TaxTMI 
TaxTMI 
2023 (2) TMI 187
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....man, Senior Advocate, for Mr.Arun C.Mohan for R-4, Mr.R.Ravindran for R-5, Mr.R.Parthasarathy for Ms.Tanushree Aravind and Ms.S.Reka for R-6, Mr.Rohan K.George Mr.Pushkar for R-7, Mr.Anirudh Krishnan for R-8 And Mr.Rahul Balaji for R-9 COMMON ORDER Background Dewan Housing Finance Limited (DHFL) issued a prospectus dated 25.08.2016 in relation to the issuance of 10,00,00,000/- secured redeemable non-convertible debentures (NCDs) of the face value of Rs.1000/- each. 63 Moons Technologies Limited (63 Moons), a company previously known as Financial Technologies (India) Ltd. applied for allotment of NCDs pursuant to the above mentioned prospectus. Based on its applications, a first lot of 10,00,000 NCDs with a coupon rate of 9.05% and aggregate face value of Rs.100 crores; and a second lot of 10,00,000 NCDs at a coupon rate of 9.25% and aggregate face value of Rs.100 crore were allotted. In this manner, 63 Moons was allotted 20 lakh NCDs of the face value of Rs.200,00,00,000/-. Interest was required to be paid on the NCDs annually at the specified coupon rate and the date of maturity was 7 years from the date of allotment. 2. In the last week of January, 2019, the news port....
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....ifth defendant is the former Chief Financial Officer (CFO) of DHFL. The sixth and seventh defendants are the credit rating agencies (CRAs) which rated the relevant NCDs. The eighth defendant was the Statutory Auditor from the financial year 2016-2017 to the financial year 2017-2018. The ninth and tenth defendants were the statutory auditors up to the financial year 2015-2016. The eleventh defendant is the Debenture Trustee. 4. In the above mentioned suit, 63 Moons filed applications seeking interim relief by way of interim injunction, appointment of commissioner, disclosure of assets, provision of security, etc. By order dated 24.06.2020, all the respondents were restrained from alienating, encumbering or dealing with any of their assets pending further orders and the first defendant was restrained from declaring and disbursing dividend. Applications were filed by the defendants to vacate the said interim orders. The said interim orders are in force as on date. In addition, the defendants filed applications to revoke leave, reject or return the plaint, strike off their names from the array of parties, stay the suit or dismiss the plaintiff's applications. All the interim app....
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....lications to reject the plaint, the following contentions were raised by learned counsel for the respective applicant: (i) The suit claim arises out of the prospectus issued by DHFL in relation to the issuance and allotment of NCDs. Upon default by DHFL in fulfilling its payment obligations under the NCDs, 63 Moons filed Summary Suit No.1332 of 2019 before the Bombay High Court. The said suit was for recovery of amounts due and payable by DHFL under the NCDs. The cause of action for the said suit and the present suit is identical. The plaintiff did not apply for or obtain leave in Commercial Summary Suit No.1332 of 2019 for filing the present suit on the same cause of action. Therefore, the present suit is barred under Order II Rule 2 CPC. (ii) The NCDs were issued by DHFL. Without joining DHFL as a party, the suit does not disclose a cause of action. Therefore, the plaint is liable to be rejected on the basis of statements made in the plaint. (iii) The ninth defendant was the Statutory Auditor until the financial year 2015-2016. The prospectus was issued on 25.08.2016, which is after the 9th defendant resigned as statutory auditor. Therefore, the ninth d....
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....icant from the array of parties. Discussion, analysis and conclusion on applications to reject the plaint and strike off parties 10. The respective applicant seeks rejection of plaint on the ground that the plaint does not disclose a cause of action and on the ground that the suit appears from the statements in the plaint to be barred by law. The main basis on which it was contended that the suit is barred by law is that the cause of action for the present suit and the suit before the Bombay High Court is identical. In order to test the validity of this contention, the plaint in the suit filed by 63 Moons before the Bombay High Court should be examined. On perusal thereof, it is evident that it is a suit to recover a debt due under the NCDs issued and allotted to 63 Moons. In Iron and Hardware (India) Co. v. Shamlal and Brothers, ILR Bom739, a Division Bench of the Bombay High Court dealt extensively with the question as to what constitutes a debt due. The Court concluded that there should be an obligation at present although the discharge of the obligation may take place subsequently. In any action to recover a debt due, therefore, there should be a subsisting obligation to ....
