subscriptions, debts, fines, fees, charges and
other monies as shall have been determined by the Governing Board to be due
to the Exchange, to the Clearing House by the former member whose right of
membership vests in the Exchange.
Liabilities relating to Contracts

second-the payment of such debts, liabilities, obligations and claims
arising out of any contracts made by such former member subject to the
Rules, Bye-laws and Regulations of the Exchange as shall have been admitted
by the Governing Board:
Provided that if the amount available be insufficient to pay and satisfy
all such debts, liabilities, obligations and claims in full they shall be
paid and satisfied pro rata; and

Surplus

third-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.

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. Deposits of cash shall not carry interest and
the securities deposited by a member valued at the market price of the day
shall exceed the sum for the time being secured thereby by such percentage
as the Governing Board may from time to time prescribe.

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.

Change of Security

41. 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.

Lien on Security

43. 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.

Return of Security

44. 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.

Letter of Declaration

46. A member providing security under the provisions of these Rules shall
sign a Letter of Declaration in the form prescribed in Appendix F to these
Rules or in such other form as the Governing Board may from time to time
prescribe.

APPENDIX F

Member’s Security Declaration Form No. 1

(Rule 46)

The Governing Board,
The Stock Exchange,
Bombay.

Gentlemen,

Having been admitted as a member of the Stock Exchange and having handed to
you in terms of the Rules thereof to be deposited in
______________________(Name of Bank) in the name of the Exchange the sum of
Rs. 20,000 and/or having transferred to the names of the Trustees of the
Exchange and/or (Name of Bank) the securities mentioned below, I hereby
declare and agree that the said Security and any cash, stock, shares or
other securities that may be added to or substituted for the said Security
by arrangement with you are subject to a first and paramount lien for any
sum due to the Exchange or to the Clearing House by me/us or by the
partnership of which I may be a partner and for any sum due to any member
of the Exchange for the due fulfillment of my engagements, obligations and
liabilities or of the partnership of which I 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. I hereby further declare and agree that the said
Security and any cash, stock, shares or other securities that may be added
to or substituted for the said Security by arrangement with you are to be
held for you and on your account by the said Trustees and/or Bank(s) at
your absolute discretion without any right whatever on the part of myself
or those in my right to call in question the exercise of such discretion on
any ground whatever so that you may at your absolute discretion as
aforesaid apply and pay the same or the proceeds thereof (in case you shall
as you shall be fully entitled to do sell the same) or cause the same to be
applied and paid to or for behalf of the Exchange or the Clearing House to
whom I or any partnership of which I may be a partner may be indebted or to
or for behalf of any member of the Exchange to whom I or any partnership of
which I may be a partner may be indebted under a claim or claims arising
from any bargains, dealings, transactions and contracts made subject to the
Rules, Bye-laws and Regulations of the Exchange during the continuance of
my membership of the Exchange. If on the completion of all bargains,
dealings, transactions and contracts entered into before the termination of
my membership or on my ceasing to do business on the Exchange the said
Security or proceeds thereof shall not have been required for payment of my
or my said partnership liabilities as above provided the same or any
balance thereof then remaining will be returned to me and a receipt signed
by me that whatever cash, stock, shares or other securities or balance
thereof is/are so returned to me is/are all to which I am entitled in terms
hereof shall be final and conclusive and bar inquiry of any kind at the
instance of myself or any one in my right in respect thereof.

Yours faithfully,

(Signature of member depositing the Security)

Securities above referred to:

Some bye-laws of the Stock Exchange are also relevant. These are:

Defaulter’s Assets

326. The Defaulters’ Committee shall call in and realise the security and
margin money and securities deposited by the defaulter and recover all
monies, securities and other assets due, payable or deliverable to the
defaulter by any other member in respect of any transaction or dealing made
subject to the Rules, Bye-laws and Regulations of the Exchange and such
assets shall vest in the Defaulters’ Committee for the benefit and on
account of the creditor members.

Payment to Defaulters’ Committee

327. All monies, securities and other assets due, payable or deliverable to
the defaulter must be paid or delivered to the Defaulters’ Committee within
such time of the declaration of default as the Governing Board or the
President may direct. A member violating this provision shall be declared a
defaulter.

Distribution

330. The Defaulters’ Committee shall at the risk and cost of the creditor
members pay all assets received in the course of realisation into such bank
and/or keep them with the Clearing House in such names as the Governing
Board may from time to time direct and shall distribute the same as soon as
possible pro rata upto sixteen annas in the Rupee but without interest
among the creditor members whose claims are admitted in accordance with
these Bye-laws and Regulations.

Application of Defaulters’ Assets and Other Amounts

400. Subject to the provisions of Bye-law 398, the Defaulters’ Committee
shall realise and apply all the money, rights and assets of the defaulter
which have vested in or which have been received by the Defaulters’
Committee (other than the amount paid by the Governing Board to the
Defaulters’ Committee pursuant to Rule 16A in respect of the consideration
received by the Governing Board for exercising the right of nomination in
respect of the defaulter’s erstwhile right of membership) and all other
assets and money of the defaulter in the Exchange or the market including
the money and securities receivable by him from any other member, money and
securities of the defaulter lying with the Clearing House or the Exchange,
credit balances lying in the Clearing House, security deposits, any bank
guarantees furnished on behalf of the defaulter, fixed deposit receipts
discharged or assigned to or in favour of the Exchange, Base / Additional
Capital deposited with the Exchange by the defaulter, any security created
or agreed to be created by the defaulter or any other person in favour of
the Exchange or the Defaulters’ Committee for the obligations of the
defaulter to the following purposes and in the following order of priority
, viz.:-

