In a landmark judgment delivered on 09.10.2023, the Hon’ble Supreme Court has finally settled the conundrum arising out of the conflicting interpretations of Rule 3 of the Electricity Rules, 2005 (“Rules”) as given by the Hon’ble APTEL in the two judgments i.e. Kadodara Power Pvt. Ltd. and Others v. Gujarat Electricity Regulatory Commission (“Kadodra Power”),  and another dated 22.09.2009, which decision was held to be per incuriam on several findings in Tamil Nadu Power Producers Association v. Tamil Nadu Electricity Regulatory Commission (“TNPPA”) dated 07.06.2021.

Vide the said decision, the Hon’ble Supreme Court has adjudicated upon the following three vital issues concerning interpretation of Rule 3:

1. Eligibility criteria for a CGP/captive user under Rule 3(1)(a) of the Rules;
2. Interpretation of the second proviso under Rule 3(1)(a) of the Rules and in particular the words “Association of persons”;
3. Whether a company set up as a Special Purpose Vehicle for generating electricity is an, “association of persons”, in terms of the second proviso to Rule 3(1)(a) of the Rules.

The key findings of the Hon’ble Supreme Court are summarized as below:

ISSUE 1 – Eligibility criteria for a CGP/captive user under Rule 3(1)(a)

Re:      Construction, maintenance or operation can be by different persons

While adjudicating upon the first issue, the Hon’ble Supreme Court inter alia observed that Section 2(8) of the Act should not be read as impliedly incorporating a prohibition to transfer of ownership once the CGP has been set up. The court clarified that the person who maintains and operates the CGP must not have necessarily also constructed the CGP.. In this regard, reliance has been placed on Rule 3 of the Rules which refers to the percentage of ownership of the captive user in the CGP, and use/consumption by the captive user in the financial year.

Following the interpretation as given by the Hon’ble APTEL in Kadodra Power the Hon’ble Supreme Court held that a CGP does not lose its captive status due to transfer of its ownership or any part of its ownership, provided that the transferee, that is, a new captive user, complies with eligibility criteria specified under Rule 3 of the Rules.

Re: Ownership and consumption requirements to be maintained continuously throughout the year

On the issue of verification of the Captive Status of a CGP, the Hon’ble Supreme Court has departed from the view taken by APTEL in TNPPA and has categorically held that as per Explanation (2) to Rule 3(1)(b), the minimum ownership requirement is required to be maintained continuously, throughout the financial year, that is, from 1st April of a year to 31st March of the next year, along with the minimum electricity consumption requirement.

ISSUE 2 - Interpretation of the second proviso under Rule 3(1)(a) of the Rules and in particular the words “Association of persons”

Insofar as the second issue is concerned, the Hon’ble Supreme Court has upheld the Hon’ble APTEL’s ruling in Kadodra Power and has accordingly observed that the last portion of the second proviso to Rule 3(1)(a) of the Rules, that is, the proportionality principle, specifies a unitary qualifying ratio. The unitary qualifying ratio is the consumption requirement divided by the shareholding requirement, that is, 51% divided by 26%. It was further stated that the said interpretation checks, “gaming”, by owners, which would amount to misuse and abuse of the Rule 3(1)(a) of the Rules. Instances of gaming have been quoted by the Hon’ble Supreme Court where a 1% or an insignificant shareholder of the CGP disproportionately uses the electricity generated, in which case he should not be treated as a group captive user and, therefore, should be denied the benefits that are given under the Act to the captive users.

On the question of applicability of the second proviso of Rule 3(1)(a) in cases where there is a change in ownership or shareholding of the CGP, the Hon’ble Supreme Court has held that in case of change of ownership, shareholding, or consumption, the principle of weighted average should be applied to ensure compliance of the proportional electricity consumption requirement stipulated under the second proviso to Rule 3(1)(a).

ISSUE 3 – Whether a company set up as a Special Purpose Vehicle for generating electricity is an, “Association of persons”, in terms of the second proviso to Rule 3(1)(a) of the Rules.

On the third question of whether a company set up as a SPV is an Association of person, the Hon’ble Supreme Court has upheld the APTEL’s ruling in Kadodra Power and has accordingly held that SPVs which own, operate and maintain CGPs are an “association of persons” in terms of the second proviso to Rule 3(1)(a) of the Rules.

The Court observed that Section 2(8) of the Act recognises two categories of CGPs, that is, single captive users and group captive users. For group captive users, only two categories of users are recognised, that is, a cooperative society and association of persons. The first proviso to Rule 3(1)(a) of the Rules creates an exception for cooperative societies. The second proviso to Rule 3(1)(a), which refers to association of persons, requires such captive users to satisfy the minimum ownership and electricity consumption requirements specified under paragraphs (i) and (ii) of Rule 3(1)(a) of Rules.

Rule 3(1)(b) of the Rules does not negate or undo the eligibility requirements specified in paragraphs (i) and (ii) to Rule 3(1)(a) of the Rules, which in case of an association of persons mandates the satisfaction of the proportionality requirement under the second proviso to Rules 3(1)(a). Rule 3(1)(b) of the Rules merely liberalises, gives flexibility and an option when a generating station owned by company, incorporated as a SPV, has multiple generating units.

Thus, to preserve the intent and essence of Section 2(8) that is, “primarily for its own use”, all group captive users which are not registered cooperative societies are mandatorily required to comply with the test of proportionality specified in the second proviso to Rule 3(1)(a).

This judgment will definitely facilitate in adding the appropriate checks and balances for curbing the misuse and abuse of the group captive system provided for under Rule 3 (1)(a). The interpretation of Rule 3 put forth by this judgment will equally preserve the intent of the legislature towards promoting legitimate CGPs that are built “primarily for their own use”.

We represented Maharashtra State Electricity Distribution Company Limited (MSEDCL) in this batch of appeals. We were led by Ld. ASG Mr. Balbir Singh and Mr. G. Saikumar.

The team at DSK comprised of Mr. Samir Malik, Ms. Nikita Choukse and Mr. Akash Lamba.