12 Feb 2121

Consent for winding up of Mutual Fund Schemes under Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 means consent by a majority of the unit-holders who have participated in the poll and not the consent of the majority of all the unit-holders - Supreme Court of India

Case : Franklin Templeton Trustee Services Private Ltd & Anr v. Amruta Garg & Ors Etc (& 8 others) Civil Appeal Nos. 498-501 of 2021

Court : Supreme Court of India

Bench : Justcie S. Abdul Nazeer and Justice Sanjiv Khanna

Decided on : 12 Feb 2121

Relevant Statutes

Securities and Exchange Board of India Act, 1992

Regulations 18(15), 39(2) and 41(1) of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996

Section 48, 55(3), 103 of the Companies Act, 2013

Brief Facts and Procedural History

1. The appellant appealed against the decision of the Division Bench of the High Court of Karnataka wherein the winding up and its procedure concerning six schemes of the Franklin Templeton Mutual Fund was restrained for not obtaining the consent of unit-holders by a simple majority.

2. The Division Bench interpreted the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 framed by the Securities and Exchange Board of India (SEBI) to hold that Regulation 18(15)(c) mandates consent of the unit-holders for winding up of mutual fund schemes even when the trustees form an opinion that the scheme is required to be wound up in terms of Regulation 392(2)(a) of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996. The unit-holders agreed to this interpretation while the Securities and Exchange Board of India opposed it as erroneous.

Issue of the Case

Whether consent would mean the majority of the unit-holders who exercise their right in the poll or the majority of all the unit-holders of the scheme?

The Observations of the Court

The Honourable Supreme Court of India observed that:

1. Common people invest in mutual funds driven by factors such as simplicity in purchase and redemption of units, the flexibility of holding and tenure, and liquidity by conversion into money. Thus, immediate directions are required as embargo prohibiting redemption of the units, effected by Regulation 404 from the date of publication of notice under Regulation 39(3)(b) for over ten months. Thereby the unit-holders had suffered privation and harassment, and public sentiments and confidence vital for investments in mutual funds were also undermined.

2. The Supreme Court rejected the argument raised by the objecting unit-holders that consent would be binding only on those who have consented to wind up 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 unit-holders’, and not consent given by individual unit-holders who alone would be bound by their consent. To accept the contra view, would be to negate the very object and purpose of Regulation 18(15)(c). It will make the Mutual Fund schemes and the winding-up provisions in the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 unworkable as there would be two different classes of unit-holders – 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.

3. The word ‘consent’ in Regulation 18(15) refers to affirmative consent to winding up by ‘the majority of the unit-holders’. Conversely, consent is denied when the ‘majority of the unit-holders’ do not approve the proposal to wind up the scheme.

4. Regulation 18(15)(c) per se does not prescribe any quorum or specify the criterion for computing majority or ratio of unit-holders required for valid consent for winding up. Regulation 39(2)(b), on the other hand, specifies that 75% of the unit-holders of a scheme can pass a resolution that the scheme is wound up. Similarly, Regulation 41(1) requires the trustees to call a meeting to approve, by a simple majority of the unit-holders present and voting, a resolution for authorizing 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 the 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.

5. Section 55(3) of the Companies Act, 2013 in case of failure to redeem or pay dividend refers to the 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.

6. In Shri Ishwar Chandra v. Shri Satyanarain Sinha and Others, (1972) 3 SCC 383 the Supreme Court on the question of quorum held that 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 thereat cannot be held to be invalid.

7. When there is a choice between two interpretations, one would avoid a ‘construction’ which would reduce the legislation to futility, and would rather accept the ‘construction’ based on the view that draftsmen would legislate only to bring about an effective result.

8. Reading prescription of a quorum as a majority of the unit-holders or ‘consent’ as implying ‘consent by the majority of all unit-holders’ in Regulation 18(15)(c) of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 will lead to an absurdity and an impossibility given the fact that mutual funds have thousands or lakhs of unit-holders. Many unit-holders due to lack of expertise, commercial understanding, relatively smallholding, etc. may not like to participate. Consent of the majority of all unit-holders of the scheme with a further prescription that ‘50% of all unit-holders’ shall constitute a quorum is a practical impossibility and therefore would be a futile and foreclosed exercise.

9. In Syed Hasan Raza Sahib Shamsul Ulama and two others v. Mir Hasan Ali Sahib and two others, AIR 1918 Mad 1131 Seshagiri Ayyar J. had distinguished definite and indefinite numbers.

10. In the case of unit-holders, the number is fluctuating and ever-changing and, therefore, indefinite. The numbers of unit-holders can increase, decrease and change with purchase or redemption. Therefore, in the context of Regulation 18(15)(c), in the absence of any express stipulation, a minimum quorum cannot be prescribed and the requirement of ‘consent by the majority of the unit-holders’ as consent by a majority of all the unit-holders cannot be read.

11. Investment in the share market, though beneficial and attractive, requires expertise in portfolio construction, stock selection, and market timing. Given 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.

12. It would be wrong to expect that many amongst these unit-holders would have definitive opinion required and necessary voting in a poll on winding up of a mutual fund scheme. Such unit-holders, 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.

13. A ‘construction’ that would lead to commercial chaos and deadlock cannot be accepted; rather a reasonable and pragmatic ‘construction’ which furthers the legislative purpose must be accepted. Therefore, silence on the part of absentee unit-holders 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 purpose for which it was enacted. 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 allow them to accept and give their consent or reject the proposal. It is not to frustrate and make winding up an impossibility.