First – to make any payments required to be made under Bye-law 391 and 394;
Second – the payment of such subscriptions, debts, fines, fees, charges and
other money as shall have been determined by the Defaulters’ Committee to
be due to the Securities and Exchange Board of India, to the Exchange or to
the Clearing House by the defaulter;
Third – the rectification or replacement of or compensation for any bad
deliveries made by or on behalf of the defaulter to any other member in the
settlement in which the defaulter has been declared a defaulter or in any
prior or subsequent settlement (unless the Governing Board has otherwise
determined in respect of such settlement or settlements under Bye-law 394)
provided the conditions of Bye-law 153 and all other applicable Rules, Bye-
Laws and Regulations and instructions of the Governing Board are complied
with;
Fourth – the balance, if any, shall be paid into the Fund to the extent of
the money paid out of the Fund (other than payments made out of Members’
refundable contributions) and not recovered by the Fund and the interest
payable by the defaulter to the Fund in respect thereof;
Fifth – the balance, if any, shall be paid into the Fund to the extent of
the money paid out of the Fund out of the refundable contributions of
members (other than the refundable contribution of the defaulter) and not
recovered by the Fund and the interest payable by the defaulter to the Fund
in respect thereof;
Sixth – subject to the Rules, Bye-Laws and Regulation of the Exchange,
including in particular Bye-Law 343, the balance, if any, shall be applied
by the Defaulters’ Committee for the payment of such unpaid outstanding,
debts, liabilities, obligations and claims to or of members of the Exchange
arising out of any contracts made by the defaulter with such members
subject to the Rules, Bye-laws and Regulations of the Exchange as shall
have been admitted by the Defaulters’ Committee; provided that if the
amount available be insufficient to pay and satisfy all such debts,
liabilities, obligations and claims in full they shall be paid and
satisfied pro rata;
Seventh – subject to the Rules, Bye-Laws and Regulation of the Exchange,
including in particular Bye-Law 343, the balance, if any, shall be applied
by the Defaulters’ Committee for the payment of such unpaid debts,
liabilities, obligations and claims to or of the defaulter’s constituents
arising out of any contracts made by such defaulter subject to the Rules,
Bye-laws and Regulations of the Exchange as shall have been admitted by the
Governing Board; provided that if the amount available be insufficient to
pay and satisfy all such debts, liabilities, obligations and claims in full
they shall be paid and satisfied pro rata;
Eighth – the balance, if any, shall be paid into the Exchange’s Customers’
Protection Fund to the extent of any and all amounts paid out of the
Customers’ Protection Fund towards the obligations or liabilities of the
defaulter and interest thereon at the rate of 2.5% per month (or such other
rate as the Governing Board may specify) from the date of payment out of
the Customers’ Protection Fund to the date of repayment to the Fund; and
Ninth – the surplus, if any, shall be paid to the defaulter.
Clarification: It is clarified that this Bye-law 400 does not
apply to the amount paid by the Governing Board to the Defaulters’
Committee pursuant to Rule 16A in respect of the consideration received by
the Governing Board for exercising the right of nomination in respect of
the defaulter’s erstwhile right of membership as the same does not belong
to the defaulter and the defaulter has no claim, right, title or interest
therein.”

9. The judgment under appeal set out two main issues which according to
it arose for determination. They are:

[A] Whether, on the facts and circumstances of this case, the TRO was right
in attaching the sale proceeds of the nomination rights of the Defaulter-
Member. If not, whether the TRO was entitled to attach under Rule 26(1) of
Schedule –II to the Income Tax Act, the Balance Surplus amount lying with
BSE out of the sale proceeds of the nomination rights of the Defaulter-
Member under rule 16(1)(iii) framed by BSE r/w the Resolution of the
General Body of BSE dated 13.10.1999?

[B] Whether deposits made by the Defaulting Member under various Heads such
as Security Deposit, Margin Money, Securities deposited by Members and
Others are attachable under Section 226(3)(i)(x) read with Rule 26(1)(a)(c)
of Schedule-II to the Income Tax Act?

10. Issue A was answered by saying that though a defaulting member had no
interest in a membership card and that the Income Tax Department was not
right in attaching the sale proceeds of such card, still money which is
likely to come in the hands of the garnishee, that is the Bombay Stock
Exchange, for and on behalf of the assessee is attachable because the
requisite condition is the subsistence of an ascertained debt in the hands
of the garnishee which is due to the assessee, or the existence of a
contractual relationship between the assessee and the Stock Exchange
consequent upon which money is likely to come in the hands of the garnishee
for and on behalf of the assessee. Issue No.2 was answered by saying that
even on vesting of all the assets of the assessee in the defaulter’s
committee, all such assets continued to belong to the assessee. Section
73(3) Civil Procedure Code mandates that Government debts have a priority
and that being so they will have precedence over other dues. It was
further held that the lien that the Stock Exchange may possess under Rule
43 does not make it a secured creditor so that debts due to the Income Tax
Department would have precedence. The judgment then goes on to say:

“11. To sum up, we hereby declare:

