The rapid growth of the Indian mutual fund industry and other pooled investment vehicles has renewed interest in a foundational question: what is the legal character of mutual fund units and unit trusts under Indian law, and do they operate as public trusts or private trusts? This characterisation has significant implications for the applicable legal framework, regulatory supervision, fiduciary obligations, investor remedies and taxation. This article examines the issue through the lens of statutory provisions, regulatory architecture and judicial precedent.
‘Unit Trusts’: Units issued by pooled funds such as Mutual Fund, REITS, InvITs, etc. Questions regarding the legal classification of such units as ‘securities’ under the Securities Contracts (Regulation) Act, 1956 have been raised time and again before the courts [See, Canbank Financial Services Ltd. v V. B. Desai & Anr., AIR 2002 Bom 247 : 2002 (112) CompCas 143 (Bom) : 2002 (2) AllMR 182] and the Securities Appellate Tribunal [See, PCS Industries Ltd. v SEBI, 2002 (35) SCL 939 (SAT) : MANU/SB/0101/2001 : 2001 SCC OnLine SAT 2]. The interpretation has largely been done by interpreting SEBI regulations de hors the historical context and evolution of corporate and trust law in which these units originated.
UK: judicial interpretation & historical origin of Unit Trusts. EU law. What we call a mutual fund is commonly referred to as a ‘unit trust’ or ‘collective investment scheme’ in other jurisdictions. The jurisprudence relating to a ‘unit trust’ as an investment vehicle goes as far back as the formation of the earliest joint stock companies in the United Kingdom around the 18th & 19th century, and is inter-linked thereto. The trading trust was a subspecies of the unincorporated joint stock company that arose to subvert the restrictions imposed by the Bubble Act (i.e. The Royal Exchange and London Assurance Corporation Act, 1719) [6 Geo I, c. 18 (UK)] which incorporated the Royal Exchange and London Assurance Corporation and forbade all other joint-stock companies not authorized by royal charter. While that Act forbade the formation of companies without authorization from the Crown or Parliament, it did not prevent the utilization of an equitable form for the issuance of transferable securities, acting for all purposes as their incorporated equivalent. [See, Re Agricultural Cattle Insurance Co., (Baird’s case), (1870) 5 Ch App 725; Re European Assurance Society (Grain’s case), (1875) 1 Ch D 307] This resulted in the formation of the unincorporated Deed of Settlement company, (The deed of settlement of unincorporated companies later developed into the Articles of Association of a modern company) where the property was conferred on a body of trustees and the management delegated to a committee of directors by the combination of a contract under seal and a settlement by way of trust. The courts held that unincorporated companies formed for public benefit reflecting in their deed of settlement fell outside the prohibition of the Bubble Act. [See, R v Webb, (1811) 14 East 406] Over the years the company law changed slowly giving individuals the right to form companies and the Joint Stock Company Act, 1856 was passed, which was later repealed by the UK Companies Act, 1862.
While the earlier unincorporated companies used the trust structure to carry on business enterprises, it was not until the second half of the 19th century that the trust structure was used as a management trust to facilitate collective investment, attracting investors by diversifying investment risk by spreading the investment over a number of different stocks. It was then the unit trust emerged. Like the unincorporated deed of settlement company before it, the unit trust took the form of a deed of mutual covenant between the trustee and the unit-holders. The unincorporated form is beneficial for a unit trust because company law does not usually permit a company to buy back or redeem its own securities and distribute its assets to its members on a continuing basis. The mutual fund formed as a unit trust gave the trustees power to the redeem the units whenever the investors, the investors need not seek out prospective buyers in the secondary market. These trusts became known as unit trusts because each investor, although a beneficial owner of a part of the investments held by the trustee, had only an undivided share in those investments. Thus, the investor only had an entitlement to redeem his share in the assets in the trust fund, but no proprietary interest in the trust fund.
The earliest litigation relating to the unit trusts involved the Governments’ and Guaranteed Securities Permanent Trust, led to the decision of Sykes v Beadon, (1879) 11 Ch D 170, wherein the court held that the trust was an illegal association of more than 20 persons under section 4 of the Companies Act, 1862, which inter alia provided that ‘no company, association or partnership of more than 20 persons shall be formed after the commencement of that Act for the purpose of carrying on any other business… that has for its object the acquisition of gain by the company, association or partnership or by an individual member thereof unless registered thereunder.’ This was a major setback.