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....iff suggests, that the trial court completely failed to construe the nature of the suit that the plaintiff herein instituted before the Bombay High Court. It is also evident that the trial court misread Section 35 of the Act of 2013 in holding that a suit under such provision "should be filed against the company and every other individual whom the plaintiff claims to be responsible for the reports made in the prospectus." The finding in such regard is clearly exceptionable. On a plain reading of the provision, it is apparent that the liability of the company and the several other persons indicated in Section 35(1) of the Act of 2013 are joint and several. That is apparent from the ordinary reading of sub-section (1) and, in any event, by virtue of sub-section (3) of Section 35 of the Act of 2013 in its use of the words "every person referred to in sub-section (1) shall be personally responsible ...". Thus, the fact that DHFL was not a party to this suit was of little consequence and the trial court erred in founding its opinion on such flawed and irrelevant consideration. Since insolvency proceedings had been commenced against DHFL by the time the suit was instituted, DHFL could no....
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....;'(emphasis added) In order to establish that a suit is barred under Order II Rule 2, it is necessary for the applicant to establish that both suits are founded on the same cause of action. As detailed earlier, the suit in the Bombay High Court was for recovery of a debt due and payable by DHFL to 63 Moons. Such debt was in terms of the debentures issued and allotted to 63 Moons, which created the debt and entailed repayment by DHFL to 63 Moons. By contrast, the present suit is for compensation or damages for alleged infraction of Section 35 of CA 2013, statutory and common law obligations imposed on one or more of the defendants herein. As on the date of the suit, the defendants are not under any legal liability to 63 Moons. Such liability would crystallize only if the suit were to be decreed wholly or in part. For reasons set out above, all the applications to reject or return the plaint are devoid of merit. Consequently, the said applications are liable to be rejected. Accordingly, Application Nos.2676, 2786 and 3069 of 2020 and Application Nos.657, 658 & 659 of 2021 are dismissed. 13. Turning to the applications seeking deletion of parties from the array of parties to....
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....hen the prospectus was issued. The eleventh defendant is the Debenture Trustee and was enjoined with the obligation of protecting the interest of debenture holders such as the plaintiff. Since the plaintiff subscribed to and, thereafter, held 20 lakh debentures by relying upon the statements made in the prospectus and the rating assigned by the CRAs, he submitted that all the defendants are liable. He also pointed out that until the Cobra Post article, neither of the rating agencies downgraded the ratings. Such ratings were downgraded for the first time in February 2019 and the default occurred a few months later in the same year. 15. Learned counsel referred to the loans extended by DHFL to sham entities. He pointed out that the ninth defendant was the auditor of several group companies to which funds were diverted such as RKW Developers, Sun Blink and Cloud Mind. By referring extensively to the forensic audit report of Grant Thornton, he pointed out that the gross misappropriation of public money is established by the said report. In particular, he pointed out that the report records that the money ostensibly disbursed against 2.6 lakh home loan accounts were actually siphoned....
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....rned counsel for the first to third defendants submitted that these applications are not maintainable because there is no debt due from the defendants to the plaintiff. By drawing reference to the judgment in Iron and Hardware (India) Co. v. Shamlal and Brothers, 1954 ILR Bom 735 and the subsequent judgment of the Hon'ble Supreme Court in Union of India v. Raman Iron Foundry, (1974) 2 SCC 231, it was submitted that the defendants cannot be called upon to provide security when there is no debt due and payable as on the date of institution of the suit. 18. Mr.P.R.Raman, learned senior counsel for the fourth defendant/former CEO, submitted that the fourth defendant resigned on 13.02.2019. He pointed out that the fourth defendant was no more than an employee of DHFL. He was not named in the prospectus. He was not a member of the audit committee or the risk management committee. Since it is an action for unliquidated damages, he contended that the defendants cannot be directed to provide security for the suit claim. Although the fourth defendant signed the financial statements up to the financial year 2017-2018, he stated that even prima facie fraud cannot be attributed to the fo....
