FRANKLIN TEMPLETON TRUSTEE SERVICES PRIVATE LIMITED AND ANOTHER versus AMRUTA GARG AND OTHERS ETC.
[2021] 5 S.C.R. 559, Supreme Court of India, 2021
Outcome: Directions issued
Segment: Ratio
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   [2021] 5 S.C.R. 559
559
FRANKLIN TEMPLETON TRUSTEE SERVICES PRIVATE
LIMITED AND ANOTHER
v.
AMRUTA GARG AND OTHERS ETC.
(Civil Appeal No. 498-501 of 2021)
JULY 14, 2021
[S ABDUL NAZEER AND SANJIV KHANNA, JJ.]
Securities and Exchange Board of India (Mutual Funds)
Regulation, 1996:
Regns. 18(15)(c) and 39 to 42 – Interpretation of – Winding
up of six mutual fund schemes – High Court interpreting Regn
18(15)(c) and Regn 39(2)(a) held that the decision of the trustees
to wind up a scheme under clause (a) to Regn 39(2) must muster the
consent of the majority of the unitholders as per Regn 18(15)(c) –
Case of SEBI, the trustees and the Asset Management Company
that prior consent of the unitholders is not envisaged when the
trustees, or SEBI directs winding up of a scheme in the interest of
the unitholders; and that the decision of the trustees and SEBI to
wind up a scheme is final and binding on the unitholders – Appeal
before this Court – This Court in its earlier order accepting the poll
results, directed winding up of six mutual fund schemes – As regards,
interpretation of Regns 39 to 42 and their interrelation with Regn
18(15)(c) and constitutional validity of Regns 39 to 42, held:
Regulations of 1996 do not suffer from the vice of manifest
arbitrariness, thus, Regulations of 1996 constitutionally valid –
Applying principle of harmonious construction to Regn 18(15)(c)
with Regns 39 to 42, would mean that the opinion of the trustees
would stand, but the
consent of the unitholders is a pre-requisite
for winding up – Securities and Exchange Board of India Act, 1992.
Constitutional validity of 1996 Regulations – Held:
Regulations of 1996 do not suffer from the vice of manifest
arbitrariness – Since the Regulations are in the nature of economic
Regulations, while exercising the power of judicial review, restraint
would be exercised unless clear grounds justify interference – Views
would not be supplanted for that of the experts as this can put the
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marketplace into serious jeopardy and cause unintended
complications – Regs. 18(15)(c) and 39 to 42.
Regn 18(15)(c) with Regns 39 to 42 – Interpretation of Regns
39 to 42, their interplay and harmonious construction with Regn
18(5)(c) – Held: Under clause (a) of Regn 39(2) the power of
winding up of a scheme is vested with the trustees, under clause (b)
with the unitholders and under clause (c) with the SEBI, however,
under Regn 18(15)(c), the trustees are required to seek consent of
the unit holders, when they by majority decide to wind up a scheme
– Use of the word ‘shall’ in Regn 18(15)(c) is couched as a command
– Expression ‘when the majority of the trustees decide to wind up’
in Regn 18(15)(c) manifestly refers to clause (a) to Regn 39(2) as
this is the only Regulation which entitles the trustees to wind up the
scheme – Regn 18(15)(c), when it refers to trustees’ decision to wind
up, it implies the trustees’ opinion to wind up the scheme – Applying
principle of harmonious construction in the context of the
Regulations of 1996, would mean that the opinion of the trustees
would stand, but the consent of the unitholders is a pre-requisite
for winding up – This interpretation does not in any way dilute or
render clause (b) to Regn 39(2) meaningless or redundant – This
clause applies where the winding up process is initiated at the
instance of 75% of the unitholders – Clause (b) does not in any
manner reflect that
clause (c) to Regn 18(15) should not be read as
it ordains in simple words – Regn 41 refers to and relates to the
procedure and manner of winding up which cannot be equated with
the requirement of consent as postulated by Regn 18(15)(c) – Regn
41(1) applies even in cases where 75% unitholders have passed
the resolution for winding up of the scheme under Regn 39(2)(b) or
where SEBI directs the scheme to be wound up in the interest of the
unitholders under Regn 39(2)(c) – On the other hand Regn 18(15)(c)
applies only when majority of the trustees form an opinion and
decide to wind up or prematurely redeem the units in entirety, a
situation covered by Regn 39(2)(a) – To ignore the mandate of Regn
18(15)(c) would nullify the legislative intent – Need to obtain consent
of the unitholders is mandated under clause (c) to sub-Regn 15 to
Regn 18 when the trustees under clause (a) to Regn 39(2) decide to
wind up a scheme – To deny the unitholders a say, when Regn
18(15)(c) requires their consent, debilitates their role and right to
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participate – ‘Consent’ for the purpose of Regn 18(15)(c) refers to
the consent of the majority of the unitholders present and voting –
Harmoniously interpreting Regns 39 to 42, it is held that the consent
of the unitholders, is not required before publication of the notices
under Regn 39(3) – Consent of the unitholders should be sought
post publication of the notice and disclosure of the reasons for
winding up under Regn 39(3) – Thus, the High Court rightly held
that the consent of unitholders of the scheme would be necessary if
the majority of the directors of the trustee company decide to wind
up a scheme.
Regn 39(2)(a), 39(3) – Trustees – Power of – Held: There are
sufficient guidance and safeguards in the Regulations itself on the
power of the trustees to decide on winding up of the fund – It cannot
be accepted that the trustees under clause (a) to Regn 39(2) have
been given absolute and unbridled power to wind up a scheme –
Language of clause (a) to Regn 39(2) states that the trustees must
form an opinion on the happening of any event which requires the
scheme to be wound up – Further, as per Regn 39(3), the trustees
are bound to give notice disclosing the circumstances leading to
the winding up of the scheme – Trustees are, thus, required to come
to a conclusion that due to specific circumstances articulated in
writing, the scheme is required to be wound up – Trustees hold the
assets of the scheme in fiduciary capacity on behalf of the investors
–
They are experts in the field and, thus, conferred the power under
Regn 39(2)(a) to decide whether or not a scheme should be wound
up – Expression ‘occurrence of any event’ is not to be read in
isolation but with the words ‘requires the scheme to be wound up’ –
Read in this manner, there is no vagueness which can be described
as transcending into realm of arbitrariness, on the other hand, the
prerequisite statutory mandate is clear – This is not a case of
excessive delegation wherein the legislative function has been
abdicated and passed on to the trustees who can act as per their
whims and fancies – Thus, the High Court’s holding that the opinion
of the trustees under clause (a) to Regn 39(2) must be consented to
by the unitholders in terms of the mandate of Regn 18(15)(c) is
accepted.
Unitholders and creditors – Difference between – Held:
Regulations rightly draw the distinction between creditors and the
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unitholders – Unit holders are investors who take the risk and,
thus, entitled to profits and gains and they must also bear the losses,
if any – Unitholders are not entitled to fixed return or protection of
the principal amount whereas creditors are entitled to fixed return
as per mutually agreed contracts – Their rate of return is in the
nature of interest and not profit or loss – Creditors are not risk
takers as is the case with the unitholders – To equate the unitholders
with either the creditors or the home buyers will be unsound and
incongruous.
Regn 53 – Provision regarding despatch of dividend warrents
or proceeds by mutual fund and asset management company-AMC
– Interpretation of – Clause (b) to Regn 53 requires that the AMC to
despatch the redemption or repurchase proceeds within ten working
days from the date of redemption or repurchase – Issue as regards
whether the AMC or the trustees are bound to honour and pay the
redemption or repurchase proceeds for requests received before the
date of publication of notice in terms of Regn 39(3) – High Court
held the expression ‘business’ in clause (a) of Regn 40 refers to
business activity and, thus, would include payment of redemption
proceeds to the unit holders, which would include the request for
redemption received prior to the date of publication under Regn
39(3) – On appeal, held: There is a need for greater clarity on the
factual matrix, which would be
possible once the pending
proceedings are concluded – In view thereof, several issues left
open at this stage – Observations in the instant Order and the earlier
Order not to be read as binding factual findings or conclusions on
any disputed facts, which could be a subject matter of a show-
cause notice and consequent decision, though legal interpretation
of Regn 18(15)(c) and Regns 39 to 42 are conclusive and binding.
Securities and Exchange Board of India Act, 1992: s. 11, 11B
– Functions of Securities and Exchange Board of India-SEBI –
Power to issue directions and levy penalty – Explained.
Interpretation of statutes: Process of interpretation – Three
stage, literal interpretation, propositional interpretation and
purposive interpretation – Held: Interpretation is sometimes a three-
stage process – At first, the words being interpreted should be
understood according to their grammatical meaning in their literal
and popular sense – In the second stage, it is considered whether
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in the given context the plain meaning is obscure as the text gives
rise to choice of more than one interpretation, or the propositional
interpretation fails to achieve the manifest purpose of the legislation
– In such cases at the third stage, the court applying interpretative
tools selects an interpretation advancing the legislative intent without
rewriting the provision – Legislative intent is gathered from the object
and purpose of the provision and the legislation – Courts do lean
towards a pragmatic and purposive interpretation as there is an
assumption that the draftsmen legislate to bring about a functional
and working result.
Alka Synthetics and Trading v. SEBI (1999) 95 Comp
Cas 663; Nikhil T. Parikh v. Union of India (2014) 2
GLH 582 – approved.
State of Tamil Nadu and Another v. T. Krishnamurthy
and Others (2006) 4 SCC 517 : [2006] 3 SCR 396;
Shayara Bano v. Union of India and Others (2017) 9
SCC 1 : [2017] 9 SCR 797; Senior Superintendent of
Post Offices, Allahabad and Others v. Izhar Hussain
(1989) 4 SCC 318 : [1989] 3 SCR 796; Director
General, Central Reserve Police Force and Others v.
Janardan Singh and Others. (2018) 7 SCC 656 : [2018]
5 SCR 81; Pioneer Urban Land and Infrastructure
Limited and Another v. Union of India and Others
(2019) 8 SCC 416 : [2019] 10 SCR 381; Sterlite
Industries (India) Ltd. v. SEBI 2001 SCC OnLine SAT
28; Nisha Priya Bhatia v. Union of India and Another
(2020) 13 SCC 56; B.K. Educational Services Private
Limited v. Parag Gupta and Associates, (2019) 11 SCC
633 : [2018] 12 SCR 794; Union of India v. Raman
Iron Foundry (1974) 2 SCC 231 : [1974] 3 SCR 556 –
referred to.
Case Law Reference
[2006] 3 SCR 396
referred to
Para 49 (f)
[2017] 9 SCR 797
referred to
Para 49 (f)
[1989] 3 SCR 796
referred to
Para 49 (f)
[2018] 5 SCR 81
referred to
Para 49 (f)
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[2019] 10 SCR 381
referred to
Para 49 (h)
(1999) 95 Comp Cas 663
approved
Para 55
(2014) 2 GLH 582
approved
Para 55
(2020) 13 SCC 56
referred to
Para 58
[2018] 12 SCR 794
referred to
Para 62
[1974] 3 SCR 556
referred to
Para 62
CIVIL APPELLATE JURISDICTION : Civil Appeal Nos. 498-
501 of 2021.
From the Judgment and Order dated 24.10.2020 of the High Court
of Karnataka, at Bengaluru in Writ Petition Nos. 8545, 8644, 8748 of
2020 and Writ Appeal No. 399 of 2020.
With
Civil Appeal Nos.502, 503, 504-507, 508, 509 of 2021, Special
Leave Petition (Civil) No. 1486 Of 2021 And Special Leave Petition
(Civil) (D) No.1563 of 2021.
Tushar Mehta, SG., Harish Salve, Dr. Abhishek Manu Singhvi,
Arvind P. Datar, Ms. Meenakshi Arora, Ravindra Shrivastava, V. Giri,
Sr. Advs., Ashish Bhan, Mohit Rohatgi, Jasmeet Singh, Asim Sood,
Rajendra Dangwal, Saif Ali, Ms. Madhavi Khanna, Pratap Venugopal,
Ms. Surekha Raman, Akhil Abraham, Vijay Valsan, For M/S. K J John
and Co., Nithyaesh Natraj, Vaibhav R. Venkatesh, Gopal Singh, Puneet
Jain, Harshit Khanduja, Harsh Jain, Akshat Maheshwari, Harshvardhan
Sharma, Neeraj Sharma, Ms. Christi Jain, Arjun Garg, Abhinav
Shrivastava, Abhijeet Shrivastava, Ms. Garima Tiwari, Arpit Jain, Karan
Kohli, Nirmal Prasad, Ms. Aditi Shrivastava, Shivam Singh, Sahil Raveen,
Jaideep Khanna, Manish Kumar, Paritosh Gupta, Ms. Supriya Juneja,
Aditya Singla, Ms. Aishwarya Reddy, Ms. Cheshta Jetly, Ms. Madhumita
Bhattacharjee, Ms. Arti Jain, Ms. Srija Choudhury, Rajat Nair, Ms. Garima
Prasad, Ms. Priyanka Das, Arvind Kumar Sharma, Anirudh Sriram,
Dheeraj Nair, Kumar Kislay, Angad Baxi, Sanjay Kapur, Ms. Megha
Karnwal, V. M. Kannan, Sambit Panja, Arjun Bhatia, Advs. for the
appearing Parties.
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The Order of the Court was passed by
SANJIV KHANNA, J.
