2121 OF 2004 The Karur Vysya Bank Employees Unionrep. by its PresidentNo.20 v. 1. The Securities and Exchange Board of India Earnest House

IN THE HIGH COURT OF JUDICATURE AT MADRAS DATE : 29.08.2007CORAMTHE HONOURABLE MR. JUSTICE S.J.MUKHOPADHAYAANDTHE HONOURABLE MS. JUSTICE K.SUGUNAW.A. NO. 2121 OF 2004The Karur Vysya Bank Employees Unionrep. by its PresidentNo.20, West Anjaneya Temple RoadBasavangudi, Bangalore 560 004... Appellant/petitioner in WP.11544/95.- Vs -1. The Securities and Exchange Board of India Earnest House, rep. by its Chairman 14th Floor, No.194, Nariman Point Mumbai 400 021.2. The Reserve Bank of India Central Office Department of Banking Operations & Development Cuffee Parade, World Trade Centre Centre-I, Mumbai 500 005.3. The Karur Vysya Bank Limited rep. By its Chairman Erode Road Karur 639 002.4. Union of India rep. by Secretary to Government Ministry of Finance New Delhi... Respondents/Respondents inWP.11544/95.Writ Appeal filed against the order dated 20th Sept., 2002, passed bythe learned single Judge in W.P. No.11544 of 1995W.P. No.11544 of 1995 : Writ Petition filed under Article 226 of theConstitution of India, praying to issue a Writ of Certiorarified Mandamuscalling for the records of the first respondent in the OrderNo.IMID/RM/194/195/95 dated 11.1.1995 quash the same and direct therespondents to make a Special allotment of shares to existing employees interms of the Resolution of the Annual General Body meeting of the 3rdRespondent bank held on 16.9.94. https://hcservices.ecourts.gov.in/hcservices/ For Appellant : Mr. R.Yashod Vardhan, SC, for Mr. P.Vinod KumarFor Respondents : Mr.Shivakumar for R-1 Mr. C.Mohan for M/s.King & Paridge for R-2 Mr. S.L.Rajah for R-3 Mr. P.Wilson, Asst. Solicitor General for R-4JUDGMENTS.J.MUKHOPADHAYA, J.The Karur Vysya Bank Employees Union (hereinafter referred to as the'Union') has preferred this appeal against the order dated 20th Sept.,2002, in W.P. No.11544/95 whereby and whereunder learned single Judgedismissed the writ petition on the ground that the said writ petition hasbecome infructuous.2. The matter relates to issuance of shares of banks to theiremployees/workers. On 16th March, 1985, while introducing the Finance Billin the Parliament, the Finance Minister also introduced a scheme called'The Employees Stock Option Scheme'. The scheme was voluntary in natureon the part of the employer company as well as on the part of theemployees irrespective of their nature of appointment. According to thepetitioner, as per the Bill aforesaid, the employees were to be given freeoption of savings under the scheme and the saving was for a period of fiveyears since joining of employee under the scheme. On completion of thefifth year, the amount would compulsorily get converted into equity sharesand conversion will take place at a price determined in the year in whichthe scheme was introduced by the company. This would however bepermissible only at 80% of the average market price of the company'sequity shares or the fair value of the shares as determined by theController of Capital Issues, whichever is less, but not less than thefair value of the shares. The equity shares issued against the debentureswould also have a lock-in period of three years from the date of issue.3. The guideline was issued by the Government of India on 1st Aug.,1985, circulating the 'Employees Stock Option Scheme' (ESOS). In regardto Issue of Capital – reservation for employees, following guideline wasissued on 1st Aug., 1985, from the Ministry of Finance, Department ofEconomic Affairs, as quoted hereunder :-"Issue of Capital – Reservation for Employees – Guidelines dated 1.8.1995The Finance Minister, while making his Budget Speech on16th march, 1985, announced the introduction of StockOption Scheme for employees as follows :-"The Government is also considering the introduction of ascheme of stock option to the employees and workers ofcompanies to encourage their participation in management".1. Keeping in view the above announcement, companies areadvised that while proposing a further issue of capital to https://hcservices.ecourts.gov.in/hcservices/ the Controller of Capital Issues, they should make areservation of 5 per cent of the further issue to theiremployees/workers on an equitable basis. In the case ofpublic issues, the shares not taken up byemployees/workers, would be added to the public issue. Inthe case of rights issue an additional offer to theemployees should be made simultaneously with the offer tothe existing shareholders at a price to be fixed by theController of Capital Issues. Right of renunciation neednot be given to the employees and the unsubscribed portionwould lapse if not taken up by the employees. Necessaryresolutions under the provisions of Section 81 of theCompanies Act, 1956 should be produced