Supreme Court: In a sequel to its earlier order directing winding up of six mutual fund schemes of Franklin Templeton Mutual Fund, a Division Bench of S. Abdul Nazeer and Sanjiv Khanna, JJ. ruled that the trustees are required to seek consent by majority of the unit holders, when they by majority decide to wind up a mutual fund scheme. Also, consent by majority of the unit holders should be sought post-publication of the notice and disclosure of the reasons for winding up.
In its earlier order dated 12-2-2021 [Franklin Templeton Trustee Services (P) Ltd. v. Amruta Garg, 2021 SCC OnLine SC 88], the Supreme Court has allowed the winding up of six mutual fund schemes by Franklin Templeton Mutual Funds, by holding that as per the poll results, the unit holders of the six schemes have given their consent by majority to wind up the six schemes. It had however not examined certain aspects then. The task before the Supreme Court now was two-fold. First, decide whether the decision of the trustees to wind up a scheme under Regulation 39(2)(a) of the SEBI (Mutual Funds) Scheme, 1996 must muster the consent of the majority of the unit holders as per Regulation 18(15)(c). And second, decide the challenge to the constitutional validity of certain provisions of the SEBI (Mutual Funds) Regulations, 1996 itself.
Below is a comprehensive analysis of the entire discussion by the Supreme Court:
(A) Interpretation of Regulations 39 to 42, their interplay and harmonious construction with Regulation 18(15)(c) of the Mutual Funds Regulations, 1996
Regulations 39 to 42 and 18(5)(c)
Regulation 39 relates to ‘winding up’ of a scheme of a mutual fund. In terms of sub-regulation (2), a scheme of a mutual fund can be wound up: (a) on the happening of any event, which, in the opinion of the trustees[1], requires the scheme to be wound up; (b) if 75% of its unit holders[2] pass a resolution for winding up of the scheme; or (c) SEBI directs winding up of the scheme in the interest of the unit holders. 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 newspapers as specified.
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 Asset Management Company (“AMC”)[3] 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. Regulation 41 relates to the procedure and manner of winding up. 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. Regulation 42-A 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.
Regulation 18(15)(c), which relates to rights and obligations of the trustees, in simple words requires the trustees to take consent of the unit holders, when they, by majority, decide to wind up or prematurely redeem the units.
Decision of the High Court
The judgment of the Karnataka High Court which was under challenge, interpreted Regulation 18(15)(c) and Regulation 39(2)(a) to hold 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 unit holders as per Regulation 18(15)(c).
The Challenge
Contesting the finding of the High Court, the SEBI, the trustees and the AMC argued that the unit holders do not come into the picture when the trustees and the 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 unit holders. Only when the unit holders want to wind up a scheme, in terms of clause (b), a resolution by 75% of the unit holders is mandated. Thus, they contended that the findings of the High Court to the contrary should be reversed.
Analysis and Decision
(i) Interpretation of the term ‘consent’ in Regulation 18(15)(c)
In its order dated 12-2-2021 (2021 SCC OnLine SC 88), the Supreme Court interpreted Regulation 18(15)(c) and the word ‘consent’ therein. It held that the underlying thrust behind Regulation 18(15)(c) is to inform the unit holders 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.
The Court in the said earlier order had concluded that Regulation 18(15)(c) need not have affirmative consent of majority of all or entire pool of unit holders. The words ‘all’ or ‘entire’ are not incorporated and found in that Regulation. It was held:
“Thus, consent of the unit holders for the purpose of Regulation 18(15)(c) would mean simple majority of the unit holders present and voting.”
(ii) Trustees are required to seek consent of unit holders
Discussing Regulation 18(15)(c) and Regulations 39 to 42 at length, the Court concluded that Regulation 18(15)(c) mirrored by use of the word ‘shall’ is couched as a command. Regulation 39(2) under clause (a) vests the power of winding up of a scheme with the trustees, and with the unit holders 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.
The Court was of the opinion that 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. It was held:
“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 unit holders is a pre-requisite for winding up.”
The Court said that such interpretation in no way dilutes or renders clause (b) to Regulation 39(2) meaningless or redundant. That clause applies where the winding up process is initiated at the instance of the unit holders, i.e. upon 75% of unit holders of the scheme passing a resolution for winding up. It was observed:
“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.”
The Court rejected the argument that the unit holders are lay persons and not well versed with the market conditions. It was noted that investments by the unit holders constitute the corpus of the scheme. To deny the unit holders 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 unit holders exercise informed choice and discretion when they invest or redeem the units. Regulations envision the unit holders not as domain experts, albeit as discerning investors who are perceptive and prudent. The Court observed:
“The unit holders, 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 unit holders 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.”
A hypothetical submission that the unit holders may reject a valid and well-considered opinion of the trustees for winding up, and therefore Regulation 18(15)(c) is directory, was again rejected by the Court. It said that:
“Assumptions cannot be a ground to wrongly interpret Regulation 18(15)(c).”