In view of this judgment, various other unit trusts either wound up or got incorporated under the company law, save for the Submarine Cables Trust. Investment in submarine cable companies was a risky business, and many of the earliest ones failed to begin operation or encountered technical difficulties. A unit trust diversified this risk by investing its members’ fund in several different companies who enjoyed regular dividends if any of them turned out successful. The Submarine Cable Trust had a Board of Trustees numbering less than twenty and more than twenty investors, yet it refused to incorporate even after the judgment of Sykes v Beadon. It faced an action from the English authorities who alleged that it was an illegal association of more than twenty members carrying on business in common with a view to profit.
The Submarine Cable Trust continued in existence and contended that Sykes v Beadon was wrongly decided. The Court of Appeals inter alia upheld the validity of the unit trust on the following grounds, –
- The investors collectively did not constitute an ‘association’, as they had no relationship with each other, only with the trustee;
- Members merely had a common interest that was to be divided between them;
- The deed of trust did not provide for the carrying on of a business, rather its only single purpose was of holding the trust property vested in the trustees, albeit the trustees also had some management powers. Thus, the trust was not formed for the purpose of carrying on a business;
- Business, if any, was carried on by the trustees who were less than the prohibited number and not by the members.
Thus, the Court of Appeal reversed Sykes v Beadon in the landmark judgment of Smith v Anderson, (1880) 15 Ch D 247. It wasn’t until the 1930’s that unit trusts re-emerged after the Submarine Cable Trust. It was the Court of Appeal’s judgment Smith v Anderson that had opened the way for unincorporated unit trusts to operate in UK and other countries that had similar company law. The revival of unit trusts was due to the increasing controls being imposed on the flotation of new issues of securities. This led to the promulgation of the Prevention of Fraud (Investments) Act, 1939 which inter alia regulated unit trusts and also became the basis of Indian securities laws. [The Securities Contracts (Regulation) Act, 1956 is based upon this UK enactment. See, the Statement of Objects and Reasons of the Securities Contracts (Regulation) Act, 1956].
Thus, the legal validity of the ‘unit trusts’ as a trust for the benefit of public investors is practically derived from the 19th century Court of Appeals judgment in Smith v Anderson.
Interestingly, unit trusts are the oldest form of collective investment schemes in English law. In the European Union, the term collective investment scheme is defined by the EU UCITS (Undertakings for Collective Investment in Transferable Securities), Council Directive 2009/65/EC dated 13.07.2009 amended by Directive 2014/91/EU of 23.07.2014, (which replaced the similar Council Directive 85/611/EEC dated 20.12.1985 on the subject) which includes mutual funds. This is also reflected in section 235 of the UK Financial Services and Markets Act, 2000. They are now completely governed by these enactments instead of the general law of trusts. Unlike Indian law where a trust structure is used for close-ended and open-ended mutual funds, in English law a unit trust structure is used for close-ended schemes and an investment company (incorporate company empowered by law to purchase its own share capital as part of its commercial activities) is used for running open-ended schemes.
Origin of mutual fund regulation in India. It is interesting to note that the legal structure of Mutual Funds (MFs) in the trust form (other than Unit Trust of India, which was established as a corporation, see section 3 of the Unit Trust of India Act, 1963) was first mandated by the Government by way of an executive instruction. The first Guidelines for mutual funds were issued by the Stock Exchange Division of the Finance Ministry (F. No. 1/45/AC/86-Part IV), dated June 28, 1990 which inter alia mandated that mutual funds except the statutory funds (i.e. Unit Trust of India) shall be constituted as trusts under the Indian Trusts Act, 1882 [See, Kinetic Engineering Ltd. v Unit Trust of India & Ors., 1995 (84) CompCas 811 (CLB) : 1994 (3) CompLJ 307 (CLB). Also see, Kinetic Engineering Ltd. v Unit Trust of India & Anr., AIR 1995 Bom 194 : 1995 (84) CompCas 910 (Bom.) : 1995 (3) SCL 33]. After the SEBI Act was promulgated SEBI started regulating the securities markets and it too issued regulations on similar lines. Regulation 14 of the SEBI (Mutual Funds) Regulations, 1993 also mandated that private mutual funds shall be formed as private trusts under the Indian Trusts Act, 1882. The present-day SEBI (Mutual Funds) Regulations, 2026 do not contain a specific mandate, but the position has continued even today.
