India: Transfer Of Title Of Dematerialised Shares – Prevailing Ambiguity

The legal principles governing the transfer of title of physical shares are well-defined and clear. However, this is not the case when it comes to dematerialised shares. Given that the bulk of transfers occur with respect to shares in dematerialised form, it is imperative that there is absolute clarity in this regard. Moreover, determining the elements for transfer of title of dematerialised shares is crucial as it has repercussions on the legal obligations of listed companies. In this article, we first highlight some instances where assessing the date of transfer of demat is of vital importance. We then discuss the law governing transfer of title of physical shares and dematerialised shares.

The Need for Determining the Conditions for Transfer of Title of Dematerialised Shares

Listed companies are required to comply with a whole host of obligations under the regulatory regime. Various such obligations relate to the shareholding of the listed company. For instance, listed companies are required to disclose the shareholding pattern with stock exchanges on a quarterly basis.¹ Shareholding pattern of a company reflects the number shares legally held by a given shareholder/class of shareholders in the company. Shareholding pattern of a company would change if there is transfer of title in the shares of a company from one individual to another. Let us assume that a promoter places an order for purchase of 20,000 equity shares of their company on 29 June 2021. As per the T+2 rolling settlement mechanism, the shares would be credited into the promoter's demat account on 1 July 2021. In such a situation, is the title to the 20,000 shares transferred on 29 June 2021 and does the shareholding pattern for the quarter ending June 2021 have to reflect the increased shareholding of the promoter? Or is the title transferred on 1 July 2021 and the increase in shareholding has to be disclosed in the quarter ending September 2021?

Take another scenario. According to Regulation 42 of the Listing Regulations, every listed is required to intimate the ‘record date' to the stock exchange for the purposes of declaration of dividend, issue of right or bonus shares, corporate actions like mergers, etc. Assuming that the record date is 31 March 2021, and an individual places a sell order of shares of the company on 30 March 2021, but the consideration for the sale of shares is credited only on 1 April 2021, would the seller be eligible for the benefits referred to in Regulation 42?

These issues revolve around the transfer of title in dematerialised shares and require an examination of the legal regime governing such transfers. Before that, however, it is important to discuss the principles governing the transfer of physical shares.

Transfer of Title of Shares in Physical Form

The transfer of shares in physical form impacts three entities, viz. the transferor, the transferee, and the company whose shares are being transferred. The tests for determining the status of a transferee vis-à-vis the company and the transferee are different.

Insofar as the position of the transferee as against the company is concerned, a valid transfer results into the transferee becoming a ‘shareholder' of the company. The word ‘shareholder' is not defined in the Companies Act, 2013 (“2013 Act”), nor was it defined in the Companies Act, 1956 (“1956 Act”). Section 2(55) of the 2013 Act, which corresponds to Section 41 of the 1956 Act, defines a ‘member' and as the Supreme Court has held,² the term ‘member' has been used synonymously with ‘shareholder' in the 1956 Act (and similarly, in the 2013 Act).

Section 2(55)(ii) of the 2013 Act³ lays down two requirements for becoming a member of a company:⁴ a) the person must agree to become a member; and b) the person's name must be registered in the register of members of the company. These two requirements have been held to be cumulative.⁵ Thus, in order to become a member (i.e. a shareholder) of a company, it is not sufficient that there is an agreement for transfer of shares. In fact, even the execution of blank transfer deeds by the transferor does not make the transferee a member of the company.⁶ The transferee becomes a member only when its name is recorded in the register of members of the company.⁷ In other words, till such time as the transferee's name is recorded in the register of members, from the company's perspective, it is the transferor who continues to be the member/shareholder.

