TaxTMI 
TaxTMI 
2023 (2) TMI 187
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....ohan 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 portal, Cobrapost.com (Cobra Post), published an ....
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....cer (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 applications are dealt with and disposed of by this co....
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....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 defendant is liable to be deleted from the array of parties. The fourth and eighth de....
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....ike 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 be performed by the defendant for the plaintiff. As regards the Bombay suit, DHFL was under a subsisting obligation to....
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....fore 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 not have been impleaded as a party by virtue of Section 14 of the Code of 2016 and the punishment attracted under Section 74(2) t....
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....s 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 the suit, these applications are premised on the assumption that the said parties are not necessary or proper parties to the suit. In the suit, the plainti....
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....ers 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 off to off-balance sheet loan accounts, which came to be referred to as the Bandra books. For the same purpose, he also relied upon the report submitted by the C....
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....sequent 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 fourth defendant. He referred to the judgment of the United States Court of Appeals for the Second Circuit in Alex E. Rinehart and others v. John F. Akers and others, Judgment dated 15.07.2013, and pointed out that even after the collapse of Lehman Brothers, a mega financial institution, liabili....
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....ed 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 18.06.2014, he pointed out that the rating is reviewed on quarterly basis for listed companies. For purposes of such review, he stated that capital adequacy, profitability, and the extent of non performing assets are the key considerations. He then referred to the rationale for ratings followed by the sixth defendant over a period of time. With ....
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....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 Another v. Axis Bank Ltd. And others, 2015 SCC Online Del 9869. (5) HDFC Bank Limited v. Ashapura Minechem Limited, MANU/GJ/1686/2017. (6) Punjab National Bank v. J.Samsath Beevi and others 2010 (3) CTC 310. (7) NCC Limited v. Sembcorp Gayatri Power Ltd and Others, MANU/AP/0762/2017. (8) S.Krishnaswamy and others v. South India Film Chamber of Commerce and others, 1967 SCC Online Mad 132. (9) Svenska Handelsbanken....
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.... 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 (20130 1 LW 452. (5) Parsvnath Developers Ltd v. SEBI 2019 SCC Online SEBI 37. (6) Berg Sons Co. Ltd and others v. Adams and others, (1992) BCC 661 (7) Plan Assure PAC v. Gaelic Inns Pte. Ltd, [2007] SGCA 41 (8) Department of Company Law Administration, Ministry of Commerce and Industry v. R.N.Raja Iyer, Chartered Accountant and another, (1964) 77 LW 207. (9) B.Ganesh v. Superintendent of Police, Central Bureau of Investigation, Economic Offences Wing, MANU/TN/ 4219/2017. (10) International Air Transport Associati....
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....isclosure 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 barred even in a suit for compensation. As regards the alleged non-joinder of DHFL or any other party, he submitted that the plaintiff is dominus litis and that such non-joinder does not absolve the defendants of liability. Although the plaintiff is financially literate, he submitted that the plaintiff is not an expert. As regards the NSEL dispute, he contended that the said dispute is irrelevant for purposes of the present case. By drawing reference to Section 14 and 74(2) of the Insolvency and Bankruptcy Code, 2016 (the IBC), he submitted that it is not possible to implead DHFL and that the plaintiff would be liable to be prosecuted if DHFL....
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....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 DHFL, who meet the requirement for being classified as key managerial personnel under CA 2013. The two CRAs, the sixth and seventh defendants, fall into a distinct category inasmuch as they were experts whose services were utilized by DHFL for rating the relevant security. Admittedly, both the CRAs assigned the highest rating to the securities. Such ratings were downgraded for the first time in 2019 after the Cobra Post article. The eighth to tenth Defendants form a separate category. These firms were the statutory auditors of DHFL either when the prospectus was issued or in the preceding financial years. The eleventh defendant is the Debenture Tr....
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....e 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 of them provides security to the extent of 15% of the suit claim. The CRAs 31. As regards the liability of the sixth and seventh defendants, the plaintiff asserted that they were the named experts in the prospectus. The plaintiff further contended that they had assigned the highest credit rating to the NCDs and that such credit rating was relied upon by the plaintiff in subscribing to NCDs. The plaintiff also contended that such rating was not downgraded until the Cobra Post article was published in January 2019. 32. The CRAs do not deny that they rated the NCDs or that they provided the highest rating to the NCDs. The admitted position is that they do....
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.... 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 of a branch or office of the noticee from carrying out activities for a specified period. Thus, the CRA Regulations impose statutory obligations on CRAs and provide a statutory mechanism for dealing with infractions inter alia by the above mentioned measures being taken by the designated member of SEBI on recommendation by the designated authority. But the CRA Regulations do not deal with or regulate the liability of the CRA to investors in securities rated by it. Whether there is a duty of care and liability under common law is considered next. Duty of care and liability under common law 34. Here, the debentures had a tenure of seven years. Consequently, the CRAs were under the....