Indian company law similar to UK law & validity of Unit Trusts. Indian company law has grown from the English law on the subject. Section 464 of the Companies Act, 2013 is similar to the prohibition against illegal associations found in UK Company law and reads as follows, –
“464. Prohibition of Association or Partnership of Persons Exceeding Certain Number. (1) No association or partnership consisting of more than such number of persons as may be prescribed shall be formed for the purpose of carrying on any business that has for its object the acquisition of gain by the association or partnership or by the individual members thereof, unless it is registered as a company under this Act or is formed under any other law for the time being in force:
Provided that the number of persons which may be prescribed under this sub-section shall not exceed one hundred.
(2) Nothing in sub-section (1) shall apply to—
(a) a Hindu undivided family carrying on any business; or
(b) an association or partnership, if it is formed by professionals who are governed by special Acts.
(3) Every member of an association or partnership carrying on business in contravention of sub-section (1) shall be punishable with fine which may extend to one lakh rupees and shall also be personally liable for all liabilities incurred in such business.”
In view of the above, the decision of the UK’s Court of Appeal in Smith v Anderson is applicable even in the Indian context. Both Indian and UK law prohibit certain associations formed for carrying on a business which has for its object the acquisition of gain. This requirement is essential, hence prior to demutualisation though an association, stock exchanges were held to be not illegal associations prohibited under company law as they were not formed for the purpose of carrying on a business. [See, V. V. Ruia v S. Dalmia, AIR 1968 Bom 347 : 1968 (1) CompLJ 226 (Bom) : 1968 (38) CompCas 572 (Bom)]
Thus, unit trusts such as Alternate Investment Funds (AIFs), MFs, Real Estate Investment Trusts (REITs), Infrastructure Investment Trusts (InvITs) etc., formed as a trust do not amount to an illegal association in India, since the number of trustees never exceed the prohibited number and they are formed predominantly for the benefit of the investors. Further, even the trustees of an association were to exceed the prohibited number of 20, section 464(2) of the Companies Act, 2013 goes further and exempts certain associations which are governed by special enactments.
Unit Trusts in USA and its relation to Indian law. While unit trusts disappeared temporarily from the UK in the late 19th century, they became popular in the USA, especially in the state of Massachusetts, which like the British Parliament in the 18th & 19th century was one of the last provinces of USA to permit incorporation without a special legislative act. [See, Jared W. Speier, Clarifying the Business Trust in Bankruptcy: A Proposed Restatement Test, 43 Pepp. L. Rev. 1065 (2016)] This encouraged the formation of business trusts, and ultimately unit trusts due to the elongated period during which the prohibition against incorporation of companies remained in force. Just like the courts in UK, over a period of time the Supreme Judicial Court of Massachusetts in various cases [Phillips v Blatchford, 137 Mass. 510 (1884); Mayo v Moritz, 24 N. E. 1083 (Mass. 1890) : 151 Mass 481; Williams v Inhabitants of Milton, 102 N. E. 355 (Mass. 1913) : 215 Mass 1; Larson v Sylvester, 185 N. E. 44 (Mass. 1933)] recognised that business trusts that issue securities were distinct from companies or partnerships, drawing upon the reasoning of the English Court of Appeal in Smith v Anderson. Over time other states also recognised separate unincorporated associations that issue securities.[See, See, Minnesota State Statutes Business, Social, and Charitable Organizations (Ch. 300-323A) General provisions, § 318.02. The subdivision 2., reads as follows, – “Any such association heretofore or hereafter organized shall be a business trust and a separate unincorporated association, not a partnership, joint-stock association, agency, or any other relation except a business trust. A business trust is also known as a common law trust and Massachusetts trust for doing business.”]
The Constitution of India in Entries 10 & 21 of List III of the Seventh Schedule recognizes trusts of various kinds including commercial trusts. This resonates with the concept of ‘business trusts’ in USA. Thus, the Report of High-Level Committee Under the Chairmanship of Justice (Retd.) Anil R. Dave on the Measures for Strengthening the Enforcement Mechanism of the Board and Incidental Issues in Part D, Section II: ‘Business Trusts’ and ‘Monies Held In Trust’: What Is The Nature Of ‘Trust Vehicles’ Registered under Indian Securities Laws And Those Who Fail To Register? inter alia refers to the American law in this respect of unincorporated associations developing into mutual funds.
