NSEL is not a financial establishment and does not fall within the ambit of MPID Act: Bombay HC

In this case before the Bombay High Court, a significant and axial issue was involved in two writ petitions revolving around the National Spot Exchange Limited (NSEL) and the parties were diversificated on the issue as to whether NSEL is a Financial Establishment or not, and whether it accepted deposits from investors.

The petitioner, 63 Moons Technologies Ltd. challenged the Constitutional validity of Sections 4 and 5 of the Maharashtra Protection of Interests of Depositors in Financial Establishments Act, 1999 (MPID Act) being violative of Articles 14, 19 and 300A of the Constitution and also to the levy of attachment on the petitioner’s assets by the State of Maharashtra by invoking the powers conferred on the authority under the said enactment.

An FIR was registered alleging that by unilaterally closing down the Exchange, the NSEL defaulted in repayment of approximately Rs.5600 crore which was due to be paid to approximately 13,000 investors.

It was also alleged that the money collected by NSEL from the investors fell within the definition of the term “deposit” as per section 2(c) of the MPID Act and hence the provisions of MPID Act were invoked and applied. The petitioner, who claimed that NSEL was one of its subsidiaries and that the petitioner held 99.99% shares of NSEL, was roped in as NSEL did not have sufficient money or property to return the deposits or make payment of interest or render services against which the deposits were received in terms of Section 4 of the MPID Act. The properties of its promoters i.e. petitioners were also held liable for attachment.

A writ petition was filed questioning the applicability of provisions of the MPID Act. The petitioner contended that NSEL was an electronic platform for trading of forward contracts of one day duration in commodity between willing buyers and sellers acting through their respective brokers. Further, it was contended that NSEL never accepted any deposits and, therefore, it was not a Financial Establishment as defined under Section 2(d) of the MPID Act, thereby attracting the provisions of the said enactment.

The core issue involved in the case before the Bombay High Court was whether the NSEL is a financial establishment within the meaning of Section 2(d) of MPID Act. The State, therefore, deemed it expedient to make a suitable legislation to curb the unscrupulous activities of such financial establishments in the State and enacted the Maharashtra Protection of Interest of Depositors Act, 1999.

On hearing the learned counsel for the parties and on perusal of the writ petition, in order to effectively adjudicate the issues raised, the High Court of Bombay dealt with the issues under the following particular heads:

I] The nature of transaction entered into by the NSEL.

II] The FIR filed and the subsequent invocation and application of provisions of MPID Act against NSEL.

III] An action taken against the present petitioner which is the promoter of NSEL by issuing notifications under Section 4 of MPID Act.

IV] The constitutional validity of the MPID.

The Court further noted that after 31st July 2013, 24 sellers and their brokers who had entered into reverse trades and received monies thereunder failed to honor their commitment of squaring off their position by buying back the commodities. As a result, 148 buyers and brokers could not receive monies on their open positions due to defaults committed by 24 sellers and their brokers. This was noted as a violation of the exemption conferred on the NSEL and the exemption from forward contracts of one day duration for sell and purchase of commodities traded on the NSEL came to be withdrawn. Resultantly, the NSEL was not in a position to settle the accounts and was required to dwindle on its activity.

The Forward Contracts Regulations Act, 1952 (FCRA) is an enactment to provide for regulation to certain matters relating to forward contracts, the prohibition of options in goods and for the matters connected therewith. Forward contract is defined under the said Act to mean a contract for delivery of goods and which is not ready delivery contract.

The Bombay High Court perused the bye-laws of NSEL and found that a broker or member of the NSEL had access to the online trading system set up by NSEL on his computer terminal. The pay-­in and pay-out mechanism took place through the clearing house of NSEL in which it received transaction fees. It also allegedly maintained a Settlement Guarantee Fund (SGF) where contributions were made by the members. This fund was exclusively used to pay off in case of defaults by one of the members in which event, the short fall was also made up by further contributions from the members themselves. NSEL received the margin money which was again used towards pay-­in and pay-­out obligation of the members.

