The Supreme Court on May 12, 2022 in the matter of PTC India Financial Services Ltd v. Venkateswarlu Kari and another held that the Indian Contract Act 1872 does not recognize the sale of the pledged goods by a pawnee to himself in the event of default of payment by the pawnor.

In the instant matter, one company (“MHPL”) pledged its shares with the appellant PTC India Financial Services Ltd (“PIFSL”) company as guarantee for a loan. After the pledge, those shares were registered with the depository with the appellant as the “beneficial owner”. The issue was whether such registration as “beneficial owner” of shares would amount to sale of shares. This question arose in the insolvency proceedings of the debtor company. When PIFSL raised a claim as a financial debtor, MHPL (the guarantor company which pledged the shares) objected. MHPL argued that the PIFSL has sold the pledged shares and has thereby realized its debts and therefore, it is MHPL which will step into the shoes of the financial creditor.

The Court noted that as per Section 176 of the Contract Act, in the event of default by the pawnor, the pawnee may bring a suit or sell the pledged items on giving the pawnor reasonable notice of the sale. As per Section 177, the pawnor has right to redeem the pledged goods before the actual sale of them. The Court further noted that a pawnee has only special rights over the pledged goods – to retain them as security for the debt- and no general rights over them.

Referring to various precedents, and analyzing the differences between “ownership”, “pledge” and “mortgage”, the bench observed-

“Several other High Courts have similarly opined and we agree that the Contract Act does not conceive of sale of the pawn to self and consequently, the pawnor’s right to redemption in terms of Section 177 of the Contract Act survives till ‘actual sale’.”

The Bench overruled the solitary judgment of the single judge of the Punjab and Haryana High Court Dhani Ram and Sons v. The Frontier Bank Ltd. and Another AIR 1962 P&H 321 and said that this decision proceeds on the incorrect understanding of precedents and is to be overruled.

Thus, the Court held that registration of the pawn, that is the dematerialised shares, in favour of PIFSL as the ‘beneficial owner’ does not have the effect of sale of shares by the pawnee. The pledge has not been discharged or satisfied either in full or in part. MHPL is entitled to redeem the pledge before the sale to a third party is made. The Court allowed the appeal of PIFSL and set aside the orders of the NCLT and NCLAT which held MHPL as a secured creditor of the corporate debtor.