Franklin Templeton case: Karnataka HC says MF trustees cannot be indemnified

The Karnataka High Court’s 336-page order relating to the winding up case of debt funds of Franklin Templeton Mutual Fund (FT MF) rules that giving indemnity to trustees (i.e. protection against liabilities) cannot be allowed, unless unitholders agree to such a proposal. The HC examined arguments on the role of trustees during the winding-up and questions that were raised on granting of indemnity to trustees. In its order, the HC said, “Sub-clause (ii) clause (2) of regulation 15 clearly indicates that the trustees or AMCs are responsible for any loss or damage caused to the unit-holders by their acts of negligence or acts of commission or omission. The reason is that it is provided that there cannot be a clause indemnifying the trustees for such a loss or damage.” Seeking immunity In June, Franklin Templeton Trustee Services called for an extraordinary general (EGM) meeting to grant indemnity to directors of the trustee company, in relation to any liability with the decision to wind up the six debt schemes. The EGM notice read, “It is also being proposed to widen the scope of indemnity. This would include covering any liability that may result from regulatory action. It would also be applicable in case of negligence, default, breach of duty, and breach of trust by any person under this indemnity.” The notice pointed out that the articles of association of the company (Franklin Templeton Trustee Services) offers indemnity cover to every director against liability in respect of matters which arise from “acts or omission of such person in the ordinary course of discharging his/her authorised duties in good faith and in the company’s best interests.” Reading between the lines The regulation 15 of the mutual fund (MF) regulations of Securities and Exchange Board of India (SEBI) deals with the composition of a trust deed. The court also cited clause 17 from the third schedule of SEBI’s regulations, which state that no amendment to the trust deed shall be carried out without taking the prior approval of SEBI and unitholders. “Indemnity is there for normal course of action. But, if it is granted to protect any potential negligence or wilful breach, it would defeat the purpose,” says Ajay Shaw, partner, DSK Legal. Says the chief executive officer of a fund house, requesting anonymity, “The HC’s interpretation shows that trustees cannot absolve their responsibilities. Even if they say they have relied upon a fund house, they would have to demonstrate that they applied their own mind, especially in critical decisions.” It remains to be seen how the Supreme Court (SC) views the HC’s interpretation, as FT MF is expected to file an appeal in the SC to get clarity on issues such as protecting the investment value if schemes are re-opened for redemptions, and seek interim direction to disburse funds from cash-positive schemes. The HC has also come down heavily on SEBI for not playing a proactive role in the winding-up matter. The court observed that SEBI “ought to have been cautious and ought to have played a very active role.” “SEBI was expected to play a very proactive role by questioning AMC, trustees and sponsor about the compliances with the provisions of the mutual funds regulations,” HC said.