That, the Other Assets (as described hereinabove) are attachable and
recoverable under provisions of section 226(3)(i)(x) read with Rule
26(1)(a)(c) of Schedule-II to the Income Tax Act.
That, the Government and Other Creditors such as BSE, the Clearing House
and Other Creditor-Members under Rules and Bye-laws of the Stock Exchange
are creditors of equal degree and under Section 73(3), Civil Procedure
Code, the Government dues shall have priority over other such creditors.
That, in the matter of application of Defaulters’ Asset under bye-law 400,
the Defaulters’ Committee shall give priority to the debt due to the
Government and the balance, if any, shall be distributed in terms of the
Bye-laws 324 alongwith Bye-law 400 of the BSE.
That, a sum of Rs. 34,06,680 representing Balance Surplus lying with the
Exchange out of sale proceeds of the nomination rights of the Defaulter-
Member is attachable under the above provisions of the Income Tax Act read
with Rule 16 of the BSE Rules and consequently, the said amount is directed
to be paid over to the TRO under the impugned Prohibitory Order.
We hereby direct the BSE also to hand the securities lying in Members
Security Deposit Accounts to the TRO, who would be entitled to sell and
appropriate the sale proceeds towards the claim of the Income Tax
Department against the Defaulting Broker-Member. If the TRO so direct,
those securities could also be sold by BSE and the realized value, on the
date of the sale, could be handed over to the TRO. It is for the TRO to
decide this point. We further direct credit balance its the Clearing House
of Rs. 1,53, 538/- to be paid over to the TRO and that the TRO would be
entitled to appropriate the said amount towards the dues of the Department.
In short, we are directing BSE to pay a sum of Rs. 35, 60, 218/- to the TRO
and in addition thereto, the TRO would be entitled to the realized value of
the Securities as on the date of sale. In this case, the Prohibitory Order
is before the date of insolvency of the Broker concerned.
In future, the principles laid down by this judgment should be followed by
BSE and the TRO would to attach such Other Assets and appropriate the
amounts towards its claim under the Income Tax Act.”
11. Mr. Arvind Datar, learned senior counsel appearing on behalf of the
Stock Exchange raised essentially three submissions. The first submission
is that by virtue of the judgment in Stock Exchange, Ahmedabad v. Asstt.
Commisioner of Income Tax, Ahmedabad, 2001 (3) SCC 559, the sale proceeds
of a membership card and the membership card itself being only a personal
privilege granted to a member cannot be attached by the Income Tax
Department at any stage. The moment a member is declared a defaulter all
rights qua the membership card of the member cease and even his right of
nomination vests in the Stock Exchange. The High Court was therefore not
correct in saying that though a membership card is only a personal
privilege and ordinarily the Income Tax Department cannot attach the sale
proceeds, yet since these amounts came into the hands of the Stock Exchange
for and on behalf of the assessee they were attachable. The second
argument was made on conjoint reading of Rule 38 and 44. The learned
senior counsel argued that 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. The argument
therefore is that what is contemplated is a transfer of these shares by
virtue of which the member ceases to be owner of these shares for the
period that they are “transferred” and this being so, the Income Tax
Department cannot lay their hands on these shares or the sale proceeds
thereof as the member ceases to have ownership rights of these shares.
Shri Datar also argued that 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.

12. Shri R.P.Bhat, learned senior counsel arguing on behalf of Revenue
refuted these contentions and stated that on a conjoint reading of the
Rules and the Bye-Laws a membership card may not be directly attachable but
that the High Court’s reading of Rule 16 is correct. Further, on a
conjoint reading of the various Rules relating to member’s security, it is
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 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.

13. Mr. Datar also handed over during the course of argument certain
annual reports and letters to buttress his argument that in point of fact
shares were actually transferred by the member under the direction of the
Stock Exchange to the Bank of India who actually became owner of the shares
and was treated as such. The fact that dividends were to be paid to the
member concerned was only because of an internal arrangement between the
Exchange and the member, and that in fact the right to the dividend as well
as the right to vote all belonged to the Bank of India who was to act as a
trustee for the Stock Exchange.

14. We will deal with each one of the contentions seriatim.

Re.: (1)

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 no longer res integra.

15. In Isha Valimohamad and Anr. vs. Haji Gulam Mohamad & Haji Dada
Trust 1975 (1) SCR 720 the Supreme Court made a distinction between
“privilege” and “accrued right”.
“Mr. Patel for respondent contended that even
if the landlord had no accrued right, he at least had a ‘privilege’ as
visualised in Section 51, proviso (1)(ii) of the Bombay Act and that the
privilege should survive the repeal.
A privilegium, in short, is a special act
affecting special persons with an anomalous advantage, or with an anomalous
burthen. It is derived from privatum, which, as opposed to publican,
signified anything which regards persons considered individually; publicum
being anything which regards persons considered collectively, and forming a
society
(See Austin’s Jurisprudence, Vol. II, 5th ed. (1911)
P. 519)
The meaning of that word in jurisprudence has
undergone considerable change after Austin wrote. According to Hohfeld:

… a privilege is the opposite of a duty,
and the correlative of a ‘no-right’. For instance, where “X has a right or
claim that Y should stay off the land (of X), he himself has the
‘privilege’ of entering on the land; or, in equivalent words, X does not
have a duty to stay off.
Fundamental Legal Conceptions (1923) pp. 38-
39)
Arthur L. Corbin writes:
We say that B had a right that A should not
intrude and that A had a duty to stay out. But if B had invited A to enter,
we know that those results would not occur. In such case we say that B had
no right that A should stay out and that A had the privilege of entering.
(See “Legal Analysis and Terminology”, 29
Yale Law Journal 163)
According to Kocourek:
Privilege and inability are correlatives.
Where there is a privilege there must be inability. The terms are
correlatives. The dominus of a Privilege may prevent the servus of the
Inability from exacting an act from the dominus
(See “Jural Relations”, 2nd ed., p.
24)
Patton says:

The Restatement of the law of Property defines
a privilege as a legal freedom on the part of one person as against another
to do a given act or a legal freedom not to do a certain act.
(See Jurisprudence, 3rd ed. (1964), p. 256)
We think that the respondent-landlord had the
legal freedom as against the appellants to terminate the tenancy or not.
The appellants had no right or claim that the respondent should not
terminate the tenancy and the respondent had, therefore, the privilege of
terminating it on the ground that appellants had sub-let the premises. This
privilege would survive the repeal. But the problem would still remain
whether the respondent had an accrued right or privilege to recover
possession of the premises under Section 13(1) of the Saurashtra Act on the
ground of the sub-letting before the repeal of that Act. The fact that the
privilege to terminate the tenancy on the ground of sub-letting survived
the repeal does not mean that the landlord had an accrued right or
privilege to recover possession under Section 13(1) of that Act as that
right or privilege could arise only if the tenancy had been validly
terminated before the repeal of the Saurashtra Act.”

(at Pages 725, 726)

It is clear therefore that no accrued right to property was ever vested in
the defaulting member.

16. Further, the rules and the bye-laws also make this clear. Under
Rule 16(iii), whenever the Governing Board exercises the right of
nomination in respect of a membership which vests in the Exchange, the
ultimate surplus that may remain after the membership card is sold by the
Exchange comes only to the Exchange – it does not go to the member. This
is in contrast with bye-law 400 (ix) which, as has been noted above deals
with the application of the defaulting member’s other assets and
securities, and in this case ultimately the surplus is paid only to the
defaulting member, making it clear that these amounts really belonged to
the defaulting member.

17. In the Ahmedabad Stock Exchange case, 2001 (3) SCC 559, this Court
has held that:

“9. The Stock Exchange Rules, Bye-laws and Regulations have been approved
by the Government of India under the Securities Contracts (Regulation) Act,
1956. There is no challenge to these Rules. The question whether right of
membership confers upon the member any right of property is, therefore, to
be examined within the framework of the Rules, Bye-laws and Regulations of
the Exchange. On a plain and combined reading of the Rules, it is clear
that right of membership is merely a personal privilege granted to a
member, it is non-transferable and incapable of alienation by the member or
his legal representatives and heirs except to the limited extent as
provided in the Rules on fulfilment of conditions provided therein. The
nomination wherever provided for is also not automatic. It is hedged by
Rules. On right of nomination vesting in the Stock Exchange under the
Rules, that right belongs to the Stock Exchange absolutely. The
consideration received by the Stock Exchange on exercise of the right of
nomination vesting in it, is to be applied in the manner provided in Rule
16.

13. In the present case Rule 16 was properly applied by the Stock Exchange.
The membership right in question was not the property of the assessee and,
therefore, it could not be attached under Section 281-B of the Income Tax
Act. No amount on account of Rajesh Shah was due from or held by the Stock
Exchange and, therefore, Section 226(3) could not be invoked. We are unable
to sustain the judgment under appeal holding that in substance the right of
membership or membership card was a right of property which could be
attached under Section 281-B of the Income Tax Act.”

It is clear therefore that the conclusion of the High Court that the
proceeds of a card which has been auctioned can be paid over to the Income
Tax Department for the dues of the member by virtue of Rule 16 (iii) is
incorrect as such member at no point owns any property capable of
attachment, as has been held in the Ahmedabad Stock Exchange case. On this
point therefore Shri Datar is on firm ground and must succeed.

Re: (2)

Rules 36 to 46 belong to a Chapter in the Rules entitled “Membership
Security”. Rule 36 specifies that a new member shall on admission provide
security and shall maintain such security with the Stock Exchange for a
determined sum at all the times that he carries on business. Rule 37 deals
with the form of such security and states that it may be in the form of a
deposit of cash or deposit receipt of a Bank or in the form of security
approved by the Governing Board. Rule 38 deals with how these securities
are held. Rule 41 enables the member to withdraw any security provided by
him if he provides another security in lieu thereof of sufficient value to
the satisfaction of the Governing Board. Rule 43 states that the security
provided shall be a first and paramount lien for any sum due to the Stock
Exchange and Rule 44 deals with the return of such security under certain
circumstances. On a conjoint reading of these Rules what emerges is as
follows:

The entire Chapter deals only with security to be provided by a member as
the Chapter heading states;

The security to be furnished can be in various forms. What is important is
that cash is in the form of a deposit and securities are also “deposited”
with the Stock Exchange under Rule 37;

Rule 38 which is crucial 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”. Blacks
Dictionary defines “transfer” as follows:

“Transfer means every mode, direct or indirect, absolute or conditional,
voluntary or involuntary, of disposing of or parting with property or with
an interest in property, including retention of title as a security
interest and foreclosure of the debtor’s equity of redemption.”

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 in
Vasudev Ramchandra Shelat v. Pranlal Jayanand Thakur & Ors., 1975 (2) SCR
534 at 541, 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.

