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Kar HC | Franklin Templeton and the provisionary application of SEBI Mutual Fund Regulations; Petition allowed with necessary directions

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Karnataka High Court

Karnataka High Court: A Division Bench of Abhay S. Oka CJ. and Ashok S.Kinagi J., while allowing the present writ petition held, “the decision of the Trustees (the Franklin Templeton Trustee Services private Limited) to wind up six Schemes mentioned in paragraph-1 of the Judgment by taking recourse to sub-clause (a) of clause (2) of Regulation 39 of the Mutual Funds Regulations cannot be implemented unless the consent of the unit-holders is obtained in accordance with sub-clause (c) of clause (15) of Regulation 18.”

 Facts of the Case

Withdrawal of 6 schemes by Franklin Templeton Mutual Fund enumerated herewith, were in challenge. Three separate petitions were moved under High Courts of Delhi, Gujarat and Madras which by an order dated 19-06-2020 by the Supreme Court was transferred to the Karnataka High Court, for final disposal. The matter also includes the challenge to the validity of Regulations 39, 40 and 41 of the Mutual Funds Regulations by SEBI.

Schemes of the Franklin Templeton Mutual Fund under challenge;

i) Franklin India Low Duration Fund

ii) Franklin India Ultra Short Bond Fund

iii) Franklin India Short Term Income Plan

iv) Franklin India Credit Risk Fund

v) Franklin India Dynamic Accrual Fund

vi) Franklin India Income Opportunities Fund

 Issues

  1. Whether the present writ petition against AMC, Trustees and Sponsors maintainable?
  2. Whether the Regulations 39 to 42 of the Mutual Funds Regulations are ultra vires the provisions of the Securities and Exchange Board of India Act, 1992 and unconstitutional being vague, manifestly arbitrary and unreasonable?
  3. Whether obtaining the consent of the unit-holders in accordance with the provision of clause (15)(c) of Regulation 18 of the Mutual Funds Regulations is a condition precedent for winding up of a Scheme in accordance with the provision of sub-clause clause (2)(a) of Regulation 39 of the Mutual Funds Regulations?
  4. Whether compliance with clause (15A) of Regulation 18 of the Mutual Funds Regulations is a condition precedent for winding up of a Scheme in accordance with sub-clause (a) of clause (2) of Regulation 39?
  5. Whether SEBI has jurisdiction under Section 11B of SEBI Act to interfere with the decision of winding up of a Scheme, taken pursuant to sub-clause (a) of clause (2) of Regulation 39?
  6. Whether, after issue and publication of notice as contemplated by clause (3) of Regulation 39, AMC or Trustees can borrow money for the purposes of repayment of a loan or for the purposes of meeting the requisition for redemption requests received?
  7. Assuming that the decision of winding up is valid, whether the Trustees have established that they have complied with sub-clauses (a) and (b) of clause (3) of Regulation 39?
  8. Whether the Court exercising writ jurisdiction, interfere with the decision of the Trustees to wind up of the said Schemes by going into the merits of the decision?
  9. Whether it is justified to make public, a copy of the report by the forensic auditor?
  10. Whether the petitioners are entitled to have true/original copy of the resolutions dated 20th April 2020 and 23rd April 2020 passed by the Board of Directors of the Trustees?
  11. Whether any directions are required to be issued against SEBI? 