Mutual funds etc.: Private trusts or Public trusts? Several courts have noted that that mutual funds are being formed under the Indian Trust Act, 1882 [See, Axis Mutual Fund, through its trustee Axis Mutual Fund Trustee Co. Ltd. v State of Maharashtra & Ors., 2018 (59) GSTR 212 (Bom) : MANU/MH/2340/2018 : 2018 SCC Online Bom 2030 (holding that floating of multiple mutual fund schemes by a mutual fund formed under the Indian Trust Act, 1882 does not amount to creation of multiple trusts i.e. the trust is the broad registered structure and not the schemes under which monies are raised and managed as per different scheme objectives); Canara Bank & Ors. v National Thermal Power Corporation & Ors., 2000 (1) SCALE 139 : 2001 (1) SCC 43 : 2001 (104) CompCas 97 (SC) (holding that when a public sector undertaking is shown to be acting not as an undertaking but as a Trustee of a Mutual Fund formed under the Indian Trust Act, 1882, disputes between it and another government undertaking cannot be referred to Government Committees)]. However, none have ventured into the possible consequences of such a formation. Establishing a mutual fund as a private trust under the Indian Trusts Act, 1882 has several problems and is inherently contradictory.
Firstly, a mutual fund was defined under Regulation 2 (q) the SEBI (Mutual Funds) Regulations, 1996 as ‘as a fund established in the form of a trust to raise monies through the sale of units to the public or a section of the public under one or more schemes for investing in securities including money market instruments or gold or gold related instruments or real estate assets.’ [Similarly see, Regulation 2(1)(gg) of the SEBI (Mutual Funds) Regulations, 2026] Further, Regulation 18 (12) made it clear that ‘the trustees shall be accountable for, and be the custodian of, the funds and property of the respective schemes and shall hold the same in trust for the benefit of the unitholders in accordance with these regulations and the provisions of trust deed.’ [Similarly see, Regulation 12(3)(d) of the SEBI (Mutual Funds) Regulations, 2026]
At the time of formation of the trust, the mutual fund does not follow the scheme of the Indian Trust Act, 1882 in as much as the entrustment of trust property or monies happens after the mutual fund is registered/formed, it thereafter issues the offer documents of its schemes to the public and the public subscribe to the mutual fund. Thus, two things become plain, –
- The manner in which a mutual fund is created under the regulations is contrary to the scheme of the Indian Trust Act, 1882. Section 6 of that Act makes it clear that the trust is formed when the author of the trust transfers the property to the trust i.e. the formation of trust is simultaneous with the act of entrustment. In a mutual fund the person/investor transferring the monies is not the author of the trust but the beneficiary; and the author is actually the Sponsor of the mutual fund who registers it with SEBI even before any scheme is offered. Regulation 2 (x) of the SEBI (Mutual Funds) Regulations, 1996 defines the “sponsor” as the person who establishes the mutual fund. However, the “sponsor” does not dedicate any property for the purposes of the trust while establishing it. [Similarly see, Regulation 2(1)(xx) of the SEBI (Mutual Funds) Regulations, 2026] Simply, put the formation of a mutual fund is unlike the mode in which a trust can be formed under the Indian Trust Act, 1882. In fact, a mutual fund is a quite a unique trust in the sense, the beneficiaries are the one who transfer the asset to an existing fund i.e. the entrustment of trust property happens after the trust is registered and formed;
- The Indian Trust Act, 1882 governs only private trusts for private purposes. [See, Joint Commissioner, H. R. & C. E. Administration Department v Jayaraman & Ors., 2006 (1) SCC 257 : AIR 2006 SC 104; Thayarammal (dead) by L.R.s v Kanakammal & Ors., 2005 (1) SCC 457 : AIR 2005 SC 1588] Private trusts do not possess juristic personality, they are not incorporated under any law. [See, Vijay Sports Club & Ors. v State of West Bengal & Ors., 2019 SCC OnLine Cal 233 : MANU/WB/2361/2019; Duli Chand v Mahabir Pershad Trilok Chand Charitable Trust, Delhi, 1983 SCC OnLine Del 270 : (1984) 6 DRJ 153 : (1984) 25 DLT 70 (DB) : AIR 1984 Del 145 : (1984) 1 AP LJ (DNC) 15 (DB); Commissioner of Income Tax (TDS), Kanpur & Anr. v Canara Bank, (2018) 9 SCC 322 : 2018 SCC Online SC 677 : AIR 2018 SC 3458.] A private trust is governed by the Indian Trust Act, 1882 and it is merely ‘an obligation annexed to the ownership of property, and arising out of the confidence reposed in and accepted by the owner, or declared and accepted by him, for the benefit of another, or of another and the owner’ u/s 3 of the Indian Trusts Act, 1882.