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 ………..”
Obviously, first and foremost the cash lodged and the shares transferred
are only deposits. Secondly, they are entirely at the risk of the member
who provides the security 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;

Under Rule 41 a member may withdraw any security provided by him if he
satisfies the conditions of the Rules. This again shows that what is sought
to be withdrawn is a security which the member owns;

By Rule 43 a lien on securities is provided to the Stock Exchange. Such
lien is only compatible with the member being owner of the security, for
otherwise no question arises of an owner (the Stock Exchange, if Shri Datar
is right) having a lien on its own moveable property;

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;

Bye-law 326 and 330 also refer to securities that are “deposited” by the
defaulter and recovery of securities and “other assets” due. Obviously,
therefore, securities which are handed over to the exchange continue to be
assets of the member which can be liquidated on default.

Shri Datar’s argument would also create a dichotomy between “cash lodged”
and Bank Deposit Receipts and securities “transferred”. The form a
particular security takes cannot possibly lead to a conclusion that cash
lodged, being only a deposit, continues to belong to the member, whereas
Bank Deposit Receipts and securities, being “transferred” would belong to
the Stock Exchange.

In Bombay Stock Exchange v. Jaya Shah, 2004 (1) SCC 160, this Court
was confronted with a claim made by a non-member against a member which had
fructified into an arbitration award under the 1940 Arbitration Act which
was then made a Rule of the Court and a decree followed. The Bombay High
Court made the garnishee notice of the non-member creditor absolute and the
Supreme Court was faced with the correct construction of bye-laws relating
to defaulter members. The Supreme Court held:

“39. How the card money is to be dealt with has been provided under the
Rules. A dichotomy, however, has been created under the Rules and Bye-laws
as regards the amount received by sale of membership card and amount
recovered from the defaulter’s other assets. On a plain reading of the
Rules and Bye-laws it appears that the authority to deal with the card
money and the liability of the members by the Defaulters’ Committee is
different, but having regard to the scheme of distribution of the
liabilities of the Exchange, clearing house, members and non-members, all
the assets shall be placed at the hands of the Defaulters’ Committee. But
as would appear from the discussions made hereinafter the application
thereof would be separate and distinct.

40. In terms of the Bye-laws, a Defaulters’ Committee is to be constituted
which is a Standing Committee consisting of six members of the Exchange.
Such a Committee is constituted in terms of Rule 170(a)(ii) of the Stock
Exchange Rules, Bye-laws and Regulations, 1957. It is not a juristic
person. It is merely an association of persons.
46. Vesting of such assets of the defaulter in the Defaulters’ Committee is
not absolute. The Defaulters’ Committee is merely a trustee. It holds the
said amount vested in it for the benefit and on account of the creditor
members. Once the liabilities of the creditors from the defaulters are paid
to the members, in terms of Rule 44, the assets devolve upon the
Defaulters’ Committee in terms of Bye-law 326 for a limited purpose and as
contradistinguished from the Rules in terms whereof the card may vest in
the Exchange, do not vest in it absolutely.
47. The Defaulters’ Committee takes in its custody the amount realised from
other assets not as an owner thereof and the vestment thereof would, thus,
be coterminous with the satisfaction of the claims of the member. It, as
soon as the purpose of Bye-law 326 is satisfied, comes to an end.
48. The assets of a defaulting member can broadly be divided into two
categories, namely, card membership and other assets.
57. There cannot, however, be any doubt that so long as the claims of the
awardees, both of members as also non-members, are dealt with by the
Defaulters’ Committee, the Exchange or the Defaulters’ Committee would not
be a debtor in relation to an awardee. But once the Defaulters’ Committee
determines such claims and a surplus is available in the hands of the
Defaulters’ Committee, as the surplus amount would become payable to the
defaulting members, the same would become an asset of the defaulting
member. In other words, other assets continue to remain assets of the
defaulting members subject to the vesting thereof for the purposes
mentioned in Bye-law 326 and as soon as the purpose is satisfied, the
ownership which was under animated suspension or eclipsed would again
revive to the defaulting member. The awardees, however, so long as the
assets remain under the control of the Defaulters’ Committee would be
entitled to get their claim on a pro rata basis and not in its entirety.
58. If it is held that despite the fact that claims, having regard to the
priority clause contained in Rule 16, remain in the hands of the
Defaulters’ Committee and an order of attachment would be enforceable, the
same would result in an incongruity. Unfortunately, no clear picture
emerges from the Rules and Bye-laws as there does not appear to be any
provision how the card money as also other assets belonging to the
defaulting member can be handled by the Defaulters’ Committee. But the
Rules and Bye-laws have to be read harmoniously. They have to be read
together so as to make them effective and workable. So read, the
Defaulters’ Committee constituted in terms of Bye-laws would apply to the
other assets, dues and payments of the members on a pro rata basis
whereafter the dues of non-members can be disbursed. While doing so,
however, such claims can be determined only having regard to the cut-off
date which must be prescribed by the Governing Board in terms of clause
(vii) of Bye-law 343. So far as card money is concerned, the same must be
disbursed having regard to the priority clause contained in Rule 16, in
which event, upon discharge of the dues of the Exchange and clearing house,
the same has to be distributed according to the dues of members and non-
members. It bears repetition to state that there does not exist any
distinction between a member and a non-member in terms of Rule 16 and in
the event the amount of the card money available in the hands of the
Exchange is not sufficient to satisfy all the claims, the same has to be
distributed on a pro rata basis. However, any amount remaining surplus even
thereafter would be subject to a decision of the Governing Board. The
Governing Board may in a given situation, having regard to the hardship
which may be faced by the members and non-members in realising their dues,
may direct that such amount would be available for disbursement towards the
said dues. It, however, we may hasten to add, is free to apply the surplus
for a different purpose which, evidently cannot be dehors the purpose and
object for which the Exchange has been constituted.”

