Supreme Court on Applicability of the Regime on Collective Investment Schemes

The Supreme Court of India earlier this month ruled on the applicability of the regulatory regime relating to collective investment schemes (“CIS”). In Securities and Exchange Board of India v. Gaurav Varshney, the legal question was rather straightforward. On 25 January 1995, section 12(1B) was inserted into the Securities and Exchange Board of India Act, 1992 (the “SEBI Act”). It provided that no person shall carry out a CIS unless he or she obtains a certificate of registration from the Securities and Exchange Board of India (“SEBI”) “in accordance with the regulations”. However, the “regulations” referred to in the said provision were enacted by SEBI only with effect from 15 October 1999 in the form of the SEBI (Collective Investment Schemes) Regulations, 1999 (the “CIS Regulations”). In the interim, on 3 July 1995, the respondents in the principal appeal, Gaurav Varshney and Vinod Kumar Varshney, began carrying out CIS operations through a company they incorporated. The legal question therefore was whether by carrying out CIS activity during the period when section 12(1B) (that imposes a bar on such activity without registration) was in force but not the CIS Regulations (that prescribe the mode of obtaining SEBI approval), the Varshneys were in breach of the legal regime so as to be subject to criminal action. The High Court below quashed SEBI’s action under section 482 of the Criminal Procedure Code. It is against this decision that SEBI appealed before the Supreme Court.
The Ruling
In answering the legal question, the Supreme Court interpreted section 12(1B) of the SEBI Act, which reads as follows:
No person shall sponsor or cause to be sponsored or carry on or cause to be carried on any venture capital funds or collective investment scheme including mutual funds, unless he obtains a certificate of registration from the Board in accordance with the regulations:
Provided that any person sponsoring or cause to be sponsored, carrying or causing to be carried on any venture capital funds or collective investment scheme operating in the securities market immediately before the commencement of the Securities Laws (Amendment) Act, 1995 for which no certificate of registration was required prior to such commencement, may continue to operate till such time regulations are made under clause (d) of sub-section (2) of section 30.
After analyzing the provision, the Supreme Court concluded that it has two parts. The first, signified by the main provision, relates to persons who had not commenced CIS activity prior to 25 January 1995, when the provision was brought into force, i.e. those who began the business afresh after that date.[1]The second, signified by the proviso, relates to those who were carrying on CIS activity even prior to that date, i.e. existing activity.[2]After doing so, the Court concluded that the case relating to the Varshneys would fall within the first part of section 12(1B), i.e. new activity. The question therefore was whether the bar against commencement of CIS activity after 25 January 1995 (when section 12(1B) came into force) would operate from that date or only when the regulations prescribed by SEBI thereunder came into force. Here, the court was emphatic in its conclusion that the bar against commencing CIS activity without registration would operate with effect from the date that the statutory provision (i.e. section 12(1B)) came into force and not only when the regulations were notified. The Court observed:
21. … Our inevitable conclusion is, that sponsoring or carrying on any collective investment activity, for the first time, on or after 25.1.1995, was a complete bar, in the absence of a certificate of registration from ‘the Board’. It accordingly follows, that if a person/entity had commenced to sponsor or carry on a collective investment scheme after 25.1.1995, without obtaining a certificate of registration from ‘the Board’, it would tantamount to breaching the express mandate contained in Section 12(1B) of the SEBI Act.
22. In our considered view, there can be no doubt, that the date when the Collective Investment Regulations came into force (-15.10.1999), has no relevance, insofar as the breach of Section 12(1B) of the SEBI Act, with reference to such new entrepreneurs, is concerned. The bar to sponsor or cause to be sponsored, or carry on or cause to be carried on any collective investment activity by a new entrepreneur (-who had not commenced the concerned activities, before 25.1.1995) under Section 12(1B) of the SEBI Act, was not dependent on the framing of the regulations. The above bar was absolute and unconditional, till the new entrepreneur (described above) obtained a certificate of registration, in accordance with the regulations. …
Although on this legal question the Supreme Court held in favour of SEBI, it upheld the decision of the High Court below in quashing the criminal proceedings against the Varshneys. This was on account of procedural issues. The Court placed considerable emphasis on the fact that SEBI’s complaint was made under the proviso category, i.e. where a person was carrying on existing CIS activity when section 12(1B) was brought into force. On the other hand, the complaint ought to have been made under the non-proviso category, i.e. in respect of new businesses that were commenced after the section as brought into force on 25 January 1995. This distinction was found to be rather crucial, and the fact SEBI proceeded under the wrong category was found to be fatal to its prosecution.
Hence, while the substantive legal question was decided in favour of SEBI, the procedural question was answered for the benefit of the Varshneys, due to which SEBI’s complaint against them was quashed. Apart from the case relating to Varshneys, the Supreme Court also dealt with the disposed off certain related appeals on similar and other related questions.
From a broader perspective, the Supreme Court’s decision has implications on restrictions of commercial activity imposed by legislation, especially when such activity is subject to licensing or registration requirements. Since such restrictions are subject to detailed rules or regulations to be promulgated by the regulatory authorities, the decision has implications on how persons may carry out such activities between the time that the legislation has imposed a restriction and before the regulatory authorities promulgate the rules or regulations. The Court’s resounding answer is that the activity cannot be carried out in the interim, and this operates as a total prohibition. That prohibition will be lifted only when the rules or regulations are subsequently promulgated. The issue becomes even more acute when there is a considerable delay between the imposition of the legislative restriction and the subsequent promulgation of the rules or regulations, as was the case with section 12(1B) and the CIS Regulations, which faced a delay of over three years. This puts affected parties at a disadvantage, as no CIS activity could have been carried on in the interim period. The lesson from this decision for the regulatory authorities would be that they ought to institute mechanisms for licensing or registration as soon as any such restrictions are imposed by legislation, without any delays in the interim.
On the other hand, the procedural aspect of the decision has the impact of imposing an onerous burden on the regulators in that they are required to be more specific regarding the offence that has been committed by a party. In circumstances such as in the present case, where section 12(1B) contains two parts, i.e. for existing businesses and new businesses, the regulator will have to specify whether the violation in a given case is under either of the two parts. If the regulator fails to do so, then prosecution for an offence under the SEBI Act could end up being futile as it turned out in the present case.