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....inted out that the suit and the present applications are liable to be dismissed in limine on account of non-joinder of DHFL. In order to establish this contention, he referred to Section 35 of CA 2013 which uses the expression ''the company and every person who''. In view of the express language of Section 35, he contended that this action is not maintainable unless the company is joined as a party thereto. 20. Mr.Parthasarathy made submissions on behalf of the sixth defendant (CARE). By referring to the report of the US Securities and Exchange Commission (the SEC) in January,2003, he submitted that a CRA is not an auditor. A fortiori, a CRA is certainly not a forensic auditor. He submitted that a CRA relies on financial statements provided by the company concerned. By drawing reference to the order dated 22.09.2020 of SEBI, he pointed out that the role of a CRA was discussed therein at paragraphs 21, 23 and 85. After referring to the paragraphs of the plaint which relate to the CRAs, he contended that the plaintiff failed to discharge the burden of providing particulars of fraud as required by Order VI Rule 4 CPC. By turning to the rating agreement dated 18.06.2....
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....int which referred to the seventh defendant, he contended that the ingredients of Order 38 Rule 5 CPC were not satisfied. By referring to the judgment in Jindal Power and the Credit Rating Agency Regulations, 1999(the CRA Regulations), he outlined the duties of a CRA. He thereafter referred to the rating policy of the seventh defendant. With reference to the periodical reviews conducted by the seventh defendant, he submitted that all statutory obligations under CA 2013 and the CRA Regulations were adhered to strictly by the seventh defendant. He also referred to the SEBI order on the plaintiff's role in the collapse of the NSEL to underscore the fact that the plaintiff is complicit in financial wrong doing and cannot claim equity before this Court. In support of these contentions, learned counsel referred to and relied upon the following judgments: (1) Guna Narain Gupta v. Tiluckram Chowdhry and others, (1887- 88) 15 IA 119. (2) Balbir Singh Mayal and others v. Municipal Corporation of Delhi and others, MANU/DE/1698/2009. (3) Bhavani Stores Pvt Ltd. v. National Fertilizers Ltd, 1995 SCC Online Del 877. (4) Golf Technologies (p) Ltd and Anothe....
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....itor for any of the Bandra entities. By drawing reference to Section 35 of CA 2013, he submitted that the plaintiff failed to provide any particulars of the alleged misstatement. By drawing reference to the judgment in Moore Stephens v. Stone Rolls Limited, (2009) UKHL 39, he submitted that the duty of care of the auditor is primarily to the company and not to the debenture holders. He concluded his submissions by referring to the judgment of the Hon'ble Supreme Court in Raman Tech and Process Engineering Co v. Solanki Traders(Raman Tech), (2008) 2 SCC 302 and pointed out that the power under Order 38 Rule 5 CPC is a drastic power which should not be exercised except where really warranted since it would have the effect of converting an unsecured liability into a secured liability. The other judgments relied upon by learned counsel are set out below: (1) Bhushan Steel and Strips Limited v. Prem H Lalwani, (2000) 53 DRJ 483. (2) Renox Commercials Limited v. Inventa Technologies Private Limited, AIE 2000 Mad 213. (3) Fertilizer Corporation of India Limited v. Indian Explosive Ltd., (2005) SCC Online Cal 622. (4) Gem Graphics v. Sri Sai Papers (....