18. Ultimately, the matter was remanded to find out what was the cut off
date for purposes of limitation.

19. Though this judgment has no direct application to the facts before us
it does hold that after the assets of the defaulting member are pooled
together and amounts are realized, the payments that would be made from
such pool would be from the assets of the defaulting member. To that
extent, therefore, the aforesaid judgment reinforces what we have stated
above. Mr. Datar’s second contention must therefore fail.

Re: (3)

It is settled law that Government debts have precedence only over
unsecured creditors. This was held in Dena Bank v. Bhikabhai Prabhudas
Parekh Co., 2000 (5) SCC 694 as follows:

“10. However, the Crown’s preferential right to recovery of debts over
other creditors is confined to ordinary or unsecured creditors. The common
law of England or the principles of equity and good conscience (as
applicable to India) do not accord the Crown a preferential right for
recovery of its debts over a mortgagee or pledgee of goods or a secured
creditor. It is only in cases where the Crown’s right and that of the
subject meet at one and the same time that the Crown is in general
preferred. Where the right of the subject is complete and perfect before
that of the King commences, the rule does not apply, for there is no point
of time at which the two rights are at conflict, nor can there be a
question which of the two ought to prevail in a case where one, that of the
subject, has prevailed already. In Giles v.Grover [(1832) 131 ER 563 : 9
Bing 128] it has been held that the Crown has no precedence over a pledgee
of goods. In Bank of Bihar v. State of Bihar [(1972) 3 SCC 196 : AIR 1971
SC 1210] the principle has been recognised by this Court holding that the
rights of the pawnee who has parted with money in favour of the pawnor on
the security of the goods cannot be extinguished even by lawful seizure of
goods by making money available to other creditors of the pawnor without
the claim of the pawnee being first fully satisfied. Rashbehary Ghose
states in Law of Mortgage (TLL, 7th Edn., p. 386) — “It seems a government
debt in India is not entitled to precedence over a prior secured debt.”

What has been argued before us is that the moment the Stock Exchange
has a lien over the member’s securities, it would have precedence over
income tax dues. We find there is force in this submission.

The Provincial Insolvency Act defines “secured creditor” under
Section 2 (e) as follows:

(e) “Secured creditor” means a person holding a mortgage, charge or lien on
the property of the debtor or any part thereof as a security for a debt due
to him from the debtor;”

Similarly, the Securitisation and Reconsruction of Financial Assets
and Enforcement of Security Interest Act, 2002 in Section 2 (z)(f) defines
“security interest” as follows:

“Section 2(zf) “security interest” means right, title and interest of
any kind whatsoever upon property, created in favour of any secured
creditor and includes any mortgage, charge, hypothecation, assignment other
than those specified in Section 31”

In Triveni Shankar Saxena v. State of U.P. & Ors., 1992 Suppl. 1 SCC
524 at para 17 in an instructive passage the Supreme Court held as follows:
“17. We shall now examine what the word ‘lien’ means. The word ‘lien’
originally means “binding” from the Latin ligamen. Its lexical meaning is
“right to retain”. The word ‘lien’ is now variously described and used
under different context such as ‘contractual lien’, ‘equitable lien’,
‘specific lien’, ‘general lien’, ‘partners lien’, etc. etc. in Halsbury’s
Laws of England, Fourth Edition, Volume 28 at page 221, para 502 it is
stated :

In its primary or legal sense “lien” means a right at common law in one man
to retain that which is rightfully and continuously in his possession
belonging to another until the present and accrued claims are satisfied.”

Similarly, in K.S. Saradambal v. Jagannatham K Brothers, (1972) 42
Companies Case 359, the Madras High Court held:

“It would be sufficient only to refer to the following observation in
Halsbury’s Laws of England, third edition, volume 24, at page 143:

“A legal lien differs from a mortgage and a pledge in being an
unassignable personal right which subsists only so long as possession of
the goods subsists. A mortgage is an assignable right in the property
charged and does not depend on possession. A pawn or pledge gives a special
assignable interest in the property to the pawnee. A lien is, however,
included in the definition of mortgage in the Law of Property Act, 1925.
There an equitable mortgage is created by deposit of title deeds, the
mortgagee has a legal lien on the deeds deposited.”

This leads us to the question as to what right is available to the
applicant-company, as the holder of lien. That again takes us to the
question as to what is meant by “lien”. The word “lien” is defined in the
Law Lexicon by Ramanatha Iyer as:

“A lien may be defined to be a charge on property for the payment of a
debt or duty, and for which it may be sold in discharge of the lien………A
lien, in a limited and technical sense, signifies the right by which a
person in possession of personal property holds and retains it against the
owner in satisfaction of a demand due to the party retaining it; but in its
more extensive meaning and common acceptation it is understood and used to
denote a legal claim or charge on property, either real or personal, as
security for the payment of some debt or obligation; it is not strictly a
right in or right to the thing itself but more properly constitutes a
charge or security thereon.” The word “lien” is defined in Stroud’s
Judicial Dictionary, third edition, at page 1644, as:

“A lien- (without effecting a transference of the property in a thing) –
is the right to retain possession of a thing until a claim be satisfied;
and it is either particular or general”.