1. By the order dated 12th February 2021, interpreting Regulation
18(15)(c) of the Securities and Exchange Board of India (Mutual Funds)
Regulations, 1996 (hereafter referred to as ‘Regulations’) and accepting
the poll results, we have directed winding up of six mutual fund schemes:
(i)
Franklin India Low Duration Fund (Number of Segregated
portfolios – 2),
(ii)
Franklin India Ultra Short Bond Fund (Number of
Segregated portfolios – 1),
(iii)
Franklin India Short Term Income Plan (Number of
Segregated portfolios – 3),
(iv)
Franklin India Credit Risk Fund (Number of Segregated
portfolios – 3),
(v)
Franklin India Dynamic Accrual Fund (Number of
Segregated portfolios – 3), and
(vi)
Franklin India Income Opportunities Fund (Number of
Segregated portfolios – 2).
2. We would now proceed to interpret Regulations 39 to 42 and
their interrelation with Regulation 18(15)(c). We shall also examine and
decide the challenge to the constitutional validity of Regulations 39 to
42. As elucidated in the course of hearings and reflected in the order
dated 12th February 2021, it would be inopportune to decide and dispose
of these appeals, as facts remain disputed and are sub-judice along with
other substantive issues in the adjudication proceedings under the
Securities and Exchange Board of India Act, 1992 (hereafter referred
to as the ‘SEBI Act’). The forensic report of the auditors, possibly the
foundation of the show
cause notice(s), is a subject matter of
consideration before the statutory authorities that are bestowed with
wide powers. It is not anyone’s case that the statutory adjudication
proceedings should be eschewed or nullified. At the same time, we are
not inclined to dispose of these appeals as this would not be in the interest
of the unitholders, who are hopeful, yet concerned and apprehensive.
Final and conclusive adjudication, on contested factual and related issues,
post the statutory adjudication would be in the interest of the parties. No
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prejudice should be caused. Directions to await the orders in the
adjudication proceeding have been incorporated in the order dated 12th
February 2021. We hope and trust that the proceedings under the SEBI
Act would conclude expeditiously.
General overview of the Regulations
3. We shall begin with an overview of the Regulations as they
would aid us in deciding the two issues; though, to avoid prolixity, we are
not reproducing the Regulations. We would subsequently selectively quote
the Regulations requiring interpretation.
4. The Regulations envisage a three-tier structure for mutual funds
in the form of the sponsor, the board of trustees or the trustee company,
and the asset management company (the AMC). The sponsor, as defined
by Regulation 2(x), means a person who, acting alone or in combination
with another body corporate, establishes a mutual fund. For this purpose,
the sponsor is required to make an application to the Securities and
Exchange Board of India (hereinafter referred to as the ‘SEBI’) in the
prescribed form for registration of the mutual fund. Chapter II of the
Regulations spells out the eligibility criteria and requirements for
registration of a mutual fund.
5. The term ‘trustees’ has been defined in Regulation 2(y) to mean
the board of trustees or the trustee company who hold the property of
the mutual fund in trust for the benefit of the unitholders. The expression
‘unit’ has been defined in
Regulation 2(z) to mean the interest of the
unitholders in the scheme, which consists of each unit representing one
undivided share in the assets of the scheme, and the term ‘unitholder’
has been defined in Regulation 2(z)(i) to mean a person holding a unit in
the scheme of a mutual fund.
6. The AMC is a company, approved by SEBI under Regulation
21(2), which undertakes business activities in the nature of management
and advisory services provided to the pooled assets. The services may
be specified by SEBI from time to time. The AMC is forbidden by the
Regulations from acting as a trustee of any mutual fund.
7. Chapter III relates to the constitution and management of
mutual funds and operation of trustees etc. Regulation 14 stipulates that
a mutual fund shall be constituted in the form of a trust and the instrument
of the trust shall be in the form of a deed, registered under the provisions
of the Indian Registration Act, 1908, executed by the sponsor in favour
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of the trustees. Regulation 15(1) requires that the trust deed shall
incorporate such clauses as are mentioned in the Third Schedule of the
Regulations, and such other clauses as are necessary for safeguarding
the interests of the unitholders. Regulation 15(2) mandates that no trust
deed shall contain a clause which has the effect of – (a) limiting or
extinguishing the obligations and liabilities of the trust in relation to any
mutual fund or the unitholders; or (b) indemnifying the trustees or the
AMC for loss or damage caused to the unitholders by acts of negligence
or acts of commission or omission on part of the trustees or the AMC.
Regulation 16 itemises the criteria for disqualification from appointment
as a trustee. In effect, it stipulates the eligibility requirements for
appointment of the trustees. In particular, it states that two-thirds of the
trustees shall be independent persons, not associated with the sponsors
in any manner. Further, a person appointed as a trustee of a mutual fund
is not eligible to be appointed as a trustee of another mutual fund. An
AMC and its directors (including independent director), officers or
employees are ineligible to be appointed as a trustee of any mutual fund.
Regulation 17 requires prior approval of SEBI before a person is appointed
as a trustee. In the case of existing trustees of any mutual fund, they
may form a trustee company to act as a trustee, albeit with prior approval
of SEBI. The trustees are
bound by the Code of Conduct specified in
the Fifth Schedule, as well as general and specific due diligence mandates.
8. Regulation 18 is critical as it elaborately enlists the rights and
obligations of the trustees, in as many as 29 sub-regulations. The trustees
and the AMC, as per Regulation 18(1), can enter into an investment
management agreement with the prior approval of SEBI. Such an
agreement must contain clauses mentioned in the Fourth Schedule and
other clauses as are necessary for the purpose of making investments.
The sub-regulations enumerate the requirements to be satisfied before a
scheme is launched by the AMC. They obligate that the trustee shall
ensure that the AMC has been diligent in empanelling the brokers, and in
monitoring securities transactions with the brokers and in avoiding undue
concentration of business with any broker. The trustees have to also
ensure and check that the AMC has not given any undue or unfair
advantage to any associates or dealt with any of its associates in any
manner detrimental to the interest of the unitholders and that the
transactions entered into by the AMC are in accordance with the
regulations and the scheme. The trustees are entitled to call for details
of transactions in securities by the key personnel of the AMC in their
FRANKLIN TEMPLETON TRUSTEE SERVICES PVT. LTD.  v.
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own name or on behalf of the AMC and report the same to SEBI, as and
when required. The sub-regulations require the trustees to carry out
quarterly reviews of all transactions between the mutual funds, the AMC
and its associates. The trustees are to also review the net worth of the
AMC on a quarterly basis. In case of any shortfall in net worth, the
trustees were to ensure that the AMC makes up for the shortfall in
terms of Regulation 21(1)(f).1 The trustees are to furnish to SEBI, on a
half-yearly basis, a report on the activities of the mutual fund with
certificates that there have been no instances of self-dealing or front
running by any of the trustees, directors or key personnel of the AMC,
and that the AMC has been managing the schemes independently of
any other activities, and in case any activities of the nature referred to in
Regulation 24(b) have been undertaken by the AMC, that it has taken
adequate steps to ensure that the interests of the unitholders are
protected.2
9. Chapter IV of the Regulations relates to the constitution and
management of the AMC and the custodian. The AMC is appointed by
the sponsor, or by the trustee, if so authorised by the trust deed. However,
the appointment needs approval by SEBI under Regulation 21(2). As
per Regulation 20(2), the appointment of the AMC can be terminated by
majority of the trustees or by 75% of the unitholders of the scheme.
Regulation 20(3) states that any
change in the appointment of the AMC
is subject to the approval of SEBI and the unitholders. Regulation 21
enumerates the eligibility criteria for appointment as an AMC. The
directors of the AMC should be persons having adequate professional
experience in finance and financial services related fields and should not
be found guilty of moral turpitude or convicted of any economic offence
or violation of any securities laws. The key personnel of the AMC should
not have been found to be guilty of the above, nor should they have
worked for any AMC/mutual fund/intermediary during the period when
its registration was suspended or cancelled by SEBI. The board of
directors of the AMC must have at least 50% of directors who are not
associates, or associated in any manner with the sponsor or any of its
subsidiaries or the trustee. The net worth of the AMC should not be less
than Rs.50 crores. Regulation 24 specifies the restrictions on the business
activities of the AMC. Regulation 25 specifies the obligations and the
1 The position post the SEBI (Mutual Funds) (Amendment) Regulations, 2021 with
effect from 5th March 2021 has not been examined.
2 Legal effect of Regulation 24 has not been examined.
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responsibilities of the AMC, which include taking reasonable steps and
exercising due diligence to ensure that the investment of funds pertaining
to any scheme is not contrary to the provisions of the regulations and the
trust deed. The AMC is responsible for the acts of commission or omission
by its employees, or persons whose services have been procured by the
AMC. Sub-regulation (6) states that the AMC and its directors,
notwithstanding any contract or agreement, shall not be absolved of the
liability to the mutual fund for their acts of omission and commission,
while holding such position or office.
10. There are a number of stipulations and restrictions to ensure
objectivity, fidelity and transparency in business transactions by the AMC
and compliance with the Regulations. A system of regulation involving
checks, responsibility and power of free decision is envisaged. The Chief
Executive Officer, by whatever name called, is mandated by sub-regulation
(6A)3 to Regulation 25 to ensure that the mutual fund complies with all
the provisions of the Regulations, guidelines and circulars issued in relation
thereto from time to time and that the investments made by the fund
managers are in the interest of the unitholders. This officer is responsible
for the overall risk management function of the mutual fund. Sub-
regulation (6B)4 to Regulation 25 states that the fund managers, whatever
be the designation, shall ensure that the funds are invested to achieve
the objectives of the scheme and in the interest of the unitholders.
11. Chapter V deals with schemes of mutual funds and Regulation
28(1) thereunder states that no scheme shall be launched by the AMC
unless it is approved by the trustees and a copy of the offer document
has been filed with SEBI. Regulations 32 and 33 pertain to the listing
and repurchase respectively of units in close-ended schemes, while
Regulation 35 deals with the allotment of units and refunds of moneys.
In terms of Regulation 38, guaranteed return is not to be provided in a
scheme, unless such returns are fully guaranteed by the sponsor or the
AMC, and a statement to that effect is made in the offer document,
indicating the name of the person who will guarantee the return and the
manner in which the guarantee is to be met. Regulation 38A permits
launching of a capital protection-oriented scheme subject to: (a) the units
of the scheme being rated by a registered credit rating agency from the
viewpoint of the ability of its portfolio structure to attain the protection
3 SEBI (Mutual Funds) (Second Amendment) Regulations, 2020, w.e.f. 29.10.2020
4 Ibid.
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of the capital invested therein; (b) the scheme being close-ended; and
(c) compliance with other requirements as may be specified by SEBI.
Regulation 48 requires that every mutual fund shall compute the Net
Asset Value of each scheme as specified and the same shall be calculated
on daily basis and disclosed in the manner as stated by SEBI.
12. Regulation 49 is titled ‘pricing of units’ and states that the
price at which the units may be subscribed / sold / repurchased by the
mutual fund shall be made available to the investors in the manner
specified by SEBI. The methodology for calculating the sale and
repurchase price of the units is to be provided by the mutual fund in the
manner specified by SEBI. Sub-regulation (3) states that in determining
the price of the units, the mutual fund shall ensure that the repurchase
price is not lower than 93% of the Net Asset Value and the sale price is
not higher than 107% of the Net Asset Value. As per the second proviso
to sub-regulation (3), difference between the repurchase price and the
sale price of the unit shall not exceed 7% calculated on the sale price.5
13. Regulations 54 and 55 relate to the annual report and the
auditor’s report respectively. Regulation 56 requires providing a copy of
the annual report and the summary thereof to the unitholders. Regulation
58 mandates periodic and continual disclosures by the AMC, the trustee,
the sponsors, and the custodians,
requiring them to make such disclosures
and submit such documents as may be provided by SEBI and comply
with sub-regulations (2) and (3). Regulation 59 deals with half-yearly
disclosures. Regulation 60 imposes a general obligation to disclose
information and, being of some importance, is reproduced below:
“Disclosures to the investors
60. The trustee shall be bound to make such disclosures as are
essential in order to keep them informed about any information
which may have an adverse bearing on their investments.”
The trustees are mandated and bound to make such disclosures
to the unitholders as are essential to keep them informed about any
information that may have adverse bearing on their investments.
14. Chapter VIII relates to and empowers SEBI to authorise and
conduct inspection and audit. SEBI, under Regulation 61(1), may appoint
5 Post amendment w.e.f. 5.3.2021 Regulation 49(3) states that the repurchase price of
units of an open-ended scheme shall not be lower than 95 % of the NAV. There is no
stipulation in the Regulations regarding the sale price.
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one or more persons as the inspecting officers to undertake inspection
of the books of accounts, records, documents, and infrastructure, systems,
and procedures or to investigate the affairs of the mutual fund, the trustees,
and the AMC for the purposes stipulated therein. Regulation 62 requires
that SEBI shall issue not less than ten days’ notice to the mutual fund,
trustees, or AMC, as the case may be, before ordering an inspection or
investigation. However, under sub-regulation (2), notwithstanding sub-
regulation (1), SEBI can direct such inspection or investigation without
any notice when it is satisfied that in the interest of the investors no such
notice should be given. Regulation 63 prescribes the duties and obligations
of the mutual fund/ trustees/ AMC whose affairs are being inspected or
investigated. The investigating officer can, during the course of the
investigation, examine or record the statements of any director, officer,
or employee of the mutual fund/ trustee/ AMC and every such mutual
fund/ trustee/ AMC is duty-bound to give to the investigating officer all
assistance in connection with the inspection or investigation. The
inspecting officer is to submit, as soon as possible, a report to SEBI on
completion of the investigation. Regulation 65 states that SEBI or the
Chairman shall after consideration of inspection or investigation report
take such action as SEBI or the Chairman may deem fit and appropriate
under Chapter V of the
Securities and Exchange Board (Intermediaries)
Regulations, 2008.