However, the scheme of SEBI (Mutual Funds) Regulations makes it clear that the purpose of the fund is to benefit the investing public. The assets are held for the benefit of the investing public. It is relevant here to understand the distinction between a public trust and a private trust. The Supreme Court has categorically stated that the essential distinction between a public trust and a private trust is that in a public trust the beneficial interest is vested in an uncertain and fluctuating body of persons, either the public at large or some considerable portion of it answering a particular description; in a private trust the beneficiaries are definite and ascertained individuals or who within a definite time can be definitely ascertained. [See, Mahant Ram Saroop Dasji v S. P. Sahi, Special Officer-in-charge of the Hindu Religious Trusts & Ors., AIR 1959 SC 942 : 1959 Suppl (2) SCR 583; Deoki Nandan v Murlidhar, 1956 SCR 756 : AIR 1957 SC 133; Bala Shankar Mama Shankar Bhattjee & Ors. v Charity Commissioner, State of Gujarat, 1994 Suppl (2) SCR 687 : AIR 1995 SC 1967 : 1995 Supp (1) SCC 48; Dhaneshwarbuwa Guru Pursottambuwa owner of Shri Vithalkrukha v Charity Commissioner, State of Bombay, AIR 1976 SC 871 : 1976 (3) SCR 518 : 1976 (2) SCC 417; Mahant Shri Srinivasa Ramanuj Das v Surajnarayan Dass & Anr., AIR 1967 SC 256 : 1966 SCR 436]
Where the beneficiaries are not specified individuals and not identifiable from the description indicated in the document creating the trust, the trust can only be a public trust. Further, even after the mutual fund is formed its trustees have no way to identify the prospective investors; it is only after a public offer is made and an application for subscription is made can they be identified. However, even this body of investors is a fluctuating body. Since it matters not whether the schemes of the mutual fund are ‘open-ended’ or ‘close-ended’ because the investors remain a fluctuating body either due to issuance or redemption of units or because the investors trade the units between themselves.
This above reasoning applies even to other pooled investment trusts such as REITS, AIFs, and InvITs, even if they are doing private placement. Private placement is simply the manner of raising funds to pre-identified person and below a certain numerical threshold, however, the trust is registered much before the units are issued to any person is identified. Further, even in these cases, the units are transferable and the body of investors can fluctuate and the funds are accumulated for public purpose and not a private purpose.
Secondly, establishing a mutual fund as a private trust under the Indian Trust Act, 1882 is not at all advisable since the nature of creation of a trust and the scheme of duties and liability of trustees are not in line with the nature of a private trust. Like all subordinate legislation, the SEBI Regulations must confirm to the parent statute, other parliamentary statutes and the Constitution. No over-riding status has been conferred by law to these subordinate legislations over the Indian Trust Act, 1882. Further, section 32 of the SEBI Act, 1992 makes it clear that the SEBI Act is in addition to and not in derogation of other laws. In which case, even the regulations made thereunder should not be in derogation of other statutes.
Thirdly, establishing a mutual fund as a private trust under the Indian Trust Act, 1882 would mean that the disposition of monies in trust must not be in contravention of the law relating to three uncertainties [Knight v Knight, (1840) 3 Beav 148 : (1840) 49 ER 58 (The law of three uncertainties applied to trusts); The Trustees of Tribune Press, Lahore v Commissioner of Income Tax, Punjab, 1939 UKPC 46 : 1939 (7) ITR 415 (PC) : AIR 1939 PC 208 : 1939 (41) BomLR 1150; M. Kesava Gounder (deceased) & Ors. v D. C. Rajan & Ors., 1976 (1) MLJ 56 : AIR 1976 Mad 102 : 89 L.W. 205; Re Vallabhdas Karsondas Natha, AIR 1947 Bom 382 : 1947 (15) ITR 32 (Bom)](uncertainty regarding objects, uncertainty regarding subject matter and uncertainty of intention) and the rule against perpetuity. Essentially any disposition if void if it permits the accumulation beyond a certain period, which is reflected in sections 14 to 17 of the Transfer of Property Act, 1882. The only exception to these rules is reflected in section 18 of the Transfer of Property Act, 1882 which deals with transfers beneficial for the public or mankind. [Re Vallabhdas Karsondas Natha, AIR 1947 Bom 382 : 1947 (15) ITR 32 (Bom.)] This exception is what applies to trusts. It is common knowledge that several mutual fund schemes have existed for quite a long period which would easily violate these rules if they are private trusts. [ET Online report ‘25 years of pvt sector mutual funds: How are the oldest schemes performing?’, available at <https://economictimes.indiatimes.com/mf/analysis/25-years-of-pvt-sector-mutual-funds-how-are-the-oldest-schemes-performing/articleshow/64971825.cms>; Financial Express Report ‘How India’s oldest Mutual Fund scheme has turned Rs 1 lakh into Rs 1 crore’ dated 21.10.2019, available at <https://www.financialexpress.com/money/mutual-funds/how-indias-oldest-mutual-fund-scheme-has-turned-rs-1-lakh-into-rs-1-crore/1742032/>; Rupeeiq report ‘India’s oldest mutual fund schemes give 18-21% annualised returns since launch’ dated 10.04.2018, available at <https://www.rupeeiq.com/content/indias-oldest-mutual-fund-schemes-give-18-21-annualised-returns-since-launch/>.]
