Supreme Court Clarifies Unitholder Consent for Mutual Fund Winding Up: Franklin Templeton Case (2021)

Date of the Judgment: 12 February 2021

Citation: (2021) INSC 78

Judges: S. Abdul Nazeer, J., Sanjiv Khanna, J.

Can a mutual fund scheme be wound up without the explicit consent of all its unitholders? The Supreme Court of India recently addressed this critical question in the context of the Franklin Templeton Mutual Fund case. This judgment clarifies the interpretation of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, specifically regarding the necessity of unitholder consent for winding up mutual fund schemes. The bench comprised Justices S. Abdul Nazeer and Sanjiv Khanna, with the majority opinion authored by Justice Sanjiv Khanna.

Case Background

The case arose from the decision of Franklin Templeton Trustee Services Private Limited to wind up six of its mutual fund schemes. These schemes included:

• Franklin India Low Duration Fund
• Franklin India Ultra Short Bond Fund
• Franklin India Short Term Income Plan
• Franklin India Credit Risk Fund
• Franklin India Dynamic Accrual Fund
• Franklin India Income Opportunities Fund

The decision to wind up these schemes was challenged by some unitholders, who alleged mismanagement and dereliction of duty by the Asset Management Company (AMC) and the trustees. They claimed that more than Rs. 15,000 crores were withdrawn from the schemes prior to the winding-up decision. The objecting unitholders argued that the winding-up was a smokescreen to hide misfeasance and malfeasance. The core issue was whether the trustees could wind up the schemes without the consent of the unitholders, particularly in light of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996.

Timeline:

Course of Proceedings

The Karnataka High Court had ruled that the consent of the unitholders was necessary for winding up of the mutual fund schemes, even when the trustees had formed an opinion that the scheme needed to be wound up under clause (a) of sub-regulation (2) of Regulation 39 of the Mutual Fund Regulations. This decision was appealed by the trustees and SEBI to the Supreme Court. The Supreme Court decided to address the limited aspect of “unitholders’ consent to winding up” first, to ensure disbursement of funds and liquidation of assets, while other issues of mismanagement and liability were to be examined later.

Legal Framework

The core of the dispute revolves around the interpretation of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996. Specifically, the following regulations are pertinent:

Regulation 18(15): This regulation outlines the rights and obligations of the trustees and states:

“(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 unit-holders of any scheme; or
(c) when the majority of the trustees decide to wind up or prematurely redeem the units.”

Regulation 39(2): This regulation specifies the conditions under which a mutual fund scheme may be wound up:

“(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
(c) if the Board so directs in the interest of the unitholders.”

The key question was whether clause (c) of Regulation 18(15) mandates unitholder consent even when the trustees have formed an opinion to wind up a scheme under clause (a) of Regulation 39(2). The Supreme Court had to interpret the meaning of “consent of the unitholders” in this context.

Arguments

Objecting Unitholders’ Arguments:

• The objecting unitholders argued that the trustees’ decision to wind up the schemes was a smokescreen to conceal mismanagement and fraud.
• They contended that the term ‘consent’ in Regulation 18(15)(c) requires the consent of a simple majority of all unitholders, not just those who voted.
• They argued that the consent should be binding only on those who have consented to winding up of the mutual fund schemes and cannot be imposed on others.
• They raised concerns about the appointment of KFin Technologies for the e-voting platform, alleging its association with Karvy Stock Broking Limited, which had faced regulatory issues.
• They pointed out that the notice for e-voting was misleading and prompted unitholders to vote in favor of winding up.
• They highlighted that the forensic experts’ report indicated that complete database activity monitoring logs were not provided.
• They argued that the IP addresses captured for many votes were the IP address of the Load Balancing Server of KFin Technologies.
• They submitted that only 38% of the unitholders had voted.

Trustees/AMC Arguments:

• The trustees argued that the decision to wind up the schemes was necessary due to severe market dislocation and illiquidity caused by the COVID-19 pandemic.
• They contended that Regulation 39(2)(a) is a standalone provision and unitholders’ consent is not required when trustees form an opinion to wind up the scheme.
• They submitted that the term ‘consent’ in Regulation 18(15)(c) should be interpreted as the consent of the majority of unitholders who participate in the voting process.
• They argued that the e-voting process was conducted fairly and transparently, and that KFin Technologies was a reputable service provider.
• They explained that the notice for e-voting was intended to inform unitholders of the reasons for winding up and the potential benefits of an orderly liquidation.
• They clarified that the IP address issue was due to technical reasons and that the details of each customer were available.
• They submitted that the votes cast represent approximately 54% of the total number of units outstanding.

Issues Framed by the Supreme Court

The Supreme Court framed the following key issue for consideration:

1. What is the meaning of “consent of the unitholders” under clause (c) of sub-regulation (15) of Regulation 18 of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996? Does it mean consent by a majority of all unitholders, or a majority of those who participate in the voting process?
2. Whether the procedure prescribed by Regulation 41 is required to be followed in the present case?

The court also considered the issue of whether the e-voting process was conducted fairly and transparently.