for reservation toemployees while submitting the proposal to the Controllerof Capital Issues."According to the petitioner, as far as banking companies areconcerned, no bank had been permitted to issue debentures for raisingfurther capital and the issue of further capital is only done throughissue of equity shares. Hence, insofar as banking companies areconcerned, the question of issue of convertible debentures would notarise, but 5% of the further capital to be released in the form of equityshares would be reserved for its employees. On 1st Dec., 1990, theerstwhile Controller of Capital Issues issued guideline on per cent ofshares. It followed by a detailed guideline issued by Reserve Bank ofIndia (hereinafter referred to as 'RBI'), Department of Banking Operationsand Development on 17th June, 1994 vide DBOD No.BC 76/16.13.100/94. AllIndian commercial banks in private sectors, including Karur Vysya Bank(hereinafter referred to as the 'Bank') were directed to follow suchguideline in exercise of power conferred by Section 35 of the BankingRegulation Act, 1949. The following directions were issued :-"3. In view of the above mentioned factors and in exerciseof the powers conferred under Section 35A of the BankingRegulation Act, 1949, the RBI having considered itnecessary in public interest and in the interest ofbanking policy, issues the following directions :-i) Public IssuesThe pricing of shares to be issued by banks should notbe less than that based on the net asset valueaccording to the guidelines of erstwhile Controller ofCapital Issues (CCI) in December, 1990. For thepurpose of determining the profit earning capacityvalue, the capitalisation factor shall be taken as 10per cent.ii) Preferential issue of sharesWhile the preferential allotment of shares atpreferential prices would generally be discouraged,the RBI may permit banks to make such allotmentselectively to prevent the destabilisation of theexisting well performing managements, subject to thefollowing conditions :-a) The preferential allotment should be backed bythe resolutions of the Board of Directors and the https://hcservices.ecourts.gov.in/hcservices/ General Body.b) While approving the preferential allotment, themajority of the shareholders, excluding thebeneficiaries, should support the preferentialallotment at the preferential price.c) Every preferential allotment of shares by banksshall be at not less than the market value of theshares to be determined on the basis of theiraverage price during the immediate preceding sixmonths at the main listing centre calculated on themonthly average of high and low rates quoted forthe shares at such centres. However, in theabsence of a market price (as in the case ofunlisted companies or where shares are notregularly traded) the value of shares should be notless than the value on the basis of the net assetvalue and earnings per share according to theguidelines of the erstwhile CCI in December, 1990,as explained at (i) above.iii) Rights issue and special allotment to employeesIn order to ensure that adequate reserves are builtup, in the case of rights issue to all suchshareholders or special allotment to employees, theprice should not be less than half of the price fixedfor the public issue determined according to the CCIformula of December, 1990.iv) Bonus issuesThe bank managements are free to take decisions onbonus issues provided such issues are madesimultaneously with rights/public issues made underthese directions and subject to banks following SEBIguidelines, as applicable."4. In the present case, we are concerned with the rights issue andspecial allotment to the employees as shown in the guideline dated 17thJune, 1994 at clause (3) and quoted above.The bank in question, vide letter No.CS/FIM/382/94-95 dated 20th June,1994, sought permission from RBI for issue of rights/bonus equity sharesto its employees. The RBI, vide their letter DBOD No.16.01.065/94 dated8th July, 1995, agreed and granted such permission subject to approval ofSecurities Exchange Board of India (hereinafter referred to as 'SEBI'),relevant portion of which is quoted hereunder :-"Dear Sir,Issue of Rights/Bonus Equity SharesPlease refer to your letter No.CS/FIM/382/94-95 dated 20thJune, 1994, on the above subject. We are agreeable toyour bank's capital issues as under, subject to approvalof SEBI and the bank complying with legal and otherformalities in this regard.(a) Twenty lakhs rights shares of Rs.10/- each at apremium of Rs.25/- per share in the ratio of 1:1.