Completing the interpretation of Regulation 18(15), the Court recorded that clause (a) applies and requires the trustees to obtain consent of the unit holders whenever required by SEBI in the interest of the unit holders. Clause (b) states that the trustees would obtain consent of the unit holders whenever required to do so on the requisition made by three-fourths of the unit holders of any scheme. Accordingly, clause (a) would apply whenever SEBI mandates and clause (b) applies whenever three-fourths of the unit holders of the scheme make a requisition.
(iii) At what stage consent of unit holders is required
Harmoniously interpreting Regulations 39 to 42, the Court opined that the consent of the unit holders, as envisaged under 18(15)(c), is not required before publication of the notices under Regulation 39(3). It was held:
“Consent of the unit holders should be sought post-publication of the notice and disclosure of the reasons for winding up under Regulation 39(3).“
(B) Constitutional validity of the Mutual Funds Regulations
One of the appellants raised a challenge to the constitutional validity of the SEBI (Mutual Funds) Regulations, 1996.
The Challenge
Regulation 39(2)(a) was assailed as suffering from the vice of excessive delegation. It gives unbridled power to the trustees to wind up a scheme. It was submitted that Regulation 39(2)(a) suffers from manifest arbitrariness in the absence of any prescription regulating the exercise of the power by the trustees.
It was also submitted that Regulation 39(3) equally suffers from the vice of manifest arbitrariness. 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.
It was further contended that 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. Lastly, it was contended that Regulation 42 is also manifestly arbitrary as SEBI is to perform only ministerial functions, much less than the functions of a regulator.
Analysis and Decision
(i) Power of SEBI to pass directions in interest of unit holders
After referring to the provisions of the SEBI Act, 1992 and elucidating the powers of SEBI, the Supreme Court expressed its reservations on the High Court’s observation regarding powers of SEBI under 11-B (Power to issue directions and levy penalty). The Supreme Court was of the opinion that if there is a violation of the regulations, i.e. Regulation 39(2)(a), 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 11-B of the SEBI Act. The Court said that:
“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 11-B.“
(ii) Power of trustees not unbridled
The Court refused to accept that the trustees under Regulation 39(2)(a) have been given absolute and unbridled power to wind up a scheme. The Court noted that the language of clause (a) 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 unit holders by publication in newspapers. The trustees are, therefore, required to come to a conclusion that due to specific circumstances articulated in writing, the scheme is required to be wound up. The Court concluded that:
“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. … There are … sufficient guidance and safeguards in the Regulations itself on the power of the trustees to decide on winding up of the fund.“
(iii) Unit holders not creditors
Culling out the distinction between unit holders and creditors drawn from the Mutual Fund Regulations, the Court noted that 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. Unit holders are not entitled to fixed return or even protection of the principal amount. 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 takers as is the case with the unit holders. It was the Court’s opinion that:
“In this sense, unit holders are somewhat at par with the shareholders of a company. “
It was held that the argument that the unit holders should be treated pari passu with the creditors is farfetched. Similarly, the contention that unit holders are identically placed as home buyers under the Insolvency and Bankruptcy Code, was held to be equally frail and a weak argument.
(iv) Manifest arbitrariness and Scope of judicial review
The Court observed that the Mutual Fund Regulations being in the nature of economic regulations, the Court would exercise restrain while exercising power of judicial review unless clear grounds justify interference.
It was noted that 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. However, held the Court:
“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.“
(C) Grey Area ─ Regulation 53
Referring to issue related to the interpretation of Regulation 53 (Despatch of warrants and proceeds) of the Mutual Fund Regulations, the Court said that it is a grey area which the Court would not like to decide at this stage, till it has full facts and decision in the pending adjudication proceedings. 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.
Issue in question would 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 in terms of Regulation 39(3).
The High Court has held the expression ‘business’ in clause (a) of Regulation 40 refers to business activity and, therefore, 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 Regulation 39(3). The case set up by some parties was at variance with the dictum pronounced by the High Court.
The Court said that before it can answer this aspect, it would like to have greater clarity on the factual matrix, which would be possible once the pending proceedings are concluded.
(D) Closing and Clarification
The Court refrained from referring and commenting on facts and left several issues open at this stage. Nevertheless, it clarified that the observations in the instant Order and the earlier Order dated 12-2-2021 (2021 SCC OnLine SC 88) should not be read as binding factual findings or conclusions on any disputed facts. Of course, the legal interpretation of Regulation 18(15)(c) and Regulations 39 to 42 are conclusive and binding. It was also clarified that any finding given by the High Court on facts or even on legal issues not subject matter of the instant Order or the earlier Order dated 12-2-2021 (2021 SCC OnLine SC 88) would not be treated as conclusive and binding as the findings are sub-judice and pending before the Supreme Court on interpretation as well as merits. [Franklin Templeton Trustee Services (P) Ltd. v. Amruta Garg, 2021 SCC OnLine SC 464, decided on 14-7-2021]
[1] ‘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 unit holders.
[2] ‘Unit holder’ has been defined in Regulation 2(z)(i) to mean a person holding a unit in the scheme of a mutual fund. It may be understood as akin to shareholder in a company.
[3] 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.