Covid-19 Injunction – Bombay High Court order immunizes sale of pledged shares Covid-19 or popularly known as Coronavirus has taken the world by storm or, to be more accurate, unleashed a storm of unknown severity. It has now spread to 209 countries and territories with 1,174,8551 confirmed cases of infection. Apart from affecting human lives and health, it has caused unprecedented disruption to businesses and economies around the world. Disruption has affected performances under contracts, impacted financial transactions, shuttered businesses, affected employment and has sent the international financial and commodities markets into a tailspin. India has also not remained unaffected by it. Indian Government has been quick in responding to the situation and has announced regular changes to law and policy to deal with the consequences.
Disruption is also throwing up questions and situations of a novel nature. The Bombay High Court was faced with one such situation recently, in the case of Rural Fairprice Wholesale Limited & Anr. v. IDBI Trusteeship Services Limited & Ors2. The order passed by it in the case on 30 March, 2020 granting an injunction/stay against sale of pledged shares (Bombay High Court Order) taking note of the Covid-19 pandemic has thrown up some interesting questions.
Brief facts of the case are below.
Future Corporate Resources Pvt. Ltd. (FCRPL) is the promoter of Future Retail Ltd. (FRL), a company listed on Indian stock exchanges, and the holding company of Rural Fairprice Wholesale Ltd. (RFWL). FCRPL had pledged its equity shares in FRL, to secure a loan granted to RFWL by UBS AG, London Branch (Lender). The pledge was created in favour of the defendant, IDBI Trusteeship Services Limited (IDBI), the trustee holding security in relation to the loan. It appears that because of the stock market crash resulting from the Covid-19 pandemic, value of FRL's shares offered as security for the loan dropped significantly and the loan document covenant regarding prescribed security cover was breached. IDBI served notices on the Applicants, i.e., FCRPL and RFWL, dated March 17, 2020 and notice of sale dated March 18, 2020 for sale of pledged shares. The Applicants approached the Bombay High Court and sought an ad-interim injunction against IDBI going ahead with the sale.
Applicants' case was that they had taken a loan of INR 610 crores and market value of the shares pledged which was INR 350 per share at the time of taking the loan had fallen to below INR 100 per share at the time of hearing before the court. Applicants also submitted that the lender was fully secured in terms of the security documents and that if the sale of pledged shares was permitted, they would suffer irreparable losses. On the other hand, the lender and IDBI opposed the grant of ad-interim injunction and submitted that against the loan amount of INR 610 crores, the value of pledged shares had fallen to around INR 350 crores.
Taking note of Covid-19 and the resultant share market crash which led to a fall in per share price of pledged shares from INR 350 to below INR 100, the court, in a first of its kind ruling relating to Covid-19, granted an ad-interim injunction to the Applicants till the next date of hearing3 and restrained the lender/IDBI from selling the pledged shares in the market. The court also declared invalid the sale, if any, of the pledged shares prior to the filing of the suit by the Applicants.
Analysis
Section 37 of Specific Relief Act, 1963 which deals with grant of injunction provides that "... temporary Injunctions are such as are to continue until a specified time, or until the further order of the court, and they may be granted at any stage of a suit ...". Order XXXIX of the Code of Civil Procedure, 1908 provides the procedure for seeking temporary injunction. While grant of temporary injunction is a discretionary relief, it is well settled that temporary injunction must be normally granted if the following conditions are met:
- there is a prima facie case in favour of the plaintiff;
- balance of convenience lies in favour of the plaintiff; and
- irreparable loss will be caused to the plaintiff as compared to the defendant if the request for temporary injunction was not agreed.
