Justice G. R. Swaminathan observed, “Rating is an exercise that is carried out by financial analysts and professionals. Writ Court should not assume jurisdiction in matters which are better handled by experts.”

The Madras High Court on Monday (12th October) held that a Credit Rating Agency cannot be characterized as “State” within the meaning of Article 12 of the Constitution of India and cannot be considered as discharging any public function.

Significantly, the Bench of Justice G. R. Swaminathan observed,

“Rating is an exercise that is carried out by financial analysts and professionals. Writ Court should not assume jurisdiction in matters which are better handled by experts.”

Background of the Case

The writ petitioner (Mahasemam Trust) before the Court is a registered public trust. Its activities include micro-financing women Self Help Groups. It is a Non-Banking Finance Company (NBFC).

The petitioner is a client of the third respondent (India Rating and Research Pvt. Ltd.) which is a credit rating agency. The rating agency had downgraded the petitioner’s bank loans’ rating to ‘IND BB+’ from ‘IND BBB-‘.

The petitioner has been availing term loans from various banks and has fixed ambitious targets for the coming year. The petitioner’s track record of repayment is claimed to be very good.

Following the COVID-19 pandemic outbreak, the Reserve Bank of India (RBI) announced a moratorium for the period up to 31st May, 2020 vide Circular dated 27.03.2020.

Pursuant thereto, the petitioner also granted the benefit of the moratorium to all the joint liability Self Help Groups, in order to enable them to tide over the economic fallout arising out of the pandemic disruption.

Securities and Exchange Board of India (SEBI) also issued policy Circular dated 30.03.2020 setting out relaxation norms.

[NOTE: Since the issue turned on the construction of the circular issued by SEBI, the Court suo motu impleaded it as the fourth respondent in the matter.]

According to the petitioner, the third respondent downgraded the petitioner’s rating disregarding the said Circular (setting out relaxation norms in sync with RBI’s circular).

Claiming that this would have a direct bearing on the capacity of the petitioner to raise loans from the banking institutions (as its rating was downgraded), this writ petition came to be filed.

Arguments put forth

The core argument of the Petitioner’s Counsel was that the Credit Rating Agencies discharge public functions and therefore they are clearly amenable to Writ jurisdiction.

Though the dispute between the parties may appear to be contractual in nature, in substance, it throws up questions of public law.

[NOTE: Since COVID outbreak had caused widespread disruption, RBI came out with its policy package vide circular dated 27.03.2020 which permitted the lending institutions to grant a moratorium of three months on payment of all instalments falling due between 1st March 2020 and 31st May, 2020. It was further extended from 31st May, 2020 to 30th September, 2020.

Further, SEBI also out with its Circular dated 30.03.2020 which was in sync with the RBI’s circular.]

Importantly, in this context, it was argued that even a bare textual reading of the above-stated two circulars can lead to only one conclusion, namely, that the events that have taken place during the moratorium period cannot be factored into the rating process.

The Counsel for the petitioner further submitted that the impugned action of the third respondent (the rating agency) was not in consonance with the policy announcements made by RBI and SEBI and thus, he called upon the Court to strike it down.

However, when the Petitioner was asked if the lending institutions have granted a moratorium in favour of the petitioner, the Petitioner could not answer the question categorically

Stand of the Credit Rating Agency

The third respondent submitted before the Court that it can’t be considered as a “State” within the meaning of Article 12 of the Constitution of India. Hence, it is not amenable to writ jurisdiction.

It was further stated that the relationship between the petitioner and the third respondent is purely contractual in nature. The agreement between the parties is known as rating agreement.

Lastly, it was submitted that a dispute arising out of rating agreement cannot be resolved in writ proceedings.

The Court’s observations

The High Court cited the Apex Court’s ruling in the case of Rajbit Surajbhan Singh V. The Chairman, Institute of Banking Personnel Selection, Mumbai [(2019) 14 SCC 189], wherein it was held that the question as to whether a corporation/society would fall within the meaning of Article 12 should be decided after examining whether the body is financially, functionally and administratively dominated by or under the control of the Government. Such control should be particular to the body in question and must be pervasive. A control which is merely regulatory under the statute or otherwise would not make the body ‘State’ Under Article 12.

In this context, the Court said,

“Rating is an evaluation and assessment of creditworthiness of an individual or company. The debtor’s ability to repay the debt is analyzed and based on the same, credit-risk associated with lending is projected. These are normal corporate functions.”

Further, the Court said,

“Merely because they have implications for the general public and lending institutions tend to go by them, credit rating agencies cannot be considered as discharging public function or public duty. Secondly, SEBI has only regulatory and supervisory control over the credit rating agencies.”

Applying the aforesaid decision of the Apex Court, the Court held that the third respondent cannot be characterised as “State” within the meaning of Article 12 of the Constitution of India and that it is not discharging any public function.

Further, when SEBI was asked to clarify its position, its standing counsel submitted before the Court that the petitioner’s understanding of circular was incorrect.

It was also pointed out that the instant case pertains to the rating of bank loans of the petitioner and does not pertain to the rating of debt securities. In the case of bank loan rating, relevant guidelines issued by the Reserve Bank of India would be applicable.

Importantly, the Court said,

“Credit Rating indicates the fiscal health of the person or the institution concerned. It is one thing to say that notwithstanding the actual position, ameliorative relief must be provided. It is one thing to say that loans should be provided notwithstanding the downgrading. But it would be a completely different matter to say that rating should not reflect the actual state of affairs. Any remedial treatment must be preceded by correct diagnosis. If the patient is going to insist that the symptoms should be disregarded, then there can be no proper diagnosis, not to speak of the resulting treatment.” (emphasis supplied)

Lastly, the Court clarified that it had held that

a) The third respondent is a private body and not a “State” within the meaning of Article 12 of the Constitution

b) By rating its clients, the third respondent is not discharging any public function

c) The subject matter involves analysis by financial experts

d) And the petitioner is having effective alternative remedies,

Therefore, the Petition was dismissed as not maintainable.

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