This implies that all rights arising out of the shareholding of a company can only be exercised by the transferor till such time as the transferee's name is recorded in the register of members. For instance, the company shall pay dividend to the transferor, voting rights can be exercised only by the transferor, the transferor is entitled to any rights issue, etc.⁸

The position on transfer of shares as amongst the transferor and the transferee is different. This transfer is not contingent on the registration of the transferee's name in the register of members of the company. This was explained by the Supreme Court in Vasudev Ramchandra Shelat v. Pranlal Jayanand Thakar,⁹ where it distinguished between the full rights of ownership of the shares of a company and the right of the transferee to have their name registered in the register of members of the company. The latter right is acquired by the transferee upon the completion of the transfer. In other words, as against the transferor, the transferee acquires the title to the shares once the transfer is complete as per the laws of transfer of moveable property (i.e. shares).

The relationship between the transferor and the transferee after the completion of the transfer and till the registration of the transferee's name in the register of members is that of a trustee and ‘cestui que trust'. As the Supreme Court held in LIC v. Escorts Ltd.,¹⁰ “the transferor is bound to comply with all the reasonable directions that the transferee may give. He also becomes a trustee of the dividends as also of the right to vote. The right of the transferee ‘to get on the register' must be exercised with due diligence and the principle of equity which makes the transferor a constructive trustee does not extend to a case where a transferee takes no active interest to get on the register'.”

Transfer of Shares in Dematerialised Form

With the coming into force of the Securities and Exchange Board of India Act, 1992 (“SEBI Act”), the Depositories Act, 1996 (“Depositories Act”) and the regulations framed these statutes, an entirely new regime has been put in place for transfer of shares in dematerialised form. It involves not only the buyer and the seller, but also other entities such as the stock exchange, depository, depository participant, clearing house, clearing bank etc. The transfer process is unique, in that the buyer and the seller are unaware of each other's identity. It is the stock exchange which matches the identity of the buyer with the seller.

The Securities and Exchange Board of India has prescribed the manner in which the transfer of shares from the seller to the buyer and the transfer of funds from the buyer to the seller must take place. The entire process is referred to as ‘settlement cycle'. SEBI Circular No. DCC/FITTC/CIR-19/2003 dated 4 March 2003 prescribed that with effect from 1 April 2003, the settlement cycle for trading on stock exchange would be on ‘T+2 rolling settlement' basis. ‘T' refers to the date on which the trade occurs, i.e. when the buyer places the orders for purchaser of shares and the seller places the order for sale of shares. The shares are debited from the seller's demat account and the purchase consideration is debited from the buyer's bank account on the date of trading. However, the shares are credited into the buyer's demat account and the consideration is credited into the seller's bank account two days after the date of trading, i.e. T+2 day. In these circumstances, the question that arises is whether the title to the shares passes to the buyer at the time of placing the order on the date of trading (i.e. ‘T'), or at the time when the shares are delivered to the buyer two days after placing the order (i.e. ‘T+2'), or on any other date.

In the case of physical shares, the successful completion of the transfer is examined from two different perspectives: first, the transfer of title from the perspective of the company; and second, the transfer as amongst the seller and the buyer. Similarly, the issue of transfer of title of demat shares will be examined from these two perspectives.

Transfer of ownership of demat shares from the company's perspective

Title in demat shares vests only as a beneficial owner in the records of the depository, since the registered owner of the shares is always the depository.¹¹ This is in view of Section 10(1) of the Depositories Act, which states that the depository is always the registered owner of the shares. The persons holding shares in their demat accounts are only beneficial owners. Section 10(3) of the Depositories Act clarifies that all rights and benefits and all liabilities arising out of the shares are of the beneficial owner, and not of the depository.

In case of physical shares, Section 2(55)(ii) of the 2013 Act¹² stipulates that in order to be a member (i.e. a shareholder), the person's name must be entered in the register of shares of the company. In case of demat shares, Section 2(55)(iii) of the 2013 Act¹³ prescribes that a member is a person: a) ‘holding shares of the company'; b) whose name is entered as a beneficial owner in the records of the depository. This two-fold requirement under Section 2(55)(iii) must be established before the buyer of shares in demat form can assert its rights a member/shareholder of the company.¹⁴