Having regard to the foregoing definitions the question arises whether
the holder of a lien, as the applicant company in the instant case, can be
considered to be a secured creditor under the company law. Section 529 of
the Act is important and it reads:

“529. Application of the insolvency rules in winding up of insolvent
companies.- (1) In the winding up of an insolvent company, the same rules
shall prevail and be observed with regard to –

Debts Probable;

The valuation of annuities and future and contingent liabilities; and

The respective rights of secured and unsecured creditors;

As are in force from the time being under the law of insolvency with
respect to the estates of persons adjudged insolvent.

(2) All persons who in any such case would be entitled to prove for and
receive dividends out of the assets of the company, may come in under the
winding up, and make such claims against the company as they respectively
are entitled to make by virtue of this section.

Provided that if a secured creditor instead of relinquishing his security
and proving for his debt proceeds to realize his security, he shall be
liable to pay the expenses incurred by the liquidator (including
provisional liquidator, if any), for the preservation of the security
before its realization by the secured creditor”.

Though the expression “insolvent company” is not defined, obviously it
refers to a company which has been ordered to be wound up on a petition
founded upon section 433 (c), that is, the company being unable to pay its
debts. According to section 529, in the winding up of such a company, the
same rules shall prevail and be observed with regard to debts provable as
are in force for the time being under the law of insolvency with respect to
the estates of the persons adjudged insolvent.

The question is whether only the insolvency rules are applicable or all the
relevant provisions of the insolvency law are applicable to a case of
winding up of an insolvent company.

The intention underlying section 529 is that all the provisions of the
insolvency law are applicable to the case of winding up of an insolvent
company with regard to matters enumerated in section 529. That was also
the view taken by a full bench of the Allahabad High Court in Hans Raj v.
Official liquidators, Dehradun, Mussorie Electric Tramway Co. Ltd. AIR 1929
All 353 (F.B.). A similar view was taken by the Oudh Chief Court in B.
Anand Bihari Lal v. Dinshaw & Co. (1944) 12 Comp. Cas. 137 (Oudh). Thus,
according to section 529, the provisions of the insolvency law are
applicable to debts provable in the winding up of an insolvent company.
That takes us to the question as to what are the provisions of the
insolvency law that are applicable to a debt covered by a lien. The
provincial Insolvency Act, 1920, and the Presidency Towns Insolvency Act,
1909, define “secured creditor”. In the former Act, section 2(e) defines
that expression as:

“2.(e) ‘Secured creditor’ means a person holding a mortgage, charge or
lien on the property of the debtor or any part thereof as a security for a
debt to him from the debtor.”

In the latter Act, Section 2(g) defines that expression as:

“Secured creditor’ includes a landlord who under any enactment for the
time being in force has a charge on land for the rent of that land.”

The latter definition is an inclusive definition. According to the
former definition even a person holding a lien on the property of a debtor
is a secured creditor. In dealing with the question as to who a secured
creditor is in company law, it is observed in Palmer’s Company Law, 21st
edition, at page 765.:

“Secured creditor is one, who has some mortgage, charge or lien on the
company’s property…….A solicitor who holds a lien on documents of a
liquidating company for his costs against the company is a secured
creditor, and must mention his lien in his proof.”

On a consideration of Section 529 read with the relevant provisions of
the insolvency law, I come to the conclusion that the holder of a statutory
lien or the holder of a lien created by contract and registered as required
by Section 125 is a secured creditor in the matter of winding up of the
insolvent company with regard to, among other things, debts provable in the
winding up proceedings. The applicant-company being the holder of a
statutory lien is thus in the position of a secured creditor…..”

20. In the present case, the first and paramount lien given to the Stock
Exchange is by Rule 43 of the Rules made under Section 8 of the Securities
Contract Act. Sections 7A, 8 and 30 of the Securities Contracts
(Regulation) Act 1956 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 Securities Contracts (Regulation) Act respectively. Whereas, the
rules made under Section 7A and Section 8 are made by recognized Stock
Exchanges with the approval of the Central Government and published in the
Official Gazette, rules made under Section 30 are made by the Central
Government itself for purposes of carrying into effect the objects of the
Securities Contracts (Regulation) Act. Sub-section (3) of Section 30 is
material.
“Section 30 sub-section (3): Every rule made under this Act shall be laid,
as soon as maybe after it is made, before each House of Parliament, while
it is in session for a total period of thirty days which may be comprised
in one session or in two or more successive sessions, and if, before the
expiry of the sessions immediately following the sessions or the successive
sessions aforesaid, both Houses agree in making any modification in the
rule or both Houses agree that the rule should not be made, the rule shall
thereafter have effect only in such modified form or be of no effect, as
the case may be; so, however, that any modification or annulment shall be
without prejudice to the validity of anything previously done under the
rule. “

21. It will be seen that whether a rule is made under section 7-A,
Section 8 or Section 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. The fact that the Stock Exchange makes
these rules under Sections 7A and 8 as opposed to the Central Government
making them under Section 30 does not take the matter very much further.
Section 3(51) of the General Clauses Act defines “Rules” as meaning “a rule
made in exercise of power conferred by law and shall include a Regulation
made as a rule under any enactment.” It is clear from this definition of
‘Rule’ also that Stock Exchanges who make rules in exercise of powers
conferred by the Securities Contracts (Regulation) 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.

