Karnataka HC tells Franklin to seek unitholders’ consent for winding up 6 debt funds; what next?

The Karnataka High Court order delivered on Saturday sets in motion different possibilities and investors must take a considered view of things before rushing to a decision

Kumar Shankar Roy Oct 24, 2020

Franklin Vodafone debtWith the Karnataka High Court delivering its verdict on the contentious Franklin 6 debt funds winding up issue, it is important for investors to now understand the implications of the judgment and consider the various scenarios that can build up. While the High Court did not interfere in Franklin Trustees’ decision to wind up six debt schemes managing Rs 26,000 crore, the court did direct the fund-house to take consent, by simple majority, of unitholders for the winding-up move. The operation of the HC order has been stayed for six weeks to give time to FT India to appeal the order. Till then status quo on refund, redemptions should be maintained, the court has ruled. What does it mean for your money? How soon will you get it? In this article, we will try to shed light on the evolving situation.

Court decision

At the risk of repeating, the six FT debt schemes in question are Franklin India Low Duration Fund, Franklin India Dynamic Accrual Fund, Franklin India Credit Risk Fund, Franklin India Short Term Income Plan, Franklin India Ultra Short Bond Fund, Franklin India Income Opportunities Fund.

In a nutshell, the High Court decision balances the entire issue. It has upheld Franklin Templeton Trustee Services’ voluntary decision to wind up its suite of six fixed-income funds on April 23, 2020, taken in light of the severe market dislocation and illiquidity caused by the Covid-19 pandemic. The verdict, however, clarified that a simple majority consent of unitholders was required to move ahead and now Franklin will have to do it.

Remember the e-voting — which was scheduled to begin on June 9 and had got deferred after the Gujarat High Court stayed the scheduled voting and soon after rejected a Franklin petition to vacate it –  was not for the consent required for winding up. The e-voting was to decide the course of monetisation to be adopted for the six schemes’ assets.

According to a Bar and Bench report, a Division Bench of Chief Justice Abhay S Oka and Justice Ashok S Kinagi held as follows:

“We hold that, no interference is called for in the decision of the Trustees taken on 23rd April, 2020 of winding of the said six schemes. We hold and declare that the decision of the Trustees to wind up 6 schemes mentioned in paragraph 1 of the judgment, by taking recourse to sub-clause (a) of clause 2 of Regulation 39 of the Mutual Fund 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. Hence, we restrain the trustees from taking any further steps on the basis of the impugned notices dated 23rd April 2020 and 28th May 2020, with the consent of the unitholders by a simple majority till the decision of winding up is obtained by the Trustees in accordance with sub-clause (c) of clause 15 of Regulation 18 of the Mutual Fund Regulations.”

The High Court judgment operation is now stayed for a period of six weeks, during which the order can be challenged in the Supreme Court which is now on vacation. During this period, there will be no redemption by investors, the trustees cannot make any borrowings, or clear any liabilities during this period.

The Court also held that SEBI should have played a more (pro)active role in the matter. The market regulator has been directed to take a decision on taking action against the company after receiving the Forensic Audit report, within six weeks.

Responding to the development, a Franklin Templeton spokesperson said: “The Hon’ble Karnataka High Court has upheld the authority and decision taken by the Trustees to wind-up the schemes under regulation 39(2)(a).”

The fund-house said, “As per the judgement, for operationalizing such a decision, approval of the unitholders will be required under regulation 18(15)(c). We are considering the order and will take appropriate steps in consultation with our legal experts in the best interest of the unitholders. Our focus remains on maximizing value for unitholders in these schemes and returning monies as soon as possible.”

Impact – The Court decision protects your money, although you may not like it. If the Court had allowed the verdict to be operationalized, then on Monday morning, FT had to open all the 6 debt funds for redemption.

What happens when everybody wants their money? This situation could mean an avalanche of redemption requests and also could force FT to resort to fire-sale of the debt securities in order to honour the request. In such a situation, the value of your already diminished investments in those schemes would be eroded further as smart buyers of those debt securities would bargain hard before letting FT monetize them.

Road ahead

* If Franklin appeals the HC decision – If FT chooses to appeal the HC decision within 6 weeks, two things can happen.

One, the Supreme Court accepts the appeal and works on it. In case the SC admits the appeal, then expect some more time to be required before giving final order. In the meantime, everything will continue like it has so far – Investors won’t be able to redeem entire money and will have to wait. No active monetization of assets will happen, although interest payments, prepayments of securities etc. in the portfolio will trickle in.

One possibility is that Franklin somehow convinces the SC to allow the fund-house to distribute the cash lying in 4 funds to unitholders, which will give investors some money. About Rs 5,000 crore is waiting as cash to be distributed in 4 funds. Two funds are still in debt.

Two, the SC does not even admit the appeal. If the SC does not admit the FT appeal, then Franklin will have to seek consent of the nearly 3 lakh investors in those 6 schemes on winding-up decision. The timing of when FT will make the appeal to SC is crucial, because the Supreme Court will take sometime to understand the situation.

* When Franklin seeks unit holder consent – The consent issue can go either way, and both ways have key implications for your money.

If unit holders dont give a simple majority to winding-up, Franklin will have to forget the winding up road. It will have to re-open the 6 schemes for investors, who will be free to take any money as long as it lasts. This scenario is fraught with risks that there will be no orderly exit for investors and also the maximization of fund assets value may not happen if all investors want money at the same time.

If unit holders do give a simple majority to winding-up, Franklin will next take the e-voting step to decide the course of active monetization of assets. This scenario can mean orderly exit for investors and also the maximization of fund assets value.

Kumar Shankar Roy

Kumar Shankar Roy is contributing editor with RupeeIQ. Kumar is a financial journalist, with a functional experience of 15 years. He tracks mutual funds, insurance, pension, PMS, fixed income/debt and alternative investments markets closely. He has worked for The Times of India, The Hindu Business Line, Deccan Chronicle Group, DNA, and Value Research, among others, across different cities in India. He is deeply interested in marrying data insights with actionable opinion. He can be contacted at [email protected].

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