Franklin Templeton Trustee … vs Amruta Garg And Ors. Etc. Etc. on 14 July, 2021


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Supreme Court of India

Franklin Templeton Trustee … vs Amruta Garg And Ors. Etc. Etc. on 14 July, 2021

Author: Sanjiv Khanna

Bench: S Khanna, S A Nazeer

                                                                                REPORTABLE

                                    IN THE SUPREME COURT OF INDIA

                                     CIVIL APPELLATE JURISDICTION

                                   CIVIL APPEAL NOS. 498-501 OF 2021

                 FRANKLIN TEMPLETON TRUSTEE SERVICES
                 PRIVATE LIMITED AND ANOTHER                          .....   APPELLANT(S)

                                         VERSUS

                 AMRUTA GARG AND OTHERS ETC.                          ..... RESPONDENT(S)

                                                   WITH

                                      CIVIL APPEAL NO. 502 OF 2021

                                      CIVIL APPEAL NO. 503 OF 2021

                                   CIVIL APPEAL NOS. 504-507 OF 2021

                                      CIVIL APPEAL NO. 508 OF 2021

                                      CIVIL APPEAL NO. 509 OF 2021

                           SPECIAL LEAVE PETITION (CIVIL) NO. 1486 OF 2021

                                                    AND

                          SPECIAL LEAVE PETITION (CIVIL) NO. ______ OF 2021)
                                  (ARISING OUT OF DIARY NO. 1563 OF 2021)



                                                ORDER

SANJIV KHANNA, J.

Signature Not Verified

Digitally signed by
Anita Malhotra
Date: 2021.07.14
By the order dated 12th February 2021, interpreting Regulation
15:18:34 IST
Reason:

18(15)(c) of the Securities and Exchange Board of India (Mutual

Page 1 of 77
Funds) Regulations, 1996 (hereafter referred to as ‘Regulations’)

and accepting the poll results, we have directed winding up of six

mutual fund schemes:

(i) Franklin India Low Duration Fund (Number of Segregated

portfolios – 2),

(ii) Franklin India Ultra Short Bond Fund (Number of Segregated

portfolios – 1),

(iii) Franklin India Short Term Income Plan (Number of

Segregated portfolios – 3),

(iv) Franklin India Credit Risk Fund (Number of Segregated

portfolios – 3),

(v) Franklin India Dynamic Accrual Fund (Number of Segregated

portfolios – 3), and

(vi) Franklin India Income Opportunities Fund (Number of

Segregated portfolios – 2).

2. We would now proceed to interpret Regulations 39 to 42 and their

interrelation with Regulation 18(15)(c). We shall also examine and

decide the challenge to the constitutional validity of Regulations 39

to 42. As elucidated in the course of hearings and reflected in the

order dated 12th February 2021, it would be inopportune to decide

and dispose of these appeals, as facts remain disputed and are sub-

judice along with other substantive issues in the adjudication

Page 2 of 77
proceedings under the Securities and Exchange Board of India Act,

1992 (hereafter referred to as the ‘SEBI Act’). The forensic report of

the auditors, possibly the foundation of the show cause notice(s), is

a subject matter of consideration before the statutory authorities that

are bestowed with wide powers. It is not anyone’s case that the

statutory adjudication proceedings should be eschewed or nullified.

At the same time, we are not inclined to dispose of these appeals as

this would not be in the interest of the unitholders, who are hopeful,

yet concerned and apprehensive. Final and conclusive adjudication,

on contested factual and related issues, post the statutory

adjudication would be in the interest of the parties. No prejudice

should be caused. Directions to await the orders in the adjudication

proceeding have been incorporated in the order dated 12th February

2021. We hope and trust that the proceedings under the SEBI Act

would conclude expeditiously.

General overview of the Regulations

3. We shall begin with an overview of the Regulations as they would

aid us in deciding the two issues; though, to avoid prolixity, we are

not reproducing the Regulations. We would subsequently selectively

quote the Regulations requiring interpretation.

4. The Regulations envisage a three-tier structure for mutual funds in

the form of the sponsor, the board of trustees or the trustee

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company, and the asset management company (the AMC). The

sponsor, as defined by Regulation 2(x), means a person who, acting

alone or in combination with another body corporate, establishes a

mutual fund. For this purpose, the sponsor is required to make an

application to the Securities and Exchange Board of India

(hereinafter referred to as the ‘SEBI’) in the prescribed form for

registration of the mutual fund. Chapter II of the Regulations spells

out the eligibility criteria and requirements for registration of a

mutual fund.

5. The term ‘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 unitholders. The

expression ‘unit’ has been defined in Regulation 2(z) to mean the

interest of the unitholders in the scheme, which consists of each unit

representing one undivided share in the assets of the scheme, and

the term ‘unitholder’ has been defined in Regulation 2(z)(i) to mean

a person holding a unit in the scheme of a mutual fund.

6. 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. The services

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may be specified by SEBI from time to time. The AMC is forbidden

by the Regulations from acting as a trustee of any mutual fund.

7. Chapter III relates to the constitution and management of mutual

funds and operation of trustees etc. Regulation 14 stipulates that a

mutual fund shall be constituted in the form of a trust and the

instrument of the trust shall be in the form of a deed, registered

under the provisions of the Indian Registration Act, 1908, executed

by the sponsor in favour of the trustees. Regulation 15(1) requires

that the trust deed shall incorporate such clauses as are mentioned

in the Third Schedule of the Regulations, and such other clauses as

are necessary for safeguarding the interests of the unitholders.

Regulation 15(2) mandates that no trust deed shall contain a clause

which has the effect of – (a) limiting or extinguishing the obligations

and liabilities of the trust in relation to any mutual fund or the

unitholders; or (b) indemnifying the trustees or the AMC for loss or

damage caused to the unitholders by acts of negligence or acts of

commission or omission on part of the trustees or the AMC.

Regulation 16 itemises the criteria for disqualification from

appointment as a trustee. In effect, it stipulates the eligibility

requirements for appointment of the trustees. In particular, it states

that two-thirds of the trustees shall be independent persons, not

associated with the sponsors in any manner. Further, a person
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appointed as a trustee of a mutual fund is not eligible to be

appointed as a trustee of another mutual fund. An AMC and its

directors (including independent director), officers or employees are

ineligible to be appointed as a trustee of any mutual fund.

Regulation 17 requires prior approval of SEBI before a person is

appointed as a trustee. In the case of existing trustees of any mutual

fund, they may form a trustee company to act as a trustee, albeit

with prior approval of SEBI. The trustees are bound by the Code of

Conduct specified in the Fifth Schedule, as well as general and

specific due diligence mandates.

8. Regulation 18 is critical as it elaborately enlists the rights and

obligations of the trustees, in as many as 29 sub-regulations. The

trustees and the AMC, as per Regulation 18(1), can enter into an

investment management agreement with the prior approval of SEBI.

Such an agreement must contain clauses mentioned in the Fourth

Schedule and other clauses as are necessary for the purpose of

making investments. The sub-regulations enumerate the

requirements to be satisfied before a scheme is launched by the

AMC. They obligate that the trustee shall ensure that the AMC has

been diligent in empanelling the brokers, and in monitoring

securities transactions with the brokers and in avoiding undue

concentration of business with any broker. The trustees have to also

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ensure and check that the AMC has not given any undue or unfair

advantage to any associates or dealt with any of its associates in

any manner detrimental to the interest of the unitholders and that

the transactions entered into by the AMC are in accordance with the

regulations and the scheme. The trustees are entitled to call for

details of transactions in securities by the key personnel of the AMC

in their own name or on behalf of the AMC and report the same to

SEBI, as and when required. The sub-regulations require the

trustees to carry out quarterly reviews of all transactions between

the mutual funds, the AMC and its associates. The trustees are to

also review the net worth of the AMC on a quarterly basis. In case of

any shortfall in net worth, the trustees were to ensure that the AMC

makes up for the shortfall in terms of Regulation 21(1)(f).1 The

trustees are to furnish to SEBI, on a half-yearly basis, a report on

the activities of the mutual fund with certificates that there have

been no instances of self-dealing or front running by any of the

trustees, directors or key personnel of the AMC, and that the AMC

has been managing the schemes independently of any other

activities, and in case any activities of the nature referred to in

Regulation 24(b) have been undertaken by the AMC, that it has

1The position post the SEBI (Mutual Funds) (Amendment) Regulations, 2021 with effect from 5th
Marcch 2021 has not been examined.

Page 7 of 77
taken adequate steps to ensure that the interests of the unitholders

are protected.2

9. Chapter IV of the Regulations relates to the constitution and

management of the AMC and the custodian. The AMC is appointed

by the sponsor, or by the trustee, if so authorised by the trust deed.

However, the appointment needs approval by SEBI under

Regulation 21(2). As per Regulation 20(2), the appointment of the

AMC can be terminated by majority of the trustees or by 75% of the

unitholders of the scheme. Regulation 20(3) states that any change

in the appointment of the AMC is subject to the approval of SEBI

and the unitholders. Regulation 21 enumerates the eligibility criteria

for appointment as an AMC. The directors of the AMC should be

persons having adequate professional experience in finance and

financial services related fields and should not be found guilty of

moral turpitude or convicted of any economic offence or violation of

any securities laws. The key personnel of the AMC should not have

been found to be guilty of the above, nor should they have worked

for any AMC/mutual fund/intermediary during the period when its

registration was suspended or cancelled by SEBI. The board of

directors of the AMC must have at least 50% of directors who are

not associates, or associated in any manner with the sponsor or any

2 Legal effect of Regulation 24 has not been examined.

Page 8 of 77
of its subsidiaries or the trustee. The net worth of the AMC should

not be less than Rs.50 crores. Regulation 24 specifies the

restrictions on the business activities of the AMC. Regulation 25

specifies the obligations and the responsibilities of the AMC, which

include taking reasonable steps and exercising due diligence to

ensure that the investment of funds pertaining to any scheme is not

contrary to the provisions of the regulations and the trust deed. The

AMC is responsible for the acts of commission or omission by its

employees, or persons whose services have been procured by the

AMC. Sub-regulation (6) states that the AMC and its directors,

notwithstanding any contract or agreement, shall not be absolved of

the liability to the mutual fund for their acts of omission and

commission, while holding such position or office.

10. There are a number of stipulations and restrictions to ensure

objectivity, fidelity and transparency in business transactions by the

AMC and compliance with the Regulations. A system of regulation

involving checks, responsibility and power of free decision is

envisaged. The Chief Executive Officer, by whatever name called, is

mandated by sub-regulation (6A)3 to Regulation 25 to ensure that

the mutual fund complies with all the provisions of the Regulations,

guidelines and circulars issued in relation thereto from time to time

3 SEBI (Mutual Funds) (Second Amendment) Regulations, 2020, w.e.f. 29.10.2020

Page 9 of 77
and that the investments made by the fund managers are in the

interest of the unitholders. This officer is responsible for the overall

risk management function of the mutual fund. Sub-regulation (6B)4

to Regulation 25 states that the fund managers, whatever be the

designation, shall ensure that the funds are invested to achieve the

objectives of the scheme and in the interest of the unitholders.