(b) One lakh shares of Rs.10/- each at a premium ofRs.25/- per share to the permanent employees of thebank. https://hcservices.ecourts.gov.in/hcservices/ (c) Twenty lakhs bonus shares in the ratio of 1:1.This will be excluded for the rights issue beingoffered now by the bank.2. Please note that the Reserve Bank of India does not inany manner undertake any responsibility for the financialsoundness or otherwise of the issues.Yours faithfully,Deputy Chief Officer"5. With regard to rights issue and special allotment to employees, theRBI, in order to ensure that adequate resources are built up, decided thatin the case of rights issue to all the share holders or special allotmentto employees, the price should not be less than half of the price fixedfor the public issue determined according to formula issued by theController of Capital Issues in December, 1990. It was also informed thatthe above requirement should be complied with and in addition to thoseprescribed guidelines of the SEBI insofar as the latter are notinconsistent with or contrary to the directions of the RBI.6. At the 75th Annual General Meeting of the Bank on 16th Sept., 1994,a resolution was passed to raise the authorised capital of the bank fromRs.3 Crores to Rs.12 Crores. A further resolution was passed inaccordance with the provisions of Section 81 (1) (A) and subject to theapproval of the RBI that 1,01,300 shares of Rs.10/= each should be offeredto the permanent employees at a premium of Rs.25/= per share if they areon the rolls of the bank as on 23rd March, 1994. Each employee wasentitled to 50 shares with a lock-in period of three years from the dateof allotment. In the meantime, a special resolution at item No.12 of themembers of the Bank was passed as held in its 75th Annual General Meeting,which is relevant, is as follows :-"12. To consider and, if thought fit, to pass thefollowing resolution with or without modification, as aSPECIAL RESOLUTION.Resolved that in accordance with the provisions ofSection 81 (A) and other applicable provisions, if any, ofthe Companies Act, 1956, and subject to approval ofReserve Bank of India and such other approvals,permissions and sanctions as may be necessary and subjectto such condition and modification as may be imposed bySEBI and as may be considered necessary by the Board ofDirectors of the Bank or as may be prescribed in grantingsuch approvals, permissions and sanctions which may beagreed to by the Board of Directors of the Bank, theconsent of the Bank be and is hereby granted to the Boardof Directors of the Bank to offer 1,01,300 shares ofRs.10.00 each at a premium of Rs.25.00 per share to thepermanent employees who were on the rolls of the Bank ason 23.03.1994 and each employee is entitled to 50 (fiftyonly) shares with a lock in period of 3 years from thedate of allotment.Resolved further that for the purpose of giving effect tothe above, the Board of Directors be and are herebyauthorised to do all things necessary for the purpose ofissue of equity shares to the permanent employees of the https://hcservices.ecourts.gov.in/hcservices/ Bank and to take such action or give such directions asmay be necessary or desirable and to accept anymodification in the proposal and terms of issue as may beconsidered by the Board of Directors as may be prescribedin granting approval to the issue which may be acceptableto the Board of Directors and to decide the basis ofallotment and to settle any question of difficulty thatmay arise in regard to issue and allotment of equityshares to the permanent employees of the Bank."The RBI, by letter No. DBOD No.367/16.01.065/94 dated 1st Sept. 1994,granted approval for issue of 1,01,300/= shares of Rs.10/= each for cashat premium of Rs.25/= per share to the permanent employees of the bank asagainst 50 shares proposed earlier by bank subject to approval of SEBI andbank's compliance with the legal and other formalities. However when thematter was considered by SEBI, it, vide letter No.IMID/RM/194/195/95 dated11th Jan., 1995, rejected such proposal on the ground that it is not inconformity with their circular No.7 dated 5th Aug., 1994. For properappreciation of the case, the relevant portion of the letter dated 11thJan., 1995, is extracted hereunder :"Our observations :CAPITAL STRUCTURE1) The Lead manager should ensure that the bonus sharesshall be allotted, dispatched to the shareholders andlisted before the opening of the issue and the ex-bonusand ex-rights price per share should be indicated in theoffer document.2) With respect to the proposed preferential allotment tothe employees of the bank the lead manager should notethat such allotments are governed by SEBI Circular No.7dated August 5, 1994 regarding preferential allotment toselect group of persons and the present proposal is not inconformity with the above and hence the same shall bedeleted from the offer document and corresponding chargesshall be effected in the capital structure, financialprojections, etc."7. As noticed earlier, in absence of any stay, shares having beensold, learned single Judge declared that the writ petition has becomeinfructuous, but the appeal has been