Lastly, the terms according to which a mutual fund is established make it clear that it is a trust for public benefit rather than serving private interests. Even the preamble of the Unit Trust of India Act, 1963 made it clear that the statutory mutual fund was being established with view to encouraging saving and investment and participation in the income, profits and gains accruing to the Corporation from the acquisition, holding, management and disposal of securities. Non-statutory mutual funds also have similar objectives in their Deed of Trust. [See, Axis Mutual Fund, through its trustee Axis Mutual Fund Trustee Co. Ltd. v State of Maharashtra & Ors., 2018 (59) GSTR 212 (Bom) : MANU/MH/2340/2018 : 2018 SCC Online Bom 2030; Canara Bank & Ors. v National Thermal Power Corporation & Ors., 2000 (1) SCALE 139 : 2001 (1) SCC 43 : 2001 (104) CompCas 97 (SC).]
Thus, it is the view of the Author that mutual funds (and other investment trusts) are not private trusts and their formation under the Indian Trusts Act, 1882 is in derogation of the law of trusts and the very definition of a mutual fund given in the regulations made by SEBI; and the original Central Government Guidelines which led to the present situation were void to begin with.
Unit Trusts & Laws relating to public trusts. ‘Commercial trusts’. A trust, which is not a private trust, is invalid if it not formed for a public, religious or charitable purpose [See, Maulana Mohammad Ibrahim Riza Malak v Commissioner of Income Tax, Nagpur, AIR 1930 PC 226 : 57 IA 260; Mohd. Yusuf & Ors. v Azim-uddin & Ors, AIR 1941 All 235; East India Industries (Madras) Pvt. Ltd. v Commissioner of Income Tax, Madras, 1967 (65) ITR 611 (SC) : AIR 1967 SC 1554 : 1967 (3) SCR 359; Yogiraj Charity Trust v Commissioner of Income Tax, New Delhi, AIR 1976 SC 1836 : 1976 (3) SCR 947 : 1976 (3) SCC 378; Commissioner of Income Tax, Kanpur v Kamla Town Trust, 1996 (217) ITR 699 (SC) : AIR 1996 SC 620 : 1996 (7) SCC 349; Union of India v Moolchand Kharaiti Ram Trust, AIR 2018 SC 5426 : 2018 SCC Online SC 675 : 2018 (8) SCC 321 (relying on Halsbury’s Laws of England on the subject).]; since such a trust would be unenforceable by any human beneficiary. This position of general law is also reflected in various State enactments, which incorporate a provision saving public trusts from being invalid if some of the purposes are non-charitable or non-religious e.g. Section 11 of the Bombay Public Trust Act, 1950, Section 4 of the Rajasthan Public Trusts Act, 1959, etc. In the absence of the such specific provisions the trust would have been invalid. The term charitable is extremely wide and covers any purpose which benefits the public. A trust formed for advancing trade which leads to economic prosperity ensures benefit to the entire community is a public trust. [See, Commissioner of Income Tax, Madras v Andhra Chamber of Commerce, 1965 (55) ITR 722 (SC) : AIR 1965 SC 1281 : 1965 (1) SCR 565] There is no particular enactment for public trusts relating to many States in India save a few such as Maharashtra, Gujarat, Rajasthan, etc. A question may arise if a unit trust is required to be registered under such state laws. However, just like the difficulties faced in applying the Indian Trusts Act, 1882 similar difficulties are faced when applying these State public trust enactments. Neither is it possible for such commercial public trusts formed for public investment benefit to be formed in the streamlined manner of dedication of property by a settlor as suggested by these State Acts nor is it possible for such trusts to function while holding, investing, or disposing their trust fund in the risky securities markets (which is generally prohibited) or act independently (without seeking the permission of the Charity Commissioner). There is authority atleast in English law that the investment of monies by an investor in a unit trust does not constitute a ‘settlement’ or ‘disposition’ by such investor. See Midland Bank Executor & Trustee Co. Ltd. v A.E.G. Unit Trust (Managers) Ltd., per Wynn-Parry J., [1957] Ch 415, 420 : [1957] 3 W.L.R. 95 : [1957] 2 All ER 506. However, it must be considered that unless the investors entrust the monies to the trustees, the unit trust would be an empty or null trust; hence in the view of the Author the actual entrustment of funds is still relevant for imposing the trust obligations of a trustees of the unit trust and the manager acting on the authority of the trustees.
