Franklin Templeton Trustee Services Pvt Ltd Vs Amruta Garg: Disproportionate Power In Delegated Legislation Can Be Arbitrary

DATE OF JUDGEMENT
14July 2021

CORUM
Hon’ble Mr. Justice S. Abdul Nazeerand Hon’ble Mr. Justice Sanjiv Khanna

PARTIES
Franklin Templeton Trustee Services Pvt.Ltd.andAnr.(Appellants)
Amruta Garg and Others (Respondents)

ISSUE

Whether the Regulations 39 to 42 of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 are constitutionally valid.

SUMMARY

The petitioners challenged the constitutional validity of the provisions of the SEBI (Mutual Funds) Regulations, 1996 which was decided against the petitioners. The Court upheld the validity of the provisions and stated that when the Court is dealing with the validity of provisions that deal with the economy, it should be done with utmost care. When excessive power is given in delegated legislation, it might be arbitrary.

IMPORTANT PROVISIONS

• Regulations 18, 39, 40, 41 and 42 of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996
• Section 11 and 11 B of the Securities and Exchange Board of India Act, 1992

OVERVIEW

• On 12 February 2021, the Court had interpreted Regulation 18 (15) (c) of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 (herein after, ‘the Regulations’) and ordered for the winding up of 6 mutual funds schemes.
• The petitioners challenged the constitutional validity of the Regulations 39 to 42 of the SEBI Regulations, 1996.
• The Court relied on the interpretation of the regulations of the SEBI Regulation and held that manifest arbitrariness necessitates action in the form of delegated legislation that is arbitrary, irrational, or lacks a valid decision foundation.
• The regulations provide sufficient limitations to guarantee that the trustees' power to wind up a fund is not unduly excessive. The delegated legislation provision must be used in conjunction with the statute. Excessively or disproportionately burdensome delegated legislation might likewise be unreasonable.

ARGUMENTS BY THE APPELLANT

• The Regulations 39 to 42 are a comprehensive code that governs the winding up of a mutual fund scheme. The initiators and requirements to be met under Regulation 39(2) clauses (a), (b), and (c) differ.
• The previous approval of the unitholders is not required when the trustees, in any incident, determine that a scheme must be wound up, or when SEBI, in accordance with clause (c), orders the scheme’s winding up in the unitholders’ best interests. Only when the unitholders choose to wind up a scheme, in accordance with clause (b), must a majority of the unitholders vote to do so.
• Combining Regulation 18(15)(c) into Regulations 39 to 42 would have an unrealistic and disastrous result. Even if the trustees decide to wound up a scheme under Regulation 39(2)(a), obtaining prior consent from unitholders would certainly delay the issuance of public notices as required by Regulation 39 (3) and would lead to chaos and confusion.
• As required by clause (a) of Regulation 39(2), trustees acting in a fiduciary capacity as domain experts act for and in the best interests of unitholders. Without domain expertise, unitholders have been given the incorrect ability to veto and override domain experts’ decisions by the High Court. Given the serious ramifications for the sponsor, trustees, and AMC, a decision to wind up a scheme is made with extreme care and prudence after thorough consideration.

ARGUMENTS BY THE RESPONDENT

• The term ‘any event’ in Regulation 39 gives unfettered powers to the trustees to wind up the scheme whereas SEBI has the power to wind up the scheme when it is done in interest of the unitholders. No guidelines regarding the formation of opinion for winding up has been provided.
• SEBI was constituted as a watchdog and it having no role in setting aside the decision of the trustees is contrary to the scheme of SEBI. There is no provision to challenge the decision of the trustees.Regulation 39 (3) is also arbitrary because it only serves as a drop box.
• The sale proceeds under clause (a) are to be applied to the scheme's due and payable liabilities, with the remaining funds being distributed to unitholders in proportion to their individual interests in the scheme's assets, as of the date the decision to wind up was made, according to Regulation 41 (2) (b).
• Regulation 42 is arbitrary because SEBI's role is limited to ministerial activities, not that of a regulator.

