[Kajal Singh and Nikunj Maheshwari are 4th year law students at the Institute of Law, Nirma University, Ahmedabad.]
Credit rating is a mechanism to address the asymmetry of information in the debt investment market, where the independent credit rating agencies (‘CRA’) rate the debt instruments issued by the borrower company (‘client’). Clients, to get their instruments rated, enter into an agreement with CRAs, which effectively governs their relationship. Additionally, CRAs are regulated by Securities Exchange Board of India (Credit Rating Agencies) Regulations, 1999 (‘CRA Regulations’) and also have to comply with periodic notifications and circulars issued by the Reserve Bank of India (‘RBI’) and the Securities Exchange Board of India (‘SEBI’); violation of which may attract strict actions from the SEBI.
Notably, there is a growing concern among the regulators about the credibility and reliability of such ratings. However, neither the regulations nor any notification or circular provides clients with a direct remedy to initiate litigation against CRAs providing incorrect ratings.
Recently the Delhi High Court (‘the HC’) in the case of Jindal Power Limited v. ICRA Limited was presented with an opportunity to reflect upon the same. The HC remarkably enumerated the grounds on which companies can challenge ratings issued by CRAs. Additionally, the judgment clarifies that CRAs are bound to observe the obligations as mentioned in the regulations and the same cannot be done away with by agreements concluded between the client and the CRA.
Jindal Power Limited (‘JPL’), in the present case, entered into an agreement in 2016 with ICRA to rate the debt instruments issued by it to banks in exchange for borrowings. The agreement stipulated that ICRA will have to provide both initial ratings when the company will borrow money and rating during the surveillance period i.e. till the complete satisfaction of the debt. The professional duty of ICRA, as per the contract was subject to acceptance of rating by JPL. JPL initially, accepted both the initial and the periodic ratings issued by ICRA during the preliminary years of the surveillance period. However, a dispute arose between them concerning the ratings issued in April 2020. JPA declined to accept the ratings and asked ICRA to pull down the ratings it has published on its website and in its press release. Since ICRA refused to pull down the ratings, JPL approached the HC seeking a relief to declare the credit rating rationales issued by ICRA as null, void, and unenforceable.
JPL argued that ICRA is not a statutory body and the relationship between them is based on an agreement. The agreement specifically provided that acceptance of rating by JPL was a sine qua non prior to the publication of rating. ICRA by not following the same has violated the agreement and thus they are liable to pull down the publication.
Additionally, they argued that ICRA has employed rating factors unreasonably. They have failed to appreciate that JPL has not faced the wrath of Covid-19 pandemic because of its involvement in essential services. Further, its creditworthiness has improved over the years. Lastly, it already has a letter of credit against its largest debtor, which has not yet been enforced. Thus, ICRA has not only violated the terms of the agreement but also unreasonably considered the rating factors to come up with the credit rating. Hence, the credit rating rationale is liable to be held void and arbitrary.
ICRA on the other hand, refuted these arguments by contending that by virtue of the CRA regulations and the RBI circular they are mandated to publish the ratings despite non-acceptance by JPL. Thus, by a conjoint reading of the concerned laws and the agreement, JPL could have objected to the initial ratings based on which ICRA would be prohibited from publishing them. However, once the ratings are accepted, then ICRA is under a statutory mandate to publish them despite non-acceptance of rating by the client. Furthermore, ICRA being a body of professionals and experts, has considered all relevant rating factors before issuing the ratings. They have given sufficient merit to all credit strengths and credit challenges as per the market in which JPL functions and thus, the ratings are not liable to be held void or arbitrary.
The HC relied on the judgment of Madras High Court in the case of First Leasing Company of India v. ICRA and held that in order to provide timely information to investors and prospective investors, CRAs are under a statutory mandate to publish the credit rating, despite their non-acceptance by the client. Thus, JPL in the present case had the right to reject only the initial rating, after which ICRA could not have published them. However, if JPL has once accepted the initial rating then ICRA will be under statutory obligation to publish credit ratings during the surveillance period as well.