Units trusts are a sui generis form of public commercial trusts recognised under the general law, and are of various kinds, such as mutual funds, collective investment schemes (CIS), infrastructure investment trusts (InvIT), real estate investment trusts (REIT), alternative investment funds (AIF). They are public commercial trusts formed for public investment benefit regulated primarily by the securities laws coupled with underlying principles of the law of trusts. Unlike a dedication of property made by a person for public benefit, which is regulated under State public trust enactments, in a unit trust the trustees thereof enable individual members of the public to come together and pool assets to benefit each other due to economies of scale and use the management skill of expert investment advisors which would otherwise not be available to small investors. Thus, it arguable that instead of a dedication of tangible assets, a unit trust involves the dedication of special intangible skill (though the services of a trustee are chargeable it is regulated by law) of the trustees and the investment manager to provide economies of scale to the public investors. Unit Trusts constitute a complex trust structure in which principles of property law and contract law are used to generate trust structures by third parties to enable the public to organise sharing their property for joint investment. It is probably due to the unique nature of unit trusts in India, that they have not been dealt with as charitable trusts under the Income Tax Act, 1961. That Act separately deals with the various kinds of unit trusts i.e. Mutual funds, business trusts, etc. Interestingly, even the Constitution of India recognizes trusts of various kinds including commercial trusts as detailed earlier. Thus, such trust may be considered as public commercial trusts regulated by the SEBI Act, 1992 and distinct from simplicitor public trusts regulated under various State enactments on public trusts.
PCS Industries Ltd. v SEBI. The Securities Laws (Amendment) Act, 1995 inter alia amended the Securities and Exchange Board of India Act, 1992 and the Securities Contracts (Regulation) Act, 1956 and inter alia introduced penalty provisions for defaults in units of mutual funds, though till 2004, there was no specific mention of mutual fund units in the definition of ‘securities’ in the Securities Contracts (Regulation) Act, 1956. A more reasonable and meaningful way to understand this approach of amending the SEBI Act, 1992 without first amending the Securities Contracts (Regulation) Act, 1956 to recognize ‘mutual funds’, is that the common law already recognized that unit trusts had a right to issue marketable securities to investors due to the similarity in trust and corporate law between India and UK.
In India till the decision of the Securities Appellate Tribunal in PCS Industries Ltd. v SEBI, it was not clear whether a mutual fund organised as a trust (as opposed to a body corporate) could issue securities due to an earlier contrary order passed by the Hon’ble Bombay High Court in the matter of Canbank Financial Services Ltd. v V. B. Desai and Anr. The Tribunal noted that the definition of securities in clause (h) of Section 2 of Securities Contracts (Regulation) Act, 1956 is an inclusive one.
The Tribunal’s decision implied that the units issued by such funds are ‘securities’ even prior to the 2004 insertion of sub-clause (id) ie. units or any other such instrument issued to the investors under any mutual fund scheme, in the definition of ‘securities’ by the Securities Laws (Amendment) Act, 2004, Sec. 2, w.e.f. 12.10.2004. It merely removed the confusion created by the order in Canbank Financial Services Ltd. v V. B. Desai and Anr.