11. Chapter V deals with schemes of mutual funds and Regulation 28(1)

thereunder states that no scheme shall be launched by the AMC

unless it is approved by the trustees and a copy of the offer

document has been filed with SEBI. Regulations 32 and 33 pertain

to the listing and repurchase respectively of units in close-ended

schemes, while Regulation 35 deals with the allotment of units and

refunds of moneys. In terms of Regulation 38, guaranteed return is

not to be provided in a scheme, unless such returns are fully

guaranteed by the sponsor or the AMC, and a statement to that

effect is made in the offer document, indicating the name of the

person who will guarantee the return and the manner in which the

guarantee is to be met. Regulation 38A permits launching of a

capital protection-oriented scheme subject to: (a) the units of the

scheme being rated by a registered credit rating agency from the

viewpoint of the ability of its portfolio structure to attain the

4 Ibid.

Page 10 of 77
protection of the capital invested therein; (b) the scheme being

close-ended; and (c) compliance with other requirements as may be

specified by SEBI. Regulation 48 requires that every mutual fund

shall compute the Net Asset Value of each scheme as specified and

the same shall be calculated on daily basis and disclosed in the

manner as stated by SEBI.

12. Regulation 49 is titled ‘pricing of units’ and states that the price at

which the units may be subscribed / sold / repurchased by the

mutual fund shall be made available to the investors in the manner

specified by SEBI. The methodology for calculating the sale and

repurchase price of the units is to be provided by the mutual fund in

the manner specified by SEBI. Sub-regulation (3) states that in

determining the price of the units, the mutual fund shall ensure that

the repurchase price is not lower than 93% of the Net Asset Value

and the sale price is not higher than 107% of the Net Asset Value.

As per the second proviso to sub-regulation (3), difference between

the repurchase price and the sale price of the unit shall not exceed

7% calculated on the sale price.5

13. Regulations 54 and 55 relate to the annual report and the auditor’s

report respectively. Regulation 56 requires providing a copy of the
5 Post amendment w.e.f. 5.3.2021 Regulation 49(3) states that the repurchase price of units of an open-
ended scheme shall not be lower than 95 % of the NAV. There is no stipulation in the Regulations
regarding the sale price.

Page 11 of 77
annual report and the summary thereof to the unitholders.

Regulation 58 mandates periodic and continual disclosures by the

AMC, the trustee, the sponsors, and the custodians, requiring them

to make such disclosures and submit such documents as may be

provided by SEBI and comply with sub-regulations (2) and (3).

Regulation 59 deals with half-yearly disclosures. Regulation 60

imposes a general obligation to disclose information and, being of

some importance, is reproduced below:

“Disclosures to the investors

60. The trustee shall be bound to make such
disclosures as are essential in order to keep them
informed about any information which may have an
adverse bearing on their investments.”

The trustees are mandated and bound to make such

disclosures to the unitholders as are essential to keep them

informed about any information that may have adverse bearing on

their investments.

14. Chapter VIII relates to and empowers SEBI to authorise and

conduct inspection and audit. SEBI, under Regulation 61(1), may

appoint one or more persons as the inspecting officers to undertake

inspection of the books of accounts, records, documents, and

infrastructure, systems, and procedures or to investigate the affairs

of the mutual fund, the trustees, and the AMC for the purposes

Page 12 of 77
stipulated therein. Regulation 62 requires that SEBI shall issue not

less than ten days’ notice to the mutual fund, trustees, or AMC, as

the case may be, before ordering an inspection or investigation.

However, under sub-regulation (2), notwithstanding sub-regulation

(1), SEBI can direct such inspection or investigation without any

notice when it is satisfied that in the interest of the investors no such

notice should be given. Regulation 63 prescribes the duties and

obligations of the mutual fund/ trustees/ AMC whose affairs are

being inspected or investigated. The investigating officer can, during

the course of the investigation, examine or record the statements of

any director, officer, or employee of the mutual fund/ trustee/ AMC

and every such mutual fund/ trustee/ AMC is duty-bound to give to

the investigating officer all assistance in connection with the

inspection or investigation. The inspecting officer is to submit, as

soon as possible, a report to SEBI on completion of the

investigation. Regulation 65 states that SEBI or the Chairman shall

after consideration of inspection or investigation report take such

action as SEBI or the Chairman may deem fit and appropriate under

Chapter V of the Securities and Exchange Board (Intermediaries)

Regulations, 2008.

Page 13 of 77
Regulations 39 to 42 and 18(15) of the Securities and Exchange
Board of India (Mutual Funds) Regulations, 1996.

15. Regulations 39 to 42 read as under:

“Winding Up

39. (1) A close-ended scheme shall be wound up on
the expiry of duration fixed in the scheme on the
redemption of the units unless it is rolled over for a
further period under sub-regulation (4) of regulation 33.

(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.

(3) Where a scheme is to be wound up under sub-
regulation (2), the trustees shall give notice disclosing
the circumstances leading to the winding up of the
scheme:

“(a) to the Board; and

(b) in two daily newspapers having circulation all
over India, a vernacular newspaper circulating at
the place where the mutual fund is formed.

Effect of winding up

40. On and from the date of the publication of notice
under clause (b) of sub-regulation (3) of regulation 39,
the trustee or the asset management company as the
case may be, shall—

Page 14 of 77
“(a) cease to carry on any business activities in
respect of the scheme so wound up;

(b) cease to create or cancel units in the scheme;

(c) cease to issue or redeem units in the scheme.

Procedure and manner of winding up

41. (1) The trustee shall call a meeting of the
unitholders to approve by simple majority of the
unitholders present and voting at the meeting resolution
for authorising the trustees or any other person to take
steps for winding up of the scheme:

Provided that a meeting of the unitholders shall not be
necessary if the scheme is wound up at the end of
maturity period of the scheme.

(2)(a) The trustee or the person authorised under sub-
regulation (1) shall dispose of the assets of the scheme
concerned in the best interest of the unitholders of that
scheme.

(b) The proceeds of sale realised under clause (a),
shall be first utilised towards discharge of such
liabilities as are due and payable under the scheme
and after making appropriate provision for meeting the
expenses connected with such winding up, the balance
shall be paid to the unitholders in proportion to their
respective interest in the assets of the scheme as on
the date when the decision for winding up was taken.

(3) On the completion of the winding up, the trustee
shall forward to the Board and the unitholders a report
on the winding up containing particulars such as
circumstances leading to the winding up, the steps
taken for disposal of assets of the fund before winding
up, expenses of the fund for winding up, net assets
available for distribution to the unit holders and a
certificate from the auditors of the fund.

Page 15 of 77
(4) Notwithstanding anything contained in this
regulation, the provisions of these regulations in
respect of disclosures of half-yearly reports and annual
reports shall continue to be applicable until winding up
is completed or the scheme ceases to exist.

Winding up of the scheme

42. After the receipt of the report under sub-regulation
(3) of regulation 41, if the Board is satisfied that all
measures for winding up of the scheme have been
complied with, the scheme shall cease to exist.”

16. Regulation 18(15)(c) reads as under:

“Rights and obligations of the trustees.

18.

xx xx xx

(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 unitholders of any scheme; or

(c) when the majority of the trustees decide to wind up
or prematurely redeem the units.”

Interpretation of Regulations 39 to 42, their interplay and
harmonious construction with Regulation 18(15) (c) of the Securities
and Exchange Board of India (Mutual Funds) Regulations, 1996.

17. Regulation 39, as the heading states, relates to ‘winding up’ of a

scheme of a mutual fund. Sub-regulation (1) to Regulation 39

Page 16 of 77
applies to close-ended schemes and is accordingly not relevant as

the six schemes in question are open-ended schemes.6

18. Sub-regulation (2) to Regulation 39 uses the expression ‘a scheme

of a mutual fund,’ and accordingly applies to both open-ended and

close-ended schemes.7 It is an undisputed position that sub-

regulation (2) to Regulation 39 applies to the six schemes. In terms

of sub-regulation (2) to Regulation 39, a scheme of a mutual fund

can be wound up: (a) on the happening of any event, which, in the

opinion of the trustees, requires the scheme to be wound up; (b) if

75% of its unitholders8 pass a resolution for winding up of the

scheme; or (c) SEBI directs winding up of the scheme in the interest

of the unitholders. Under each clause the initiator is different, and

the condition to be satisfied is stipulated. Clause (a) empowers the

trustees, while clauses (b) and (c) empower the unitholders and

SEBI respectively.

19. 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 two daily newspapers having all India circulation

6 Regulation 2(f) – “close-ended scheme” means any scheme of a mutual fund in which the period of
maturity of the scheme is specified.

7 Regulation 2(s) – “open-ended scheme” means a scheme of a mutual fund which offers units for sale

without specifying any duration for redemption.
8 2(z)(i) of SEBI (Mutual Fund) Regulation 1996, “unit holder” means a person holding unit in a scheme

of mutual fund.

Page 17 of 77
and in a vernacular paper having circulation where the mutual fund

is located. The public notice should state the circumstances leading

to winding up of the scheme. The trustees are also required to write

to SEBI and disclose the circumstances leading to winding up of the

scheme.

20. On and from the date of publication, the cease and freeze mandate

of Regulation 40 triggers. 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 AMC 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.

21. Regulation 41, as per the heading, relates to the procedure and

manner of winding up. The trustees, in terms of sub-regulation (1) to

Regulation 41, are required to call a meeting of the unitholders for

authorising either the trustees or any other person to take steps for

winding up of the scheme. Voting at the meeting is by simple

majority of the unitholders present and voting. In this meeting the

unitholders do not examine, affirm or reject the decision to wind up

the scheme. The voting is restricted to selection of the person –

Page 18 of 77
either the trustee or a third person – who would take ‘steps for

winding up of the scheme’.

22. Regulation 41(2)(a), requires that the person or the trustee

authorised under Regulation 41(1) must dispose of the assets of the

scheme in the best interest of the unitholders. Clause (b) to sub-

regulation (2) to Regulation 41, states that the sale proceeds shall

be first utilised towards discharge of liabilities due and payable

under the scheme. Secondly, appropriate provision is to be made for

meeting the expenses connected with the winding up. The balance

amount shall be paid to the unitholders in proportion to their

respective interests in the scheme as on the date when the decision

for winding up was taken. The clause differentiates between the

creditors whose liability is due and payable, and the unitholders.

Payment of the amount due and payable to the creditors is

prioritised and takes precedent. Thereafter, appropriate provision is

required to be made for expenses connected with the winding up.

The balance amount is payable to the unitholders.

23. In terms of Regulation 42(2), the unitholders are to be paid in

proportion to their respective interest in the assets of the scheme.

The interest of the unitholders in the assets of the scheme as

mentioned in Regulation 42(2) is computed on the basis of the date

Page 19 of 77
when the decision for winding up of the scheme was taken. As per

Regulation 41(3), on completion of winding up, the trustees have to

forward to SEBI and to the unitholders a report on the winding up

containing particulars such as circumstances leading to the winding

up, the steps taken for disposal of the assets for winding up,

expenses for winding up, net assets available for distribution to the

unitholders and a certificate from the auditors. Sub-regulation (4), a

non-obstante provision, states that the requirement in respect of

disclosures in the form of half-yearly report and annual report shall

continue until winding up is completed or the scheme ceases to

exist. 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.