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.... (8) South Delhi Municipal Corporation and another v. Today Homes and Infrastructure Private Limited and others, (2020) 12 SCC 680. (9) Tri-Sure India Ltd. v. A.F.Ferguson and Co. & others,(1987) 61 Comp Cas 548. He concluded his submissions by referring to the judgment of the Hon'ble Supreme Court in Bachhaj Nahar with regard to the critical role played by pleadings in civil suits. In the absence of any particulars in the plaint, he submitted that the plaintiff is not entitled to any interim relief. 26. By way of rejoinder, learned counsel for the plaintiff referred to Regulation 3 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations,2015 (LODR) and pointed out that both the CEO and CFO were required to provide compliance certificates to the Debenture Trustee. As regards the Bandra books, he submitted that monies were diverted by reflecting 2.6 lakh ostensible home loan accounts in the books of DHFL. In response to the contention of the defendants with regard to the nature of the suit, he submitted that the suit is both under Section 35 of CA 2013 and under tort law. As regards Order 38 Rule 5 CPC, he submitted that interim relief is not ba....
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....an action for damages, a significant aspect is that the plaintiff admittedly invested in 20 lakh debentures under two separate issuances for an aggregate sum of Rs.200,00,00,000/-. The statement from the depository, National Securities Depository Limited, is on record in this regard. It is the admitted position and judicial notice may be taken of the fact that DHFL failed to fulfil its obligations towards all debentures holders, including the plaintiff. Consequently, there is no escaping the fact that the plaintiff was put to a loss of at least Rs.200,00,00,000/-. Thus, the loss incurred by the plaintiff is self evident and does not call for a trial. What remains is the attribution of responsibility for the loss incurred by the plaintiff on account of the failure by DHFL to fulfil its obligations. 28. The plaintiff asserted that it had joined all the persons who /which played a central role in the issuance of debentures by DHFL. The persons arrayed as parties by the plaintiff may be classified into about four categories. The first to third defendants qualify as promoters of DHFL. The fourth and fifth defendants fall into a separate category because they were senior officers of D....
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....ed in 2019. Both these officers were responsible for issuing compliance certificates to the CRAs. The CFO was obligated to examine the books of accounts and involve himself in the preparation and finalization of the financial statements of DHFL. The CFO executed the Debenture Trust Deed on behalf of DHFL. The documents on record establish prima facie that large loans were extended to entities allegedly executing SRA projects by taking a charge/mortgage of development rights. These documents also prima facie indicate that the money disbursed against 2.6 lakhs home loan accounts were actually siphoned off to off-balance sheet loan accounts, which came to be referred to as the Bandra books. While third party experts such as the CRAs may be able to contend with a measure of justification that they were not responsible for the preparation of the books of accounts and financial statements, such defence is not available to the fourth and fifth defendants. At the interlocutory stage, it may be concluded that prima facie they were both negligent and failed to fulfil their statutory obligations. Therefore, the interim order shall continue to operate against these defendants also until each o....
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....efused to interfere with the rating downgrade by the CRA although the issuer refused to accept the same. Likewise, in First Leasing Company of India Ltd. v. ICRA Limited, MANU/TN/1186/2000, this Court refused to accept that the CRA should await the audited accounts before publishing a revised rating. Such rating cannot be withdrawn as long as there are outstanding obligations under the rated instruments except in limited circumstances such as the winding up, merger or amalgamation of the issuer entity. Any infraction of the CRA Regulations would render the CRA liable to the actions set out in Part V of the SEBI (Intermediaries) Regulations, 2008 (the Intermediaries Regulations). As per Regulation 26(1) of the Intermediaries Regulations, the actions that a designated authority may recommend are inter alia cancellation of the certificate of registration; suspension of the certificate of registration for a specified period; prohibition of the noticee from taking up any new assignment or contract or launching a new scheme for such period as may be specified; debarment of an officer of the noticee from being employed with a registered intermediary for a specified period or the debarment....
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....t are set out below: "591.....S&P's business included the provision of independent expert opinions on the creditworthiness of "products" and to hold itself out as doing so, amongst other things, by publicly publishing and explaining its ratings. Indeed, the only available information as to the creditworthiness of the Rembrandt notes was S&P's rating. The risk S&P assumed for reward was liability to those persons who invested in the Rembrandt notes in reliance on the rating and who then suffered loss caused by the fact that the creditworthiness of the notes was much lower than that disclosed by S&P's rating. From an allocation of risk perspective, it cannot be said that the precise identity of the recipient of the expert information was a necessary element. S&P knew the investors (described as "interested parties") existed and authorised the distribution of the rating to them. The criteria in Tepko were and are sufficient, without more, to address that aspect of the issue." "593..... Here, the class was not indeterminate. It was both known and identified. It was possible to identify the class to whom the duty was owed as investors in the Rembrandt notes....