Regulations 39 to 42 and 18(15) of the Securities and
Exchange Board of India (Mutual Funds) Regulations, 1996.
15. Regulations 39 to 42 read as under:
“Winding Up
39. (1) A close-ended scheme shall be wound up on the expiry of
duration fixed in the scheme on the redemption of the units unless
it is rolled over for a further period under sub-regulation (4) of
regulation 33.
(2) A scheme of a mutual fund may be wound up, after repaying
the amount due to the unit holders, —
“(a) on the happening of any event which, in the opinion of the
trustees, requires the scheme to be wound up; or
(b) if seventy-five per cent of the unit holders of a scheme
pass a resolution that the scheme be wound up; or
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(c) if the Board so directs in the interest of the unitholders.
(3) Where a scheme is to be wound up under sub-regulation (2),
the trustees shall give notice disclosing the circumstances leading
to the winding up of the scheme:
“(a) to the Board; and
(b) in two daily newspapers having circulation all over India, a
vernacular newspaper circulating at the place where the mutual
fund is formed.
Effect of winding up
40. On and from the date of the publication of notice under clause
(b) of sub-regulation (3) of regulation 39, the trustee or the asset
management company as the case may be, shall—
“(a) cease to carry on any business activities in respect of the
scheme so wound up;
(b) cease to create or cancel units in the scheme;
(c) cease to issue or redeem units in the scheme.
Procedure and manner of winding up
41. (1) The trustee shall call a meeting of the unitholders to approve
by simple majority of the unitholders present and voting at the
meeting resolution for authorising the trustees or any other person
to take steps for winding up of the scheme:
Provided that a meeting of the unitholders shall not be necessary
if the scheme is wound up at the end of maturity period of the
scheme.
(2)(a) The trustee or the person authorised under sub-regulation (1)
shall dispose of the assets of the scheme concerned in the best
interest of the unitholders of that scheme.
(b) The proceeds of sale realised under clause (a), shall be
first
utilised towards discharge of such liabilities as are due and payable
under the scheme and after making appropriate provision for
meeting the expenses connected with such winding up, the balance
shall be paid to the unitholders in proportion to their respective
interest in the assets of the scheme as on the date when the
decision for winding up was taken.
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(3) On the completion of the winding up, the trustee shall forward
to the Board and the unitholders a report on the winding up
containing particulars such as circumstances leading to the winding
up, the steps taken for disposal of assets of the fund before winding
up, expenses of the fund for winding up, net assets available for
distribution to the unit holders and a certificate from the auditors
of the fund.
(4) Notwithstanding anything contained in this regulation, the
provisions of these regulations in respect of disclosures of half-
yearly reports and annual reports shall continue to be applicable
until winding up is completed or the scheme ceases to exist.
Winding up of the scheme
42. After the receipt of the report under sub-regulation (3) of
regulation 41, if the Board is satisfied that all measures for winding
up of the scheme have been complied with, the scheme shall cease
to exist.”
16. Regulation 18(15)(c) reads as under:
“Rights and obligations of the trustees.
18.
xx                        xx                         xx
(15) The trustees shall obtain the consent of the unitholders –
(a) whenever required to do so by the Board in the interest of
the unitholders; or
(b) whenever required to do so on the requisition made by
three-fourths of the unitholders of any scheme; or
(c) when the majority of the trustees decide to wind up or
prematurely redeem the units.”
Interpretation of Regulations 39 to 42, their interplay and
harmonious construction
with Regulation 18(15) (c) of the
Securities and Exchange Board of India (Mutual Funds)
Regulations, 1996.
17. Regulation 39, as the heading states, relates to ‘winding up’ of
a scheme of a mutual fund. Sub-regulation (1) to Regulation 39 applies
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to close-ended schemes and is accordingly not relevant as the six
schemes in question are open-ended schemes.6
18. Sub-regulation (2) to Regulation 39 uses the expression ‘a
scheme of a mutual fund,’ and accordingly applies to both open-ended
and close-ended schemes.7 It is an undisputed position that sub-regulation
(2) to Regulation 39 applies to the six schemes. In terms of sub-regulation
(2) to Regulation 39, a scheme of a mutual fund can be wound up: (a) on
the happening of any event, which, in the opinion of the trustees, requires
the scheme to be wound up; (b) if 75% of its unitholders8 pass a resolution
for winding up of the scheme; or (c) SEBI directs winding up of the
scheme in the interest of the unitholders. Under each clause the initiator
is different, and the condition to be satisfied is stipulated. Clause (a)
empowers the trustees, while clauses (b) and (c) empower the unitholders
and SEBI respectively.
19. When a scheme “is to be wound up” under sub-regulation (2),
the trustees are required by sub-regulation (3) of Regulation 39 to issue
a public notice in two daily newspapers having all India circulation and in
a vernacular paper having circulation where the mutual fund is located.
The public notice should state the circumstances leading to winding up
of the scheme. The trustees are also required to write to SEBI and
disclose the circumstances leading to winding up of the scheme.
20. On and from the
date of publication, the cease and freeze
mandate of Regulation 40 triggers. Regulation 40, which is in the nature
of statutory injunction, states that on and from the date of publication of
notice under Regulation 39(3), the trustees and the AMC shall cease to
(a) carry on any business in respect of the scheme to be wound up; (b)
create or cancel units of the scheme; and (c) issue or redeem units of
the scheme.
21. Regulation 41, as per the heading, relates to the procedure
and manner of winding up. The trustees, in terms of sub-regulation (1)
to Regulation 41, are required to call a meeting of the unitholders for
authorising either the trustees or any other person to take steps for winding
6 Regulation 2(f) – “close-ended scheme” means any scheme of a mutual fund in which
the period of maturity of the scheme is specified.
7 Regulation 2(s) – “open-ended scheme” means a scheme of a mutual fund which offers
units for sale without specifying any duration for redemption.
8 2(z)(i) of SEBI (Mutual Fund) Regulation 1996, “unit holder” means a person holding
unit in a scheme of mutual fund.
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up of the scheme. Voting at the meeting is by simple majority of the
unitholders present and voting. In this meeting the unitholders do not
examine, affirm or reject the decision to wind up the scheme. The voting
is restricted to selection of the person – either the trustee or a third
person – who would take ‘steps for winding up of the scheme’.
22. Regulation 41(2)(a), requires that the person or the trustee
authorised under Regulation 41(1) must dispose of the assets of the
scheme in the best interest of the unitholders. Clause (b) to sub-regulation
(2) to Regulation 41, states that the sale proceeds shall be first utilised
towards discharge of liabilities due and payable under the scheme.
Secondly, appropriate provision is to be made for meeting the expenses
connected with the winding up. The balance amount shall be paid to the
unitholders in proportion to their respective interests in the scheme as on
the date when the decision for winding up was taken. The clause
differentiates between the creditors whose liability is due and payable,
and the unitholders. Payment of the amount due and payable to the
creditors is prioritised and takes precedent. Thereafter, appropriate
provision is required to be made for expenses connected with the winding
up. The balance amount is payable to the unitholders.
23. In terms of Regulation 42(2), the unitholders are to be paid in
proportion to their respective interest in the assets of the scheme. The
interest of the
unitholders in the assets of the scheme as mentioned in
Regulation 42(2) is computed on the basis of the date when the decision
for winding up of the scheme was taken. As per Regulation 41(3), on
completion of winding up, the trustees have to forward to SEBI and to
the unitholders a report on the winding up containing particulars such as
circumstances leading to the winding up, the steps taken for disposal of
the assets for winding up, expenses for winding up, net assets available
for distribution to the unitholders and a certificate from the auditors.
Sub-regulation (4), a non-obstante provision, states that the requirement
in respect of disclosures in the form of half-yearly report and annual
report shall continue until winding up is completed or the scheme ceases
to exist. Regulation 42 states that after receipt of the report under
Regulation 41(3), if SEBI is satisfied that all measures relating to winding
up have been complied with, the scheme would cease to exist.
24. Regulation 42A stipulates that the units of the mutual funds
scheme shall be delisted from the recognised stock exchange in
accordance with the guidelines as may be specified by SEBI.
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25. Regulation 18(15)(c), which relates to rights and obligations
of the trustees, in simple words requires the trustees to take consent of
the unitholders, when they, by majority, decide to wind up or prematurely
redeem the units. Words “winding up” in Regulation 18(15)(c), ex-facie
refers to the winding up of the open-ended scheme and the expression
“prematurely redeem the units” refers to premature redemption of units
under the close-ended scheme.
Decision of the High Court and contentions of SEBI, the
trustees and the AMC.
26. The judgment under challenge, interpreting Regulation
18(15)(c) and Regulation 39(2)(a) holds that the decision of the trustees
to wind up a scheme under clause (a) to Regulation 39(2) must muster
the consent of the majority of the unitholders as per Regulation 18(15)(c).
27. Contesting this finding and interpretation, the argument of SEBI,
the trustees and the AMC is that Regulations 39 to 42 are a complete
code dealing with winding up of a scheme of mutual funds. Initiators and
conditions to be satisfied under clauses (a), (b), and (c) to Regulation
39(2) are different. It is argued that prior consent of the unitholders is
not envisaged when the trustees, on the happening of any event in terms
of clause (a), form an opinion that a scheme is required to be wound up,
or when SEBI under clause (c) directs winding up of a scheme in the
interest of the unitholders. Only when the unitholders
want to windup a
scheme, in terms of clause (b), a resolution by 75% of the unitholders is
mandated. The need to obtain the consent of the unitholders vide
Regulation 18(15)(c) refers to the procedure and the manner for winding
up as mandated by Regulation 41(1). To put it differently, the unitholders
do not come into the picture when the trustees and SEBI, under clauses
(a) and (c) respectively of Regulation 39(2), decide to wind up a scheme.
Their decision is final and binding on the unitholders. It is submitted:
“a) Regulation 18(15)(c) requires Trustees to obtain consent of
Unit holders “when the majority of the Trustees decide to wind
up”. It is thus very clear that consent is required when Trustees
decide to wind up the scheme(s) and when read together with
Regulation 41, makes it amply clear that the consent is for the
purpose of Regulation 41 i.e. to authorize the Trustee or any other
person to dispose of the asset of scheme(s), in the interest of the
unit holders.
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(b) The consent envisaged under Regulation 18(15)(c) is a general
“rights and obligations” of the Trustees and that the said consent
shall be read as approval required under Regulation 41(1).
(c) It is submitted that in the event consent under Regulation
18(15)(c) is interpreted to mean that prior consent of unitholders
is required before a scheme is wound up pursuant to a decision
taken by the Trustees, the provisions of Regulation 39(2)(b) to be
rendered otiose as under the said Regulation, a scheme may be
wound up at the instance of Unit holders (upon 75% of the Unit
holders of a scheme passing a Resolution for winding up).
(d) Regulation 40 comes into effect “on and from the date of
publication of notice” by Trustees under Regulation 39(3)(b) and
not from the date of “consent of Unit holders”, which makes it
abundantly clear that consent of Unit holders is not contemplated
qua decision of Trustees to wind up a scheme(s).
(e) Further, Regulation 40 (a) provides that on and from the date
of publication of notice under 39(3)(b), the Trustees or Asset
Management Company, as the case may be, shall cease to carry
on any business activities in respect of the scheme so wound up.
Therefore, when a decision by Trustee to wind up scheme is taken,
in terms of 39(2)(a), the notice is issued and Regulation 40 comes
into operation and the requirement of obtaining consent of Unit
holders at this stage cannot arise.
(f) It is submitted that Regulation 41(1) casts an
obligation on the
Trustees to call a meeting of the unit holders to approve a resolution
authorising the Trustees or any other person to take steps for
winding up of the scheme. Regulation 18(15)(c) of the MF
Regulations cannot be erroneously interpreted so as to conclude
that before implementing Regulation 41, prior approval of the unit
holders has to be taken.”
The submission accentuates, what is submitted would be the
impractical and calamitous effect of reading Regulation 18(15)(c) into
Regulations 39 to 42. Prior-consent from the unitholders if necessary
even when the trustees ‘decide to wind up’ a scheme under Regulation
39(2)(a), would inevitably delay the publication of public notices as
envisaged by Regulation 39(3). Therefore the cease and freeze legal
effect of Regulation 40 would get postponed resulting in chaos and
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confusion, as business activities such as buying and redemption of units
etc., would continue despite the trustees having taken the decision to
wind up the scheme. In panic, most unitholders would rush for
redemptions, which achingly would be the reason for winding up. The
result would be fire-sale of sound assets in a hasty and disorganised
manner at discounted valuations in adverse market conditions. The
trustees who stand in a fiduciary capacity as domain experts, as mandated
by clause (a) to Regulation 39(2), act for and in the interest of the
unitholders. The unitholders, a large and disparate body of lay persons
without domain expertise, have been erroneously conferred the right to
veto and overrule the decision of the domain experts. Given the grave
consequences for the sponsor, trustees and AMC, a decision to wind up
a scheme is taken after in-depth analysis with great care and caution.
Thus, the findings of the High Court to the contrary should be reversed.