24. Regulation 42A 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.

25. Regulation 18(15)(c), which relates to rights and obligations of the

trustees, in simple words requires the trustees to take consent of the

unitholders, when they, by majority, decide to wind up or

prematurely redeem the units. Words “winding up” in Regulation

Page 20 of 77
18(15)(c), ex-facie refers to the winding up of the open-ended

scheme and the expression “prematurely redeem the units” refers to

premature redemption of units under the close-ended scheme.

Decision of the High Court and contentions of SEBI, the trustees and
the AMC.

26. The judgment under challenge, interpreting Regulation 18(15)(c)

and Regulation 39(2)(a) holds 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 unitholders as per Regulation

18(15)(c).

27. Contesting this finding and interpretation, the argument of SEBI, the

trustees and the AMC is that Regulations 39 to 42 are a complete

code dealing with winding up of a scheme of mutual funds. Initiators

and conditions to be satisfied under clauses (a), (b), and (c) to

Regulation 39(2) are different. It is argued that prior consent of the

unitholders is not envisaged when the trustees, on the happening of

any event in terms of clause (a), form an opinion that a scheme is

required to be wound up, or when SEBI under clause (c) directs

winding up of a scheme in the interest of the unitholders. Only when

the unitholders want to windup a scheme, in terms of clause (b), a

resolution by 75% of the unitholders is mandated. The need to

obtain the consent of the unitholders vide Regulation 18(15)(c)

Page 21 of 77
refers to the procedure and the manner for winding up as mandated

by Regulation 41(1). To put it differently, the unitholders do not

come into the picture when the trustees and 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 unitholders. It is

submitted:

“a) Regulation 18(15)(c) requires Trustees to obtain
consent of Unit holders “when the majority of the
Trustees decide to wind up”. It is thus very clear that
consent is required when Trustees decide to wind up
the scheme(s) and when read together with Regulation
41, makes it amply clear that the consent is for the
purpose of Regulation 41 i.e. to authorize the Trustee
or any other person to dispose of the asset of
scheme(s), in the interest of the unit holders.

(b) The consent envisaged under Regulation 18(15)(c)
is a general “rights and obligations” of the Trustees and
that the said consent shall be read as approval required
under Regulation 41(1).

(c) It is submitted that in the event consent under
Regulation 18(15)(c) is interpreted to mean that prior
consent of unitholders is required before a scheme is
wound up pursuant to a decision taken by the Trustees,
the provisions of Regulation 39(2)(b) to be rendered
otiose as under the said Regulation, a scheme may be
wound up at the instance of Unit holders (upon 75% of
the Unit holders of a scheme passing a Resolution for
winding up).

(d) Regulation 40 comes into effect “on and from the
date of publication of notice” by Trustees under
Regulation 39(3)(b) and not from the date of “consent
of Unit holders”, which makes it abundantly clear that
consent of Unit holders is not contemplated qua
decision of Trustees to wind up a scheme(s).

(e) Further, Regulation 40 (a) provides that on and from
the date of publication of notice under 39(3)(b), the
Trustees or Asset Management Company, as the case

Page 22 of 77
may be, shall cease to carry on any business activities
in respect of the scheme so wound up. Therefore, when
a decision by Trustee to wind up scheme is taken, in
terms of 39(2)(a), the notice is issued and Regulation
40 comes into operation and the requirement of
obtaining consent of Unit holders at this stage cannot
arise.

(f) It is submitted that Regulation 41(1) casts an
obligation on the Trustees to call a meeting of the unit
holders to approve a resolution authorising the
Trustees or any other person to take steps for winding
up of the scheme. Regulation 18(15)(c) of the MF
Regulations cannot be erroneously interpreted so as to
conclude that before implementing Regulation 41, prior
approval of the unit holders has to be taken.”

The submission accentuates, what is submitted would be the

impractical and calamitous effect of reading Regulation 18(15)(c)

into Regulations 39 to 42. Prior-consent from the unitholders if

necessary even when the trustees ‘decide to wind up’ a scheme

under Regulation 39(2)(a), would inevitably delay the publication of

public notices as envisaged by Regulation 39(3). Therefore the

cease and freeze legal effect of Regulation 40 would get postponed

resulting in chaos and confusion, as business activities such as

buying and redemption of units etc., would continue despite the

trustees having taken the decision to wind up the scheme. In panic,

most unitholders would rush for redemptions, which achingly would

be the reason for winding up. The result would be fire-sale of sound

assets in a hasty and disorganised manner at discounted valuations

in adverse market conditions. The trustees who stand in a fiduciary

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capacity as domain experts, as mandated by clause (a) to

Regulation 39(2), act for and in the interest of the unitholders. The

unitholders, a large and disparate body of lay persons without

domain expertise, have been erroneously conferred the right to veto

and overrule the decision of the domain experts. Given the grave

consequences for the sponsor, trustees and AMC, a decision to

wind up a scheme is taken after in-depth analysis with great care

and caution. Thus, the findings of the High Court to the contrary

should be reversed.

Interpretation of the term ‘consent’ in Regulation 18(15)(c) vide order
dated 12th February, 2021

28. In our order dated 12th February 2021, we have interpreted

Regulation 18(15)(c) and the word ‘consent’ therein in the following

manner:

“8. However, we begin by rejecting the argument raised by
some of the objecting unitholders that consent would be
binding only on those who have consented to winding up
of 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 unitholders’,
and not consent given by individual unitholders who alone
would be bound by their consent, that is, it excludes
unitholders who are not agreeable. To accept the second
or contra view, as pleaded by some of the objecting
unitholders, would be to negate the very object and
purpose of clause (c) to sub-regulation (15) of Regulation

18. In fact, the submission, if accepted, will make the
Mutual Fund schemes and the winding up provisions in
the Mutual Fund Regulations unworkable as there would

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be two different classes of unitholders – 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.

9. Black’s Law Dictionary (10th Edition) defines the word
‘consent’ as “a voluntary yielding to what another
proposes or desires; agreement, approval, or permission
regarding some act or purpose, esp. given voluntarily by a
competent person; legally effective assent.” The dictionary
also defines ‘general consent’ to mean “adoption without
objection, regardless of whether every voter affirmatively
approves.” Shackleton on the Law and Practice of
Meetings, 14th Edn., while defining majority, and the
binding effect of majority, has opined:

“Definition

7-30. Majority is a term signifying the greater
number. In legislative and deliberative
assemblies, it is usual to decide questions by a
majority of those present and voting. This is
sometimes expressed as a “simple” majority,
which means that a motion is carried by the mere
fact that more votes are cast for than against, as
distinct from a “special” majority where the size of
the majority is critical.

The principle has long been established that the
will of a corporation or body can only be
expressed by the whole or a majority of its
members, and the act of a majority is regarded
as the act of the whole.

A majority vote binds the minority

7-31. Unless there is some provision to the
contrary in the instrument by which a corporation
is formed, the resolution of the majority, upon any
question, is binding on the majority and the
corporation, but the rules must be followed.”

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

10. However, the question which still remains to be
answered is whether ‘consent’ would mean majority of the
unitholders who exercise their right in the poll, or majority
of all the unitholders of the scheme. Connected with the
question is the concern of quorum, which means the
minimum number of members of the entire body of
members required to be present to legally transact
business.

11. Shackleton in the above quotation has referred to
distinction between simple and special majority. More
appropriate for our discussion is William Paul White’s
thesis ‘History and Philosophy of the Quorum as a Device
of Parliamentary Procedure’ published in 1967, in which
he elucidates:

“Much of the controversy that has been
historically associated with the quorum can be
traced to the problem of simply determining just
what is meant by a quorum. “From the very
earliest times it has been recognised as a
general rule that a majority of a group is
necessary to act for the entire group.” In the case
of a public body, the power or authority which
establishes the body may also determine what
constitutes a quorum. Sturgis states that
common parliamentary law fixes the quorum as a
“majority of the members”. The constitution of the
United States sets the quorum requirement in the
House of Representatives at a majority of the
membership. But to state that a quorum is a
majority of the membership opens the way to
potential conflict; which is precisely what has
happened on numerous occasions.”

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After examining the various definitions of the
term quorum, the author observes that the
definitions by themselves give no key as to how
to determine what is minimum number or what
constitutes majority. The expression ‘majority’
can mean – (i) majority of total membership list;

(ii) exclude or include delinquent members; (iii)
members present and voting; or (iv) those
present, voting and not voting. Different
meanings, he observed, have added to the
confusion around the concept of the quorum.

Albeit referring to the position in 1967, the author
observed:

“As we have emerged into the modern era, it is
not surprising that by now the method, which has
been legally agreed upon by the courts, to
determine minimum and majority, is well
established.”

12. Clause (c) to sub-regulation (15) of Regulation 18 per
se does not prescribe any quorum or specify the criterion
for computing majority or ratio of unitholders required for
valid consent for winding up. Clause (b) of Regulation
39(2), on the other hand, specifies that seventy-five per
cent of the unitholders of a scheme can pass a resolution
that the scheme be wound up. Similarly, Regulation 41(1)
requires the trustees to call a meeting to approve, by
simple majority of the unitholders present and voting, a
resolution for authorising 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 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. Sub-section (3) to Section 55 of the Companies Act,
2013 in case of failure to redeem or pay dividend refers to
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.

Page 27 of 77

13. In Shri Ishwar Chandra v. Shri Satyanarain Sinha
and Others
, this Court on the question of quorum has
held:

“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 there at cannot be held
to be invalid.”

This decision had also relied on the exposition on the
subject of quorum in the Halsbury’s Laws of England,
Third Edition (Vol. IX, page 48, para 95), which reads:

“95. Presence of quorum necessary. The acts of
a corporation, other than a trading corporation,
are those of the major part of the corporators,
corporately assembled. In other words, in the
absence of special custom or of special provision
of the constitution, the major part must be
present at the meeting, and of that major part
there must be a majority in favour of the act or
resolution contemplated. Where, therefore, a
corporation consists of thirteen members, there
ought to be at least seven present to form a valid
meeting, and the act of the majority of these
seven or greater number will bind the
corporation. In considering whether the requisite
number is present, only those members must be
included who are competent to take part in the
particular business before the meeting. The
power of doing a corporate act may, however, be
specially delegated to a particular number of
members, in which case, in the absence of any
other provision, the method of procedure
applicable to the body at large will be applied to
the select body.

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If a corporate act is to be done by a definite body
along, or by definite body coupled with an
indefinite body, a majority of the definite body
must be present.

Where a corporation is composed of several
select bodies, the general rule is that a majority
of each select body must be present at a
corporate meeting; but this rule will not be
applied in the absence of express direction in the
constitution, if its application would lead to an
absurdity or an impossibility. …” (emphasis
supplied)

14. The concept of ‘absurdity’ in the context of
interpretation of statutes is construed to include any result
which is unworkable, impracticable, illogical, futile or
pointless, artificial, or productive of a disproportionate
counter mischief. Logic referred to herein is not formal or
syllogistic logic, but acceptance that enacted law would
not set a standard which is palpably unjust, unfair,
unreasonable or does not make any sense. When an
interpretation is beset with practical difficulties, the courts
have not shied from turning sides to accept an
interpretation that offers a pragmatic solution that will
serve the needs of society. Therefore, when there is
choice between two interpretations, we would avoid a
‘construction’ which would reduce the legislation to futility,
and should rather accept the ‘construction’ based on the
view that draftsmen would legislate only for the purpose of
bringing about an effective result. We must strive as far as
possible to give meaningful life to enactment or rule and
avoid cadaveric consequences.