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....it is unclear whether such certificates were provided by DHFL to the CRAs and, if so, until when. 37. The CRAs placed for consideration the rating reviews carried out by them and these make for interesting reading. Unlike banks, NBFCs do not have the benefit of low cost current account and savings account (CASA) funds. Therefore, it is common knowledge that one of the biggest challenges faced by NBFCs is ensuring that sufficient liquidity is available by averting asset-liability mismatches. In the review conducted by BWR on 07.07.2016, it is stated that the liquidity position is comfortable both in the short and long term. In the next available review on 20.07.2017, BWR states that the liquidity position is comfortable for the short to medium term but that housing finance companies (HFCs) have mismatches in the long-term which need to be managed appropriately. More or less identical language is seen in the reviews that followed on 04.05.2018 and 03.09.2018. What is noticeable during the above reviews is that the specific cash flow data: projected inflow versus outflow of funds is not set out. Between 03.09.2018 and 02.02.2019, there is no review on record. The review on 03.02.20....
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....fulfil their statutory and common law obligation to monitor and review the ratings so as to provide a true and accurate rating. For such reason, they are prima facie liable. Therefore, the CRAs cannot be absolved from liability. The Auditors 40. The three firms of auditors (the eight to tenth defendants) endeavoured to absolve themselves of responsibility on the ground that they were not responsible for the financial statements, which were referred to and relied on in the prospectus. While the eighth defendant contended that the financial statements for the financial years 2011-2012 to 2015-2016 were relied upon in the prospectus and that the eighth defendant did not carry out audit during the said period, the ninth defendant contended that the prospectus was issued in the financial year 2016-2017 after the said defendant had resigned. However, the question arises as to whether they owe a duty of care to the plaintiff. Statutory Duty 41. Chapter IX of CA 2013 deals with the accounts of companies and Chapter X deals with audit and auditors. As per Section 134(2), the auditor's report shall be attached to every financial statement. Section 136(1), subject to the limit....
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.... an audit is carried out for the purpose of examining whether the financial statements and the underlying accounts represent a true and fair view of the financial status of the company. After recognising the role of proximity and fairness in fixing the duty of care, Lord Bridge of Harwich quoted with approval the following passage from Lord Denning's dissent (subsequently affirmed as stating the law correctly in Hedley Byrne & Co. Ltd. v. Heller & Partners Ltd. [1964] A.C.465) in Candler v. Crane Christmas & Co.[1951] 2 K.B.164: "....Secondly, to whom do these professional people owe this duty? I will take accountants, but the same reasoning applies to the others. They owe the duty, of course, to their employer or client; and also I think to any third person to whom they show the accounts, or to whom they know their employer is going to show the accounts, so as to induce him to invest money or take some other action on them." In the specific factual context of the investment being made after the audit report was provided, Lord Bridge recorded the following findings: "....The situation is entirely different where a statement is put into more or less general ....
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....t of an action by a company in liquidation for fraud by its former controlling shadow director. Moore Stephens, however, turned largely on the ex turpi causa principle since the fraud was perpetrated by the former controlling shadow director of a company construed as a one-person company and the company was the plaintiff. As would be evident from the provisions of CA 2013, which were reproduced previously, the position, role and responsibilities of an auditor in India substantially mirror that in the UK. Therefore, even in the Indian context, I do not see any reason to depart substantially from the principles laid down in Caparo Industries. The conclusion that may be drawn thereby is that the auditor owes a duty of care to the company and all registered shareholders and debenture holders at the time of submission of the audit report and its adoption by the members. 44. Applying these principles to the fact situation, 63 Moons became a debenture holder upon subscribing to the debentures floated under the prospectus. In the case of shareholders, whose interest is ordinarily aligned with that of the company, an argument that the company should espouse the cause may be required to b....