Interpretation of the term ‘consent’ in Regulation 18(15)(c)
vide order dated 12th February, 2021
28. In our order dated 12th February 2021, we have interpreted
Regulation 18(15)(c) and the word ‘consent’ therein in the following
manner:
“8. However, we begin by rejecting the argument raised by some
of the objecting unitholders that consent would be binding only on
those who have consented to winding up of the mutual fund
schemes and cannot be imposed on
others. The word ‘consent’,
in the context of the clause, clearly refers to ‘consent of the
majority of the unitholders’, and not consent given by individual
unitholders who alone would be bound by their consent, that is, it
excludes unitholders who are not agreeable. To accept the second
or contra view, as pleaded by some of the objecting unitholders,
would be to negate the very object and purpose of clause (c) to
sub-regulation (15) of Regulation 18. In fact, the submission, if
accepted, will make the Mutual Fund schemes and the winding
up provisions in the Mutual Fund Regulations unworkable as there
would be two different classes of unitholders – one bound by the
consent, and others who are not bound by consent. Consequently,
the scheme would not wind up. The intent behind the provision is
to bind even those who do not consent.
9. Black’s Law Dictionary (10th Edition) defines the word
‘consent’ as “a voluntary yielding to what another proposes
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or desires; agreement, approval, or permission regarding
some act or purpose, esp. given voluntarily by a competent
person; legally effective assent.” The dictionary also defines
‘general consent’ to mean “adoption without objection,
regardless of whether every voter affirmatively approves.”
Shackleton on the Law and Practice of Meetings, 14th Edn.,
while defining majority, and the binding effect of majority, has
opined:
“Definition
7-30. Majority is a term signifying the greater number. In
legislative and deliberative assemblies, it is usual to decide
questions by a majority of those present and voting. This is
sometimes expressed as a “simple” majority, which means that
a motion is carried by the mere fact that more votes are cast
for than against, as distinct from a “special” majority where
the size of the majority is critical.
The principle has long been established that the will of a
corporation or body can only be expressed by the whole or a
majority of its members, and the act of a majority is regarded
as the act of the whole.
A majority vote binds the minority
7-31. Unless there is some provision to the contrary in the
instrument by which a corporation is formed, the resolution of
the majority, upon any question, is binding on the majority and
the corporation, but the rules must be followed.”
The word/expression ‘consent’ in sub-regulation (15) to
Regulation 18 refers to affirmative consent to winding up by
‘the majority of the unitholders’.
Conversely, consent is denied
when ‘majority of the unitholders’ do not approve the proposal
to wind up the scheme.
10. However, the question which still remains to be answered is
whether ‘consent’ would mean majority of the unitholders who
exercise their right in the poll, or majority of all the unitholders of
the scheme. Connected with the question is the concern of quorum,
which means the minimum number of members of the entire body
of members required to be present to legally transact business.
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11. Shackleton in the above quotation has referred to distinction
between simple and special majority. More appropriate for our
discussion is William Paul White’s thesis ‘History and Philosophy
of the Quorum as a Device of Parliamentary Procedure’ published
in 1967, in which he elucidates:
“Much of the controversy that has been historically associated
with the quorum can be traced to the problem of simply
determining just what is meant by a quorum. “From the very
earliest times it has been recognised as a general rule that a
majority of a group is necessary to act for the entire group.” In
the case of a public body, the power or authority which
establishes the body may also determine what constitutes a
quorum. Sturgis states that common parliamentary law fixes
the quorum as a “majority of the members”. The constitution
of the United States sets the quorum requirement in the House
of Representatives at a majority of the membership. But to
state that a quorum is a majority of the membership opens the
way to potential conflict; which is precisely what has happened
on numerous occasions.”
After examining the various definitions of the term quorum,
the author observes that the definitions by themselves give no
key as to how to determine what is minimum number or what
constitutes majority. The expression ‘majority’ can mean - (i)
majority of total membership list; (ii) exclude or include
delinquent members; (iii) members
present and voting; or (iv)
those present, voting and not voting. Different meanings, he
observed, have added to the confusion around the concept of
the quorum. Albeit referring to the position in 1967, the author
observed:
“As we have emerged into the modern era, it is not surprising
that by now the method, which has been legally agreed upon
by the courts, to determine minimum and majority, is well
established.”
12. Clause (c) to sub-regulation (15) of Regulation 18 per se does
not prescribe any quorum or specify the criterion for computing
majority or ratio of unitholders required for valid consent for
winding up. Clause (b) of Regulation 39(2), on the other hand,
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specifies that seventy-five per cent of the unitholders of a scheme
can pass a resolution that the scheme be wound up. Similarly,
Regulation 41(1) requires the trustees to call a meeting to approve,
by simple majority of the unitholders present and voting, a resolution
for authorising the trustees or any other person to take steps for
winding up of the scheme. Section 48 of the Companies Act, 2013
states that where share capital of a company is divided into
different classes of shares, the rights attached to the shares of
any class may be varied with the consent in writing of the
shareholders of not less than three-fourths of the issued shares of
that class. Sub-section (3) to Section 55 of the Companies Act,
2013 in case of failure to redeem or pay dividend refers to consent
of holders of three-fourths in value of the preference shares.
Section 103 of the Companies Act, 2013 prescribes minimum
quorum for shareholder meetings.
13. In Shri Ishwar Chandra v. Shri Satyanarain Sinha and
Others, this Court on the question of quorum has held:
“If for one reason or the other one of them could not attend,
that does not make the meeting of others illegal. In such
circumstances, where there is no rule or regulation or any other
provision for fixing the quorum, the presence of the majority of
the members would constitute it a valid meeting and matters
considered there at cannot be held to be invalid.”
This decision had also relied on the exposition on the subject of
quorum in the Halsbury’s Laws of England, Third Edition (Vol.
IX, page 48, para 95), which reads:
“95. Presence of quorum necessary. The acts of a corporation,
other than a trading corporation, are those of the major part of
the corporators, corporately assembled. In other words, in the
absence of special custom or of special provision of the
constitution, the major part must be present at the meeting,
and of that major part there must be a majority in favour of the
act or resolution contemplated. Where, therefore, a corporation
consists of thirteen members, there ought to be at least seven
present to form a valid meeting, and the act of the majority of
these seven or greater number will bind the corporation. In
considering whether the requisite number is present, only those
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members must be included who are competent to take part in
the particular business before the meeting. The power of doing
a corporate act may, however, be specially delegated to a
particular number of members, in which case, in the absence
of any other provision, the method of procedure applicable to
the body at large will be applied to the select body.
If a corporate act is to be done by a definite body along, or by
definite body coupled with an indefinite body, a majority of the
definite body must be present.
Where a corporation is composed of several select bodies, the
general rule is that a majority of each select body must be
present at a corporate meeting; but this rule will not be applied
in the absence of express direction in the constitution, if its
application would lead to an absurdity or an impossibility. ...”
(emphasis supplied)
14. The concept of ‘absurdity’ in the context of interpretation of
statutes is construed to include any result which is unworkable,
impracticable, illogical, futile or pointless, artificial, or productive
of a disproportionate counter mischief. Logic referred to herein is
not formal or syllogistic logic, but acceptance that enacted law
would not set a standard which is palpably unjust, unfair,
unreasonable or does not make any sense. When an interpretation
is beset with practical difficulties, the courts have not shied from
turning sides to accept an interpretation that offers a
pragmatic
solution that will serve the needs of society. Therefore, when there
is choice between two interpretations, we would avoid a
‘construction’ which would reduce the legislation to futility, and
should rather accept the ‘construction’ based on the view that
draftsmen would legislate only for the purpose of bringing about
an effective result. We must strive as far as possible to give
meaningful life to enactment or rule and avoid cadaveric
consequences.
15. We would neither hesitate in stating the obvious, that modern
regulatory enactments bear heavily on commercial matters and,
therefore, must be precisely and clearly legislated as to avoid
inconvenience, friction and confusion, which may, in addition, have
adverse economic consequences. The legislator in the present
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case must, therefore, reflect and take remedial steps to bring about
clarity and certainty in the Mutual Fund Regulations.
16. Reading prescription of a quorum as majority of the unitholders
or ‘consent’ as implying ‘consent by the majority of all unitholders’
in Regulation 18(15)(c) of the Mutual Fund Regulations will not
only lead to an absurdity but also an impossibility given the fact
that mutual funds have thousands or lakhs of unitholders. Many
unitholders due to lack of expertise, commercial understanding,
relatively small holding etc. may not like to participate. Consent
of majority of all unitholders of the scheme with further prescription
that ‘fifty percent of all unitholders’ shall constitute a quorum is
clearly a practical impossibility and therefore would be a futile
and foreclosed exercise.
17. Conscious of the problem of quorum and majority in indefinite
electorate, 1st Edition of Halsbury’s Laws of England on the
question of quorum and meetings, had referred to the following
principles:
“791. Where a corporation consists of a definite number of
corporate electors, a majority of that number must be present
in order to constitute a valid election. But where a corporation
consists of an indefinite number of corporate electors, a majority
only of those existing at the time of the election need be present.
When an election is to be made by a definite body only, or the
electoral assembly is to consist of a definite and an indefinite
body, the
majority of the definite body must, as a general rule,
be present in order to render the election legal. It is not
necessary that a majority of the indefinite body should be present
so long as there is majority of the definite body. If a constituent
part of a corporation refuses to be present at an election, it
cannot be held, and an election by the remaining parts will be
void. But electors present at an election and abstaining from
voting are deemed to acquiesce in the election made by those
who vote.”
The aforesaid exposition, for the purpose of majority and
quorum, draws distinction between an electorate consisting of
definite number and an electorate composed of indefinite
number. Justice Seshagiri Ayyar of the Madras High Court in
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his concurring judgment in Syed Hasan Raza Sahib Shamsul
Ulama and two others v. Mir Hasan Ali Sahib and two
others had drawn distinction between definite and indefinite
numbers in the following manner:
“…In the first class of cases, the number of the select body is
fixed. In the second class of cases, the number is subject to
variation every year or at stated periods. For example, the
number of electors of a Temple Committee or the number for
a Municipality is liable to fluctuation. Residence for a particular
period, or the attaining of age of minors can bring in new
electors. Whereas in the case of a Select Committee, the
number is fixed…”
In the case of unitholders, the number is fluctuating and ever
changing and, therefore, indefinite. Numbers of unitholders can
increase, decrease and change with purchase or redemption.
Therefore, in the context of clause (c) of Regulation 18(15),
we would not, in the absence of any express stipulation,
prescribe a minimum quorum and read the requirement of
‘consent by the majority of the unitholders’ as consent by
majority of all the unitholders. On the other hand, it would mean
majority of unitholders who exercise their right and vote in
support or to reject the proposal to wind up the mutual fund
scheme. The unitholders who did not exercise their choice/
option cannot be counted as either negative or positive votes
as either denying or giving consent to the proposal for winding
up.
18. Investment in share market, though beneficial and attractive,
requires expertise in portfolio construction, stock selection and
market timing. In view of attendant risks, diversification of portfolio
is preferred but this consequentially requires a larger investment.
Mutual funds managed by professional fund managers with
advantages of pooling of funds and operational efficiency are the
preferred mode of investment for ordinary and common persons.
It would be wrong to expect that many amongst these unitholders
would have definitive opinion required and necessary voting in a
poll on winding up of a mutual fund scheme. Such unitholders, for
varied reasons, like lack of understanding and expertise, small
holding etc., would prefer to abstain, leaving it to others to decide.
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Such abstention or refusal to express opinion cannot be construed
as either accepting or rejecting the proposals. Keeping in view
the object and purpose of the Regulation with the language used
therein, we would not accept a ‘construction’ which would lead
to commercial chaos and deadlock. Therefore, silence on the part
of absentee unitholders can neither be taken as an acceptance
nor rejection of the proposal. Regulation 18(15)(c), upon application
in ground reality, must not be interpreted in a manner to frustrate
the very law and objective/purpose for which it was enacted. We
would rather accept a reasonable and pragmatic ‘construction’
which furthers the legislative purpose and objective. The underlying
thrust behind Regulation 18(15)(c) is to inform the unitholders of
the reason and cause for the winding up of the scheme and to
give them an opportunity to accept and give their consent or reject
the proposal. It is not to frustrate and make winding up an
impossibility. Way back in 1943, Sutherland in Statutes and Statutory
Construction, Volume 2, Third Edition at page no. 523, in Note
5109, had stated:
“Where a statue has received a contemporaneous and practical
interpretation and the statute as interpreted is re-enacted, the
practical interpretation is accorded greater weight than it
ordinarily receives, and is regarded presumptively the correct
interpretation of the law. The rule is based upon the theory
that the legislature is acquainted with the
contemporaneous
interpretation of a statue, especially, when made by an
administrative body or executive officers charged with the duty
of administering or enforcing the law, and therefore impliedly
adopts the interpretation upon re-enactment.”
With some modifications, the principle can be applied in the
present case. Practical interpretation should be accorded greater
weight than it ordinarily receives, and can be regarded as
presumptively correct interpretation as the draftsmen legislate
to bring about a functional and working result.
19. We would not read into Regulation 18(15)(c) a need to
have affirmative consent of majority of all or entire pool of
unitholders. The words ‘all’ or ‘entire’ are not incorporated
and found in the said Regulation. Thus, consent of the
unitholders for the purpose of clause (c) to sub-regulation (15)
of Regulation 18 would mean simple majority of the unitholders
present and voting.”
FRANKLIN TEMPLETON TRUSTEE SERVICES PVT. LTD.  v.
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The above interpretation resolves several grey areas and would
underpin the construction of Regulations 39 to 42 and their interplay
with Regulation 18(15)(c).
29. The quotation highlights that interpretation is sometimes a three-
stage process. At first, the words being interpreted should be understood
according to their grammatical meaning in their literal and popular sense.