It needs to be first determined as to when the buyer can be said to be ‘holding shares of the company'. The Supreme Court has held that the 1956 Act used the terms ‘member', ‘shareholder' and ‘holder of a share' synonymously, implying that a ‘holder of a share' means a member/shareholder. However, this meaning of ‘holder of a share' cannot be applied for the purposes of Section 2(55)(iii) of the 2013 Act or Section 41(3) of the 1956 Act, since it would lead to the absurd interpretation that in order to be a ‘member', a person has to be a ‘member' and whose name is entered as a beneficial owner in the records of the depository. Therefore, ‘holder of a share' for the purposes of these statutory provisions must be construed as a person who in whom the shares have vested pursuant to the transfer and who is entitled to have their name entered as a beneficial owner in the records of the depository.

The conditions for vesting of title of demat shares are not prescribed in the Companies Act, 2013, the SEBI Act or the Depositories Act. Since ‘shares' are included within the definition of ‘goods' under Section 2(7) of the Sale of Goods Act, 1930 (“Sale of Goods Act”), the provisions of the Sale of Goods Act would be applicable to determine as to when title is said to vest in the buyer.¹⁵ According to Section 19(1) of the Sale of Goods Act, title in the goods passes when the parties intend the same to pass. Section 20 states that where there is an unconditional contract for sale of specific goods in a deliverable state, title is deemed to pass when the contract is made, irrespective of the date of delivery or the date of payment for the goods. The Delhi High Court in Uday Punj v. Commissioner of Income Tax¹⁶ held that the transfer of beneficial ownership of shares takes place when the shares are transferred to the demat account of the transferee, and the date of payment of consideration for the transfer is not relevant. Similarly, in a 2009 Order, SEBI held that “presence of shares in a depository account is a sine quo non for any individual/entity to declare that he is a shareholder of the company.”¹⁷ Therefore, title vests in the buyer when the shares are credited in the buyer's demat account.

However, there are various questions that remain. Are shares in dematerialised form ascertained? What is the nature of relationship between the seller and the buyer? Are the stock exchange, depository, DP, clearing member also parties to the contractual relationship or do they simply perform statutory duties? In case of intraday trading, are the shares credited into the trading account of the trader? Some of these are yet to be judicially tested and determined.

Coming to the second requirement under Section 2(55)(iii) of the 2013 Act for becoming a member of a company, the name of the person holding the shares of a company must be entered as a beneficial owner in the records of the depository. This is a sina qua non for a person holding shares in demat form to be considered a shareholder/member. Till the time that the buyer's name is not recorded as a beneficial owner in the depository's records, the buyer cannot be considered as a shareholder.

Section 11 of the Depositories Act read with Regulation 54(1)(c) of the Securities and Exchange Board of India (Depositories and Participants) Regulations, 2018 (“DP Regulations”) requires the depository to maintain a register and index of beneficial owners. Further, Regulation 54(1)(d) of the DP Regulations requires the depository to maintain the details of holding of securities of beneficial owners as at the end of each day. Section 7(1) of the Depositories Act requires every depository to register the transfer of a security in the name of the transferee upon receipt of intimation from the depository participant. However, neither the Depositories Act nor the DP Regulations provides the time period within which the depository participant is required to intimate the depository about the transfer of a security. And the appropriate forum to be approached if the depository refuses to register the name of the buyer in the register of beneficial owners is only NCLT by making the company a party, as it may not come under the explicit jurisdiction of Securities Appellate Tribunal (SAT).

It is thus clear that a listed company is required to determine its shareholders on a given date from the register of beneficial owners maintained by the depository.

Transfer of title of shares as amongst the seller and the buyer

As discussed in the previous section, the Sale of Goods Act regulates the vesting of title in the buyer in case of a transaction involving sale of demat shares and the title vests in the buyer when the shares are transferred to the buyer's demat account. Till such date as the buyer's name is registered in the register of beneficial ownership maintained by the depository, the seller is a trustee of the buyer. However, given that the identity of the buyer and the seller is unknown to each other, during this interim period, the exercise of buyer's rights as the cestui que trust is rather cumbersome.