While the Tribunal’s judgment is based on the rationale that the mutual fund units issued by a mutual fund organized as a trust are marketable in nature and therefore ‘securities’ [Ideally, this principle has been generally applied in the context of companies or body corporates. See, A. K. Menon v Fairgrowth Financial Services Ltd. & Anr., 1994 (81) CompCas 508 (Bom) : 1995 (2) CompLJ 59 (Bom).]; but it fails to answer the primary issue, whether a mutual fund could be organized as a trust in the first place, and therefore issue such securities. It is the humble view of the Author the jurisprudence relating to unit trust organized for public benefit and issuing marketable instruments is rooted in the Anglo-American law. Since in common law units issued by unit trusts have always been considered as marketable instruments since the late 19th century judgment in Smith v Anderson it would fall within the inclusive definition of securities in section 2(h) Securities Contracts (Regulation) Act, 1956. Such an interpretation would be in line with the judgment of the Supreme Court in Sudhir Shantilal Mehta v Central Bureau of Investigation, 2009 (8) SCC 1 : 2009 (13) SCR 682 : 2009 (11) SCALE 217, which interpreted the inclusive definition of ‘securities’ [In 1992 the definition of ‘securities’ in the Securities Contracts (Regulation) Act, 1956 and the definition of ‘securities in the Special Court (Trial of Offences Relating to Transactions in Securities) Act, 1992 was the same. See Canbank Financial Services Ltd. v V. B. Desai & Anr.] contained in the Special Court (Trial of Offences Relating to Transactions in Securities) Act, 1992 to include not only the instruments mentioned therein but even those instruments which are commonly understood as securities. [This would include units trusts such as ‘mutual funds’ which existed in the commercial world but were not specifically mentioned in the Securities Contracts (Regulation) Act, 1956 & the Special Court (Trial of Offences Relating to Transactions in Securities) Act, 1992]. Quite interestingly, the Hon’ble Gujarat High Court in Essar Steel Ltd. v Gramercy Emerging Market Fund, 2002 (40) SCL 848 (Guj) : 2003 (116) CompCas 248 (Guj) followed the US law by referring to: Reves v Ernst & Young, 494 U.S. 56 (1990) : 110 S.Ct. 945 (1990) and inter alia held any instrument which are issued for the purpose of investment are to be considered as securities.
The aforesaid reasoning applies to not only to mutual funds but to all kinds of unit trusts such as Infrastructure Investment Trusts, Real Estate Investment Funds, Collective Investment Schemes, etc. since certificates of unit trusts have been commonly recognized as securities ever since the judgment of Smith v Anderson.
Thus, the Author is of the view that the legal basis of unit trusts issuing securities i.e. units, to investors in India stems from company law, the law of trusts including the UK Court of Appeal’s decision of Smith v Anderson as well as the principles relating to unincorporated associations in American law due to a shared Anglo-American jurisprudence where the courts had to deal with the legalities of commercial innovations to circumvent the long-standing prohibition against incorporation of companies, save by a special charter.
An incorrect view in retrospect: Collective investment schemes & Plantation scheme Units as ‘Bonds’. Prior to the insertion of Section 11AA in the SEBI Act, 1992 the Hon’ble Allahabad High Court in Paramount Bio-Tech Industries Ltd. & Ors. v Union of India & Ors., [2004] 49 SCL 77 (All) : 2004 (120) CompCas 18 (All) : 2004 (2) CompLJ 446 (All), interpreted plantation bonds, agro bonds, etc. issued by plantation companies as ‘bonds’. That judgment is clearly erroneous, as those instruments are not ‘bonds’ in the real sense; the court seemed to have been swayed by the use of the word ‘bond’ by the issuer.
Section 11AA of the SEBI Act, 1992 which was introduced later to deal inter alia with plantation schemes pursuant to the decision in Kirit Somaiya & Ors. v SEBI & Ors., 1999 (1) BomCR 420 : 1999 (1) ALLMR 20 : 1998 SCC OnLine Bom 553 : (2000) 2 CCC 168 (DB) : (1999) 33 CLA 373 and the SEBI (Collective Investment Schemes) Regulations, 1999 issued thereunder, clearly show that the they are meant to be in the nature of unit trusts and not bonds, similar to the law in the EU, UK, Australia and the blue-sky laws of USA.
Thus, it is imperative to recognise and law the correct foundation of unit trusts in India to prevent any challenge to the validity of unit trusts, which may unnecessarily jeopardise public investment and shake investor confidence in India’s securities law regime. For practitioners and scholars of Indian securities and trust law, the challenge going forward lies in refining doctrine at the intersection of private trust law and public regulation, ensuring that fiduciary standards in mutual funds and pooled investment vehicles evolve in tandem with market complexity while preserving the core protection of investor interests.
*******
-Suraj Chaudhary, Advocate, Bombay High Court
India-Law.org 
Leave a comment