preferred by the employees Union, asaccording to them the question of law as was involved in the writ petitionhas not been decided, which requires determination for future allotment ofshares.8. The only question that arises for consideration is whether thecircular dated 5th Aug., 1994, issued by SEBI is applicable on privatesector Indian commercial banks for the purpose of rights issue and specialallotment to its employees.9. For determination of such issue, apart from the guidelines issuedby RBI from time to time of which reference have been given and relevantportion quoted above, it is also necessary to notice the guideline dated5th Aug., 1994, issued by SEBI of which reference has been given in theirimpugned letter dated 11th Jan., 1995.The aforesaid guideline dated 5th Aug., 1994, issued by SEBI relates https://hcservices.ecourts.gov.in/hcservices/ to 'Disclosure of Investors Protection'. The need for protecting theinterest of investors were mentioned in the covering letter, as quotedhereunder :-"Guidelines for Disclosure of Investor ProtectionOf late, the practice of making preferential allotmentsof shares etc., at a price unrelated to the prevailingmarket price of such instruments seems to be on theincrease. Besides, companies have also been issuingwarrants to select persons with a right to obtain sharesin future at a price, not bearing a fair relation to themarket. The development is particularly undesirable asthe allaotments are made to select persons. Therefore,there appears to be a need for protecting the interest ofthe investors, who do not receive such preferentialtreatment by ensuring that the pricing of the preferentialallotments is market related.SEBI has issued a press release dated August 4, 1994giving guidelines governing the issue of shares orwarrants/fully convertible debentures/partly convertibledebentures or other financial instruments made on apreferential basis. A copy of the said press release isenclosed for your information and record."The press release with regard to preferential issues was circulatedwith the said guideline dated 5th Aug., 1994, whereby following guidelineswere circulated :-"Guidelines for Disclosure of Investor ProtectionOf late, the practice of making preferential allotmentsof shares etc., at a price unrelated to the prevailingmarket price of such instruments seems to be on theincrease. Besides, companies have also been issuingwarrants to select persons with a right to obtain sharesin future at a price, not bearing a fair relation to themarket. The development is particularly undesirable asthe allaotments are made to select persons. Therefore,there appears to be a need for protecting the interest ofthe investors, who do not receive such preferentialtreatment by ensuring that the pricing of the preferentialallotments is market related.2. SEBI therefore issues the following guidelinesgoverning the issue of shares or warrants/Fullyconvertible Debentures (FODs)/Partly ConvertibleDebentures (PCDs) or other financial instruments made on apreferential basis to a select group of persons underSection 81 (A) of the Companies Act, 1956. Theseguidelines are being issued in terms of Section 11 (1)read with Section 24 of the Securities and Exchange Boardof India Act, 1992, for orderly development of thesecurities market and to protect the interest of theinvestors at large.3. All issues of capital by listed companies by way ofshares/FCDs/PCDs/warrants/any other financial instrumentson a preferential basis to any select group of persons,shall henceforth be subject to fulfilment of therequirements mentioned in the following paragraphs :- https://hcservices.ecourts.gov.in/hcservices/

4. Pricing of the IssueThe issue of shares on a preferential basis can be madeat a price not less than the higher of the following :The average of the weekly high and low of the closingprices of the related shares quoted on the stockexchange during the six months preceding the relevantdateORthe average of the weekly high and low of the closingprices of the related shares quoted on a stockexchange during the two weeks preceding the relevantdate.