Calcutta High Court Allows Trial Against Directors of a Mutual Fund Trustee Company

It is well-known that directors of a mutual fund trustee company carry onerous responsibilities, both under the Companies Act, 2013 as well as the SEBI (Mutual Funds) Regulations, 1996. The trustee company of a mutual fund and its directors are responsible for ensuring that transactions carried out by the fund are in accordance with the relevant regulations. This is despite the fact that the day-to-day management activities are undertaken by the asset management company. In other words, the trustee company and its directors are foisted with key monitoring responsibilities in the interests of the investors (being unit holders of the mutual fund).

The scope of the directors’ duties and responsibilities came up for consideration (albeit at a preliminary stage) in ITC Limited v. JP Morgan Mutual Fund India Private Limited (dated 24 August 2018 in CS No. 146 of 2016).[1] The Court rejected an application for striking the names of directors of the mutual fund trustee company in an action by an aggrieved investor. In doing so, the Court recognised the significant responsibilities and liabilities that directors of a mutual fund trustee company carry under law.

The plaintiff, ITC Limited, alleged negligence and breach of fiduciary duties on the part of the directors and consequently claimed an amount in excess of Rs. 39 crores on account of loss suffered. The defendant JP Morgan had in 2014 circulated a scheme document in respect of two funds, being the Treasury Fund and the Liquid Fund by which it invited prospective investors to subscribe to units therein. Relying upon the scheme document, ITC invested substantial funds. The asset management company in 2015 purchased bonds in Amtek Auto, which thereafter rapidly began displaying signs of decline in value. This resulted in a ratings downgrade as well. ITC accordingly filed requests for redemption of its units, which it alleges JP Morgan failed to honour, except on a piecemeal basis. The delay in ITC’s exit from the investment despite the downgrading of the Amtek bonds is sought to be considered a dereliction of duty on the part of JP Morgan and its management.

Of immediate relevance in the suit is an application by five directors of the mutual fund trustee company seeking to strike off their names from the array of parties on the ground that the plaint does not disclose the circumstances in which they owed duties to ITC. A single judge of the Calcutta High Court first came to the conclusion, relying on the Supreme Court judgment in Sejal Glass Ltd. v. Navilan Merchants Pvt. Ltd. (2016), that a partial rejection of the plaint under order VII rule 11 of the Civil Procedure Code, 1908 (CPC) is impermissible in law. Hence, the plaint cannot be bifurcated against these five directors and other parties. Hence, the principal issue was whether the names of the five directors can be struck out in terms of order 1 rule 10(2) of the CPC. This is possible only if “a court comes to a finding that a party has been improperly joined or is not a necessary party for the court to come to an effective and complete adjudication of all the questions involved in the suit”.  This squarely leads to a determination of the duties and responsibilities of the directors of a mutual fund trustee company under law. More specifically, the question is whether the board of directors of the trustee company are under a “duty of care to protect the investments of the investors” and “exercise due care and skill in managing such investments” and, related to that, whether they directors failed in their duty thereby leading to a loss suffered by ITC.

In answering this question, the High Court placed emphasis on the scheme information document (SID), which described the duties of the trustee company and its directors. It found that the statements in the SID provided an impression to the investors that the trustee company and its directors are eminently suited to make a sound judgment regarding the investments and that they would review the activities of the asset management company, thereby performing a monitoring function. Thereafter, the Court set out the key question for consideration:

On a careful reading of the statements made in the plaint, together with the Scheme Information Document and the SEBI Regulations relating to Mutual Funds, in particular, the central question is whether the [directors of the trustee company] can be said to be improperly joined and wholly irrelevant for the court to decide whether ta collective duty existed on the part of the defendants; whether they collectively failed in performing that duty and whether the plaintiff suffered as a result of such collective failure on the part of the defendants arrayed as parties to the suit.

The Court held that once there is a possibility to enquire on the facts whether the directors are a necessary party to the suit, the matter must be decided on trial and not on the application for deletion of parties. Various provisions in the SEBI Mutual Fund Regulations impose duties on trustees in relation to schemes, and hence it is not possible for the directors to argue that the plaint contains no disclosure of any cause of action.

Interestingly, the Court was also seized of the question whether the directors owe their duties only to the trustee company or to the unitholders (investors) as well. It was unwilling to be drawn into the restrictive nature of general director duties enshrined in section 166 of the Companies Act, 2013, which are largely owed to the companies themselves. The Court noted:

In the view of this court however, to restrict the noble (and high-sounding) undertone of a relationship of trust and confidence to the strangehold [sic] of Section 166 of the Companies Act, would be doing immense injustice to the vision contemplated in the duty itself. Any undertaking of a responsibility, whether of person, property or the safe-keeping of another, would imply an entrustment. Hence, a failure to ensure that due care is taken to protect that which another has handed over in trust, would constitute breach of the obligation.

In other words, the Court has expanded the scope of beneficiaries of directors’ duties in case of a mutual fund trustee company over that of directors of other types of companies. Hence, the Court found the existence in the plaint of elements of the tort of negligence. Consequently, the plaint was found to survive against the directors.

While the decision of the High Court relates to a preliminary question of maintainability, it contains an interesting discussion regarding the scope of directors’ duties in relation to a mutual fund trustee company and to the persons to whom the duties are owed. That makes the roles and responsibilities of mutual fund trustee directors more onerous. However, if the matter does indeed go to trial, these issues will have to be expounded in greater detail.

[1] Accessible via Judis (http://judis.nic.in/Judis_Kolkata/All/content.asp).

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

1 comment

  • OFFHAND

    The point of issue, in a manner of critical viewing , seems to be, – whether or not duties / fiduciary relationship of/answer ability by the directors of a ‘mutual fund trustee’ company are in pari materia, -equally onerous in all material respects, – in comparison to any other ‘company’. If so, any such exercise to find a convincing adjudication is quite likely to be met with the same result as the proverbial ‘hair-splitting’-Any substantially varying view to successfully counter in a court of law ?

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