In the second stage, we consider whether in the given context the plain
meaning is obscure as the text gives rise to choice of more than one
interpretation, or the propositional interpretation fails to achieve the
manifest purpose of the legislation, reduces it to futility, is practically
unworkable or even illogical. In such cases at the third stage, the court
applying interpretative tools selects or blue-pencils an interpretation
advancing the legislative intent without rewriting the provision. The
legislative intent is gathered not by restricting it to the language of the
provision, rather in the light of the object and purpose of the provision
and the legislation. The courts do lean towards a pragmatic and purposive
interpretation as there is an assumption that the draftsmen legislate to
bring about a functional and working result.
Harmonious interpretation of Regulation 18(15)(c) with
Regulations 39 to 42
30. Regulation 39(2) under clause (a) vests the power of winding
up of a scheme with the trustees, and with the unitholders under clause
(b) and with the SEBI under clause (c), but under Regulation 18(15)(c),
the trustees are required to seek consent of the unit holders, when they
by majority decide to wind up a scheme. Regulation 18(15)(c) mirrored
by use of the word ‘shall’ is couched as a command. Further, the
expression ‘when the majority of the trustees decide to wind up’ in
Regulation 18(15)(c) manifestly refers to clause (a) to Regulation 39(2)
as this is the only Regulation which entitles the trustees to wind up the
scheme. Regulation 18(15)(c), when it refers to trustees’ decision to
wind up, it implies the trustees’ opinion to wind up the scheme. Rather
than making the decision of the trustees otiose, as suggested by SEBI,
the trustees and the AMC, Regulation 18(15)(c) itself would become
otiose in case their interpretation is accepted. Principle of harmonious
construction should be applied which, in the context of the Regulations
in question, would mean that the opinion of the trustees would stand, but
the consent of the unitholders is a pre-requisite for winding up.
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31. We do not think that this interpretation in any way dilutes or
renders clause (b) to Regulation 39(2) meaningless or redundant. This
clause applies where the winding up process is initiated at the instance
of the unitholders, i.e. upon 75% of unitholders of the scheme passing a
resolution for winding up. Clause (b) does not in any manner reflect that
clause (c) to Regulation 18(15) should not be read as it ordains in simple
words.
32. Regulation 41, as explained above, refers to and relates to the
procedure and manner of winding up which cannot be equated with the
requirement of consent as postulated by Regulation 18(15)(c). Argument
to the contrary, equating Regulation 18(15) (c) with Regulation 41(1)
overlooks the difference in language, and the object and purpose behind
the two regulations. Regulation 41(1) applies even in cases where 75%
unitholders have passed the resolution for winding up of the scheme
under Regulation 39(2)(b) or where SEBI directs the scheme to be wound
up in the interest of the unitholders under Regulation 39(2)(c). On the
other hand Regulation 18(15)(c) applies only when majority of the trustees
form an opinion and decide to wind up or prematurely redeem the units
in entirety, a situation covered by Regulation 39(2)(a). To ignore the
mandate of Regulation 18(15)(c) would nullify the legislative intent by
resorting to a rather disordered and knotted argument that Regulations
18(15)(c) and 41(1) are identical and serve the
same purpose. Clause
(c) to Regulation 18(15) does not duplicate sub-regulation (1) to Regulation
41.
33. Similarly, omission of clause (d) to Regulation 18(15) and
insertion of 18(15A) with effect from 22nd May 2000 by SEBI (Mutual
Funds) (Second Amendment) Regulations, 2000 is inconsequential. Prior
to its omission, clause (d) to Regulation 18(15) read:
“(d) when any change in the fundamental attributes of any scheme
or the trust or fees and expenses payable or any other change
which would modify the scheme or affect the interest of the
unitholders is proposed to be carried out unless the consent of not
less than three-fourths of the unit holders is obtained: Provided
that no such change shall be carried out unless three fourths of
the unit holders have given their consent and the unit holders who
do not give their consent are allowed to redeem their holdings in
the scheme.
FRANKLIN TEMPLETON TRUSTEE SERVICES PVT. LTD.  v.
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Provided further that in case of an open ended scheme, the consent
of the unitholders shall not be necessary if:
(i) the change in fundamental attribute is carried out after one
year from the date of allotment of units.
(ii) the unitholders are informed about the proposed change in
fundamental attribute by sending individual communication and
an advertisement is given in English daily newspaper having
nationwide circulation and in a newspaper published in the language
of the region where the head office of the mutual fund is situated.
(iii) the unitholders are given an option to exit at the prevailing Net
Asset Value without any exit load.
Explanation: For the purposes of this clause “fundamental
attributes” means the investment objective and terms of a
scheme.”
By the same amendment9, sub-regulation (15A) has been inserted
and reads:
“(15A) The trustees shall ensure that no change in the fundamental
attributes of any scheme or the trust or fees and expenses payable
or any other change which would modify the scheme and affects
the interest of unitholders, shall be carried out, unless –
(i) a written communication about the proposed change Is sent
to each unitholder and an advertisement is given in one English
daily newspaper having nationwide circulation as well as in a
newspaper published in the language of region where the Head
Office of the mutual fund is situated; and
(ii) the unitholders are given an option to
exit at the prevailing
Net Asset Value without any exit load.”
The distinction between Regulation 18(15A) and Regulation
18(15)(c) is evident. The words ‘winding up or premature redemption of
units’ in Regulation 18(15)(c) refers to a situation covered by Regulation
39(2)(a), that is, when the scheme is being wound up pursuant to a
decision of the trustees. On the other hand, Regulation 18(15A) does
not apply when the scheme is being wound up, rather it applies when
there is a proposal to change the fundamental attributes of the scheme,
9 SEBI (Mutual Funds) (Second Amendment) Regulations, 2000.
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fee or expense or any other change that would modify the scheme and
affect the interests of the unitholders. The effect should be not to wind
up the scheme thereby bringing it to an end, but to continue with the
scheme as modified. Therefore, for Regulation 18(15A) to apply, the
scheme should not cease to exist.
34. In cases under clause (a) to Regulation 39(2) the unitholders
have no right or option to exit or not exit the scheme and are paid in
terms of Regulation 41. Regulation 18(15A) gives the option to the
unitholders to exit at the prevailing ‘Net Asset Value’ without any exit
load or continue with the altered/modified scheme. Under the omitted
clause (d) to Regulation 18(15), consent of three-fourths of the unitholders
for fundamental changes to the scheme was sometimes necessary. This
is not necessary under Regulation 18(15A). Omission of clause (d) to
sub-regulation 18(15) and insertion of sub-regulation (15A) to Regulation
18, as observed above is inconsequential and not relevant to the present
dispute. If anything, the draftsmen having retained clause (c) to 18(15),
re-enforces its link with clause (a) to Regulation 39(2). Accordingly, the
need to obtain consent of the unitholders is mandated under clause (c) to
sub-regulation 15 to Regulation 18 when the trustees under clause (a) to
Regulation 39(2) decide to wind up a scheme.
35. The argument that the unitholders are lay persons and not
well-versed with the market conditions is to be
rejected in light of the
order dated 12th February 2021. Relevant portion of this order, at the
risk of repetition, is being reproduced below:
“18. Investment in share market, though beneficial and attractive,
requires expertise in portfolio construction, stock selection and
market timing. In view of attendant risks, diversification of portfolio
is preferred but this consequentially requires a larger investment.
Mutual funds managed by professional fund managers with
advantages of pooling of funds and operational efficiency are the
preferred mode of investment for ordinary and common persons.
It would be wrong to expect that many amongst these unitholders
would have definitive opinion required and necessary voting in a
poll on winding up of a mutual fund scheme. Such unitholders, for
varied reasons, like lack of understanding and expertise, small
holding etc., would prefer to abstain, leaving it to others to decide.
Such abstention or refusal to express opinion cannot be construed
as either accepting or rejecting the proposals. Keeping in view
FRANKLIN TEMPLETON TRUSTEE SERVICES PVT. LTD.  v.
AMRUTA GARG [SANJIV KHANNA, J.]
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the object and purpose of the Regulation with the language used
therein, we would not accept a ‘construction’ which would lead
to commercial chaos and deadlock. Therefore, silence on the part
of absentee unitholders can neither be taken as an acceptance
nor rejection of the proposal. Regulation 18(15)(c), upon application
in ground reality, must not be interpreted in a manner to frustrate
the very law and objective/purpose for which it was enacted. We
would rather accept a reasonable and pragmatic ‘construction’
which furthers the legislative purpose and objective. The underlying
thrust behind Regulation 18(15)(c) is to inform the unitholders of
the reason and cause for the winding up of the scheme and to
give them an opportunity to accept and give their consent or reject
the proposal. It is not to frustrate and make winding up an
impossibility….”
Investments by the unitholders constitute the corpus of the scheme.
To deny the unitholders a say, when Regulation 18(15)(c) requires their
consent, debilitates their role and right to participate. It is an in-contestable
position that the unitholders exercise informed choice and discretion when
they invest or redeem the units. Regulations envision the unitholders not
as domain experts, albeit as discerning investors who are perceptive
and prudent. The trustees are therefore commanded to inform and be
transparent. Summary reports, periodic and continual statements, annual
reports, audit reports, etc., mentioned in paragraph 11 above are intended
to reveal the current status of the investments, future prospects, risks
and factors that may have bearing on the returns to enable the unitholders
to take deliberative decisions, be it purchase, redemption or exercise of
the right to vote. The unitholders, when in doubt, as prudent investors
may be advised to abstain, but they are not placid onlookers, impuissant
and helpless when the trustees decide to wind up the scheme in which
they have invested. The stature and rights of the unitholders can co-
exist with the expertise of the trustees and should not be diluted because
the trustees owe a fiduciary duty to them. Thus, the contention that the
trustees being specialists and experts in the field, their decision should
be treated as binding and fait accompli has to be rejected not only in
view of the specific language of Regulation 18(15)(c), but to be in
concinnity with the objective and purpose of the Regulations.
36. A hypothetical submission that the unitholders may reject a
valid and well-considered opinion of the trustees for winding up, and
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therefore Regulation 18(15)(c) is directory, should be rejected.
Assumptions cannot be a ground to wrongly interpret Regulation
18(15)(c). Situations could arise when the trustees may err in their opinion,
in which event the unitholders may correct them. Money and investment
of the unitholders being at stake, a wrong decision would obviously have
inimical impact on the unitholders themselves. We would brace the
argument that a good and intelligible decision of winding up would
invariably be accepted by the unitholders.
37. ‘Consent’ for the purpose of Regulation 18(15)(c) refers to
the consent of the majority of the unitholders present and voting, and in
case of a poll, the computation would be with reference to the number
of units held by the unitholder. In fact, in the course of hearing, it was
conceded that majority of the unitholders belong to provident fund trusts
or pension funds. The voting pattern referred to in our earlier order
reflects that voting under Regulation 18(15)(c) is possible and can work
smoothly without much difficulty. The apprehensions expressed, therefore,
do not carry much weight. It is obvious that where the unitholders vote
against winding up, consequences would follow and accordingly the
scheme would not be wound up. This is a natural and normal consequence
which will have to be given effect to. It would, as stated above, happen
rarely and that too would not happen without any genuine and good
reason.
38. SEBI is a Member of
International Organisation of Securities
Commissions (IOSCO). IOSCO in a consultation report published in
August, 2016 on good practices for the termination of investment funds,
states that the termination plan should identify rationale for terminating
the investment fund. Key steps to be taken as part of the termination
process should be identified. Clauses (28), (29) and (30) of the good
practices under the heading ‘Decision to terminate’ read as follows:
“28. In the majority of cases, the decision to terminate is that of
the responsible entity. However, in some jurisdictions national law
or regulatory requirements will mandate that the decision of the
responsible entity is approved by investors, or the custodian in
some cases. The first step in preparing for the voluntary termination
of an investment fund is to determine whether investor approval
is required. This may depend on the legal structure of the
investment fund and whether voting rights are attributed to shares
/ units.
FRANKLIN TEMPLETON TRUSTEE SERVICES PVT. LTD.  v.
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29. Investment in an investment fund usually carries with it the
right to vote on certain matters and the voting requirements for
the approval of investors on, inter alia, liquidations and terminations
are generally prescribed in the constitutional documents and the
prospectus / offering document of the investment fund, or legal
and regulatory regime of the national regulator, or both. The
termination plan should set out the process for obtaining investor
approval, where required.
30. Where investor approval is required and investors are asked
to vote on the decision to terminate with the outcome achieving
the minimum voting requirements for approval, the decision is
binding on all, including those who do not vote. Where investor
approval is required, the rights of investors should be clear from
the termination plan. In particular, the termination plan should
document how the interests of dissenting investors will be treated.”
Good practices, as recommended by IOSCO, commend the
unitholders’ right to vote/approve on matters of termination and liquidation.
39. On and from the date of publication of notices under Regulation
39(3), the cease and freeze effect of Regulation 40 applies. The words
used in sub-regulation (3) to Regulation 39 are ‘where a scheme is to be
wound up in sub-regulation (2)’, that is, a scheme is to be wound up in
terms of clauses (a), (b) or (c) to Regulation 39(2). Sub-regulation (3) to
Regulation 39 also mandates the trustees to disclose in the public notice
the circumstances leading to winding up of the scheme. This obviously
means that where the trustees form an opinion to wind up a scheme,
they must disclose the reasons, and thereupon, the unitholders exercise
their right to vote and give or deny consent. This is the true legal effect
on harmonious reading of Regulation 18(15)(c) and Regulation 39(2)(a).