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....the audit and cannot disclaim responsibility. Whether the eighth defendant failed to exercise reasonable care should be considered next. 46. The financial statements for the previous five years were referred to in the prospectus as material documents. Therefore, they were intended to be relied upon by investors. The defence that the eighth defendant raised, in that regard, is that they did not audit the accounts in those years. While the said contention is factually correct, the prospectus indicates that the reformatted consolidated and standalone financial statements for the above mentioned financial years were examined and approved by the eighth defendant. In fact, the material documents listed therein include the consent of the auditor for the inclusion of their name and the report on the reformatted financial statements. Clearly, some responsibility and liability should be attached to a statutory auditor who examines and approves reformatted financial statements even if the weight attached thereto is not equal to that attached to an auditor's report. 47. 63 Moons has placed on record the sanction letters issued by DHFL to about ten real estate developers such as RIP D....
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.... remaining eight sanction letters for SRA projects follow the same pattern of being secured by a charge/mortgage over development rights and were issued in the financial year 2016-2017. The amounts sanctioned are in the range of Rs.360-675 crore. It cannot be discerned from the balance sheet or even the relevant note thereto whether the loans were disbursed because such granular details are unavailable. Certainly, the books of account would contain the details and the auditor was duty bound to examine the same in course of audit. The eighth defendant did not assert that these loans were not disbursed or provide any explanation in relation thereto. From the independent auditor's report of the eighth defendant, attached to both the standalone and consolidated financial statements of DHFL for the financial years 2016-2017, it is evident that there is no qualification, reservation or adverse remark in this respect or in any other. Therefore, prima facie, the eighth defendant owed a duty of care to 63 Moons and failed to discharge such duty while approving the reformatted financial statements and while auditing the accounts later. It was reasonably foreseeable that investors in the ....
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....tee, Catalyst Trusteeship Limited. Section 71 of CA 2013 and Regulation 16 of the SEBI(Debenture Trustees)Regulations, 1993 mandate that a debenture redemption reserve (DRR) should be created in the manner prescribed by a company which issues debentures. The Debenture Trust Deed provided for a first ranking pari passu charge over the receivables, both present and future, as security for the debenture holders. Undoubtedly, therefore, the Debenture Trustee owed a duty of care to the debenture holders, including 63 Moons, both under statute and common law. Upon service of notice, M/s Akhil Bhansali and Aazim Shehzad, learned counsel, appeared on behalf of the Debenture Trustee on 15.07.2020, but not thereafter. According to 63 Moons, the Debenture Trustee/eleventh defendant did not take action to protect the interest of debenture holders and the facts on record corroborate such contention. In fact, the communication dated 24.06.2019 from the Debenture Trustee discloses that DRR was not created either for the financial year ended 31.03.2018 or 31.03.2019. Therefore, there is a strong prima facie case that the Debenture Trustee was negligent and is, therefore, prima facie liable. App....
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....on. The seventh defendant is also currently facing proceedings at the instance of SEBI in relation to its functioning as a CRA. Out of the auditors, I concluded that only the eighth defendant is prima facie liable. This defendant is also based outside Chennai and may not have assets within Chennai. I also concluded that the eleventh defendant is liable. The eleventh defendant has chosen not to participate in proceedings after initially entering appearance through counsel. These facts and circumstances considered cumulatively, in context, justify the issuances of orders directing those found prima facie liable to provide security for the principal suit claim. At this juncture, liability to provide security for the suit claim cannot be apportioned with any degree of accuracy. Nonetheless, by taking into account the role played by the respective defendant, the obligation to provide security is apportioned for interlocutory purposes. 53. For reasons set out above, the following orders are issued: (1) All the applications to reject or return the plaint (Application Nos.2676, 2786 and 3069 of 2020 and Application Nos.657, 658 & 659 of 2021) are dismissed. (2) All the....