15. 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. The legislator in the present case must,
therefore, reflect and take remedial steps to bring about
clarity and certainty in the Mutual Fund Regulations.

Page 29 of 77

16. 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. Many unitholders
due to lack of expertise, commercial understanding,
relatively small holding etc. may not like to participate.
Consent of majority of all unitholders of the scheme with
further prescription that ‘fifty percent of all unitholders’
shall constitute a quorum is clearly a practical impossibility
and therefore would be a futile and foreclosed exercise.

17. Conscious of the problem of quorum and majority in
indefinite electorate, 1st Edition of Halsbury’s Laws of
England on the question of quorum and meetings, had
referred to the following principles:

“791. Where a corporation consists of a definite
number of corporate electors, a majority of that
number must be present in order to constitute a
valid election. But where a corporation consists
of an indefinite number of corporate electors, a
majority only of those existing at the time of the
election need be present.

When an election is to be made by a definite
body only, or the electoral assembly is to consist
of a definite and an indefinite body, the majority
of the definite body must, as a general rule, be
present in order to render the election legal. It is
not necessary that a majority of the indefinite
body should be present so long as there is
majority of the definite body. If a constituent part
of a corporation refuses to be present at an
election, it cannot be held, and an election by the
remaining parts will be void. But electors present
at an election and abstaining from voting are
deemed to acquiesce in the election made by
those who vote.”

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The aforesaid exposition, for the purpose of
majority and quorum, draws distinction between
an electorate consisting of definite number and
an electorate composed of indefinite number.
Justice Seshagiri Ayyar of the Madras High Court
in his concurring judgment in Syed Hasan Raza
Sahib Shamsul Ulama and two others v. Mir
Hasan Ali Sahib
and two others had drawn
distinction between definite and indefinite
numbers in the following manner:

“…In the first class of cases, the number of the
select body is fixed. In the second class of cases,
the number is subject to variation every year or at
stated periods. For example, the number of
electors of a Temple Committee or the number
for a Municipality is liable to fluctuation.

Residence for a particular period, or the attaining
of age of minors can bring in new electors.

Whereas in the case of a Select Committee, the
number is fixed…”

In the case of unitholders, the number is
fluctuating and ever changing and, therefore,
indefinite. Numbers of unitholders can increase,
decrease and change with purchase or
redemption. Therefore, in the context of clause

(c) of Regulation 18(15), we would not, in the
absence of any express stipulation, prescribe a
minimum quorum and read the requirement of
‘consent by the majority of the unitholders’ as
consent by majority of all the unitholders. On the
other hand, it would mean majority of unitholders
who exercise their right and vote in support or to
reject the proposal to wind up the mutual fund
scheme. The unitholders who did not exercise
their choice/option cannot be counted as either
negative or positive votes as either denying or
giving consent to the proposal for winding up.

18. Investment in share market, though beneficial and
attractive, requires expertise in portfolio construction,
stock selection and market timing. In view of attendant
risks, diversification of portfolio is preferred but this

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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. It would be wrong to expect that many amongst
these unitholders would have definitive opinion required
and necessary voting in a poll on winding up of a mutual
fund scheme. Such unitholders, 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.
Keeping in view the object and purpose of the Regulation
with the language used therein, we would not accept a
‘construction’ which would lead to commercial chaos and
deadlock. Therefore, silence on the part of absentee
unitholders 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 objective/purpose for
which it was enacted. We would rather accept a
reasonable and pragmatic ‘construction’ which furthers the
legislative purpose and objective. The underlying thrust
behind Regulation 18(15)(c) is to inform the unitholders 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. Way back in 1943,
Sutherland in Statutes and Statutory Construction, Volume
2, Third Edition at page no. 523, in Note 5109, had stated:

“Where a statue has received a contemporaneous
and practical interpretation and the statute as
interpreted is re-enacted, the practical interpretation
is accorded greater weight than it ordinarily
receives, and is regarded presumptively the correct
interpretation of the law. The rule is based upon the
theory that the legislature is acquainted with the
contemporaneous interpretation of a statue,
especially, when made by an administrative body or
executive officers charged with the duty of
administering or enforcing the law, and therefore

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impliedly adopts the interpretation upon re-

enactment.”

With some modifications, the principle can be applied in
the present case. Practical interpretation should be
accorded greater weight than it ordinarily receives, and
can be regarded as presumptively correct interpretation as
the draftsmen legislate to bring about a functional and
working result.

19. We would not read into Regulation 18(15)(c) a need to
have affirmative consent of majority of all or entire pool of
unitholders. The words ‘all’ or ‘entire’ are not incorporated
and found in the said Regulation. 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 above interpretation resolves several grey areas and

would underpin the construction of Regulations 39 to 42 and their

interplay with Regulation 18(15)(c).

29. The quotation highlights that interpretation is sometimes a three-

stage process. At first, the words being interpreted should be

understood according to their grammatical meaning in their literal

and popular sense. In the second stage, we consider whether in the

given context the plain meaning is obscure as the text gives rise to

choice of more than one interpretation, or the propositional

interpretation fails to achieve the manifest purpose of the legislation,

reduces it to futility, is practically unworkable or even illogical. In

such cases at the third stage, the court applying interpretative tools

Page 33 of 77
selects or blue-pencils an interpretation advancing the legislative

intent without rewriting the provision. The legislative intent is

gathered not by restricting it to the language of the provision, rather

in the light of the object and purpose of the provision and the

legislation. The courts do lean towards a pragmatic and purposive

interpretation as there is an assumption that the draftsmen legislate

to bring about a functional and working result.

Harmonious interpretation of Regulation 18(15)(c) with Regulations
39 to 42

30. Regulation 39(2) under clause (a) vests the power of winding up of a

scheme with the trustees, and with the unitholders 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. Regulation 18(15)(c)

mirrored by use of the word ‘shall’ is couched as a command.

Further, 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. Rather than making the decision of the

trustees otiose, as suggested by SEBI, the trustees and the AMC,

Page 34 of 77
Regulation 18(15)(c) itself would become otiose in case their

interpretation is accepted. 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 unitholders is a pre-requisite for winding up.

31. We do not think that this interpretation in any way dilutes or renders

clause (b) to Regulation 39(2) meaningless or redundant. This

clause applies where the winding up process is initiated at the

instance of the unitholders, i.e. upon 75% of unitholders of the

scheme passing a resolution for winding up. 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.

32. Regulation 41, as explained above, refers to and relates to the

procedure and manner of winding up which cannot be equated with

the requirement of consent as postulated by Regulation 18(15)(c).

Argument to the contrary, equating Regulation 18(15) (c) with

Regulation 41(1) overlooks the difference in language, and the

object and purpose behind the two regulations. Regulation 41(1)

applies even in cases where 75% unitholders have passed the

resolution for winding up of the scheme under Regulation 39(2)(b) or

where SEBI directs the scheme to be wound up in the interest of the

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unitholders under Regulation 39(2)(c). On the other hand Regulation

18(15)(c) applies only when majority of the trustees form an opinion

and decide to wind up or prematurely redeem the units in entirety, a

situation covered by Regulation 39(2)(a). To ignore the mandate of

Regulation 18(15)(c) would nullify the legislative intent by resorting

to a rather disordered and knotted argument that Regulations

18(15)(c) and 41(1) are identical and serve the same purpose.

Clause (c) to Regulation 18(15) does not duplicate sub-regulation

(1) to Regulation 41.

33. Similarly, omission of clause (d) to Regulation 18(15) and insertion

of 18(15A) with effect from 22nd May 2000 by SEBI (Mutual Funds)

(Second Amendment) Regulations, 2000 is inconsequential. Prior to

its omission, clause (d) to Regulation 18(15) read:

“(d) when any change in the fundamental attributes of
any scheme or the trust or fees and expenses payable
or any other change which would modify the scheme or
affect the interest of the unitholders is proposed to be
carried out unless the consent of not less than three-
fourths of the unit holders is obtained: Provided that no
such change shall be carried out unless three fourths
of the unit holders have given their consent and the
unit holders who do not give their consent are allowed
to redeem their holdings in the scheme.

Provided further that in case of an open ended scheme,
the consent of the unitholders shall not be necessary if:

(i) the change in fundamental attribute is carried out
after one year from the date of allotment of units.

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(ii) the unitholders are informed about the proposed
change in fundamental attribute by sending individual
communication and an advertisement is given in
English daily newspaper having nationwide circulation
and in a newspaper published in the language of the
region where the head office of the mutual fund is
situated.

(iii) the unitholders are given an option to exit at the
prevailing Net Asset Value without any exit load.

Explanation: For the purposes of this clause
“fundamental attributes” means the investment
objective and terms of a scheme.”

By the same amendment9, sub-regulation (15A) has been

inserted and reads:

“(15A) The trustees shall ensure that no change in the
fundamental attributes of any scheme or the trust or
fees and expenses payable or any other change which
would modify the scheme and affects the interest of
unitholders, shall be carried out, unless –

(i) a written communication about the proposed
change Is sent to each unitholder and an
advertisement is given in one English daily
newspaper having nationwide circulation as well
as in a newspaper published in the language of
region where the Head Office of the mutual fund
is situated; and

(ii) the unitholders are given an option to exit at
the prevailing Net Asset Value without any exit
load.”

The distinction between Regulation 18(15A) and Regulation

18(15)(c) is evident. The words ‘winding up or premature
9 SEBI (Mutual Funds) (Second Amendment) Regulations, 2000.

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redemption of units’ in Regulation 18(15)(c) refers to a situation

covered by Regulation 39(2)(a), that is, when the scheme is being

wound up pursuant to a decision of the trustees. On the other hand,

Regulation 18(15A) does not apply when the scheme is being

wound up, rather it applies when there is a proposal to change the

fundamental attributes of the scheme, fee or expense or any other

change that would modify the scheme and affect the interests of the

unitholders. The effect should be not to wind up the scheme thereby

bringing it to an end, but to continue with the scheme as modified.

Therefore, for Regulation 18(15A) to apply, the scheme should not

cease to exist.

34. In cases under clause (a) to Regulation 39(2) the unitholders have

no right or option to exit or not exit the scheme and are paid in terms

of Regulation 41. Regulation 18(15A) gives the option to the

unitholders to exit at the prevailing ‘Net Asset Value’ without any exit

load or continue with the altered/modified scheme. Under the

omitted clause (d) to Regulation 18(15), consent of three-fourths of

the unitholders for fundamental changes to the scheme was

sometimes necessary. This is not necessary under Regulation

18(15A). Omission of clause (d) to sub-regulation 18(15) and

insertion of sub-regulation (15A) to Regulation 18, as observed

above is inconsequential and not relevant to the present dispute. If

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anything, the draftsmen having retained clause (c) to 18(15), re-

enforces its link with clause (a) to Regulation 39(2). Accordingly, the

need to obtain consent of the unitholders is mandated under clause

(c) to sub-regulation 15 to Regulation 18 when the trustees under

clause (a) to Regulation 39(2) decide to wind up a scheme.

