1. WHAT ARE CORPORATE ACTIONS AFFECTING PLEDGED ASSETS?

When shares are pledged, legal ownership stays with pledgor, pledgee only gets security interest. But issuer company still issues:

• Cash benefits: Dividend, interest on debentures
• Stock benefits: Bonus shares, stock split, merger shares, spin-off
• Rights: Rights issue, warrants, buyback, open offer

Under Section 172-176 Indian Contract Act and Depositories Act 1996 + SEBI (Depositories & Participants) Reg 58, all accretions belong to pledgor and form part of pledged property.

SEBI 2020 Pledge Re-pledge mechanism: After Feb 2020, pledge is created via TM/CM -> "pledge" in client demat, beneficial owner remains pledgor. Pledgee cannot sell without invocation.

2. DUTY OF PLEDGEE - LAW

Section 163 Contract Act analogy + Section 176:
Pledgee must:

1. Take care of pledged property as own - duty to collect corporate actions
2. Return same goods with accretions on repayment
3. Not use goods inconsistently with bailment
4. Give reasonable notice before sale

SEBI Circular: Handling of Client Securities:
Fine of Rs 25,000/- for first failure, Rs 1,00,000/- or 1% of value for securities lying with TM not unpledged. SEBI penalizes brokers who fail to process pledge release / corporate actions.

RBI Master Direction on Loan Against Securities: Bank must credit corporate benefits to loan account.

3. LANDMARK CASE LAWS

A. STANDARD CHARTERED BANK v. CUSTODIAN (2000) INSC 226 - Supreme Court - LEADING CASE ON ACCRETIONS

Facts: Under Harshad Mehta scam, SCB held shares as pledgee. Question: Do bonus shares, dividends, interest accrued on pledged shares form part of pledge?

Held:

The letter dated 11th May 1992 created valid pledge and rights, bonus and dividends received by appellants formed part of pledge and constituted security.

Principle: Bonus, dividend, rights are accretions to pledged property, to be retained by pledgee only as additional security, and to be returned when debt repaid. They are not income of pledgee.

Ratio applied in M.K. Ramesh Kumar vs ARCIL (2007).

This means if you fail to collect bonus shares, you have failed to preserve security.

B. VIMAL CHANDRA GROVER v. BANK OF INDIA (2000) 5 SCC 122 - Supreme Court - NEGLIGENCE

Most cited for failure to process corporate action.

Facts: Vimal pledged Castrol shares to Bank of India for overdraft. He requested bank to sell shares when price high. Bank failed to sell promptly. Meanwhile company issued bonus, dividend. Bank also failed to collect and adjust.

Held:

Bank had indeed failed in its duty by not acting promptly and diligently in selling appellant's pledged shares as requested, thereby...

Bank held liable for negligence in handling pledged securities - must act as prudent man. Damages = difference between market price on date of instruction and actual sale price + loss of corporate benefits.

This case is foundation for broker liability for failure to process corporate actions.

C. PTC INDIA FINANCIAL SERVICES LTD v. VENKATESWARLU KARI (2022) - Supreme Court - INVOCATION vs BENEFICIAL OWNERSHIP

SC on 12 May 2022 examined interplay of Depositories Act and Contract Act.

Held:

Mere registration of pawn i.e. dematerialized shares in favour of creditor as beneficial owner does not have effect of sale of shares by pawnee. Pledge at that stage is not discharged and thus debt remains due.

Implication for corporate actions: Until actual sale to third party, pledgee who becomes beneficial owner is still trustee of corporate actions. If he receives dividend/bonus after becoming beneficial owner but before sale, he must account for it.

D. STCI FINANCE LTD v. SUKHMANI TECHNOLOGIES (Delhi HC, O.M.P. (COMM) 340/2017, April 2, 2024)

Delhi HC relied on PTC India case:

Mere registration of shares in favour of pledgee as beneficial owner does not amount to sale of shares, and pledgee is not required to account for sale proceeds until shares are actually sold to third party.

But must account for corporate actions - if bonus issued after pledgee becomes beneficial owner, pledgee must hold it as additional pledge.

E. SEBI vs CDSL - Penalty Rs 1 Crore - Oct 2024

Markets regulator SEBI imposed penalty of Rs 1 crore on CDSL for multiple compliance lapses, including failure to communicate reasons for rejection of pledge requests to DPs of both pledgor and pledgee.

SEBI said CDSL violated depository regulations on pledge processing. Under Sec 15HB SEBI Act, max penalty Rs 1 Crore for such failure. This is direct enforcement for failure to process corporate actions on pledged securities.

F. NSE/ BSE Penalty Structure for Client Securities

Per NSE circular NSE/INSP/47457: Clients’ securities lying with TM cannot be held beyond T+1. If not unpledged within 10 days, penalty Rs 1,00,000 or 1% of value, escalated on second instance.

4. WHAT CONSTITUTES FAILURE?

1. Not crediting dividend: Pledgee receives dividend in bank account, does not adjust against loan - breach of Sec 176, liable to pay with interest 12%
2. Not collecting bonus: Company issues 1:1 bonus, pledgee does not get it credited to pledge account - security shortfall, pledgor can sue for loss of value
3. Lapsing rights issue: Rights issue at Rs. 100, market Rs. 300. Pledgee fails to intimate pledgor / fails to subscribe or renounce - loss = (market - rights price) * entitlement - recoverable as damages under Vimal Grover
4. Corporate action during invocation: After invocation, but before sale, bonus declared - pledgee sells only original shares, bonus goes unclaimed - void sale
5. Merger/ demerger: Reliance demerger into Jio Financial - pledged RIL shares should result in JFSL shares also pledged. Failure to process = unsecured loan

5. REMEDY AND DAMAGES FORMULA

As per Vimal Chandra Grover and Standard Chartered:

• Duty of pledgee to hold pledged property as own
• Accretions form part of pledge
• If fails: Liable for (a) Market value of corporate benefit on record date, (b) Interest, (c) Loss due to fall in price after failure to sell

Defence for banks/brokers:

• Show notice to pledgor to provide funds for rights subscription
• Show corporate action was optional and pledgor did not fund
• Show pledge agreement expressly excludes obligation to subscribe (but courts usually strike down as unreasonable)