ANALYSIS OF THE JUDGEMENT

1. The Regulations provide for three-tier structure with the sponsors, the Board of Trustees and the Asset Management Company (AMC), the definitions for which have been described in the various provisions of the Regulation.
2. The Court analysed the various provisions provided in the Regulation Chapter-wise, giving special emphasis on the Regulations 39 to 42 which are under challenge in the case.
3. Regulation 39 talks about the winding up. A scheme winds up when the period of the close – ended scheme expires or after the payment of the amount due to the unit holders for which notice is to be given to the Board and two daily newspapers with circulation all over India and a vernacular newspaper of the place of formation of the mutual fund.
4. The effect of winding up of the scheme is mentioned in Regulation 40 which states that the trustee or the AMC would cease from carrying out any business activities, creation and cancellation of units, issuance or redemption of the scheme from the date of publication of the notice of winding up.
5. Regulation 41 describes the procedure and manner of the winding up of the company. Unless the scheme is wound up at the end of maturity, the trustee should call for a meeting of the unit – holders who would authorise the trustee or any person to wind up the scheme by simple majority. The authorised person would then dispose of the assets of the scheme and the utilised amount would be used for discharging the liabilities and for bearing the expenses of winding up; the remaining would be paid to the unit holders proportionate to their interest.
6. The report is to be forwarded to the Board and unit – holders containing all the details of the winding up process along with a certificate from the auditors. The half- yearly reports and annual reports would be disclosed irrespective of anything mentioned in this regulation.
7. Regulation 42 states that the scheme would cease to exist once the Board is satisfied with the measures taken by the authorised for winding up.
8. The rights and duties of the trustees are described in the Regulation 18 (15) (c). The relation between the Regulation 39 to 42 of the Regulations and the rights and duties of the trustees was discussed by the Court. It requires the trustees to obtain the consent of the unitholders when they decide to wind up or prematurely redeem the units by a majority vote. It ex-facie refers to the winding up of the open-ended scheme, and prematurely redeem the units refers to the premature redemption of units under the closed-ended scheme in Regulation 18(15)(c).
9. The words “winding up” or “premature redemption of units” in Regulation 18(15)(c) refer to a circumstance covered by Regulation 39(2)(a), namely when the plan is wound up due to the trustees' decision. Regulation 18(15A) (amended), on the other hand, does not apply when the scheme is being wound up; rather, it applies when a proposal is made to change the scheme's fundamental qualities, fee or expenditure, or any other modification that might modify the scheme and affect the unitholders' interests.
10. When Regulation 18(15)(c) requires unitholder consent, denying them a say weakens their role and right to participate. The fact that unitholders make informed decisions and use discretion when investing or redeeming their units is unarguable. The unitholders are envisioned by the regulations as discerning investors who are perceptive and prudent, not as domain specialists. As a result, the trustees are required to inform and be transparent.
11. The unitholders’ consent, as required by clause (c) of Regulation 18(15), is not necessary prior to the publication of notices under Regulation 39 (3). After publication of the notice and disclosure of the reasons for winding up under Regulation 39 (3), unitholder consent should be sought.
12. If the trustees or the AMC violate the regulations, i.e. clause (a) of Regulation 39(2), 39(3), 40, 41, or 42, SEBI has the authority to proceed in accordance with the legislation and in accordance with Section 11 and 11B of the SEBI Act. As a result, it would be inaccurate to assert that the trustees' decision under clause (a) of Regulation 39(2) cannot be made the subject of an inquiry or investigation, and that no instructions or orders under Section 11 or 11-B of the Act can be issued.
13. Creditors and unitholders are clearly distinguished under the Regulations. Unit holders are risk-takers who are entitled to profits and gains as a result of their investment. They must bear the losses, if any, after taking the assessed risk.
14. Because the Rules are in the nature of economic regulations, prudence should be maintained in exercising the power of judicial review unless obvious grounds justify involvement. Only mala fides, unreasonableness, arbitrariness, and unfairness, as well as violations of Fundamental Rights or the use of power beyond legal limitations, can be used to criticise policy decisions.
15. The principle of obvious arbitrariness necessitates that something be done in the form of delegated legislation that is arbitrary, irrational, or without a sufficient governing principle. Delegated legislation that is excessively or disproportionately prohibitive can be obviously unreasonable. The challenged regulations do not suffer from the flaw of evident arbitrariness.

CONCLUSION

The Supreme Court has dealt with the case with utmost precision. The provisions in question have been analysed in detail. The mutual fund schemes that are formed are for the benefit of the unitholders so when the decision to wind up those schemes are taken, the unitholders should have a say, but that does not entail that the trustees’ decision would not be beneficial for them. The decision can be investigated and enquired into by the SEBI who is in-charge of looking after the activities.

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