35. The argument that the unitholders are lay persons and not well-

versed with the market conditions is to be rejected in light of the

order dated 12th February 2021. Relevant portion of this order, at the

risk of repetition, is being reproduced below:

“18. Investment in share market, though beneficial and
attractive, requires expertise in portfolio construction,
stock selection and market timing. In view of 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. It would be wrong to
expect that many amongst these unitholders would
have definitive opinion required and necessary voting
in a poll on winding up of a mutual fund scheme. Such
unitholders, 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. Keeping in view the object and purpose of
the Regulation with the language used therein, we
would not accept a ‘construction’ which would lead to
commercial chaos and deadlock. Therefore, silence on
the part of absentee unitholders can neither be taken
as an acceptance nor rejection of the proposal.

Page 39 of 77

Regulation 18(15)(c), upon application in ground
reality, must not be interpreted in a manner to frustrate
the very law and objective/purpose for which it was
enacted. We would rather accept a reasonable and
pragmatic ‘construction’ which furthers the legislative
purpose and objective. The underlying thrust behind
Regulation 18(15)(c) is to inform the unitholders 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….”

Investments by the unitholders constitute the corpus of the

scheme. To deny the unitholders 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 unitholders exercise informed

choice and discretion when they invest or redeem the units.

Regulations envision the unitholders not as domain experts, albeit

as discerning investors who are perceptive and prudent. The

trustees are therefore commanded to inform and be transparent.

Summary reports, periodic and continual statements, annual

reports, audit reports, etc., mentioned in paragraph 11 above are

intended to reveal the current status of the investments, future

prospects, risks and factors that may have bearing on the returns to

enable the unitholders to take deliberative decisions, be it purchase,

redemption or exercise of the right to vote. The unitholders, when in

doubt, as prudent investors may be advised to abstain, but they are

not placid onlookers, impuissant and helpless when the trustees

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decide to wind up the scheme in which they have invested. The

stature and rights of the unitholders 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.

36. A hypothetical submission that the unitholders may reject a valid

and well-considered opinion of the trustees for winding up, and

therefore Regulation 18(15)(c) is directory, should be rejected.

Assumptions cannot be a ground to wrongly interpret Regulation

18(15)(c). Situations could arise when the trustees may err in their

opinion, in which event the unitholders may correct them. Money

and investment of the unitholders being at stake, a wrong decision

would obviously have inimical impact on the unitholders themselves.

We would brace the argument that a good and intelligible decision of

winding up would invariably be accepted by the unitholders.

37. ‘Consent’ for the purpose of Regulation 18(15)(c) refers to the

consent of the majority of the unitholders present and voting, and in

case of a poll, the computation would be with reference to the

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number of units held by the unitholder. In fact, in the course of

hearing, it was conceded that majority of the unitholders belong to

provident fund trusts or pension funds. The voting pattern referred to

in our earlier order reflects that voting under Regulation 18(15)(c) is

possible and can work smoothly without much difficulty. The

apprehensions expressed, therefore, do not carry much weight. It is

obvious that where the unitholders vote against winding up,

consequences would follow and accordingly the scheme would not

be wound up. This is a natural and normal consequence which will

have to be given effect to. It would, as stated above, happen rarely

and that too would not happen without any genuine and good

reason.

38. SEBI is a Member of International Organisation of Securities

Commissions (IOSCO). IOSCO in a consultation report published in

August, 2016 on good practices for the termination of investment

funds, states that the termination plan should identify rationale for

terminating the investment fund. Key steps to be taken as part of the

termination process should be identified. Clauses (28), (29) and (30)

of the good practices under the heading ‘Decision to terminate’ read

as follows:

“28. In the majority of cases, the decision to terminate
is that of the responsible entity. However, in some
jurisdictions national law or regulatory requirements will

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mandate that the decision of the responsible entity is
approved by investors, or the custodian in some cases.
The first step in preparing for the voluntary termination
of an investment fund is to determine whether investor
approval is required. This may depend on the legal
structure of the investment fund and whether voting
rights are attributed to shares / units.

29. Investment in an investment fund usually carries
with it the right to vote on certain matters and the voting
requirements for the approval of investors on, inter alia,
liquidations and terminations are generally prescribed
in the constitutional documents and the prospectus /
offering document of the investment fund, or legal and
regulatory regime of the national regulator, or both. The
termination plan should set out the process for
obtaining investor approval, where required.

30. Where investor approval is required and investors
are asked to vote on the decision to terminate with the
outcome achieving the minimum voting requirements
for approval, the decision is binding on all, including
those who do not vote. Where investor approval is
required, the rights of investors should be clear from
the termination plan. In particular, the termination plan
should document how the interests of dissenting
investors will be treated.”

Good practices, as recommended by IOSCO, commend the

unitholders’ right to vote/approve on matters of termination and

liquidation.

39. On and from the date of publication of notices under Regulation

39(3), the cease and freeze effect of Regulation 40 applies. The

words used in sub-regulation (3) to Regulation 39 are ‘where a

scheme is to be wound up in sub-regulation (2)’, that is, a scheme is

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to be wound up in terms of clauses (a), (b) or (c) to Regulation

39(2). Sub-regulation (3) to Regulation 39 also mandates the

trustees to disclose in the public notice the circumstances leading to

winding up of the scheme. This obviously means that where the

trustees form an opinion to wind up a scheme, they must disclose

the reasons, and thereupon, the unitholders exercise their right to

vote and give or deny consent. This is the true legal effect on

harmonious reading of Regulation 18(15)(c) and Regulation

39(2)(a).

40. The language of clauses (a) and (c) to sub-regulation (2), and sub-

regulation (3) to Regulation 39 does not envisage involvement of the

unitholders till the publication of notices in case of clauses (b) and

(c) to sub-regulation (2) to Regulation 39. Therefore, when clauses

(a) or (c) of Regulation 39(2) apply, the unitholders are to be

informed about the winding up by the trustees or SEBI by way of

public notice. Publication in terms of Regulation 39(3) is even

required when the unitholders vote for winding up of a scheme

under clause (b) of Regulation 39(2).

41. It is manifest that publication of notices under Regulation 39(3)

should be instantaneous without any interstice between the decision

of winding up by the trustees under clause (a), by the unitholders

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under clause (b) or by SEBI under clause (c). Delay would hold up

the cease-and-freeze effect of Regulation 40 and consequently

nullify the salutary purpose and object behind it.

42. In view of the above discussion and harmoniously interpreting

Regulations 39 to 42, we hold that the consent of the unitholders, as

envisaged under clause (c) to Regulation 18(15), is not required

before publication of the notices under Regulation 39(3). Consent of

the unitholders should be sought post publication of the notice and

disclosure of the reasons for winding up under Regulation 39(3).

43. Read in this manner, we can interpret clause (c) to Regulation

18(15) and Regulations 39 to 42 without the disarray as suggested,

while not displacing the legal effect of either Regulation 40 or

Regulation 18(15)(c). This interpretation takes care of the

apprehension expressed by SEBI, the trustees and AMC that delay

or time gap between a decision of the trustees under clause (a) to

sub-regulation (2) to Regulation 39 and publication of notice under

sub-regulation (3) to Regulation 39 would postpone the cease-and-

freeze effect of Regulation 40.

44. We have referred to Regulation 41(1) and that it requires calling of a

meeting of the unitholders for authorising the trustees or any other

person to take steps for winding up of the scheme. In case where
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the scheme is being wound up under Regulation 39(2)(a), it is

possible to hold a meeting of the unitholders under the said

provision where if the resolution for winding up is passed, the

unitholders can also decide by simple majority of the unitholders

present and voting whether the trustees or any other person should

take steps for winding up of the said scheme. One meeting in many

a cases would suffice.

45. To complete interpretation of Regulation 18(15), we have to record

that clause (a) applies and requires the trustees to obtain consent of

the unitholders whenever required by SEBI in the interest of the

unitholders. Clause (b) states that the trustees would obtain consent

of the unitholders whenever required to do so on the requisition

made by three-fourths of the unitholders of any scheme.

Accordingly, clause (a) would apply whenever SEBI mandates and

clause (b) applies whenever three-fourths of the unitholders of the

scheme make a requisition.

46. The impugned judgment, from paragraph 211 onwards, specifically

refers to the responsibilities and duties of the trustees incorporated

in the statement of additional information published by the mutual

fund, which reads:

“(b) The Trustees shall obtain consent of the unit
holders of the Scheme(s):

Page 46 of 77

i) When the Trustee is required to do so by SEBI in the
interests of the unit-holders; or

ii) Upon the request of three-fourths of the unit holders
of any Scheme(s) under the Mutual Fund; or

iii) If a majority of the directors of the Trustee company
decide to wind up the Scheme(s) or prematurely
redeem the units.”

Clause (iii) of the aforesaid quotation dealing with

responsibilities and duties of the trustees, requires the trustees to

obtain consent of the unitholders of the scheme if the majority of the

directors of the trustee company decide to wind up the scheme or

prematurely redeem the units. The language of clause (iii) of the

aforesaid quotation is identical to clause (c) of sub-regulation (15) to

Regulation 18. The High Court was, therefore, right in observing that

the trustees and the AMC have understood and accepted that the

consent of unitholders of the scheme would be necessary if the

majority of the directors of the trustee company decide to wind up a

scheme.

47. The impugned judgment, in paragraph 221, observes that no

material was placed on record to show compliance with sub-

regulation (3) to Regulation 39. The trustees and AMC have

disputed the said position by relying upon notice dated 23rd April

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2020 enclosed at page 1262 and the newspaper publications in both

English and vernacular languages made on 24th April 2020 enclosed

at pages 3304-3313. In view of the aforesaid factual position, which

was not seriously disputed by most of the unitholders, we would

accept that there was compliance with clause (b) of sub-regulation

(3) to Regulation 39 and accordingly the cease and freeze effect of

Regulation 40 had become effective.

48. Our attention was drawn to the Circular dated 31st May 2016 issued

by SEBI as per which the trustees have the option to suspend

redemption of units for a period of 10 days in a period of 90 days.

The relevant portion of the said circular reads as under:

“b. Restriction on redemption may be imposed for a
specified period of time not exceeding 10 working days
in any 90 days period”

SEBI has taken the stand that the benefit of this circular should not

be taken when the question of winding up is pending consideration

before the trustees. The position not being ironclad, SEBI may re-

examine whether the trustees/AMC can be permitted to take similar

benefit pending the decision on the question of winding up, when

they face frightful redemption pressure.

Page 48 of 77
Challenge to the constitutional validity of the Securities and
Exchange Board of India (Mutual Funds) Regulations, 1996

49. This challenge has been raised by one of the appellants, namely,

Amruta Garg. The contentions forwarded can be summarised as

under:

(a) The expression ‘happening of any event’ in Regulation 39(2)(a)

is unspecified and suffers from the vice of excessive delegation

as it does not give any indication of the type of events which

would be relevant for winding up of the scheme. It gives

unbridled power to the trustees to wind up a scheme which, in

the opinion of the trustees, should be wound up.