40. The language of clauses (a) and (c) to sub-regulation (2), and
sub-regulation (3) to Regulation 39 does not envisage involvement of the
unitholders till the publication of notices in case of clauses (b) and (c) to
sub-regulation (2) to Regulation 39. Therefore, when clauses (a) or (c)
of Regulation 39(2) apply, the unitholders are to be informed about the
winding up by the trustees or SEBI by way of public notice. Publication
in terms of Regulation 39(3) is even required when the unitholders vote
for winding up of a scheme under clause (b) of Regulation 39(2).
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41. It is manifest that publication of notices under Regulation 39(3)
should be instantaneous without any interstice between the decision of
winding up by the trustees under clause (a), by the unitholders under
clause (b) or by SEBI under clause (c). Delay would hold up the cease-
and-freeze effect of Regulation 40 and consequently nullify the salutary
purpose and object behind it.
42. In view of the above discussion and harmoniously interpreting
Regulations 39 to 42, we hold that the consent of the unitholders, as
envisaged under clause (c) to Regulation 18(15), is not required before
publication of the notices under Regulation 39(3). Consent of the
unitholders should be sought post publication of the notice and disclosure
of the reasons for winding up under Regulation 39(3).
43. Read in this manner, we can interpret clause (c) to Regulation
18(15) and Regulations 39 to 42 without the disarray as suggested, while
not displacing the legal effect of either Regulation 40 or Regulation
18(15)(c). This interpretation takes care of the apprehension expressed
by SEBI, the trustees and AMC that delay or time gap between a decision
of the trustees under clause (a) to sub-regulation (2) to Regulation 39
and publication of notice under sub-regulation (3) to Regulation 39 would
postpone the cease-and-freeze effect of Regulation 40.
44. We have referred to Regulation 41(1) and that it requires
calling of a meeting of the unitholders for authorising the trustees or
any
other person to take steps for winding up of the scheme. In case where
the scheme is being wound up under Regulation 39(2)(a), it is possible to
hold a meeting of the unitholders under the said provision where if the
resolution for winding up is passed, the unitholders can also decide by
simple majority of the unitholders present and voting whether the trustees
or any other person should take steps for winding up of the said scheme.
One meeting in many a cases would suffice.
45. To complete interpretation of Regulation 18(15), we have to
record that clause (a) applies and requires the trustees to obtain consent
of the unitholders whenever required by SEBI in the interest of the
unitholders. Clause (b) states that the trustees would obtain consent of
the unitholders whenever required to do so on the requisition made by
three-fourths of the unitholders of any scheme. Accordingly, clause (a)
would apply whenever SEBI mandates and clause (b) applies whenever
three-fourths of the unitholders of the scheme make a requisition.
FRANKLIN TEMPLETON TRUSTEE SERVICES PVT. LTD.  v.
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46. The impugned judgment, from paragraph 211 onwards,
specifically refers to the responsibilities and duties of the trustees
incorporated in the statement of additional information published by the
mutual fund, which reads:
“(b) The Trustees shall obtain consent of the unit holders of the
Scheme(s):
i) When the Trustee is required to do so by SEBI in the interests
of the unit-holders; or
ii) Upon the request of three-fourths of the unit holders of any
Scheme(s) under the Mutual Fund; or
iii) If a majority of the directors of the Trustee company decide to
wind up the Scheme(s) or prematurely redeem the units.”
Clause (iii) of the aforesaid quotation dealing with responsibilities
and duties of the trustees, requires the trustees to obtain consent of the
unitholders of the scheme if the majority of the directors of the trustee
company decide to wind up the scheme or prematurely redeem the units.
The language of clause (iii) of the aforesaid quotation is identical to
clause (c) of sub-regulation (15) to Regulation 18. The High Court was,
therefore, right in observing that the trustees and the AMC have
understood and accepted that the consent of unitholders of the scheme
would be necessary if the majority of the directors of the trustee company
decide to wind up a scheme.
47. The impugned judgment, in paragraph 221, observes that no
material was placed on record to show compliance with sub-regulation
(3) to Regulation 39.
The trustees and AMC have disputed the said
position by relying upon notice dated 23rd April 2020 enclosed at page
1262 and the newspaper publications in both English and vernacular
languages made on 24th April 2020 enclosed at pages 3304-3313. In
view of the aforesaid factual position, which was not seriously disputed
by most of the unitholders, we would accept that there was compliance
with clause (b) of sub-regulation (3) to Regulation 39 and accordingly
the cease and freeze effect of Regulation 40 had become effective.
48. Our attention was drawn to the Circular dated 31st May 2016
issued by SEBI as per which the trustees have the option to suspend
redemption of units for a period of 10 days in a period of 90 days. The
relevant portion of the said circular reads as under:
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“b. Restriction on redemption may be imposed for a specified
period of time not exceeding 10 working days in any 90 days
period”
SEBI has taken the stand that the benefit of this circular should
not be taken when the question of winding up is pending consideration
before the trustees. The position not being ironclad, SEBI may re-examine
whether the trustees/AMC can be permitted to take similar benefit
pending the decision on the question of winding up, when they face
frightful redemption pressure.
Challenge to the constitutional validity of the Securities
and Exchange Board of India (Mutual Funds) Regulations, 1996
49. This challenge has been raised by one of the appellants, namely,
Amruta Garg. The contentions forwarded can be summarised as under:
(a)
The expression ‘happening of any event’ in Regulation
39(2)(a) is unspecified and suffers from the vice of
excessive delegation as it does not give any indication of
the type of events which would be relevant for winding up
of the scheme. It gives unbridled power to the trustees to
wind up a scheme which, in the opinion of the trustees,
should be wound up.
(b)
In comparison, vide clause (c) to Regulation 39(2), SEBI
has been invested with the power to issue directions for
winding up a mutual fund scheme only when it is in the
interest of the unitholders.
(c)
 Further, SEBI has not prescribed/issued guidelines or policy
regarding formation of opinion by the trustees to wind up
the scheme.
(d)
The opinion of
the trustees is given paramountcy and is
supreme. Even SEBI accepts that it has no role and cannot
examine and set aside the decision of the trustees. Thus,
SEBI, as per its own contention and submission, being bound
by the opinion of the trustees, cannot interfere even when
it is necessary to do so in the interest of unitholders or when
the trustees have acted in their own vested interest. This is
contrary to the scheme of the SEBI Act whereunder SEBI
has been constituted primarily to act as a watchdog and to
FRANKLIN TEMPLETON TRUSTEE SERVICES PVT. LTD.  v.
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protect interests of the investors in the capital market,
including the unitholders.
(e)
There is no provision for appeal or internal challenge against
the decision of the trustees who may in a given case form
a wrong opinion regarding winding up of the scheme.
(f)
For the above reasons, clause (a) to Regulation 39(2) suffers
from manifest arbitrariness in the absence of any
prescription regulating the exercise of the power by the
trustees. Reliance is placed upon State of Tamil Nadu and
Another v. T. Krishnamurthy and Others;10 Shayara
Bano v. Union of India and Others;11 Senior
Superintendent of Post Offices, Allahabad and Others
v. Izhar Hussain;12 Director General, Central Reserve
Police Force and Others v. Janardan Singh and
Others.13
(g)
Regulation 39(3) equally suffers from the vice of manifest
arbitrariness as SEBI merely acts as a drop-box. Though
the trustees are required to give notice disclosing
circumstances leading to winding up of the scheme to SEBI,
this requirement is meaningless and superficial as SEBI
cannot go into the question and circumstances to be satisfied
as to existence of an event warranting the extreme action
of winding up.
(h)
Regulation 41(2)(b) is manifestly arbitrary as it states that
the sale proceeds under clause (a) shall be first discharged
for such liabilities as are due and payable under the scheme
and only the balance amount shall be paid to the unitholders
in proportion to
their respective interests in the assets of
the scheme as on the date of the decision for winding up
was taken. Regulation 41 does not prescribe any mechanism
or manner in which the authorised person or the AMC can
ascertain the liabilities which are due and payable under
the scheme. Secondly, the unitholders have been placed
below the creditors of the scheme and would therefore
10 (2006) 4 SCC 517
11 (2017) 9 SCC 1
12 (1989) 4 SCC 318
13 (2018) 7 SCC 656
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receive only the leftover. This undermines the paramount
place and position of the unitholders. Further, the SEBI has
failed to protect the interest of the unitholders who are not
only financial creditors but, as explicitly provided in
Regulation 18(12), their money is held in the mutual fund in
trust and for their benefit. Reliance is placed upon Pioneer
Urban Land and Infrastructure Limited and Another v.
Union of India and Others14 where the home buyers have
been held to be financial creditors under the Indian
Bankruptcy Code. Principle of pari passu should be made
applicable.
(i)
Regulation 42 is also manifestly arbitrary as SEBI is to
perform only ministerial functions, much less than the
functions of a regulator. Conspicuously, during the winding
up process, SEBI has been given a minimalistic role which
is contrary to the paramount object of the Act.
50. We would begin by referring to the provisions of the SEBI
Act and by elucidating the powers of SEBI. Section 11 of the SEBI Act
prescribes the functions of SEBI. Sub-section (1), in general terms, states
that it will be the duty of SEBI to protect the interests of investors in
securities and to promote the development of, and to regulate, the
securities market. SEBI is empowered to take measures in this regard
as it thinks fit. Sub-section (2), without prejudice to the generality of
sub-section (1), lists out as many as 17 specific clauses and states that
SEBI is entitled to provide for measures
relating to those clauses.
Thereunder, Clause (e) relates to prohibiting fraudulent and unfair trade
practices relating to securities markets. Clause (g) concerns prohibition
of insider trading in securities. Clauses (b), (i), (ia), (ib) and (la) relate to
registering and working of the trustees or trust deeds, investment advisors
and such other intermediaries who may be associated with the securities
market in any manner and permits SEBI to call for information from,
undertaking inspection, conducting inquiries and audits of mutual funds
and other persons associated with the securities market, intermediaries
and self-regulatory organisations. They can also ask for records from
any persons, including any bank, any other authority or board or
corporation established or constituted by or under a central or state Act
relevant for investigation or inquiry by SEBI. It is also authorised to call
14 (2019) 8 SCC 416
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for and require any agency to furnish information as may be considered
necessary by SEBI for discharge of its functions. Clause (m) is a residuary
clause which states that SEBI can perform such other functions as may
be prescribed. Sub-section (2A) to Section 11 is a non-obstante provision
which authorises SEBI to take measures to undertake inspection of any
book or register or other document or record of any listed public company
or a public company, etc. which intends to get its securities listed on a
recognised stock exchange. Sub-section (3), again, is a non-obstante
provision and states that SEBI shall exercise the same powers as are
vested in a civil court under the Code of Civil Procedure while trying a
suit in respect of discovery and production of books of account and
other documents, summoning and enforcing attendance of persons and
examining them on oath, inspection of any books, registers and documents
of any person referred to in Section 12, inspection of any book, or register,
or document, or record of a company, and issuing commissions for
examination of witnesses or documents. Sub-section (4) states that
without prejudice to the provisions contained in sub-section (1), (2), (2A)
and (3) and Section 11B, SEBI may, by an order in writing in the interest
of the investors or securities market, take the measures stipulated
thereunder either pending investigation or inquiry or upon completion of
investigation or inquiry. These include suspension of trading of any security;
restraining any person from accessing security markets; attaching, for a
period not exceeding 90 days subject to conditions and for a further
period beyond 90 days subject to confirmation by the special court, bank
accounts and other properties of any intermediary or any person
associated with the securities market in any manner involved in violation
of the provisions of the SEBI Act, or Rules or Regulations made
thereunder; direct any intermediary associated with securities market in
any manner not to dispose of or alienate any asset forming part of any
transaction under investigation subject to the condition that before or
after passing such orders an opportunity of hearing shall be given to
such intermediaries or persons concerned. Sub-section (4A) authorises
SEBI to conduct an inquiry in the prescribed manner notwithstanding
the provisions of sub-sections (1), (2), (2A), (3) and (4), Section 11B and
Section 15-I by an order and for reasons to be recorded in writing levy
penalty under Sections 15A, 15B, etc. Under sub-section (5), the amount
disgorged pursuant to the directions issued under Section 11B of the Act
or 12A of the Securities Contracts (Regulation) Act, 1956 etc. is to be
credited to the Investor Protection and Education Fund established by
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SEBI and to be utilised in accordance with the regulations framed under
the Act.
51. Section 11B of the Act reads as under:
“Power to issue directions and levy penalty.– (1) Save as
otherwise provided in section 11, if after making or causing to be
made an enquiry, the Board is satisfied that it is necessary–
(i) In the interest of investors, or orderly development of securities
market; or
(ii) to prevent the affairs of any intermediary or other persons
referred to in section 12 being conducted in a manner detrimental
to the interests of investors or securities market; or
(iii) to secure the proper management of any such intermediary
or person,
it may issue such directions, –
(a) to any person or class of persons referred to in section 12,
or associated with the securities market; or
(b) to any company in respect of matters specified in section
11 A,
as may be appropriate in the interests of investors in securities
and the securities market.
(2) Without prejudice to the provisions contained in sub-section
(1), subsection (4A) of section 11 and section 15-I, the Board
may, by an order, for reasons to be recorded in writing, levy penalty
under sections 15A, 15B, 15C, 15D, 15E, 15EA, 15F, 15G, 15H,
15HA and 15HB after holding an inquiry in the prescribed manner.
Explanation.– For the removal of doubts, it is hereby declared
that the power to issue directions under this section shall include
and always be deemed to have been included the power to direct
any
person, who made profit or averted loss by indulging in any
transaction or activity in contravention of the provisions of this
Act or regulations made thereunder, to disgorge an amount
equivalent to the wrongful gain made or loss averted by such
contravention.”