On the second issue, the Court reasoned that CRAs provide expert opinion, with which the Court cannot interfere unless they are proved to be ‘perverse, arbitrary and mala fide’. In the present case, since ICRA has taken all possible factors into account, the ratings issued by them are reasonable and thus cannot be held void.
In the following discussion, the authors will analyse the judgment highlighting the following aspects; first, the nature of the agreement concluded between the client and CRAs; and second, the significance and potential implications of providing ‘perverse, arbitrary and mala fide’ as explicit grounds for challenging the ratings before the Court.
The Nature of the Agreement
The HC observed that the agreement concluded between the client and CRAs for credit rating the debt instruments are of special nature and thus cannot be evaluated on the plain tenets of the Indian Contract Act, 1872. This is because the ratings issued by CRAs are venerated by investors in making investment decisions. In many cases, their opinion can cloud the judgment of the whole market. As in the case of IL&FS, the credit ratings issued by the concerned CRA projected the company in a healthy position even though its coverage ratio was a ramshackle.
Appositely, Calcutta High Court in the case of SERI Infrastructure Finance Ltd. v. Fitch Rating India Pvt. Ltd. noted that the agreement between CRAs and concerned client is not an ordinary agreement which is governed by the Indian Contract Act, 1872. Thus, since CRAs hold such a significant position in corporate governance, their action cannot be based solely on the agreement.
This judgment clarifies that terms of the agreement will not be accorded primacy over the statutory obligation laid down in the regulations. Thus, unlike auditors for instance, who once they are removed by the company under section 140 of the Companies Act, 2013, do not have to render their services, CRAs will be liable to continue publishing credit ratings until the satisfaction of the debt. Further, as held in para 33 of the judgement any clause in the agreement contrary to the regulation will be struck down on the ground of ‘public policy’. Though the relation between the client and the CRA will be governed by the agreement, nothing in the agreement can discharge CRA of its liability under the Regulations.
The Grounds to Challenge Ratings
The ratings issued by CRAs are regarded as an opinion, based on reasonable judgment of the expert. In umpteen Supreme Court judgments (para 28), it has been held that Courts in ordinary cases should avoid substituting their opinions for that of an expert.
The HC in the instant case held that credit rating is a professional opinion and that the Court will not look into appropriateness of the same unless it’s ‘perverse, arbitrary or mala fide’. Currently, SEBI in accordance with regulation 29 of the CRA Regulations can, on receipt of a complaint by the client, call into question the judgment of a credit rating agency. However, an inspection is ordered only when the complaint is of a ‘serious nature’. The term ‘serious nature’ is not defined. Resultantly, the regulator cannot interfere in all cases of misconduct but only those qualifying as of serious nature.
Pertinently, the absence of a direct remedy deprives issuers an opportunity to enforce obligations owed to them by CRAs. The HC by identifying specific grounds has accorded some certainty to the ambiguity surrounding the term ‘serious nature’. Arguably, given the subjective nature of the terms ‘perverse, arbitrary or mala fide’, the issue may require further litigation to test the effectiveness of the grounds and ensure that the exceptions carved out are not misused. Further, concurrent jurisdiction between SEBI and civil courts in adjudicating matters pertaining to ratings may lead to instances of forum shopping and conflict of jurisdiction. Nonetheless, a potent threat of litigation may significantly improve independence, objectivity and accountability in deciding credit ratings.
CRAs are the purveyor of information and play a significant role in the financial market. Essentially, the HC by recognizing specific grounds to challenge the credit ratings issued by CRAs has ensured that clients are guarded against inaccurate and incorrect ratings. The judgment indeed emphasizes that CRAs are expected to fulfil their statutory liabilities despite anything contrary contained in the agreement concluded between the CRA and the client.
– Kajal Singh & Nikunj Maheshwari