14. The Supreme Court refused to read into Regulation 18(15)(c) a need to have affirmative consent of a majority of all or an entire pool of unit-holders. The words ‘all’ or ‘entire’ are not incorporated and found in the said Regulation. Thus, consent of the unit-holders for Regulation 18(15)(c) would mean the simple majority of the unit-holders present and voting.

15. The unit-holders were to be provided with an e-voting facility to seek their approval/consent for winding up by an order of the Supreme Court. The trustees were undertaking the exercise of e-voting and that the Securities and Exchange Board of India would appoint an Observer in terms of the directions of the Supreme Court. The results of the e-voting would not be declared and would be produced before the Supreme Court in a sealed cover along with the report of the Observer appointed by the Securities and Exchange Board of India.

16. Notices via e-mail and text messages were sent to unit-holders, and successfully reached 97.92% of the total number of unit-holders. M/s. J. Sagar Associates, a law firm, was appointed as the Scrutiniser for the e-voting process.

17. Poll, whether in a physical meeting, by way of a postal ballot or e-poll, has an advantage as each unitholder has one vote for every unit/share held. Therefore, in cases where there is a huge disparity between the units held, or the possibility of contest/dispute, a poll is the preferred method for ascertaining the preference of the unit-holders. The value of the poll lies in the fact that the weighted voting strength based upon the number of units gives more accurate and precise results. The majority consent of the investors/unit-holders should depend upon the number of units held by them. (Sections 107 to 110 of Companies Act, 2013 are express provisions and will accordingly apply in case of a meeting of shareholders)

18. Poll results like election results are not to be regarded as vitiated by breach of rules or mistake, until and unless the breach or mistake, is proved has materially affected the result of the poll. This general principle may be deviated from only when poll/election is conducted so badly that it is not substantially under law as to elections, in which case it would not matter whether the result was affected or not. [Morgan v. Simpson, (1975) QB 151]

19. When the poll or voting is on issues or choices of commercial nature, normally it is not a part of the judicial process for the court to ferret out flaws by examining the merits or wisdom of the unit-holders who have voted. The court is not equipped and should refrain from entering into such oversights as the doctrine of internal management, institutional sovereignty, and right to opt and decide come into play. [Fertilizer Corpn. Kamgar Union (Regd.) v. Union of India, (1981) 1 SCC 568]

20. The unit-holders are the best judge and are more conversant with their interests. It just has to be seen is that broad parameters of fairness in the administration, bona fide poll/election, and that fundamental rules of reasonable management of the public business have not been breached.

21. The objectors to the e-voting results are sixteen in number. In percentage terms, the share of objectors in the total units is merely 0.024% and their share in the total Assets Under Management (AUM) is 0.033%.

22. If the rejected votes are taken into consideration, the total votes polled in proportionate terms would increase from approximately 54% to 62%.

23. The unit-holders were given a chance and option to vote and about 38% of the unit-holders in numerical terms and 54% in value terms had exercised their right to give or reject the consent to the proposal for winding up. In the absence or need for a minimum quorum, which is not provided or stipulated in the Regulations nor mandated under law, the e-voting result cannot be rejected on the ground that 38% of the unit-holders in numerical terms and 54% in value terms, even if the rejected votes not accounted for, had participated. This cannot be a ground to reject and ignore the affirmative result consenting to the proposal for winding up of the six mutual fund schemes.

24. The e-voting exercise was also supervised by a team of technical experts. Any malpractice on the part of M/s. KFin Technologies Pvt. Ltd. for providing e-voting platform services could not be proved.

25. The trustees had already decided to wind up the six schemes. Regulation 39(3) requires the trustees to disclose the circumstances leading to the winding up of the schemes. The trustees accordingly, in the notice for e-voting and meeting of the unit-holders, had furnished their explanation and reason for winding up of the six schemes. It cannot be said that the notice to the unit-holders misguides and effectively prompts and canvasses the unit-holders to give their consent for winding up when read in entirety. Its contents would not justify annulling the consent given by the unit-holders for the winding up.

26. Mr. T.S. Krishnamurthy’s appointment as the Observer by Securities and Exchange Board of India was made public belatedly, Notice for e-meeting was not digitally signed, Observer Mr. T.S. Krishnamurthy should have acted as the Scrutinizer, agreement of M/s. KFin Technologies Pvt. Ltd. was not digitally signed at the time of entering into an agreement, and the technology platform for e-voting was not specified. All these objections are mere assertions and hardly justify the rejection of the consent to winding up which has been expressed by more than 95% of the unit-holders who had voted.

The Decision Held by the Court

The Division Bench of the Supreme Court dismissed all objections to the winding up of six mutual fund schemes floated by Franklin Templeton, upheld the results of e-voting, and held that:

1. For Regulation 18(15)(c), consent of the unit-holders would mean consent by a majority of the unit-holders who have participated in the poll and not the consent of the majority of all the unit-holders of the scheme.

2. With the consent of the parties, M/s. SBI Funds Management Private Limited was appointed to undertake the exercise of winding up, which would include liquidation of the holdings/assets/portfolio and distribution/payment to the unit-holders.

3. M/s. SBI Funds Management Private Limited was asked to follow the best effort principle to ensure expeditious and timely payment to the unit-holders and assure the best possible liquidation value of the assets/ securities to the unit-holders, and directed that distribution/disbursement of funds to the unit-holders could be made in tranches without waiting for liquidation of all the securities/assets.

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