(b) In comparison, vide clause (c) to Regulation 39(2), SEBI has

been invested with the power to issue directions for winding up

a mutual fund scheme only when it is in the interest of the

unitholders.

(c) Further, SEBI has not prescribed/issued guidelines or policy

regarding formation of opinion by the trustees to wind up the

scheme.

(d) The opinion of the trustees is given paramountcy and is

supreme. Even SEBI accepts that it has no role and cannot

examine and set aside the decision of the trustees. Thus, SEBI,

as per its own contention and submission, being bound by the

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opinion of the trustees, cannot interfere even when it is

necessary to do so in the interest of unitholders or when the

trustees have acted in their own vested interest. This is contrary

to the scheme of the SEBI Act whereunder SEBI has been

constituted primarily to act as a watchdog and to protect

interests of the investors in the capital market, including the

unitholders.

(e) There is no provision for appeal or internal challenge against

the decision of the trustees who may in a given case form a

wrong opinion regarding winding up of the scheme.

(f) For the above reasons, clause (a) to Regulation 39(2) suffers

from manifest arbitrariness in the absence of any prescription

regulating the exercise of the power by the trustees. Reliance is

placed upon State of Tamil Nadu and Another v. T.

Krishnamurthy and Others;10 Shayara Bano v. Union of

India and Others;11 Senior Superintendent of Post Offices,

Allahabad and Others v. Izhar Hussain;12 Director General,

Central Reserve Police Force and Others v. Janardan Singh

and Others.13

10 (2006) 4 SCC 517
11 (2017) 9 SCC 1
12 (1989) 4 SCC 318
13 (2018) 7 SCC 656

Page 50 of 77

(g) Regulation 39(3) equally suffers from the vice of manifest

arbitrariness as SEBI merely acts as a drop-box. 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.

(h) Regulation 41(2)(b) is manifestly arbitrary as it states that the

sale proceeds under clause (a) shall be first discharged for such

liabilities as are due and payable under the scheme and only

the balance amount shall be paid to the unitholders in

proportion to their respective interests in the assets of the

scheme as on the date of the decision for winding up was

taken. 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. Secondly, the unitholders have been placed below the

creditors of the scheme and would therefore receive only the

leftover. This undermines the paramount place and position of

the unitholders. Further, the SEBI has failed to protect the

interest of the unitholders who are not only financial creditors

but, as explicitly provided in Regulation 18(12), their money is

Page 51 of 77
held in the mutual fund in trust and for their benefit. Reliance is

placed upon Pioneer Urban Land and Infrastructure Limited

and Another v. Union of India and Others14 where the home

buyers have been held to be financial creditors under the Indian

Bankruptcy Code. Principle of pari passu should be made

applicable.

(i) Regulation 42 is also manifestly arbitrary as SEBI is to perform

only ministerial functions, much less than the functions of a

regulator. Conspicuously, during the winding up process, SEBI

has been given a minimalistic role which is contrary to the

paramount object of the Act.

50. We would begin by referring to the provisions of the SEBI Act and

by elucidating the powers of SEBI. Section 11 of the SEBI Act

prescribes the functions of SEBI. Sub-section (1), in general terms,

states that it will be the duty of SEBI to protect the interests of

investors in securities and to promote the development of, and to

regulate, the securities market. SEBI is empowered to take

measures in this regard as it thinks fit. Sub-section (2), without

prejudice to the generality of sub-section (1), lists out as many as 17

specific clauses and states that SEBI is entitled to provide for

measures relating to those clauses. Thereunder, Clause (e) relates

14 (2019) 8 SCC 416

Page 52 of 77
to prohibiting fraudulent and unfair trade practices relating to

securities markets. Clause (g) concerns prohibition of insider trading

in securities. Clauses (b), (i), (ia), (ib) and (la) relate to registering

and working of the trustees or trust deeds, investment advisors and

such other intermediaries who may be associated with the securities

market in any manner and permits SEBI to call for information from,

undertaking inspection, conducting inquiries and audits of mutual

funds and other persons associated with the securities market,

intermediaries and self-regulatory organisations. They can also ask

for records from any persons, including any bank, any other

authority or board or corporation established or constituted by or

under a central or state Act relevant for investigation or inquiry by

SEBI. It is also authorised to call for and require any agency to

furnish information as may be considered necessary by SEBI for

discharge of its functions. Clause (m) is a residuary clause which

states that SEBI can perform such other functions as may be

prescribed. Sub-section (2A) to Section 11 is a non-obstante

provision which authorises SEBI to take measures to undertake

inspection of any book or register or other document or record of

any listed public company or a public company, etc. which intends to

get its securities listed on a recognised stock exchange. Sub-section

(3), again, is a non-obstante provision and states that SEBI shall

Page 53 of 77
exercise the same powers as are vested in a civil court under the

Code of Civil Procedure while trying a suit in respect of discovery

and production of books of account and other documents,

summoning and enforcing attendance of persons and examining

them on oath, inspection of any books, registers and documents of

any person referred to in Section 12, inspection of any book, or

register, or document, or record of a company, and issuing

commissions for examination of witnesses or documents. Sub-

section (4) states that without prejudice to the provisions contained

in sub-section (1), (2), (2A) and (3) and Section 11B, SEBI may, by

an order in writing in the interest of the investors or securities

market, take the measures stipulated thereunder either pending

investigation or inquiry or upon completion of investigation or

inquiry. These include suspension of trading of any security;

restraining any person from accessing security markets; attaching,

for a period not exceeding 90 days subject to conditions and for a

further period beyond 90 days subject to confirmation by the special

court, bank accounts and other properties of any intermediary or any

person associated with the securities market in any manner involved

in violation of the provisions of the SEBI Act, or Rules or

Regulations made thereunder; direct any intermediary associated

with securities market in any manner not to dispose of or alienate

Page 54 of 77
any asset forming part of any transaction under investigation subject

to the condition that before or after passing such orders an

opportunity of hearing shall be given to such intermediaries or

persons concerned. Sub-section (4A) authorises SEBI to conduct an

inquiry in the prescribed manner notwithstanding the provisions of

sub-sections (1), (2), (2A), (3) and (4), Section 11B and Section 15-I

by an order and for reasons to be recorded in writing levy penalty

under Sections 15A, 15B, etc. Under sub-section (5), the amount

disgorged pursuant to the directions issued under Section 11B of

the Act or 12A of the Securities Contracts (Regulation) Act, 1956

etc. is to be credited to the Investor Protection and Education Fund

established by SEBI and to be utilised in accordance with the

regulations framed under the Act.

51. Section 11B of the Act reads as under:

“Power to issue directions and levy penalty.– (1)
Save as otherwise provided in section 11, if after
making or causing to be made an enquiry, the Board is
satisfied that it is necessary–

(i) In the interest of investors, or orderly development
of securities market; or

(ii) to prevent the affairs of any intermediary or other
persons referred to in section 12 being conducted in a
manner detrimental to the interests of investors or
securities market; or

Page 55 of 77

(iii) to secure the proper management of any such
intermediary or person,

it may issue such directions, –

(a) to any person or class of persons referred to in
section 12, or associated with the securities market;
or

(b) to any company in respect of matters specified in
section 11 A,

as may be appropriate in the interests of investors in
securities and the securities market.

(2) Without prejudice to the provisions contained in
sub-section (1), subsection (4A) of section 11 and
section 15-I, the Board may, by an order, for reasons to
be recorded in writing, levy penalty under sections 15A,
15B, 15C, 15D, 15E, 15EA, 15F, 15G, 15H, 15HA and
15HB after holding an inquiry in the prescribed manner.

Explanation.– For the removal of doubts, it is hereby
declared that the power to issue directions under this
section shall include and always be deemed to have
been included the power to direct any person, who
made profit or averted loss by indulging in any
transaction or activity in contravention of the provisions
of this Act or regulations made thereunder, to disgorge
an amount equivalent to the wrongful gain made or loss
averted by such contravention.”

52. As the heading of Section 11B states, the provision empowers SEBI

to issue directions and levy penalty. It stipulates that such powers

can be exercised if and after making or causing any inquiry SEBI is

satisfied that it is necessary – (i) in the interest of the investors or

orderly development of the securities market, (ii) to prevent affairs of

Page 56 of 77
any intermediary or other persons referred to in Section 12 being

conducted in a manner detrimental to the interest of the investors or

securities market; or (iii) to secure proper management of such

intermediary or person. SEBI may issue directions to – (a) any

person or class of persons referred to in Section 12 or associated

with the securities market, or (b) to a company in respect of the

matters specified in Section 11A as may be appropriate, in the

interest of the investors in securities and in the securities market.

The explanation to the Section is important for it clarifies, by way of

removal of doubt, that the directions under this Section shall include

and shall always deem to include power to direct any person, who

has made profit or averted loss by indulging in any transaction or

activity in contravention of the provisions of the Act, or regulations

made thereunder, to disgorge an amount equivalent to the wrongful

gain made or loss averted by such contravention. The provisions of

Section 11B have been held to be procedural in nature and include

not only an individual but also a company. Therefore, any person

associated with the securities market who commits breach of the

SEBI Act, Rules and Regulations, can be subjected to such

directions and measures as may be imposed and issued by SEBI.

Sub-section (2) to Section 11B states that SEBI may after holding

an inquiry pass an order in writing, and, without prejudice to the

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provisions of Section (11), levy penalty under Sections 15A, 15B,

etc.

53. Referring to the provisions, the Division Bench of the High Court in

the impugned judgement has held as under:

“291. Another question is about the powers of SEBI
under Section 11B of the SEBI Act. We have already
held that the power to issue directions under Section
11B(1)
can be exercised to issue directions to AMC
and the Trustees. The said direction can be issued
when SEBI, after making or causing to be made an
enquiry, is satisfied that (a) it is necessary to issue
directions in the interest of investors or orderly
development of securities market; (b) to prevent the
affairs of any intermediary or other persons referred to
in Section 12 being conducted in a manner detrimental
to the interests of investors of securities market; or (c)
to secure the proper management of any such
intermediary or person. The first question is whether
SEBI has power to interfere with the decision taken by
the Trustees under Regulation 39(2)(a). If SEBI is to
test the correctness or validity of such decision of the
Trustees, an adjudication is required. The Trustees and
AMG will have to be heard in the adjudication process.

Section 11B does not contemplate any such
adjudication. If an entity to whom a direction under
Section 11B has been issued commits any breach
thereof or disobeys the same, it will attract penalty
under Section 15HB. Before imposing penalty,
adjudication as contemplated by Section 15-I is
required to be made. There is no provision made in
SEBI Act for issuing a notice of the proposed direction
under Section 11B and hearing the Trustees or AMC
before issuing the direction. No adjudication is
contemplated before issuing the directions. Therefore,
it is not possible for this Court to accept the contention
of the petitioners, AMC as well as the Trustees that by
exercising power under Section 11B, SEBI has power

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to adjudicate upon the correctness of the decision
taken by the Trustees to wind up a Scheme. However,
when SEBI finds that the Trustees or AMC are not
abiding by the specific provisions of the Mutual Funds
Regulations, the power to issue directions can be
exercised by SEBI. By way of illustration, we refer to
hypothetical cases. After invoking the provisions of
Regulation 39(2)(a), if the Trustees stop redemption the
units by taking recourse to Regulation 40 without
complying with the mandatory requirements of sub-
clause (a) and (b) of clause (3) of Regulation 39, SEBI
can always issue a direction under Section 11B not to
stop redemptions, unless compliance is made with
clause (3) of Regulation 39. If it is found that the
Trustees continue to carry on business activities of the
Schemes even after action under clause (3) of
Regulation 39 is taken, a direction under Section 11-B
can be issued by SEBI to stop all business activities.”