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52. As the heading of Section 11B states, the provision empowers
SEBI to issue directions and levy penalty. It stipulates that such powers
can be exercised if and after making or causing any inquiry SEBI is
satisfied that it is necessary – (i) in the interest of the investors or orderly
development of the securities market, (ii) to prevent affairs of any
intermediary or other persons referred to in Section 12 being conducted
in a manner detrimental to the interest of the investors or securities
market; or (iii) to secure proper management of such intermediary or
person. SEBI may issue directions to – (a) any person or class of persons
referred to in Section 12 or associated with the securities market, or (b)
to a company in respect of the matters specified in Section 11A as may
be appropriate, in the interest of the investors in securities and in the
securities market. The explanation to the Section is important for it
clarifies, by way of removal of doubt, that the directions under this Section
shall include and shall always deem to include power to direct any person,
who has made profit or averted loss by indulging in any transaction or
activity in contravention of the provisions of the Act, or regulations made
thereunder, to disgorge an amount equivalent to the wrongful gain made
or loss averted by such contravention. The provisions of Section 11B
have been held to be procedural in nature and include not only an
individual
but also a company. Therefore, any person associated with the securities
market who commits breach of the SEBI Act, Rules and Regulations,
can be subjected to such directions and measures as may be imposed
and issued by SEBI. Sub-section (2) to Section 11B states that SEBI
may after holding an inquiry pass an order in writing, and, without prejudice
to the provisions of Section (11), levy penalty under Sections 15A, 15B,
etc.
53. Referring to the provisions, the Division Bench of the High
Court in the impugned judgement has held as under:
“291. Another question is about the powers of SEBI under Section
11B of the SEBI Act. We have already held that the power to
issue directions under Section 11B(1) can be exercised to issue
directions to AMC and the Trustees. The said direction can be
issued when SEBI, after making or causing to be made an enquiry,
is satisfied that (a) it is necessary to issue directions in the interest
of investors or orderly development of securities market; (b) to
prevent the affairs of any intermediary or other persons referred
to in Section 12 being conducted in a manner detrimental to the
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interests of investors of securities market; or (c) to secure the
proper management of any such intermediary or person. The first
question is whether SEBI has power to interfere with the decision
taken by the Trustees under Regulation 39(2)(a). If SEBI is to
test the correctness or validity of such decision of the Trustees,
an adjudication is required. The Trustees and AMG will have to
be heard in the adjudication process. Section 11B does not
contemplate any such adjudication. If an entity to whom a direction
under Section 11B has been issued commits any breach thereof
or disobeys the same, it will attract penalty under Section 15HB.
Before imposing penalty, adjudication as contemplated by Section
15-I is required to be made. There is no provision made in SEBI
Act for issuing a notice of the proposed direction under Section
11B and hearing the Trustees or AMC before issuing the direction.
No adjudication is contemplated before issuing the directions.
Therefore, it is not possible for this Court to accept the contention
of the petitioners, AMC as well as the Trustees that by exercising
power under Section 11B, SEBI has power to adjudicate upon the
correctness of the decision taken by the Trustees to wind up a
Scheme. However, when SEBI finds that the Trustees or AMC
are not abiding by the specific provisions of the Mutual Funds
Regulations, the power to issue directions can be exercised by
SEBI. By way of illustration, we refer to hypothetical cases.
After
invoking the provisions of Regulation 39(2)(a), if the Trustees stop
redemption the units by taking recourse to Regulation 40 without
complying with the mandatory requirements of sub-clause (a) and
(b) of clause (3) of Regulation 39, SEBI can always issue a
direction under Section 11B not to stop redemptions, unless
compliance is made with clause (3) of Regulation 39. If it is found
that the Trustees continue to carry on business activities of the
Schemes even after action under clause (3) of Regulation 39 is
taken, a direction under Section 11-B can be issued by SEBI to
stop all business activities.”
54. We have reservations on the said observations for the simple
reason that if there is a violation of the regulations, i.e. clause (a) to
Regulation 39(2), 39(3), 40, 41 or 42 by the trustees or the AMC, it is
open to SEBI to proceed in accordance with law and in terms of Section
11 and 11B of the Act. It would be, therefore, incorrect to state that the
decision of the trustees under clause (a) to Regulation 39(2) cannot be
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made subject matter of inquiry or investigation and therefore no directions
or orders under Section 11 or 11B of the Act can be passed. No doubt,
clause (a) to Regulation 39(2) gives primacy to the opinion of the trustees
and does not require prior approval of SEBI, yet SEBI is entitled to
conduct an inquiry and investigation when justified and necessary to
ascertain whether the trustees have acted in accordance with their
fiduciary duty and also for reasons which would fall within the four
corners of clause (a) to Regulation 39(2). If the trustees have acted for
extraneous and irrelevant reasons and considerations, the action would
be in violation of clause (a) to Regulation 39(2) and therefore amenable
to action under the SEBI Act, including directions under Section 11B.
55. The view we have taken is in consonance with the earlier
decision of the Gujarat High Court in Alka Synthetics and Trading v.
SEBI,15 wherein it was observed that power under Section 11B is in the
nature of issuing a command to persons referred to in the provision to do
a certain act or to forbear from doing a certain act, if as a result of an
enquiry, SEBI is satisfied about the necessity of issuing such direction
for the purposes mentioned in clauses (a), (b) and (c). The Gujarat High
Court, in our opinion, rightly observed that while Section 11 operates in
the field of laying down general regulatory measures as a matter of
policy, Section 11B
operates in the field of prescribing a specified code
of conduct in relation to specified persons or classes of persons. On the
issue of application of principles of natural justice, it was noted that
Section 11B empowers SEBI to issue directions only after it is satisfied
about the conditions referred to in the provision, as a result of making or
causing to be made an enquiry – which necessarily implies a pre-
decisional hearing. Similar view was subsequently expressed in Nikhil
T. Parikh v. Union of India16, wherein the same High Court was of the
view that Section 11B, being an enabling provision, must be so construed
as to subserve the purpose for which it has been enacted. As the term
‘measure’ is not defined in the SEBI Act, the High Court gave it a meaning
prescribed in general parlance, as incorporating anything desired or done
with a view to the accomplishment of a purpose, a plan or course of
action intended to obtain some object, any course of action proposed or
adopted by a Government. The Securities Appellate Tribunal in Sterlite
Industries (India) Ltd. v. SEBI,17 has given an expansive interpretation
15 (1999) 95 Comp Cas 663
16 (2014) 2 GLH 582
17 2001 SCC OnLine SAT 28.
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to Section 11 and Section 11B of the SEBI Act, observing that they give
enormous authority to SEBI. As long as the power exercised under Section
11B is subject to the provisions of the SEBI Act and well within the legal
and constitutional frame work, intended to achieve the purposes of the
SEBI Act and subjecting the persons specified in the section, the power
will sustain. The Appellate Tribunal called it a wholesome provision
designed to achieve the objectives of the SEBI Act.
56. The Trustees and the AMC in their written submissions filed
before the High Court interpreting the SEBI Act and the Regulations
had conceded that SEBI has extensive powers with respect to the
regulation of mutual funds including the trustee’s decision to wind up a
scheme of the mutual fund. Section 11(1) of the SEBI Act states that it
is the duty of SEBI to protect the interest of investors in securities and to
promote the development of, and to regulate the securities market, by
“such measures as it thinks fit”. Under Section 11B of the SEBI Act,
SEBI has broad powers to issue appropriate directions if it is satisfied
after inquiry that such directions are necessary in the interest of investors
or for orderly development of securities market or to prevent the affairs
of any intermediary being conducted in a manner detrimental to the
interest of investors or the securities market or to secure proper
management of any intermediary or other person. The power of SEBI
extends to
regulating and monitoring the functioning and decisions taken
by mutual funds, the trustees and the AMC. SEBI has the power to pass
any direction if it deems fit in the interest of unitholders. The trustees
and the AMC have specifically stated:
“It is evident form the aforesaid provisions that the SEBI has
extensive powers to regulate, supervise, issue directions with
respect to and inspect and investigate into the affairs of a mutual
fund, including with respect to the decision of the trustee to wind
up a mutual fund scheme under Regulation 39(2)(a) of the Mutual
Funds Regulations, including to even stop the winding up of a
mutual fund scheme, if deemed necessary. The existence of such
powers of the SEBI is further reinforced by Section 11D of the
SEBI Act, which empowers the SEBI to pass an order requiring
any person who, ‘has violated, or is likely to violate, any
provisions of this Act, or any rules or regulations made
thereunder” to ‘cease and desist’ from committing such violation.
It is submitted that whether SEBI would choose to exercise this
FRANKLIN TEMPLETON TRUSTEE SERVICES PVT. LTD.  v.
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power is a matter, which may be determined by SEBI in its wisdom
and there may be numerous reasons why SEBI may not wish to
interfere in a winding up decision by a trustee under Regulation
39(2)(a) including the reasons submitted by SEBI in its affidavit
such as the fact that reversal of a decision to wind up a mutual
fund scheme would likely cause a run on the scheme as well as
severe market contagion (Reference is made to Paras 18,19 at
Pg. 6 and 7 of the Delhi Reply; Paras 34 and 35 at Pg. 11
and 12 of the Gujrat Reply; and Paras 11 and 12 at Pgs. 5
and 6 of the Madras Reply); however, on a reading of the scheme
of the SEBI Act and regulations as a whole, it is submitted that it
is clear that such a power does exist.”
57. However, we agree with the High Court that the Regulations
have been framed in exercise of power conferred by Section 30 of the
SEBI Act which authorises them to make regulations consistent with
the provisions of the SEBI Act to carry out the purpose of the SEBI Act.
The very object of the SEBI Act is to preserve confidence of the investors
and to regulate the capital market, including mutual funds. In the first
portion of this order, we have elaborately referred to the Regulations
which thereby create a three-tier system of the sponsor, the AMC and
the trustees. There are stipulations regulating the activities of the trustees
and the AMC whose powers, obligations and rights have been expressly
laid down. The power to regulate mutual funds, once accepted, would
include the power to make regulations for winding up of a scheme of the
mutual fund. Not framing any regulation in this regard would have
amounted to dereliction of duty on the part of SEBI and subjected it to
adverse comments.
58. It cannot be accepted that the trustees under clause (a) to
Regulation 39(2) have been given absolute and unbridled power to wind
up a scheme. Language of clause (a) to Regulation 39(2) states that the
trustees must form an opinion on the happening of any event which
requires the scheme to be wound up. Further, as per Regulation 39(3),
the trustees are bound to give notice disclosing the circumstances leading
to the winding up of the scheme. These notices along with the reasons
have to be communicated to SEBI and made known to the unitholders
by publication in two daily newspapers having circulation all over India
and a vernacular newspaper having circulation at the place where the
mutual fund is formed. The trustees are, therefore, required to come to
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a conclusion that due to specific circumstances articulated in writing,
the scheme is required to be wound up. Two-thirds of the trustees are
independent persons who are not associated with the sponsor,18 and no
director, officer or employee of the AMC can be appointed as a trustee.19
The trustees hold the assets of the scheme in fiduciary capacity on behalf
of the investors. They are experts in the field and, therefore, conferred
the power under Regulation 39(2)(a) to decide whether or not a scheme
should be wound up. The words used in the statute including delegated
legislation are to be understood in the light of that particular statute and
not in isolation. A duly enacted law cannot be struck down on the mere
ground of vagueness unless such vagueness transcends into the realm
of arbitrariness (See Nisha Priya Bhatia v. Union of India and
Another20). In the context of the present case, the expression
‘occurrence of any event’ is not to be read in isolation but with the
words ‘requires the scheme to be wound up’. The expression ‘any event’
is therefore qualified with the said requirement. Read in this manner,
there is no vagueness which can be described as transcending into realm
of arbitrariness, on the other hand, the pre-requisite statutory mandate is
clear. This is not a case of excessive delegation wherein the legislative
function has been abdicated and passed on to the trustees who can act
as per their whims and fancies. The essential legislative
function is the
determination of legislative policy and its formulation as a rule of conduct.
In commercial matters varied and different situations can arise which
may warrant winding up. Complexities in matters of business and
commerce can be bafflingly intricate and riddled with urgencies and
difficulties. Therefore, there is need for flexibility. Otherwise, the trustees
would be compelled to first take the approval of SEBI, which may have
its own consequences.
59. The Statement of Additional Information dated 30th June, 2019
issued by Franklin Templeton Mutual Fund, under Heading VI – ‘Duration
of the Scheme and Winding Up’, provides a general indication as to
when a scheme can be wound up under the Regulations, the relevant
portion of which is extracted below:
“VI. DURATION OF THE SCHEME AND WINDING UP
xx                    xx                   xx
18 Regulation 16(5)
19 Regulation 16(3)
20 (2020) 13 SCC 56
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However, in terms of the SEBI Regulations, the Scheme may be
wound up if:
i. There are changes in the capital markets, fiscal laws or legal
system, or any event or series of events occurs, which, in the
opinion of the Trustee, requires the Scheme to be wound up; or
xx                    xx                   xx
”
60. We have agreed with the High Court that the opinion of the
trustees under clause (a) to Regulation 39(2), therefore, must be
consented to by the unitholders in terms of the mandate of Regulation
18(15)(c). In view of this interpretation, the argument challenging
constitutional validity of the Regulations on the ground that they give
unbridled and absolute power to the trustees loses much of its sting and
force. There are, therefore, sufficient guidance and safeguards in the
Regulations itself on the power of the trustees to decide on winding up
of the fund.