22. Mr. Bhat argued that only a lien that flows from the statute
itself can be considered as a statutory lien and referred us to two
judgments, one by the Bombay High Court and one by the Supreme Court.

The Bombay High Court held in the case of Forwarding P. Ltd. and
another v. Trustees, Port of Vizagapatnam, and Anr., (1987) 61 Company
Cases 513 that the power of arrest and sale of vessel belonging to a
company in winding up by the port authorities emanates directly from
section 64 of the Major Port Trusts Act, 1963 and hence the question of
obtaining leave of the company court under section 446 of the Companies
Act, 1856 will not arise when an authority exercises independent statutory
rights.

This judgment was quoted with approval in Board of Trustees, Bombay
vs. Indian Oil Corporation, 1998 (4) SCC 302 where the Supreme Court set
out Section 64 of the Major Port Trusts Act and held as under:

“8. The Port authorities have a paramount right to
arrest a vessel and detain the same until the amounts due to it in respect
of extending the port facilities and services to the vessel are paid. Under
Sub-section (2), in case any part of the said rates, charges, penalties or
the cost of the distress or arrest or of the keeping of the same remain
unpaid for a space of five days next after any such distress or arrest has
been made, the Board may cause the vessel so distrained or arrested to be
sold. The proceeds of such sale shall satisfy such rates or penalties and
costs including the costs of sale remaining unpaid. The surplus, if any, is
to be rendered to the master of such vessel on demand.

9. The statutory right under Section 64 embodies this
overriding right of the harbour authority over the vessel for the recovery
of its dues. This right stands above the rights of secured and unsecured
creditors of a company in winding up – in the present case, the shipping
company which owns the vessel. The harbour authorities allow ships
-national or foreign to anchor and avail of the services provided by them.
For payment they look to the vessel. The owner may be foreign or even
unknown to the harbour authority. The latter’s right to recover its dues is
not affected by any pending proceedings against the owner in any court –
whether in winding up or otherwise. The harbour authority can arrest the
vessel while it is anchored in the harbour and recover its dues in respect
of that vessel by sale of the vessel if the dues are not paid. This lien of
the harbour authority over the vessel is paramount. The lien cannot be
extinguished or the vessel sold by any other authority under the directions
of the court or otherwise, unless the harbour authority consents to such
sale. Thus, in the case of Ashok Arya v. M.V. Kapitan Mitsos, the Bombay
High Court relied upon the decision in The Emilie Millon (infra) and held
that the lien given by statute to a dock or harbour authority cannot be
extinguished by court unless it be done with the authority’s express or
implied consent.

13. Therefore, the lien of a harbour authority
over the vessel is a paramount lien and realization of its dues by the
harbour authority by the sale of the vessel is above the priorities of
secured creditors. In other words, the statutory lien of a harbour
authority has paramountcy even over the claims of secured creditors in a
winding up. In exercise of its right under Section 64 the appellant is,
therefore, entitled to sell the vessel without the intervention of the
court. In exercise of that paramount right which overrides the claims of
all other creditors including secured creditors, the appellant has a right
to arrest the vessel and sell it. Without the consent of the appellant,
this right cannot be transferred to the sale proceeds of the vessel.”

It is no doubt true that the Supreme Court held that the statutory
lien of a Harbour authority over a vessel is a paramount lien which
overrides the claim of all other creditors including secured creditors.
The question, however, in the present case is somewhat different. The
question is whether the lien exercised under Rule 43 by the Stock Exchange
can be said to be a superior right to income tax dues which may become
payable by virtue of the Stock Exchange being a secured creditor.

23. It was argued that Black’s Law Dictionary 5th Edition defines
“statutory lien” as follows:

“Statutory lien: A lien arising solely by force of statute upon
specified circumstances or conditions, but does not include any lien
provided by or dependent upon an agreement to give security, whether or not
such lien is also provided by or is also dependent upon statute and whether
or not the agreement or lien is made fully effective by Statute.”

Based on this it was further argued that such lien would not include
any lien provided by or dependent on an agreement to give security, whether
or not such lien is also provided by or dependent upon statute, and whether
or not such lien is made fully effective by statute.

24. The first 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 (supra) held that Government dues only have
priority over unsecured debts and in so holding the Court referred to a
judgment in Giles vs. Grover (1832) (131) English Reports 563 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. In fact,
in Collector of Aurangabad and Anr. vs. Central Bank of India and Anr. 1967
(3) SCR 855 after referring to various authorities held that the claim of
the Government to priority for arrears of income tax dues stems from the
English common law doctrine of priority of Crown debts and has been given
judicial recognition in British India prior to 1950 and was therefore “law
in force” in the territory of India before the Constitution and was
continued by Article 372 of the Constitution (at page 861, 862).

25. In the present case, as has been noted above, 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.

26. The three issues are answered as above. The Stock Exchange’s appeal
is allowed and the impugned judgment passed by the Division Bench of the
Bombay High Court is set aside.
……………………………………….CJI
(R.M. Lodha)
………………………………..J.
(Kurian Joseph)
………………………………..J.
(R.F. Nariman)
New Delhi,
September 25, 2014

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