An important distinction between the transfer of physical shares and demat shares is that in case of the former, since the buyer and the seller are known to each other, Section 19(1) of the Sale of Goods Act allows them to agree upon the date of transfer of title as amongst them. Therefore, it does not necessarily have to be the date on which the share certificates are physically delivered to the buyer. In fact, when the buyer and the seller execute an unconditional contract for sale of ascertained shares, the title passes on the date of the contract itself, irrespective of whether the consideration has been paid or the share certificates have been delivered.¹⁸ On the other hand, in case of transfer of demat shares, since the buyer and the seller are unknown to each other, and the shares are also unascertained, there is no possibility of a prior agreement between the parties as to the date of vesting of title in the buyer.

Conclusion

The principles governing transfer of shares in demat form have not been exhaustively dealt with in existing case law. A reading of the existing statutory scheme suggests that from the company's perspective, the transferee becomes a member/shareholder of the company once the shares are credited into the transferee's demat account and the transferee's name is registered in the register of beneficial owners (in case of demat shares). As between the transferor and the transferee, the transfer is complete when the shares are credited into the transferee's demat account. Given the importance of the issue and in the absence of any conclusive judicial pronouncement on this issue, it is imperative that the legislature steps in and clarifies the position of law.

1 Regulation 31(1) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“Listing Regulations”).

2 Balkrishan Gupta v. Swadeshi Polytex Ltd., (1985) 2 SCC 167.

3 This corresponds to Section 41(2) of the 1956 Act.

4 This is in addition to the persons who are subscribers to the memorandum of association of the company. These persons are deemed to be members of the company as per Section 2(55)(i) of the 2013 Act.

5 Balkrishan Gupta v. Swadeshi Polytex Ltd., (1985) 2 SCC 167.

6 Howrah Trading Co. Ltd. v. CIT, AIR 1959 SC 775; Balkrishan Gupta v. Swadeshi Polytex Ltd., (1985) 2 SCC 167; LIC v. Escorts Ltd., (1986) 1 SCC 264.

7 Howrah Trading Co. Ltd. v. CIT, AIR 1959 SC 775;

8 LIC v. Escorts Ltd., (1986) 1 SCC 264.

9 (1974) 2 SCC 323.

10 (1986) 1 SCC 264.

11 Tendril Financial Services Pvt. Ltd. v. Namedi Leasing & Finance Ltd., 2018 SCC OnLine Del 8142. The Madras High Court in Dinesh Kumar Jhunjhunwala v. Karur Vysya Bank Ltd., 2007 SCC OnLine Mad 676 held that “it is clear that after enactment of the Depositories Act, 1996 (Act 22 of 1996), the membership of the company got widened and the beneficial owners, whose names are entered in the records of the depository, shall also be deemed to be the member of the concerned company.”

12 This provision corresponds to Section 41(2) of the 1956 Act.

13 This provision corresponds to Section 41(3) of the 1956 Act.

14 Clariant International Ltd. v. Securities & Exchange Board of India, (2004) 8 SCC 524: “The members holding equity share capital of a company and whose names are entered as beneficial owner in the records of the depository shall be deemed to be the members of the company concerned.”

15 See Vasudev Shelat v. Pranlal Thakkar, (1974) 2 SCC 323, where the Supreme Court held that the provisions of Transfer of Property Act, 1882 relating to gifts (Sections 122 and 123) would govern the transfer of shares pursuant to a gift deed.

16 2012 SCC Online Del 3517.

17 Temptation Food Ltd., In re (Non-compliance with the statutory requirements), 2009 SCC OnLine SEBI 97. Similarly, in India Power Corporation Ltd. v. Meenakshi Energy Ltd., 2020 SCC Online NCLAT 644, the National Company Law Appellate Tribunal has held that a pledgee became the beneficial owner of shares when the shares were transferred to its demat account upon the invocation of pledge.

18 This is as per Section 20 of the Sale of Goods Act.

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