Although yesterday’s decision is limited to the issues pertaining to the unitholders’ meeting and voting process, it raises some important questions relating to unitholder democracy, and exposes some chinks in the SEBI (Mutual Funds) Regulations, 1996. The Court engaged in two tasks: (i) interpreting the Mutual Funds Regulations to determine the unitholder majority requirements for winding up a scheme when the trustees so decide; and (ii) addressing some concerns of the dissentient unitholders as to the manner in which the meeting and voting process were conducted. This post confines itself to an analysis of the first aspect that governs the legal issues, and does not delve in to the procedural matters.
Intention of the Mutual Funds Regulations
The dispute at hand largely arose on account the language in regulation 18(15)(c) which states that the “trustees shall obtain the consent of the unitholders … when the majority of the trustees decide to wind up or prematurely redeem the units.” [emphasis supplied] The regulation does not specify whether the consent required to be obtained is that of all unitholders, a majority of the unitholders who hold units, or only a majority of those unitholders who are present and (validly) voting at a meeting. Contrast this with regulation 39(2)(b), which provides for a 75 percent majority of unitholders, and regulation 41(1), which provides for a simple majority of unitholder present and voting. In the absence of a such a specification of the denominator for determining the majority required under regulation 18(15)(c), the Court was called upon to supply the interpretation regarding relevant majority keeping in mind the objective of the regulations. A number of interesting and important issues arose.
Collective Decision-Making versus Individual Decision-Making
One argument the dissenting unitholders raised was the winding up of the schemes would be binding only upon those who had consented thereto, and not on those who voted against. This perhaps arose from the use of the word “consent” in regulation 18(5). The Court summarily rejected this argument, finding that consent ought to be given by way of a majority and not by individual unitholders (who may either decide to be bound by the winding up or not). It noted that the dissenting unitholders’ argument would not only be against the scheme of the Mutual Funds Regulations, but it would also end up in an unworkable solution. How can the winding up of the scheme be binding on some unitholders and not others? To the contrary, the decision is whether the schemes should be wound up (in relation to all the unitholders) or not.
Although not explicitly discussed in the judgment, this situation brings to the fore an important distinction between collective decision-making and individual decision-making. In collective decision-making, the constituents (in this case the unitholders) are making a decision by way of a requisite majority that binds the mutual fund scheme as a whole, including the dissenting unitholders. The decision is a binary one that relates to the mutual fund scheme in its entirety. This is also generally the case when shareholders of the company exercise their votes in favour of or against a decision that a company wishes to make. In such a case, the shareholders are acting as an organ of the company and are effectively “the” company.
On the other hand, individual decision-making in a corporate context relates to a choice that an individual constituent (in this case the unitholder) wishes to make that will only bind such an individual, and not the others. Takeover offers or buyback offers are emblematic of this approach. Here, individual shareholders may decide whether they wish to sell their shares in a takeover or buyback offer or retain their shares. Such a decision would only operate regarding the shares they hold, and not in relation to the decisions that others make regarding their own shareholding. Clearly, a decision to wind up a mutual fund or a scheme, by its very nature as an end-game scenario, is a corporate decision and not an individual decision. Hence, the Court arrived at the apt conclusion that such a “consent” to be obtained under section 18(5) involved a collective decision-making process rather than an individual one.
Establishing the Denominator
The next issue before the Court was to determine the nature of the majority for unitholder decision-making, i.e., whether it requires a majority of all unitholders or only of a majority of unitholders present and voting. In the absence of guidance from the Mutual Funds Regulations, the Court was compelled to rely on the literature and precedents relating to decisions of general meetings and imbibe a generous dose of pragmatism in arriving at a meaningful solution.
The Court noted that implying that regulation 18(5) requires a majority of all unitholders “will not only lead to an absurdity but also an impossibility given the fact that mutual funds have” a vast body of unitholders, many of whom suffer from the “lack of expertise, commercial understanding, relatively small holding, etc.” [para 16]. Taking into account the purpose of the Mutual Funds Regulations, the Court sought to avoid “a ‘construction’ which would lead to commercial chaos and deadlock.” [para 18]. Greater weight was provided to achieve a practical outcome, and hence the Court concluded that the requirement for purposes of regulation 18(5) is a majority of unitholders present and voting.
A number of considerations emerges from the Court’s analysis and ruling in this count. First, given the absence of explicit regulatory guidance, it was open to the Court to arrive of one of two interpretations, i.e., majority of all unitholders, or majority of only those present and voting. The requirement of a majority of all unitholders would be in favour of minority shareholders, given that the threshold requirement for winding up a mutual fund scheme is more onerous. However, that would also give holdouts greater leeway to place a spoke in the wheel and stymie a decision that would have otherwise received widespread support (at least of those present and voting). On the other hand, a majority requirement of those present and voting would be more pragmatic and facilitate a transaction such as winding up of mutual fund schemes.
Second, a majority requirement of all unitholders would operate in favour of passive unitholders. In case more of them do not attend and vote and the meeting, the less the likelihood that the proposal put forward by management will pass through. On the other hand, the requirement of majority of unitholders present and voting will operate against passive unitholders. If they do not attend and vote, the will not be recognised either in the numerator or the denominator for purpose of determination of the majority. In that sense, passivity of some shareholders favours those who actually vote in favour of the management’s proposal. Despite the difficulties posed by collective decision making and shareholder passivity, they were considered to be the very reasons why a pragmatic solution was found to be necessary in ensuring the passage of decisions such as winding up of mutual fund schemes. In all, while considering possible conflicting interests, the Court favoured pragmatism over an unwavering support for minority unitholders.
Third, the Court also engaged in a detailed discussion of quorum requirements and the literature relating thereto in arriving at the solution. Although both are protective measures for unitholder decision-making, the quorum requirements and the majority requirements perform somewhat different roles. The Court’s reliance on literature and authorities pertaining to quorum in arriving at a conclusion on majority requirements is unclear.
Number or Value Voting
Another issue arose as to whether the majority requirement was to be decided by a show of hands, where one unitholder will have one vote (referred to in some jurisdictions as the “headcount test”), or through a poll, where a unitholder would have such number of votes that is equivalent to the number of units it holds (referred to sometimes as the “value test”). This is not clear from the wording of the Mutual Funds Regulations. However, this question was moot because the voting for winding up the Franklin Templeton resulted in a majority whether one applied the headcount test or the value test.
Finally, the Court was categorical in its observation that it would not easily interfere with resulting of a voting, unless any breach or mistake in the process has the effect of altering the ultimate outcome of the decision. It provided considerable deference to matters of internal management. Moreover, not only was the winding up decision passed with the support of a substantial majority of unitholders who were present and voting, but the shares held by the dissenting shareholders who litigated before the Court was only a miniscule percentage of units in the schemes. Given the absence of any indication of material infirmities in the voting process, the Court adopted a hands-off approach and refused to overturn the results.
The interpretational issues above arose on account of gaps in the regulation. As the Court noted:
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.
One hopes that SEBI would heed the Supreme Court’s call to clarify the majority requirements in regulation 18(5). In the meanwhile, the rationale laid down by the Court would bear utility in other provisions not merely in securities regulation or company law but also in other areas of the law where the majority requirements for decision-making are set out in an inchoate manner.