[1]This the Court referred to as the “non-proviso category”.
[2]This the Court referred to as the “proviso category”.

Supreme Court Resolves Conflict Between Companies Act and SICA

[The following guest post is contributed by Aditi Jhunjhunwala, who is a partner at Vinod Kothari & Co. The author can be contacted at]
In a recent ruling in the case of Madura Coats Limited v. Modi Rubber Ltd. & Anr., the question before the Supreme Court on appeal was: where an order for winding up is passed under the Companies Act and the company has made a reference before the Board for Industrial and Financial Reconstruction (BIFR) which is registered, can the company take shelter under section 22 of Sick Industrial Companies Act, 1985 (SICA) (that relates to suspension of legal proceedings and contracts)? The Court upheld the argument and ruled that the very scheme of law is that the revival of company must be first resorted to rather than putting it to death. In paragraph 20 the Court observed that:
“The legislative intention is to ensure that no proceedings against the assets of the company are taken before any decision is taken by the BIFR because if the assets are sold or the company is wound up, it may become difficult to later restore the status quo ante.”
This post highlights some of the important issues that arise from the ruling.
Overriding effect of SICA
Section 22 of SICA is a non-obstante clause providing that any other legal proceedings under any other law in connection with the industrial company shall not be proceeded with any further and that a winding up order, if any, will also be stayed where a reference has been made before the BIFR. A similar issue was raised in the present case as well where Modi Rubber resorted to the making of an application before BIFR while the Court had passed the winding up order against it on an application made by Madura Courts Limited. However, the very scheme of law is that it does permit such an action by a company whereby it may use this leeway and take shelter under section 22 of SICA wherein the provisions of SICA would prevail over Companies Act. Similar decisions have been rendered in the case of Tata Motors Ltd v. Pharmaceutical Products of India Ltd., (2008) 7 SCC 619 and Real Value Appliances Ltd. v. Canara Bank, (1998) 5 SCC 554, which were relied upon by the Modi Rubber in the instant case.
The High Court however did not take into consideration the contention of Modi Rubber citing that what is important is not the date of filing the application with BIFR but the date of registration of the application, which in the present case was after the date of the passing of the winding up order. However, the Court thereafter took into consideration the subsequent events, namely the fact of registration of the reference and relying upon Rishabh Agro Industries Ltd. v. P.N.B. Capital Service Ltd., (2000) 5 SCC 515 it was held that Modi Rubber was entitled to the benefit of the provisions of Section 22 of the SICA. The High Court also held that a winding up order passed under the Companies Act, 1956 is not the culmination of the proceedings pending before the Company Court. The final order to be passed in the winding up proceedings is an order of dissolution of the company under Section 481 of the Act.      
Abuse of process of law
It was argued by Madura Courts that since the reference before BIFR got registered only after passing of the order of the winding up by the Court, Modi Rubber cannot take shelter under SICA and that the order for winding up should prevail. However, the Court based on various judicial pronouncements and the scheme of law discussed that the scheme is such that the company must be first allowed for revival and that only then should the period of moratorium begin. Although this scheme seems to be in the spirit of things, this provision being overriding in nature over other laws may be used as a protracting device by companies at times. The provisions of SICA prevailing over the winding up order has always been controversial. In paragraph 25 of the ruling the Court discussed that it could not be said that the provisions of Section 22 of the SICA would not be attracted after an order of winding up is passed.
In fact the Court in paragraph 20 lamented that although at times it may seem that the provision of law may be used but may cause abuse of process of law, however, the Court cannot do anything about the same as the same is for the legislature to take appropriate steps. Therefore, this become obvious that the Court also acknowledges the fact that the provisions of law could be misused as well.
Provisions under the Bankruptcy Code
The provisions of the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as the “Code”) provides for corporate insolvency process. Once the Code comes into force, the Sick Industrial Companies (Special Provisions) Repeal Act, 2003 will be enforced. Once the said Act gets enforced, SICA being the principal legislation will lose its existence. Therefore, the revival of companies will not be possible under SICA. Currently, sections 253 to 269 of the Companies Act, 2013 provide for revival of companies; however, the said sections are not yet enforced. Therefore, once SICA gets repealed one would have to take shelter under the Companies Act, 2013. However, with the Code coming into force, these sections will get omitted as one will have to proceed for revival under Chapter II of the Code.
Once an application under the Code is admitted by the National Company Law Tribunal (NCLT), all the proceedings under other laws will be stayed until the moratorium period under the Code.

Aditi Jhunjhunwala