********12. Preferential allotment to FIIs :Preferential allotments, if any, to be made in favour ofForeign Institutional Investors shall also be governed bythe guidelines issued by the Government ofIndia/SEBI/Reserve Bank of India on the subject.13. Applicability :These guidelines will come into force with immediateeffect. Cases of preferential issues approved by theGeneral Body of shareholders at meetings held between 5thMay, 1994 and 4th August, 1994 can be acted upon within aperiod of three months from the date of issue of theseguidelines. However, all cases of preferential issuesapproved by resolutions of the general body ofshareholders held prior to 5th May, 1994 would be governedby these guidelines, if they have not been acted upon by4th August, 1994."By acknowledgement card contained in letter dated 11th Jan., 1995,SEBI, while informed the bank that the vetting of document by SEBI shouldnot in any way be deemed or construed that the same has been cleared orapproved by SEBI, under the impugned letter dated 11th Jan., 1995, enclosedas Annexure-III to the covering letter, SEBI refused to grant approval forrights issue of two lakhs equity shares of Rs.10/= each for cash atpremium of Rs.25/= per share in favour of the employees of the bank.10. Counsel appearing on behalf of SEBI also referred to the circularNo.7 dated 5th Aug., 1994, issued by SEBI and submitted that the proposalof the bank was not in conformity with the aforesaid circular, whichrelates to preferential allotment to selected group of persons.On the other hand, according to the learned counsel for thepetitioner/appellant, the circular is not applicable to rights issue.11. We have noticed the different guidelines issued by Government ofIndia, RBI and SEBI, relevant portions of which have been quoted above.If the guideline issued by Government of India, RBI and SEBI are readtogether, it will be evident that they cover different fields and are notcontrary to each other. The guideline issued by the Ministry of Finance,Department of Economic Affairs, Government of India dated 1st Aug., 1985,relates to reservation of issue of capital in favour of the employeeskeeping in view the announcement made by the Finance Minister during hisbudget speech on 16th March, 1985. On introduction of stock option schemefor employees, it was decided by Government of India that while proposing https://hcservices.ecourts.gov.in/hcservices/ a further issue of capital, they should make a reservation of 5% of thefurther issue to their employees/workers on an equitable basis.So far as the guideline issued by RBI dated 17th June, 1994 isconcerned, it is binding on the bank, having issued in exercise of powerconferred u/s 35-A of the Banking Regulation Act, 1959. Clause (i) ofPara-3 relates to public issues, which should not be less than that basedon the net asset value and profit earning capacity value according to theguidelines of erstwhile Controller of Capital Issues in December, 1990.Clause (ii) of Para-3 relates to preferential issue of shares, which hasbeen discouraged, but could be permitted by banks to make such allotmentsselectively to prevent destabilisation of the well performing managementwith certain conditions as mentioned therein. Clause (iii) of Para-3relates to "rights issue and special allotment to employees", as quotedhereunder :-iii) Rights issue and special allotment to employeesIn order to ensure that adequate reserves are builtup, in the case of rights issue to all suchshareholders or special allotment to employees, theprice should not be less than half of the price fixedfor the public issue determined according to the CCIformula of December, 1990.On the other hand, Clause (iv) of Para-3 relates to bonus issues andPara-4 relates to permission of RBI for determination of the price ofvarious categories of shares.12. In the present case, we are not concerned with public issue orpreferential issue of shares or bonus issue as contained in clauses (i),(ii) and (iv) of Para-3. The present case relates only to 'rights issueand special allotment to employees'. According to the guideline, in orderto ensure that adequate resources are built up, in case of "rights issue"of share holders and special allotment to the employees, price should notbe less than half of the price fixed for public issue, determinedaccording to the CCI formula of December, 1990. It has nothing to do with"preferential issue", allotment to which cannot be made less than themarket value of the shares to be determined on the basis of their averageprice during the immediate preceding six months at the main listingcentres. The price of share is calculated for public issues, which isalso applicable for rights issues and special allotment to employees. Itis completely different than the mode of calculation of price of shares ofpreferential issues.The guideline of SEBI, No.7 dated 5th Aug., 1994, relates to pricingof issues of shares on 'preferential basis and preferential allotment toForeign Institutional Investors' and are governed by the guidelines issuedby the Government of India, SEBI and RBI. Clause (4), i.e., pricing ofissues of shares on preferential basis is not concerned with rights issueand special allotment to the employees, which is based on public issues.Clause (12) of the said guideline of SEBI dated 5th Aug., 1994, also do notrelate to employees of the bank but to foreign institutional investors.13. Learned counsel for SEBI could not lay hand on any provision tosuggest how the guideline dated 5th Aug., 1994, is attracted in the