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....he 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. This is sufficient. Liability was not indeterminate because S&P did not know the precise identity of the members of the class, the exact number of members in the class or the exact loss. S&P knew what it needed to know. It knew the characteristics of the class. S&P knew that a characteristic of the class was that each was an investor in the Rembrandt notes. S&P also knew the foreseeable type of loss. It is the nature of loss, not the precise amount which is relevant: Perre v Apand at 221-222[107]-[108]. Here, the nature of the foreseeable loss was not in doubt. S&P knew that if S&P's opinion as to the creditworthiness of the notes was careless, investors were likely to lose the money they had invested in the notes."....
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.... 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 03.02.2019 is after the Cobra Post article. During this review, the first downgrade is made from BWR AAA to BWR AA+. Even during this review, no specific information is provided with regard to liquidity. For the first time, during the review on 09.03.2019, while downgrading from BWR AA+ to BWR AA, specific information is set out regarding liquidity. BWR states that an inflow of Rs.6600 crore is due by way of EMI between March and May 2019 and that about Rs.4700 crore is available in the form of liquid assets. As against this, the outflow towards meeting obligations is stated to be Rs.10300 crore. Even if 10% of the inflow did not materialise, it is clear that a default loomed large by then. 38. As regards reviews by CARE, in the review ....
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....nded 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 limited deviation as regards listed entities, confers on members and debenture-holders, represented by the debenture trustee, the right to receive a copy of the financial statement, including the attached auditor's report. Section 142(2) provides inter alia that the audit report should state that, to the best of the auditor's information and knowledge, the accounts and financial statements give a true and fair view of the state of the company's affairs as at the end of the financial year and the profit and loss and cash flow for the year. 143(3) prescribes the statements that should be contained in the audit report. Of particular relevance, are the following: "(3) The auditor's report shall also state- (a) whether he has sough....
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....s, 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 circulation and may foreseeably be relied on by strangers to the maker of the statement for any one of a variety of different purposes which the maker of the statement has no specific reason to anticipate. To hold the maker of the statement to be under a duty of care in respect of the accuracy of the statement to all and sundry for any purpose for which they may choose to rely on it is not only to subject him, in the classic words of Cardozo C.J. to 'liability in an indeterminate amount for an indeterminate time to an indeterminate class:' see Ultramares Corporation v. Touche (1931) 174 N.E.441, 444...." "These considerations amply justify the conclusion that auditors of a public company's accounts owe no duty of care to members of the public at large who rely upon the accounts in deciding to bu....
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....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 be dealt with by a complaining shareholder. As regards debenture holders, the argument that the debenture trustee and not an individual debenture holder should espouse the cause could ordinarily be made. But, here, the plaintiff alleges with prima facie a fair measure of justification that the Debenture Trustee failed to fulfil obligations to debenture holders, including 63 Moons. Therefore, such objection is untenable. 45. The ninth and tenth defendants audited the accounts from the financial year 2011-2012 to 2015-2016, i.e. the financial years that preceded the issuance of the prospectus. As regards these defendants, on the principles discussed above, when they undertook audit, the plaintiff would not fall within the determinate class of persons who could be expected to rely on the audit reports. Moreover, it appears prima fa....
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....rly, 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 Developers Pvt. Ltd., Kanitha Real Estate Pvt. Ltd., Earleen Real Estate and the like. Out of these, two sanction letters were issued in the financial year 2015-2016. The sanction letter dated 20.10.2015 in favour of RIP Developers Pvt. Ltd. (RIP Developers) shows that a project loan of Rs.725 crore was sanctioned towards a purported slum rehabilitation authority project (SRA project). The security for the loan is an exclusive charge by way of a registered mortgage over development rights! The sanction letter dated 9.05.2015 for a sum of Rs.475 crore in favour of Kanitha Real Estate (Kanitha) for a SRA project is similarly purportedly secured by an exclusive charge over the undivided share in development rights. 48. In the documents filed by the ninth defendant, documents relating to these two loans are included. From the document rel....
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....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 NCDs would rely on the financial statements. If restricted to registered debenture holders by excluding prospective investors, they would constitute a determinate and not indeterminate class. In fact, in Manchester Builders Society, the UK Supreme Court held liable the auditor who provided technical accounting advice in relation to interest rate swaps as a method of hedging against mismatch arising out of the primary mortgage business of the company concerned. In contrast to Caparo Industries, the auditor was held liable because advice was provided with the knowledge that it would be relied upon to avoid mismatch and thereby obviate the need for higher regulatory capital. 50. 63 Moons also placed on record the report dated 27.08.2020 of Grant Thornton. This report deals extensively with 2,50,315 fictitious home loan accounts (the Bandra ....
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....ecord 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. Apportionment of liability to secure claim 52. All the defendants who were represented by counsel contended with great vigour that this is an action for unliquidated damages and, therefore, the interim order in force should be discharged and that the defendants should not be called upon to provide security. They placed reliance on several judgments such as Raman Tech. While Raman Tech and other judgments underscore that the remedy under Order 38 CPC is drastic, the law does not impose an embargo on granting such relief in an action for damages. An unusual feature of this action is that the loss incurred by 63 Moons is self-evident. Equally, the causal connection between subscribing to the debentures and the loss is also undisputed. Of course, it still remains to be decided as to the extent such loss can be attributed to each defendant for breach of their re....