54. We have reservations on the said observations for the simple

reason that if there is a violation of the regulations, i.e. clause (a) to

Regulation 39(2), 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

Section 11 and 11B of the Act. It would be, therefore, incorrect to

state that the decision of the trustees under clause (a) to Regulation

39(2) cannot be made subject matter of inquiry or investigation and

therefore no directions or orders under Section 11 or 11B of the Act

can be passed. No doubt, clause (a) to Regulation 39(2) gives

primacy to the opinion of the trustees and does not require prior

approval of SEBI, yet SEBI is entitled to conduct an inquiry and

investigation when justified and necessary to ascertain whether the

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trustees have acted in accordance with their fiduciary duty and also

for reasons which would fall within the four corners of clause (a) to

Regulation 39(2). 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 11B.

55. The view we have taken is in consonance with the earlier decision of

the Gujarat High Court in Alka Synthetics and Trading v. SEBI,15

wherein it was observed that power under Section 11B is in the

nature of issuing a command to persons referred to in the provision

to do a certain act or to forbear from doing a certain act, if as a

result of an enquiry, SEBI is satisfied about the necessity of issuing

such direction for the purposes mentioned in clauses (a), (b) and (c).

The Gujarat High Court, in our opinion, rightly observed that while

Section 11 operates in the field of laying down general regulatory

measures as a matter of policy, Section 11B operates in the field of

prescribing a specified code of conduct in relation to specified

persons or classes of persons. On the issue of application of

principles of natural justice, it was noted that Section 11B empowers

SEBI to issue directions only after it is satisfied about the conditions

referred to in the provision, as a result of making or causing to be

15 (1999) 95 Comp Cas 663

Page 60 of 77
made an enquiry – which necessarily implies a pre-decisional

hearing. Similar view was subsequently expressed in Nikhil T.

Parikh v. Union of India16, wherein the same High Court was of the

view that Section 11B, being an enabling provision, must be so

construed as to subserve the purpose for which it has been enacted.

As the term ‘measure’ is not defined in the SEBI Act, the High Court

gave it a meaning prescribed in general parlance, as incorporating

anything desired or done with a view to the accomplishment of a

purpose, a plan or course of action intended to obtain some object,

any course of action proposed or adopted by a Government. The

Securities Appellate Tribunal in Sterlite Industries (India) Ltd. v.

SEBI,17 has given an expansive interpretation to Section 11 and

Section 11B of the SEBI Act, observing that they give enormous

authority to SEBI. As long as the power exercised under Section

11B is subject to the provisions of the SEBI Act and well within the

legal and constitutional frame work, intended to achieve the

purposes of the SEBI Act and subjecting the persons specified in

the section, the power will sustain. The Appellate Tribunal called it a

wholesome provision designed to achieve the objectives of the SEBI

Act.

16 (2014) 2 GLH 582
17 2001 SCC OnLine SAT 28.

Page 61 of 77

56. The Trustees and the AMC in their written submissions filed before

the High Court interpreting the SEBI Act and the Regulations had

conceded that SEBI has extensive powers with respect to the

regulation of mutual funds including the trustee’s decision to wind up

a scheme of the mutual fund. Section 11(1) of the SEBI Act states

that it is the duty of SEBI to protect the interest of investors in

securities and to promote the development of, and to regulate the

securities market, by “such measures as it thinks fit”. Under Section

11B of the SEBI Act, SEBI has broad powers to issue appropriate

directions if it is satisfied after inquiry that such directions are

necessary in the interest of investors or for orderly development of

securities market or to prevent the affairs of any intermediary being

conducted in a manner detrimental to the interest of investors or the

securities market or to secure proper management of any

intermediary or other person. The power of SEBI extends to

regulating and monitoring the functioning and decisions taken by

mutual funds, the trustees and the AMC. SEBI has the power to

pass any direction if it deems fit in the interest of unitholders. The

trustees and the AMC have specifically stated:

“It is evident form the aforesaid provisions that the SEBI
has extensive powers to regulate, supervise, issue
directions with respect to and inspect and investigate into
the affairs of a mutual fund, including with respect to the
decision of the trustee to wind up a mutual fund scheme

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under Regulation 39(2)(a) of the Mutual Funds
Regulations, including to even stop the winding up of a
mutual fund scheme, if deemed necessary. The
existence of such powers of the SEBI is further
reinforced by Section 11D of the SEBI Act, which
empowers the SEBI to pass an order requiring any
person who, ‘has violated, or is likely to violate, any
provisions of this Act, or any rules or regulations made
thereunder” to ‘cease and desist’ from committing such
violation. It is submitted that whether SEBI would choose
to exercise this power is a matter, which may be
determined by SEBI in its wisdom and there may be
numerous reasons why SEBI may not wish to interfere in
a winding up decision by a trustee under Regulation
39(2)(a) including the reasons submitted by SEBI in its
affidavit such as the fact that reversal of a decision to
wind up a mutual fund scheme would likely cause a run
on the scheme as well as severe market contagion
(Reference is made to Paras 18,19 at Pg. 6 and 7 of
the Delhi Reply; Paras 34 and 35 at Pg. 11 and 12 of
the Gujrat Reply; and Paras 11 and 12 at Pgs. 5 and 6
of the Madras Reply); however, on a reading of the
scheme of the SEBI Act and regulations as a whole, it is
submitted that it is clear that such a power does exist.”

57. However, we agree with the High Court that the Regulations have

been framed in exercise of power conferred by Section 30 of the

SEBI Act which authorises them to make regulations consistent with

the provisions of the SEBI Act to carry out the purpose of the SEBI

Act. The very object of the SEBI Act is to preserve confidence of the

investors and to regulate the capital market, including mutual funds.

In the first portion of this order, we have elaborately referred to the

Regulations which thereby create a three-tier system of the sponsor,

the AMC and the trustees. There are stipulations regulating the

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activities of the trustees and the AMC whose powers, obligations

and rights have been expressly laid down. The power to regulate

mutual funds, once accepted, would include the power to make

regulations for winding up of a scheme of the mutual fund. Not

framing any regulation in this regard would have amounted to

dereliction of duty on the part of SEBI and subjected it to adverse

comments.

58. It cannot be accepted that the trustees under clause (a) to

Regulation 39(2) have been given absolute and unbridled power to

wind up a scheme. Language of clause (a) to Regulation 39(2)

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 unitholders by

publication in two daily newspapers having circulation all over India

and a vernacular newspaper having circulation at the place where

the mutual fund is formed. 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. Two-thirds of the

trustees are independent persons who are not associated with the

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sponsor,18 and no director, officer or employee of the AMC can be

appointed as a trustee.19 The trustees hold the assets of the scheme

in fiduciary capacity on behalf of the investors. They are experts in

the field and, therefore, conferred the power under Regulation

39(2)(a) to decide whether or not a scheme should be wound up.

The words used in the statute including delegated legislation are to

be understood in the light of that particular statute and not in

isolation. A duly enacted law cannot be struck down on the mere

ground of vagueness unless such vagueness transcends into the

realm of arbitrariness (See Nisha Priya Bhatia v. Union of India

and Another20). In the context of the present case, the expression

‘occurrence of any event’ is not to be read in isolation but with the

words ‘requires the scheme to be wound up’. The expression ‘any

event’ is therefore qualified with the said requirement. Read in this

manner, there is no vagueness which can be described as

transcending into realm of arbitrariness, on the other hand, the pre-

requisite statutory mandate is clear. 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. The essential legislative function is the determination of

legislative policy and its formulation as a rule of conduct. In
18 Regulation 16(5)
19 Regulation 16(3)
20 (2020) 13 SCC 56

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commercial matters varied and different situations can arise which

may warrant winding up. Complexities in matters of business and

commerce can be bafflingly intricate and riddled with urgencies and

difficulties. Therefore, there is need for flexibility. Otherwise, the

trustees would be compelled to first take the approval of SEBI,

which may have its own consequences.

59. The Statement of Additional Information dated 30th June, 2019

issued by Franklin Templeton Mutual Fund, under Heading VI –

‘Duration of the Scheme and Winding Up’, provides a general

indication as to when a scheme can be wound up under the

Regulations, the relevant portion of which is extracted below:

“VI. DURATION OF THE SCHEME AND WINDING UP

xx xx xx

However, in terms of the SEBI Regulations, the
Scheme may be wound up if:

i. There are changes in the capital markets, fiscal laws
or legal system, or any event or series of events
occurs, which, in the opinion of the Trustee, requires
the Scheme to be wound up; or

xx xx xx

60. We have agreed with the High Court that the opinion of the trustees

under clause (a) to Regulation 39(2), therefore, must be consented

to by the unitholders in terms of the mandate of Regulation

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18(15)(c). In view of this interpretation, the argument challenging

constitutional validity of the Regulations on the ground that they give

unbridled and absolute power to the trustees loses much of its sting

and force. There are, therefore, sufficient guidance and safeguards

in the Regulations itself on the power of the trustees to decide on

winding up of the fund.

61. The Regulations, in our opinion, rightly draw the distinction between

creditors and the unitholders. The 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.

Unitholders are not entitled to fixed return or even protection of the

principal amount (See Regulations 38 and 38A).21 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

unitholders. In this sense, unitholders are somewhat at par with the

21 Guaranteed Returns

38. No guaranteed return shall be provided in a scheme, –

(a) unless such returns are fully guaranteed by the sponsor or the asset management company;

(b) unless a statement indicating the name of the person who will guarantee the return, is made in the
offer document;

(c) the manner in which the guarantee is to be met has been stated in the offer document.

Capital Protection oriented schemes
38A. A capital protection oriented scheme may be launched, subject to the following:

(a) the units of the scheme are rated by a registered credit rating agency from the viewpoint of the ability
of its portfolio structure to attain protection of the capital invested therein;

(b) the scheme is close ended; and

(c) there is compliance with such other requirements as may be specified by the Board
in this behalf.

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shareholders of a company. The waterfall mechanism under the

Companies Act, or the Indian Bankruptcy Code, gives primacy to the

dues of the creditors over the shareholders. Identical is the position

of the unitholders. In fact, the argument that the unitholders should

be treated pari passu with the creditors is farfetched. Similarly, the

contention that unitholders are identically placed as home buyers

under the Indian Bankruptcy Code is equally frail and a weak

argument. Home buyers pay money to the builder and enter into a

contract for purchase of immovable property. Home buyers are not

risk or partakers in gains or losses like investors in a mutual fund.

Home buyers under the Bankruptcy Code are treated as creditors till

the ownership rights in the immovable property are transferred to

them, but they do not take the risks and are not entitled to benefit of

profits or suffer losses, as are taken by the unitholders who invest in

the mutual funds without any guarantee of returns and know that the

investment, including the principal, are subject to market risks. To

equate the unitholders with either the creditors or the home buyers

will be unsound and incongruous.