case ofrights issue and special allotment to employees of the bank, price ofwhich is to be fixed as per public issue. He also could not point out howthe mode of fixation of price of preferential issue of share has anything https://hcservices.ecourts.gov.in/hcservices/ to do with rights issue and special allotment to employees, which is basedon public issue.Therefore, it will be evident that the guideline issued by theGovernment of India dated 1st Aug., 1985, while relates to reservation of5% of the further issues in favour of the employees/workers on equitablebasis, the statutory guideline issued by RBI dated 17th June, 1994, whichis also binding on the bank, clause (iii) of para-3 therein is applicablein the present case, which relates to rights issue and special allotmentto employees. The guideline dated 5th Aug., 1994, issued by SEBI do notcover the field of rights issue and special allotment to employees andthus the rejection as made by SEBI while refusing approval by impugnedletter dated 11th Jan., 1997, cannot be upheld, the reasons given thereinbeing bad in law.14. Counsel for the parties brought to our notice the said guidelineissued by the Reserve Bank of India on 20th March, 2002, vide letter Ref.DBOD. No.PSBS.BC.79/16.13.100/2001-2002. Therein giving reference toearlier guidelines dated 17th June, 1994 and 10th July, 1999, instructionshave been given as to how pricing of shares of private sector banks,rights issue and preferential issue were to be fixed, as quotedhereunder :-"Issue and pricing of shares by private sector banksPlease refer to our circulars DBOD.No.BC.76/16.13.100/94dated June 17, 1994 and DBOD.No.PSBS.BC.72/16.13.100/98-99dated July 10, 1998 respectively, in terms of whichguidelines on issue and pricing of shares had beenprescribed. In terms of extant instructions, banks inprivate sector, whose shares are not listed on the stockexchanges, are required to obtain prior approval ofReserve Bank of India (RBI) for issue of all types ofshares, viz., public, preferential, rights/specialallotment to employees and bonus shares. However, bankswhose shares are listed on the stock exchanges need notseek prior approval of RBI for issue of shares exceptbonus shares, which is to be linked with rights/publicissues by all the banks in private sector. The matter hassince been reviewed and issue and pricing of shares byprivate sector banks would be governed by the followingguidelines.********3. Rights Issues :RBI approval would not be required for rights issues byboth listed and unlisted banks.********5. Preferential Issue :All preferential issues would require prior approval ofRBI. Pricing of preferential issues by listed banks be asper SEBI formula, while for unlisted banks the fair valuemay be determined by a chartered accountant or a merchantbanker."From the aforesaid guidelines issued by RBI, it will be clear thatshares and special allotment can be made in favour of the employees of thebank, including bonus shares and prior approval of RBI is required only incase the bank is not listed on the stock exchange. https://hcservices.ecourts.gov.in/hcservices/

15. Learned counsel appearing on behalf of the respondent/SEBIsubmitted that the notice which was published for issuance of shares havenow been sold in favour of others and thus it was suggested that the writpetition has become infructuous, but we do not subscribe to suchsubmission as the ratio laid down by us will cover the future allotment,if made by bank, which may make special allotment of shares and bonusshares in favour of its employees having regard to the guidelines issuedby Government of India and RBI.We, accordingly, set aside the impugned letter dated 11th Jan., 1995,issued by SEBI and remit the case to the respondents for determination ongrant of rights issue and special allotment of shares to its employees, ifmade in future, in accordance with reservation as made by Government ofIndia and at a price to be fixed as per guidelines of the RBI. The writappeal is allowed with aforesaid observation. However, there shall be noorder as to costs.Sd/-Asst. Registrar./true copy/Sub Asst. Registrar.GLNTo1. The Chairman Securities and Exchange Board of India Earnest House 14th Floor, No.194 Nariman Point Mumbai 400 021.2. The Reserve Bank of India Central Office Department of Banking Operations & Development Cuffee Parade, World Trade Centre Centre-I, Mumbai 500 005.3. The Secretary to Government Government of India Ministry of Finance New Delhi. https://hcservices.ecourts.gov.in/hcservices/

4. The Chairman, The Karur Vysya Bank Limited Erode Road Karur 639 002.+ 1 CC To Mr. P.Wilson, ASG Advocate SR NO.54130+ 1 CC To Mr. P.Vinod Kumar, Advocate SR NO.53812+ 1 CC To M/s.King and Patridge, Advocate SR NO.53829+ 1 CC To Mr. Shivakumar, Advocate SR NO.53854 W.A. NO. 2121 OF 2004 msm[co]gp/6.9.