The FCRA contains a provision for imposing penalty for certain acts mentioned in Section 20 and make such acts punishable. Thus, any violation of the provision of FCRA is punishable by taking recourse to the said enactment. It was not in dispute that the NSEL was granted exemption from the operation of FCRA. The Bombay High Court also noted that the Economic Offences Wing, Mumbai had already registered a separate FIR against the NSEL brokers and others under the FCRA. However, the withdrawal of exemption on violation of certain conditions subject to which the exemption was granted would entail the consequences under the FCRA 1952 and there were separate consequences which could then fall upon the NSEL. However, the present offence which has been registered against the NSEL fell under the provisions of IPC and the provisions of MPID had been invoked and applied.

The Bombay High Court noted that the as per the charge contained in the chargesheet, the exchange had SGF of 738.55 crores. However, during the interaction with the Board of NSEL, it was informed that the SGF had only 62 crores. Thus, the NSEL was charged with providing misleading information and serious doubt was raised about its authenticity. The direction was also issued to appoint a recruited forensic auditors firm to establish the credibility of books of accounts and records maintained by the exchange.

The fact that the accounts of the petitioner and the suppliers of the goods are not tallying with each other due to bogus entries and the physical delivery of the commodities have not been verified and there was no control over the stock lying in the warehouse. According to the High Court, this amounted to an offence under sections 465, 467 of Indian Penal Code, 1860. The Court did not absolve the NSEL or the petitioner if it has any role to play as a promoter from any of these liabilities and held that it would be imperative on them to be subjected to the regime of the penal laws.

The Court found that the NSEL on one hand, was accepting deposits by promising fixed returns of 14 to 16% and was further advancing unsecured loans to the defaulting companies and in some cases, it was established that there was no stock at all, yet huge amounts were loaned out to the traders by NSEL.

The Bombay High Court further held that the Supreme Court in certain precedents has considered the beneficial nature of the legislations to protect the interest of small depositors who invest their life’s earning and savings in schemes floated by unscrupulous investment in companies and who end up losing their entire deposit.

In light of the emerging scenario where the Court already recorded that NSEL did not accept deposits and such observation made on the basis of the entire transaction conducted on the platform of NSEL placed before the Court, it was concluded that the NSEL is not a Financial Establishment and resultantly, the petitioner who is a promoter of the said establishment cannot be proceeded under the provisions of MPID Act.

The audit report conducted as a part of investigation clearly pointed out a finger to the sellers/defaulters and disclosed that it was these defaulters who utilized the amount received by them for some other business purpose and the audit reports fixed the liability pertaining to trade obligation on the said defaulters.

The Court also held that the clients trading on the NSEL platform did not invest with the NSEL in form of Fixed Deposits, equity or debentures of NSEL but they traded commodities on the platform of NSEL. The NSEL had even instituted recovery suits against the defaulters. Since the investors raised an alarm about the losses caused to them, as a knee jerk reaction, the NSEL and its promoter came to be proceeded under the provisions of the MPID Act without deliberating on the core issue to be determined as a jurisdictional fact as to whether the entity was a Financial Establishment, thereby permitting the authorities to proceed against it under the statute intended to govern Financial Establishments.

The respondent authorities proceeded on the assumption that NSEL is a Financial Establishment and the entire course of action that followed by issuing notification under Section 4 of the MPID Act attaching the properties and NSEL is a fall out of an assumption that it is dealing with an Financial Establishment.

The High Court concluded that the NSEL is not a Financial Establishment and resultantly, the petitioner who is a promoter of the said establishment cannot be proceeded under the provisions of MPID Act. The Court quashed and set aside the action to which the petitioner was subjected to by taking recourse to the provisions of MPID Act.

A Bench of Justices Ranjeet More and Bharati H. Dangre presided over the case.

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