Setting aside an arbitral award that had gone in favour of a retail trader who earned substantial profits by exploiting a technical glitch in the trading system of Kotak Securities Ltd, the Bombay High Court (HC) ruled that gains made from an erroneous margin credit cannot be lawfully retained.
In an order last month, the bench of justice Sandeep V Marne says, "There is no dispute to the position that Kotak Securities' (petitioner’s) system is solely responsible for making available the margin money to the respondent, who has used his skills to make the most of the opportunity and has earned profits. Someone will have to be given those profits. Given that there is a system glitch attributable to the petitioner, coupled with failure to invoke adequate and timely risk protocols, the petitioner cannot be permitted to retain the profits. On the other hand, the respondent is not responsible in any manner for the development of the system glitch and has used his own skills and has taken the risk in executing the trades. Therefore, if only one out of the two parties can be permitted to retain the profits, it would be the respondent and not the petitioner."
"It is not that the findings of the respondent’s entitlement to profits are something which no fair-minded person can ever record in the facts and circumstances of the case. Even otherwise, this Court is unable to accept the position that Kotak Securities would commit a mistake and though it has not suffered any losses out of that mistake, it would enrich itself by claiming profits out of the trades executed by the respondent. For trades effected by the respondent, Kotak Securities would still earn brokerage and would benefit to some extent. Therefore, this Court is not inclined to take a view different from the one taken by the appellate arbitral tribunal," the HC says.
The dispute arose from trades executed on 26 July 2022, when Gajanan Ramdas Rajguru (the respondent), a client of Kotak Securities, received an unintended margin credit due to a system error at the brokerage. At the time, he had an actual margin balance of just over ₹3,000. However, taking advantage of the erroneous credit, he executed futures and options (F&O) trades worth nearly ₹95 crore within a brief window of about 20 minutes.
According to Kotak Securities, the trades would ordinarily have required a margin of around ₹40 crore. By the time the technical glitch was rectified, Mr Rajguru had already booked profits of about ₹1.75 crore.
The HC observed that, apart from its own system failure, Kotak Securities apparently did not take the adequate and timely measures to mitigate the consequences arising out of malfunctions of the system. "There is sufficient material on record to indicate that Kotak Securities did not invoke risk control protocols. Far from warning Mr Rajguru that it was unauthorisedly trading on erroneous margin, Kotak Securities issued contract notes upon execution of trades, deducted levies and even charged interest for use of margin. It even credited the net profit in Mr Rajguru’s ledger."
While the brokerage initially credited the amount through a contract note, it later reversed the profit after adjusting statutory charges, citing the wrongful use of margin.
Mr Rajguru objected to the reversal and eventually approached investor grievance redressal mechanisms, culminating in arbitration proceedings. While the initial arbitral tribunal ruled in favour of Kotak Securities, the appellate arbitral tribunal overturned that decision and directed the broker to restore the reversed amount to Mr Rajguru.
Kotak Securities then moved the Bombay HC under the Arbitration and Conciliation Act, arguing that the appellate award was contrary to fundamental principles of law and ignored statutory provisions under the Indian Contract Act.
The HC agreed with the brokerage’s submissions, holding that the case squarely attracted Sections 71 and 163 of the Contract Act, which deal with obligations arising from non-gratuitous acts and the duty to return benefits received without lawful entitlement.
The Court observed that Mr Rajguru was fully aware that he did not possess the requisite margin to execute trades of such magnitude and nevertheless proceeded to place orders after receiving the erroneous credit. It held that a client cannot be permitted to profit from a system failure when the underlying trades were executed without fulfilling mandatory margin requirements under stock exchange regulations.
Justice Marne noted that Mr Rajguru used his own skill and assumed the risk of loss in converting the undue opportunity into profit. The Court says, “The margin reflected in his account merely opened doors for him to trade on the exchange platform. The opportunity came with risk of incurring losses or to earn profit, depending on Mr Rajguru’s skill.”
Refusing to accept Kotak Securities' contention that it must be permitted to retain the profits so that the sanctity of the risk management system is maintained, Justice Marne says, "Considering the peculiar circumstances of the case, I am unable to accept the contention raised on behalf of Kotak Securities."
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