Observations & Decision

  1. While answering the said issue in affirmation, the Court placed reliance over the case of Praga Tools Corporation v. CA Imanual, (1969) 1 SCC 585 and Rohtas Industries Ltd. v. Rohtas Industries Staff Union, (1976) 2 SCC 82. The said case essentially dealt with the maintainability of a dispute between a private entity and its employees, against award rendered by the Arbitrator. The Court held a similar rationale observing that, the power of the Court under Article 226 is of the widest amplitude and covers within the disputes of private entity, irrespective of any alternate remedy available. Clarifying further the Court reiterated the findings of the former case mentioned above; “An order of mandamus is, in form, a command directed to a person, corporation or an inferior tribunal requiring him or them to do a particular thing therein specified which appertains to his or their office and is in the nature of a public duty. It is, however, not necessary that the person or the authority on whom the statutory duty is imposed need be a public official or an official body. A mandamus can issue, for instance, to an official of a society to compel him to carry out the terms of the statute under or by which the society is constituted or governed and also to companies or corporations to carry out duties placed on them by the statutes authorising their undertakings. A mandamus would also lie against a company constituted by a statute for the purposes of fulfilling public responsibilities.”
  2. Declaring Regulations 39 to 40 of the Mutual Funds Regulations valid, the Court held, “(…) the Regulations which have been framed for regulating the action of winding up of the Schemes can be said to have been framed for carrying out the purposes of the SEBI Act. In absence of Regulations 39 to 42, the action of winding up of the Schemes will remain completely unregulated which will defeat the very object of enacting the SEBI Act”
  3. “When the Board of Directors of a Trustee company, by majority, decides to wind up a Scheme by taking recourse to sub-clause (a) of clause (2) of Regulation 39, the Trustee company is bound by its statutory obligation under sub-clause (c) of clause (15) of Regulation 18 of obtaining consent of the unit-holders of the Scheme. The consent of unit-holders will be by a simple majority. In view of the obligation of the Trustees under sub-clause (c) of clause (15) of Regulation 18, a notice as required by clause (3) of Regulation 39 can be issued and published only after making compliance with the requirement of obtaining consent of the Unit-holders.” The Court further relied on OP Singla v. Union of India, (1984) 4 SCC 450, Union of India v. Brigadier PS Gill, (2012) 4 SCC 463 so to establish a constructive interpretation of any provision.
  1. “Clause 15A of Regulation 18 of the Mutual Funds Regulations 1996 operates in a different field which has nothing to do with the process of winding up of a Scheme. Therefore, compliance with Clause 15A of Regulation 18 is not a condition precedent for winding up of a Scheme pursuant to sub-clause (a) of clause (2) of Regulation 39.”
  1. The Court reproduced Section 11B of the SEBI Act which mentions about power to issue directions and levy penalty in addition to Section 30 enumerating SEBI’s power to make regulations. “In exercise of the powers under Section 11B of the SEBI Act, SEBI has no jurisdiction to interfere with the decision of winding up of a Scheme made by taking recourse to Regulation 39 (2) (a).”
  1. “On compliance being made with sub-clauses (a) and (b) of clause (3) of Regulation 39, Regulation 40 triggers in and therefore, AMC or Trustees have no right to continue the business activities of the Schemes which will include borrowings. Similarly, from the date of publication of the notice in accordance with sub-clause (b) clause (3) of Regulation 39, AMC is disentitled to honour the redemption requests made earlier.” 
  1. The said issue was answered against the trustees. The Court discussed the obligations of Trustees finding that the same was not complied with in the present case.
  1. “Considering the duties of the Trustees under the Mutual Funds Regulations, they perform a public duty. Therefore, when it is found that the Trustees have violated the provisions of the SEBI Act or Mutual Funds Regulations, a Writ Court, in exercise of its jurisdiction under Article 226 of the Constitution of India, can always issue a writ of mandamus, requiring the Trustees to abide by the mandatory provisions of the SEBI Act or the Mutual Funds Regulations.” Reflecting upon the powers of Court while examining the decision of the Trustees, under Article 226, it was said, “no interference can be made with the decision of the Trustees dated 23rd April 2020 of winding up of the said Schemes. However, the decision can be implemented only after obtaining the consent of unit-holders as required by sub-clause (c) of clause 15 of Regulation 18. Issue No.(v) is answered accordingly.”
  1. “The copy of the Forensic Audit report produced in a sealed cover, does not contain final findings and it is specifically mentioned therein that after taking the views/responses of SEBI, AMC and Trustee company, some of the conclusions in the report may undergo a change. Hence, the said report can at best be termed as a tentative report. Hence, the same is not relevant for deciding these petitions. As the said document is not relevant, it is not necessary for this Court to go into the legality of the claim for privilege.” 
  1. Clause (22) of Regulation 18 clearly lays down that the Trustees shall abide by the Code of Conduct as specified in the Fifth Schedule. Clause (2) of the Code of Conduct prescribed in the Fifth Schedule reads; “2. Trustees and asset management companies must ensure the dissemination to all unit-holders of adequate, accurate, explicit and timely information fairly presented in a simple language about the investment policies, investment objectives, financial position and general affairs of the Scheme.”
  1. “After receiving the final findings/report of the Forensic Auditors, SEBI is bound to consider of initiating an action as contemplated by Regulation 65, depending upon the findings recorded therein.”

 [SEBI v. Franklin Templeton,  2020 SCC OnLine Kar 1650, decided on 24-10-2020]

Sakshi Shukla, Editorial Assistant has put this story together

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