Franklin Templeton scheme investors’ wait gets longer despite favourable verdict — Here’s why

Even as the Karnataka High Court (HC) has upheld the view that unitholders’ consent is a must before wind-up of any mutual fund (MF) scheme, the investors expecting at least partial funds to come from the cash-positive schemes of FT MF after three months of court hearings may have to wait a little longer.

When responding to a petition that a direction be issued to return money to the investors, the HC said that as the decision of trustees to wind up schemes is held valid, the investors will be entitled to receive money as per the existing wind-up regulations.

“The investors will get the money only after sale of assets of the scheme and that also after making payment to the creditors and making a provision for expenses of liquidation. In case the decision of the trustees is held to be bad in law, then the unit-holders will have to make requests for redemption,” the HC order read.

HC observed that the investors will be able to get their funds as per sub-clause (b) of clause (2) of regulation 41 (of SEBI MF regulations), which deals with the procedure and manner of winding up.

As of October 15, 2020, four of the six FT MF schemes under wind-up, are cash positive. These include Franklin India Ultra Short Bond Fund (40 percent assets in cash), Franklin India Dynamic Accrual Fund (19 percent), Franklin India Low Duration Fund (19 percent) and Franklin India Credit Risk Fund (4 percent). Overall, the six wound-up FT MF schemes have received total cash flows of Rs 8,302 crore (as of October 15, 2020), from maturities, pre-payments and coupon payments since the wind-up was announced, of which close to Rs 5,000 crore is available to be distributed to unitholders, after paying off the fund house’s lenders.

Franklin Templeton had shut six debt mutual fund schemes on April 23, citing redemption pressures and lack of liquidity in the bond market.

Why more clarity is needed?

After the judgment was pronounced, Janak Dwarkadas, the counsel for FT MF and Franklin Templeton Trustee Services Private Limited sought a stay on the operation part of the judgment.

While some of the other petitioners opposed this plea, the HC granted a stay for six weeks, starting from October 24, 2020.

According to some of the parties involved in the matter, the stay was sought so that FT MF can appeal to the Supreme Court (SC) against the judgment.

Experts say more clarity is needed. “If the unitholders don’t agree with the wind-up decision and the schemes are opened for redemptions, it could potentially lead to stress-sale and more borrowings by schemes to meet this redemption pressure,” said Kirtan Shah, chief financial planner of SRE.

“Such a sale could also potentially lead to challenges for other bondholders as this kind of a firesale would lead to spike in yields of several corporate bonds,” he added.

Sources suggest that not only FT MF is likely to appeal to SC soon, but also seek an interim order that can allow funds from cash-positive schemes to be transferred to the investors. This, experts point out, is perceived to be a middle-ground for the fund house to ensure investors get some money now. And then the rest of the money, as and when it can sell the other underlying securities or when they naturally come up for maturity.

Where HC has found lapses?

While the HC has come down heavily on Sebi’s handling in the wind-up matter, it has held the view that the decision to wind up schemes can only be taken after permission of the unitholders is taken.

“We hold and declare that the decision of the trustees (the Franklin Templeton Trustee Services Private Limited) to wind up six schemes mentioned … by taking recourse to sub-clause (a) of clause (2) of regulation 39 of the mutual funds regulations cannot be implemented unless the consent of the unit-holders is obtained in accordance with sub-clause (c) of clause (15) of Regulation 18,” the HC order read.

This regulation simply states that the trustees shall obtain the consent of unitholders, when the majority of the trustees decide to wind up or prematurely redeem (withdraw) the units.

The HC has barred trustees from taking any further steps till consent of unitholders by a simple majority is taken for the wind-up. FT MF in its statement has said, “The Hon’ble Karnataka HC has upheld the authority and decision taken by the trustees to wind-up the schemes under regulation 39(2)(a). As per the judgement, for operationalising such a decision, approval of the unitholders will be required under regulation 18(15)(c).”