Treatment of the Issue by the Court

The following table demonstrates how the Court decided the issues:

Authorities

The Supreme Court considered the following authorities:

Legal Provisions Considered:

• Securities and Exchange Board of India (Mutual Funds) Regulations, 1996:
  • Regulation 18(15): Rights and obligations of the trustees.
  • Regulation 39(2): Conditions for winding up a mutual fund scheme.
  • Regulation 40: Effect of winding up.
  • Regulation 41: Procedure and manner of winding up.
• Companies Act, 2013:
  • Section 48: Variation of class rights.
  • Section 55(3): Redemption of preference shares.
  • Section 103: Quorum for shareholder meetings.

Judgment

How each authority was viewed by the Court:

• The Supreme Court relied on Wahid Ullah Khan v. District Magistrate, Nanital* to define the term “majority,” agreeing with the Allahabad High Court’s interpretation.
• The Court cited State of Madhya Pradesh and Another v. Mahendra Gupta and Others* to support the principle that a majority vote binds the minority.
• Shri Ishwar Chandra v. Shri Satyanarain Sinha and Others* was used to discuss quorum requirements, emphasizing that the presence of a majority of members constitutes a valid meeting.
• The Court referred to Halsbury’s Laws of England to further clarify quorum requirements.
• Bennion on Statutory Interpretation was cited to explain the concept of “absurdity” in statutory interpretation.
• Principles of Statutory Interpretation by Justice G.P. Singh was cited to highlight the need for a meaningful interpretation of statutes.
• The Court referred to Syed Hasan Raza Sahib Shamsul Ulama and two others v. Mir Hasan Ali Sahib and two others* to distinguish between definite and indefinite numbers in an electorate.
• Sutherland in Statutes and Statutory Construction was cited to emphasize the importance of practical interpretation of statutes.
• Morgan v. Simpson* was cited to highlight that poll results are not to be lightly interfered with.
• Fertilizer Corpn. Kamgar Union (Regd.) v. Union of India* was cited to emphasize the doctrine of internal management.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the need to ensure a practical and workable interpretation of the Mutual Fund Regulations. The Court emphasized that interpreting “consent” to mean the majority of all unitholders would lead to an absurd and impossible situation, given the large and fluctuating number of unitholders in mutual fund schemes. The Court also considered the need to protect the interests of the unitholders by enabling the winding-up process to proceed efficiently and ensure the disbursement of funds.

The Court’s reasoning was based on the following logical steps:

The Court considered alternative interpretations, such as requiring the consent of all unitholders, but rejected them due to their impracticality. The final decision was reached by prioritizing a functional and workable interpretation of the regulations that would serve the interests of the unitholders.

The Court stated:

“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.”

“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.”

“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.”

The Court’s decision was unanimous. There were no dissenting opinions.

Key Takeaways

• The Supreme Court clarified that for winding up a mutual fund scheme under Regulation 18(15)(c), the consent of the unitholders means the consent of the majority of unitholders who participate in the voting process, not all unitholders.
• This decision provides a practical framework for mutual fund trustees to proceed with winding up schemes when necessary, without facing insurmountable hurdles due to the large number of unitholders.
• The judgment underscores the importance of transparency and fairness in the e-voting process.
• The court emphasized that the practical interpretation of regulations should be preferred to avoid commercial chaos and deadlock.
• The decision allows for the disbursement of funds to unitholders in a timely manner, which is crucial for maintaining investor confidence.

Directions

The Supreme Court directed that:

• M/s. SBI Funds Management Private Limited would undertake the exercise of winding up, including liquidation of assets and distribution to unitholders.
• Distribution of funds to unitholders can be made in tranches without waiting for the liquidation of all assets.
• M/s. SBI Funds Management Pvt. Ltd. shall follow the best effort principle to ensure expeditious and timely payment to the unitholders and assure the best possible liquidation value of the assets/ securities to the unitholders.

Specific Amendments Analysis

There are no specific amendments discussed in the judgment.

Development of Law

The ratio decidendi of this case is that the term “consent of the unitholders” in clause (c) of sub-regulation (15) of Regulation 18 of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, means the consent of the majority of the unitholders who participate in the poll, and not the consent of the majority of all the unitholders of the scheme. This clarifies the interpretation of the regulation and provides a practical approach for winding up mutual fund schemes. This decision clarifies the ambiguity that existed regarding the interpretation of “consent” in the context of winding up of mutual fund schemes and provides a clear path for future cases.

Conclusion

The Supreme Court’s judgment in the Franklin Templeton case clarifies the meaning of “consent of the unitholders” for winding up mutual fund schemes. The Court held that consent means the majority of unitholders who participate in the voting process, not all unitholders. This decision provides a practical and workable approach for mutual fund trustees and ensures the protection of unitholders’ interests by enabling the efficient disbursement of funds. The Court also upheld the validity of the e-voting process, finding it to be fair and transparent. While the court addressed the issue of consent, it left open the other issues of mismanagement, fraud, and the applicability of Regulation 18(15)(c) when the trustees form an opinion under Regulation 39(2)(a) for future consideration.