While the Bombay High Court Order is not descriptive and the facts that may have convinced the court to grant the injunction are not recorded, based on material in public domain and inference drawn from the contents of the order, it is unclear whether the Applicants/plaintiff satisfied the above conditions. It appears that because of the fall in value of shares pledged as security for the loan, security cover covenant in the loan document may have been breached. As is customary for such loan transactions, in case of a breach, the borrower is required to either pledge more shares or pay a cash margin to cure the security cover breach. Presumably, in this situation, the lender would have approached the borrower to cure the security cover breach as per the loan documents which the borrower perhaps failed to do either because of lack of availability of more shares to be pledged or poor financial situation of the borrower/security provider. Failure to cure the breach of security cover covenant may have prompted the lender to go for the sale of pledged shares.
In the above background, it is difficult to understand how the Applicants met the prima facie case condition. Clearly, the borrower breached the security cover covenant and perhaps failed to cure it. It is unlikely, and the Bombay High Court Order doesn't suggest, that there was a dispute between the parties regarding the breach. Given these likely facts, granting an injunction amounts to giving a benefit to the party breaching the contract whereas the principle ordinarily is that injunction is granted to protect the party affected by breach of contract or who suffers an injury. It is also not clear how the balance of convenience was more in favour of the borrower and pledgor of shares in comparison to the lender. While irreparable loss would have been caused to the pledgor if the shares were sold by the lender how his loss would be greater than of the lender if injunction was not granted is arguable.
This gives rise to a question, what happens if, as a result of the continuing business disruption brought about by the Covid-19 situation, before the next date of hearing, borrower's situation deteriorates to a point of pushing it into financial sickness or bankruptcy and the value of pledgor's shares drops even further and security cover becomes even lower. In that situation, the lender would find itself unable to recover its debt or recover even a lower portion of it by sale of pledged shares (if the injunction was lifted on the next date of hearing). As it turns out, the value of pledged shares has continued to fall and on April 3, 2020 was around INR 71 resulting in further erosion of security cover available to the lender.
Other points that arise for consideration are why should a borrower claim or deserve a preferential treatment over the lender in the situation arising from Covid-19. While the pledgor runs the risk of financial loss and losing control of his company if sale was allowed, because of sale being injuncted, the lender runs the risk of losing capital. In a free market economy, market forces should normally be allowed to operate freely to deal with the consequences unleased by them particularly between entities having somewhat equal bargaining power. State should step in only to protect the weak, marginalised and to deal with any aberrations. Moreover, why shouldn't contracts be enforced as per their terms and why should a party responsible for breach of contract be given a favourable treatment over the party affected by such breach.
Unlike other commercial contracts, loan and security transactions are not subject to force majeure protections. Even in contracts with force majeure provisions, it is well settled that payments which have been become due are not excused by force majeure and change in financial condition of a party affected by force majeure or a force majeure event making performance commercially more onerous doesn't excuse performance. Therefore, even if it is argued that Covid-19 is a valid force majeure, that should not excuse performance under a security transaction to benefit the security provider.
The court's ruling, while a big relief for the Applicants, can have widespread ramifications if other courts were to grant similar injunctions in cases of enforcement/invocation of securities. Well-functioning financial markets are important to promote economic growth in the long term and for efficient allocation of capital. This principle assumes greater significance in the face of short-term impact of Covid-19 on the economy and likely long-term effects. Measures that have the potential to tamper with free play of market forces and shake the confidence of the market participants in its efficient functioning need to be avoided. Share backed financing is a popular lending structure because of its simplicity and ease of enforcement. If these features are not available, it will affect the availability of capital and increase the cost of lending, both undesirable outcomes in the post Covid 19 world. Given the sharp fall in stock prices in India suggestions were being made from different quarters to lock down stock exchanges as well. However, both the Government and regulator did well to resist the urge to do so despite significant erosion of investor wealth. Covid-19 will blow over sooner than later. Hence, solutions that alleviate the short-term pain but may introduce systemic risk need to be avoided.
Footnotes
1 https://www.who.int/emergencies/diseases/novel-coronavirus-2019
2 Rural Fairprice Wholesale Limited & Anr. v. IDBI Trusteeship Services Limited & Ors Commercial Suit No. (L) 307 of 2020
3 The next date of hearing is fixed for May 4, 2020
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