62. The expression ‘due and payable’ with reference to the liabilities is

significant. The words ‘due and payable’ have to be interpreted with

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reference to the context in which the words appear.22 In the context

in question they refer to the present liabilities which may be in

praesenti or in futuro. There must be an existing obligation though

the appointed date of payment may not have arrived. ‘Payable’, in

this context, means capable of being paid, suitable to be paid and

legally enforceable. It would exclude labilities that are time barred or

those not payable in facts or in law.23 In case of any dispute a

summary but thorough inquiry may be made to ascertain whether

the liability is due and payable.24 Obviously, the liabilities which are

not due and payable would not get preferential treatment, thereby

reducing the amounts payable to the unitholders.

63. Since the Regulations are in the nature of economic regulations,

while exercising the power of judicial review, we would exercise

restraint unless clear grounds justify interference. We would not

supplant our views for that of the experts as this can put the

marketplace into serious jeopardy and cause unintended

complications. Policy decisions can only be faulted on the grounds

of mala fides, unreasonableness, arbitrariness and unfairness, in

addition to violation of fundamental rights or exercise of power

beyond the legal limits. The principle of manifest arbitrariness

22 B.K. Educational Services Private Limited v. Parag Gupta and Associates, (2019) 11 SCC 633.
23 Union of India v. Raman Iron Foundry, (1974) 2 SCC 231
24 Regulations do not bar civil remedy.

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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. 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.

64. However, we must now refer to a grey area, which we would, at this

stage, not like to decide till we have full facts and decision in the

adjudication proceedings. The issue relates to interpretation of

Regulation 53, which reads:

“53. Every mutual fund and asset management
company shall,

(a) despatch to the unitholders the dividend warrants
within 189[30] days of the declaration of the dividend;

(b) despatch the redemption or repurchase proceeds
within 10 working days from the date of redemption or
repurchase;

(c) in the event of failure to despatch the redemption or
repurchase proceeds within the period specified in sub-
clause (b), the asset management company shall be
liable to pay interest to the unitholders at such rate as
may be specified by SEBI for the period of such delay;

(d) notwithstanding payment of such interest to the unit-

holders under sub-clause (c), the asset management
company may be liable for penalty for failure to

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despatch the redemption or repurchase proceeds
within the stipulated time.

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. Regulation 40, as

noticed above, states that on or from the date of publication of

notice under Regulation 39(3)(b), the trustees of the AMC, as the

case may be, shall cease to cancel or create units of the scheme;

cease to issue or redeem units of the scheme; and cease to carry

on any business activity in respect of the scheme so wound up.

65. Issue in question would, therefore, 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). Interpreting the word ‘business’

in clause (a) of Regulation 40, the Division Bench of the High Court

has held that this expression refers to business activity and,

therefore, would include payment of redemption proceeds to the

unitholders, which would include the request for redemption

received prior to the date of publication under Regulation 59(3). The

High court has, accordingly, held:

“228. As regards redemption requests received prior to
compliance with clause (3) of Regulation 39, the
argument of AMC and the Trustees was that in view of

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clause (d) of Regulation 53, the redemption or
repurchase proceeds are required to be dispatched
within ten working days from the date of redemption
notwithstanding the decision of winding up. As held
earlier, the dispatch of redemption proceeds or
repayment of redemption proceeds is also a part of
business activity of a Scheme which is completely
prohibited once the Regulation 40 triggers in.
Therefore, the argument that the redemption requests
made by the unit-holders on 23rd April, 2020 were
required to be honoured even after Regulation 40 had
triggered in cannot be accepted. Once there is a
compliance with clause (3) of Regulation 39, the
mandatory provisions of Regulation 40 forthwith
operate. There is no exception carved out to any of the
clauses in Regulation 40. It is obvious that such a
failure to dispatch the redemption or repurchase
proceeds due to applicability of provision of Regulation
40 cannot be termed as a failure within the meaning of
sub-clause (c) of Regulation 53. Therefore, the
consequences such as payment of interests and
penalty as provided in clause (c) of Regulation 53 may
not follow.”

66. On the aspect of borrowings etc. by the AMC to make payment

towards redemption, the High Court has held:

“225. But, in the context of the Scheme of the Mutual
Funds Regulations, this Court will have to consider the
meaning of ‘business activities’. As stated in the earlier
part of our discussion, a Scheme is launched by AMC
with the approval of the Trustees. There are different
categories of Schemes in which the investments are
made by the members of the public. From plain reading
of the provisions of Regulation 43, it is clear that the
money received from the unit-holders and investors is
required to be invested by AMC strictly in accordance
with Regulation 43. The investments are to be made
subject to investment restrictions specified in the
seventh schedule. As far as borrowings are concerned,

Page 72 of 77
clause (2) of Regulation 44 provides that the Mutual
Fund shall not borrow except to meet temporary
liquidity needs of the Mutual Fund for the purpose of
repurchase, redemption of units or payment of interest
or dividend to the unit-holders. The proviso to clause
(2) of Regulation 44 clearly provides that a Mutual Fund
shall not borrow more than twenty percent (20%) of the
net assets of the Scheme and the duration of such
borrowing shall not exceed a period of six months.

Thus, in short, the business of a Mutual Fund consists
of (i) launching Schemes, (ii) receiving the investments
from the unit-holders/investors, (iii) investing the money
so collected from the unit-holders/investors in
accordance with Regulation 43 and other relevant
Regulations and (iv) paying the returns in various
modes to the unit-holders/investors. The returns can be
in the form of repurchase of the units, redemption of
units, payment of interest or dividend to the unit-
holders, as the case may be, depending upon the
nature of the Scheme. Making such returns is certainly
a business activity of a Scheme. The income so
generated by investments made in accordance with
Regulation 43, can also be invested by AMC. Clause
(3) Regulation 44 provides that save as otherwise
expressly provided, a Mutual Fund shall not advance
any loans for any purposes. However, clause (4) of
Regulation 44 provides that a Mutual Fund may lend
and borrow securities in accordance with the
framework relating to short selling and securities
lending and borrowing specified by SEBI. The
provisions of Mutual Funds Regulations are intended to
regulate activities of Mutual Funds for promoting its
healthy growth and for protecting interest of unit-
holders. In a case of Taxation law, the rules of
interpretation applicable provide that if there are two
interpretations possible, the one in favour of assessee
will have to be preferred. In case of Mutual Funds
Regulations, a construction needs to be adopted which
will subserve the object of SEBI Act.

Page 73 of 77

226. It is pertinent to note here that clause (a) of
Regulation 40 uses the words “business activities in
respect of the Scheme” and not merely business of the
Scheme. As siated earlier, the activities of repurchase
of units, redemption of units or payment of interest or
dividend are also a part of business of a Scheme. In
view of clause (2) of Regulation 44, a Mutual Fund can
borrow only for the purposes of meeting temporary
liquidity needs for the purpose of repurchase,
redemption of units, payment of interests or dividend to
the unit-holders. For example, if there are large number
of requests for redemption of units by the unit-holders
in respect of ‘open ended Scheme’, a Mutual Fund may
face temporary liquidity crunch. In such a situation, it is
permissible for a Mutual Fund to make borrowings only
for payment of redemption amount. Therefore,
borrowings made as specified in clause (2) of
Regulation 44 will certainly amount to ‘business
activities’ of a Mutual Fund or a Scheme, inasmuch as,
such borrowings are made for the purpose of meeting
demand for redemption which is a part of business of
the Scheme.

227. Regulation 40 is interlinked with Regulation 41. In
view of Regulation 40, the moment compliance is made
with clause (3) of Regulation 39, the ‘business
activities’ of the Scheme of a Mutual Fund must stop.
The creation or cancellation of units and issue or
redemption of the units of the said Scheme must also
cease. The reasons is, as required by sub-clause (a) of
clause (2) of Regulation 41, all the assets of the
Scheme under winding up are required to be disposed
of in the best interest of unit-holders and thereafter, as
per sub-clause (b) of clause (2) of Regulation 41, the
proceeds of the sale are required to be applied firstly
towards discharge of liabilities of the Scheme.
Secondly, the expenses in connection with the winding
up are required to be set apart and thirdly, the balance
amount remaining after clearing the liabilities has to be
distributed to the unit-holders in proportion to their
respective interest in the assets of the Scheme. The

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object of Regulation 40 of the Mutual Funds Regulation
is to ensure that the moment compliance is made with
clause (3) of Regulation 39, the assets available at that
point of time should be made available for sale. The
assets cannot be allowed to be depleied by creating
more liability. That is the reason why the redemption
must immediately cease. Therefore, it must be held that
the borrowings made by AMC, in terms of clause (2) of
Regulation 44, are business activities’ of a Scheme
within the meaning of clause (a) of Regulation 40. If
borrowings are made in accordance with clause (2) of
Regulation 44, the act of replacement of the borrower,
as done by the AMC and the Trustees in the present
case, will have to be also held to be a part of business
activities in respect of the Scheme.”

67. The case set up by some parties is at variance with the dictum

pronounced by the High Court. They have submitted that the mutual

fund must honour the request for redemptions received on or before

the date of publication of notice under Regulation 39(3). In other

words, Regulation 53(b) must be honoured and complied with even

if the time of payment of redemption, the 10 days period stipulated

therein, would fall after the date of publication of the notice under

Regulation 39(3). They are of the opinion that it would be illegal not

to honour the valid redemption requests. They are also of the

opinion that the AMC should be allowed and permitted to borrow

money within the prescribed limits to honour such valid redemption

requests as long as the valid redemption requests are received prior

to the cut-off date for winding up.

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68. Before we answer this aspect, we would like to have greater clarity

on the factual matrix, which would be possible once the proceedings

in pursuance of show-cause notices etc. are concluded. Notably,

many of the appellants have not addressed us on this aspect, their

grievance being that the Forensic Audit Report has not been made

available to them. At the same time, they did refer to news reports or

articles to suggest irregularities and illegalities of different kinds,

including preferential payments, breach of trust and mis-

management in deployment of funds of the scheme, violation of

investment objectives stated in the offer document or scheme

information document and breach of trust by withholding price

sensitive information etc. Once the facts are clear and ascertained,

we would be able to appreciate and understand the practical impact

of the respective interpretations, i.e. the interpretation placed by the

High Court and the interpretation sought to be placed and preferred

by SEBI, the appellants, the trustees and the AMC. This is also the

reason why we have refrained from referring and commenting on

facts and left the several issues open at this stage. Nevertheless,

we clarify that our observations in this Order and the earlier Order

should not be read as binding factual findings or conclusions on any

disputed facts, which could be a subject matter of a show-cause

notice and consequent decision. Of course, the legal interpretation

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of Regulation 18(15)(c) and Regulations 39 to 42 to the extent

indicated above are conclusive and binding. For clarity, we would

also observe that any finding given by the High Court on facts or

even on legal issues not subject matter of this Order or our earlier

Order dated 12th February, 2021 would not be treated as conclusive

and binding as the findings are sub-judice and pending before this

Court on interpretation as well as merits.

………………………………..J.

(S. ABDUL NAZEER)

………………………………..J.

(SANJIV KHANNA)
NEW DELHI;

JULY 14, 2021.

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