61. The Regulations, in our opinion, rightly draw the distinction
between creditors and the unitholders. The unit holders are investors
who take the risk and, therefore, entitled to profits and gains. Having
taken the calculated risk, they must also bear the losses, if any. Unitholders
are not entitled to fixed return or even protection of the principal amount
(See Regulations 38 and 38A).21 Creditors, on the other hand, are entitled
to fixed return as per mutually agreed contracts. Their rate of return is
in the nature of interest and not profit or
loss. Creditors are not risk
21 Guaranteed Returns
38. No guaranteed return shall be provided in a scheme, -
(a) unless such returns are fully guaranteed by the sponsor or the asset management
company;
(b) unless a statement indicating the name of the person who will guarantee the return,
is made in the offer document;
(c) the manner in which the guarantee is to be met has been stated in the offer document.
Capital Protection oriented schemes
38A. A capital protection oriented scheme may be launched, subject to the following:
(a) the units of the scheme are rated by a registered credit rating agency from the
viewpoint of the ability of its portfolio structure to attain protection of the capital
invested therein;
(b) the scheme is close ended; and
(c) there is compliance with such other requirements as may be specified by the Board
in this behalf.
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takers as is the case with the unitholders. In this sense, unitholders are
somewhat at par with the shareholders of a company. The waterfall
mechanism under the Companies Act, or the Indian Bankruptcy Code,
gives primacy to the dues of the creditors over the shareholders. Identical
is the position of the unitholders. In fact, the argument that the unitholders
should be treated pari passu with the creditors is farfetched. Similarly,
the contention that unitholders are identically placed as home buyers
under the Indian Bankruptcy Code is equally frail and a weak argument.
Home buyers pay money to the builder and enter into a contract for
purchase of immovable property. Home buyers are not risk or partakers
in gains or losses like investors in a mutual fund. Home buyers under the
Bankruptcy Code are treated as creditors till the ownership rights in the
immovable property are transferred to them, but they do not take the
risks and are not entitled to benefit of profits or suffer losses, as are
taken by the unitholders who invest in the mutual funds without any
guarantee of returns and know that the investment, including the principal,
are subject to market risks. To equate the unitholders with either the
creditors or the home buyers will be unsound and incongruous.
62. The expression ‘due and payable’ with reference to the liabilities
is significant. The words ‘due and payable’ have to be interpreted with
reference to the context in which the words appear.22
In the context in
question they refer to the present liabilities which may be in praesenti
or in futuro. There must be an existing obligation though the appointed
date of payment may not have arrived. ‘Payable’, in this context, means
capable of being paid, suitable to be paid and legally enforceable. It
would exclude labilities that are time barred or those not payable in facts
or in law.23 In case of any dispute a summary but thorough inquiry may
be made to ascertain whether the liability is due and payable.24 Obviously,
the liabilities which are not due and payable would not get preferential
treatment, thereby reducing the amounts payable to the unitholders.
63. Since the Regulations are in the nature of economic regulations,
while exercising the power of judicial review, we would exercise restraint
unless clear grounds justify interference. We would not supplant our
views for that of the experts as this can put the marketplace into serious
jeopardy and cause unintended complications. Policy decisions can only
22 B.K. Educational Services Private Limited v. Parag Gupta and Associates, (2019)
11 SCC 633.
23 Union of India v. Raman Iron Foundry, (1974) 2 SCC 231
24 Regulations do not bar civil remedy.
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be faulted on the grounds of mala fides, unreasonableness, arbitrariness
and unfairness, in addition to violation of fundamental rights or exercise
of power beyond the legal limits. The principle of manifest arbitrariness
requires something to be done in exercise in the form of delegated
legislation which is capricious, irrational or without adequate determining
principle. Delegated legislations that are forbiddingly excessive or
disproportionate can also be manifestly arbitrary. In view of the
interpretation placed by us and the discussion above, the Regulations
under challenge do not suffer from the vice of manifest arbitrariness.
64. However, we must now refer to a grey area, which we would,
at this stage, not like to decide till we have full facts and decision in the
adjudication proceedings. The issue relates to interpretation of  Regulation
53, which reads:
“53. Every mutual fund and asset management company shall,
(a) despatch to the unitholders the dividend warrants within 189[30]
days of the declaration of the dividend;
(b) despatch the redemption or repurchase proceeds within 10
working days from the date of redemption or repurchase;
(c) in the event of failure to despatch the redemption or repurchase
proceeds within the period specified in sub-clause (b), the asset
management company shall be liable to pay interest to the
unitholders at such rate as may be specified by SEBI for the
period of such delay;
(d)
notwithstanding payment of such interest to the unit-holders
under sub-clause (c), the asset management company may be
liable for penalty for failure to despatch the redemption or
repurchase proceeds within the stipulated time.
Clause (b) to Regulation 53 requires that the AMC shall despatch
the redemption or repurchase proceeds within 10 working days from the
date of redemption or repurchase. Regulation 40, as noticed above, states
that on or from the date of publication of notice under Regulation 39(3)(b),
the trustees of the AMC, as the case may be, shall cease to cancel or
create units of the scheme; cease to issue or redeem units of the scheme;
and cease to carry on any business activity in respect of the scheme so
wound up.
65. Issue in question would, therefore, arise whether the AMC or
the trustees are bound to honour and pay the redemption or repurchase
proceeds for requests received before the date of publication of notice
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in terms of Regulation 39(3). Interpreting the word ‘business’ in clause
(a) of Regulation 40, the Division Bench of the High Court has held that
this expression refers to business activity and, therefore, would include
payment of redemption proceeds to the unitholders, which would include
the request for redemption received prior to the date of publication under
Regulation 59(3). The High court has, accordingly, held:
“228. As regards redemption requests received prior to compliance
with clause (3) of Regulation 39, the argument of AMC and the
Trustees was that in view of clause (d) of Regulation 53, the
redemption or repurchase proceeds are required to be dispatched
within ten working days from the date of redemption
notwithstanding the decision of winding up. As held earlier, the
dispatch of redemption proceeds or repayment of redemption
proceeds is also a part of business activity of a Scheme which is
completely prohibited once the Regulation 40 triggers in. Therefore,
the argument that the redemption requests made by the unit-holders
on 23rd April, 2020 were required to be honoured even after
Regulation 40 had triggered in cannot be accepted. Once there is
a compliance with clause (3) of Regulation 39, the mandatory
provisions of Regulation 40 forthwith operate. There is no
exception carved out to any of the clauses in Regulation 40. It is
obvious that such a failure to dispatch the redemption or
repurchase proceeds due to applicability of provision
of Regulation
40 cannot be termed as a failure within the meaning of sub-clause
(c) of Regulation 53. Therefore, the consequences such as
payment of interests and penalty as provided in clause (c) of
Regulation 53 may not follow.”
66. On the aspect of borrowings etc. by the AMC to make payment
towards redemption, the High Court has held:
“225. But, in the context of the Scheme of the Mutual Funds
Regulations, this Court will have to consider the meaning of
‘business activities’. As stated in the earlier part of our discussion,
a Scheme is launched by AMC with the approval of the Trustees.
There are different categories of Schemes in which the investments
are made by the members of the public. From plain reading of the
provisions of Regulation 43, it is clear that the money received
from the unit-holders and investors is required to be invested by
AMC strictly in accordance with Regulation 43. The investments
are to be made subject to investment restrictions specified in the
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seventh schedule. As far as borrowings are concerned, clause
(2) of Regulation 44 provides that the Mutual Fund shall not borrow
except to meet temporary liquidity needs of the Mutual Fund for
the purpose of repurchase, redemption of units or payment of
interest or dividend to the unit-holders. The proviso to clause (2)
of Regulation 44 clearly provides that a Mutual Fund shall not
borrow more than twenty percent (20%) of the net assets of the
Scheme and the duration of such borrowing shall not exceed a
period of six months. Thus, in short, the business of a Mutual
Fund consists of (i) launching Schemes, (ii) receiving the
investments from the unit-holders/investors, (iii) investing the
money so collected from the unit-holders/investors in accordance
with Regulation 43 and other relevant Regulations and (iv) paying
the returns in various modes to the unit-holders/investors. The
returns can be in the form of repurchase of the units, redemption
of units, payment of interest or dividend to the unit-holders, as the
case may be, depending upon the nature of the Scheme. Making
such returns is certainly a business activity of a Scheme. The
income so generated by investments made in accordance with
Regulation 43, can also be invested by AMC. Clause (3) Regulation
44 provides that save as otherwise expressly provided, a Mutual
Fund shall not advance any loans for any purposes. However,
clause (4) of Regulation 44 provides that
a Mutual Fund may lend
and borrow securities in accordance with the framework relating
to short selling and securities lending and borrowing specified by
SEBI. The provisions of Mutual Funds Regulations are intended
to regulate activities of Mutual Funds for promoting its healthy
growth and for protecting interest of unit-holders. In a case
of Taxation law, the rules of interpretation applicable provide that
if there are two interpretations possible, the one in favour of
assessee will have to be preferred. In case of Mutual Funds
Regulations, a construction needs to be adopted which will
subserve the object of SEBI Act.
226. It is pertinent to note here that clause (a) of Regulation 40
uses the words “business activities in respect of the Scheme” and
not merely business of the Scheme. As siated earlier, the activities
of repurchase of units, redemption of units or payment of interest
or dividend are also a part of business of a Scheme. In view of
clause (2) of Regulation 44, a Mutual Fund can borrow only for
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the purposes of meeting temporary liquidity needs for the purpose
of repurchase, redemption of units, payment of interests or dividend
to the unit-holders. For example, if there are large number of
requests for redemption of units by the unit-holders in respect of
‘open ended Scheme’, a Mutual Fund may face temporary liquidity
crunch. In such a situation, it is permissible for a Mutual Fund to
make borrowings only for payment of redemption amount.
Therefore, borrowings made as specified in clause (2) of
Regulation 44 will certainly amount to ‘business activities’ of a
Mutual Fund or a Scheme, inasmuch as, such borrowings are
made for the purpose of meeting demand for redemption which is
a part of business of the Scheme.
227. Regulation 40 is interlinked with Regulation 41. In view of
Regulation 40, the moment compliance is made with clause (3) of
Regulation 39, the ‘business activities’ of the Scheme of a Mutual
Fund must stop. The creation or cancellation of units and issue or
redemption of the units of the said Scheme must also cease. The
reasons is, as required by sub-clause (a) of clause (2) of Regulation
41, all the assets of the Scheme under winding up are required to
be disposed of in the best interest of unit-holders and thereafter,
as per sub-clause (b) of clause (2) of Regulation 41, the proceeds
of the sale are required to be applied firstly towards discharge of
liabilities of the Scheme. Secondly, the expenses in connection
with the winding up
are required to be set apart and thirdly, the
balance amount remaining after clearing the liabilities has to be
distributed to the unit-holders in proportion to their respective
interest in the assets of the Scheme. The object of Regulation 40
of the Mutual Funds Regulation is to ensure that the moment
compliance is made with clause (3) of Regulation 39, the assets
available at that point of time should be made available for sale.
The assets cannot be allowed to be depleied by creating more
liability. That is the reason why the redemption must immediately
cease. Therefore, it must be held that the borrowings made by
AMC, in terms of clause (2) of Regulation 44, are business
activities’ of a Scheme within the meaning of clause (a) of
Regulation 40. If borrowings are made in accordance with clause
(2) of Regulation 44, the act of replacement of the borrower, as
done by the AMC and the Trustees in the present case, will have
to be also held to be a part of business activities in respect of the
Scheme.”
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67. The case set up by some parties is at variance with the dictum
pronounced by the High Court. They have submitted that the mutual
fund must honour the request for redemptions received on or before the
date of publication of notice under Regulation 39(3). In other words,
Regulation 53(b) must be honoured and complied with even if the time
of payment of redemption, the 10 days period stipulated therein, would
fall after the date of publication of the notice under Regulation 39(3).
They are of the opinion that it would be illegal not to honour the valid
redemption requests. They are also of the opinion that the AMC should
be allowed and permitted to borrow money within the prescribed limits
to honour such valid redemption requests as long as the valid redemption
requests are received prior to the cut-off date for winding up.
68. Before we answer this aspect, we would like to have greater
clarity on the factual matrix, which would be possible once the
proceedings in pursuance of show-cause notices etc. are concluded.
Notably, many of the appellants have not addressed us on this aspect,
their grievance being that the Forensic Audit Report has not been made
available to them. At the same time, they did refer to news reports or
articles to suggest irregularities and illegalities of different kinds, including
preferential payments, breach of trust and mis-management in
deployment of funds of the scheme, violation of
investment objectives
stated in the offer document or scheme information document and breach
of trust by withholding price sensitive information etc. Once the facts
are clear and ascertained, we would be able to appreciate and understand
the practical impact of the respective interpretations, i.e. the interpretation
placed by the High Court and the interpretation sought to be placed and
preferred by SEBI, the appellants, the trustees and the AMC. This is
also the reason why we have refrained from referring and commenting
on facts and left the several issues open at this stage. Nevertheless, we
clarify that our observations in this Order and the earlier Order should
not be read as binding factual findings or conclusions on any disputed
facts, which could be a subject matter of a show-cause notice and
consequent decision. Of course, the legal interpretation of Regulation
18(15)(c) and Regulations 39 to 42 to the extent indicated above are
conclusive and binding. For clarity, we would also observe that any finding
given by the High Court on facts or even on legal issues not subject
matter of this Order or our earlier Order dated 12th February, 2021 would
not be treated as conclusive and binding as the findings are sub-judice
and pending before this Court on interpretation as well as merits.
Nidhi Jain
Directions issued.