Credit Rating Agency Liability Claims

1. Meaning

Credit Rating Agency (CRA) Liability Claims are legal claims or regulatory proceedings against a credit rating agency for alleged failure to perform its rating functions with the required due diligence, independence, objectivity, care, accuracy, surveillance and regulatory compliance.

A credit rating is generally an expert opinion about the credit risk of a debt instrument or issuer, rather than a guarantee that the investor will receive payment. This distinction is important: an incorrect rating does not automatically make the CRA liable. Liability generally becomes stronger where there is negligence, fraud, conflict of interest, inadequate investigation, failure of surveillance, misleading disclosure or violation of SEBI requirements.

In India, CRAs are regulated by SEBI under the SEBI (Credit Rating Agencies) Regulations, 1999, as amended. The regulations impose obligations concerning monitoring, review, internal procedures, disclosure, confidentiality and rating processes.

2. Nature of a Credit Rating

A credit rating generally expresses an opinion regarding the likelihood of timely payment of financial obligations.

For example:

AAA → very high credit quality

AA → high credit quality

A → comparatively lower but adequate credit quality

BBB → moderate/investment-grade risk

Lower ratings generally indicate progressively greater credit risk.

However:

Credit rating ≠ guarantee of repayment.

Therefore, a CRA normally cannot be held liable merely because an issuer subsequently defaults.

The legal question is usually:

Did the CRA exercise the level of professional diligence, independence and regulatory compliance required in the circumstances?

3. Indian Legal Framework

The principal regulatory framework is the SEBI (Credit Rating Agencies) Regulations, 1999.

The regulations require CRAs to comply with a Code of Conduct and impose obligations concerning:

• due diligence;
• professional care;
• independent judgment;
• objective rating;
• adequate research;
• monitoring;
• periodic review;
• disclosure of rating rationale;
• maintenance of records;
• confidentiality;
• avoidance of conflicts;
• internal rating procedures.

SEBI's Code of Conduct specifically requires a CRA to exercise due diligence, proper care and independent professional judgment and to maintain an adequate basis for rating evaluations.

Regulation 34 also provides for regulatory action where a CRA contravenes the applicable statutory or regulatory requirements, including suspension or cancellation mechanisms.

The current SEBI CRA framework continues to be based on the 1999 Regulations, with amendments; SEBI's published version was last amended on November 28, 2024.

4. Who Can Bring a Liability Claim?

Potential claimants may include:

A. Issuer

An issuer may challenge a rating where it alleges:

• arbitrary downgrade;
• failure to follow contractual procedures;
• consideration of irrelevant factors;
• breach of rating agreement.

B. Investors

Investors may potentially claim where they can establish an actionable legal duty and causation, particularly in cases involving:

• fraudulent representations;
• misleading statements;
• negligent misrepresentation;
• statutory violations.

C. Regulators

SEBI can take regulatory or enforcement action against a CRA for breach of securities laws and CRA regulations.

D. Other market participants

Depending on the circumstances, trustees, lenders or other parties may have contractual or statutory rights.

5. Major Grounds of CRA Liability

5.1 Negligence

A CRA may face a negligence-based claim where it:

1. owed an applicable duty;
2. breached the required standard of care;
3. caused legally recoverable loss;
4. satisfies applicable causation and remoteness requirements.

Merely making an unpopular or ultimately incorrect professional judgment is not necessarily negligence.

5.2 Fraud

Liability becomes substantially stronger where a CRA:

• knowingly publishes false information;
• deliberately suppresses material facts;
• manipulates ratings;
• knowingly ignores serious adverse information;
• participates in a fraudulent scheme.

The CRA Regulations prohibit untrue statements, suppression of material facts and misrepresentation in information furnished to regulators and the public.

5.3 Failure of Due Diligence

A CRA is expected to possess a reasonable and adequate basis for its rating evaluation.

Potential failures include:

• insufficient investigation;
• unreliable data;
• inadequate verification;
• ignoring material financial information;
• defective analytical methodology;
• inadequate documentation.

6. Failure of Surveillance

A rating does not necessarily end once it has been initially assigned.

CRAs have continuing monitoring obligations.

The regulatory framework requires periodic review and monitoring of ratings.

Therefore, liability issues can arise where a CRA:

becomes aware of significant deterioration but fails to conduct appropriate surveillance or review.

This issue was particularly important in the Brickwork Ratings proceedings discussed below.

7. Conflict of Interest

The credibility of a CRA depends heavily on independence.

Potential conflicts may arise where:

• the issuer pays the CRA;
• the CRA provides other services;
• the CRA has relationships with the issuer;
• employees hold financial interests;
• the CRA is pressured to maintain a particular rating.

SEBI has specifically taken measures aimed at strengthening CRA governance and mitigating conflicts of interest.

8. Rating Shopping

Rating shopping occurs when an issuer seeks a favourable rating by approaching agencies perceived to be more accommodating.

This creates a significant integrity problem because the CRA may have a commercial incentive to satisfy the issuer.

The CRA Code of Conduct therefore requires independence and prohibits unfair competitive practices involving promises of higher ratings.

9. Wrongful Downgrading

CRA liability is not limited to ratings that are too high.

An issuer may challenge an allegedly unjustified downgrade.

However, courts are generally cautious because credit ratings involve specialised financial judgment.

The leading Indian authority is:

Jindal Power Ltd. v. ICRA Ltd.

2020 SCC OnLine Del 790

Jindal Power challenged ICRA's downgrade of its credit rating and sought, among other reliefs, declarations and mandatory injunctions against publication of the rating.

The Delhi High Court held that a credit rating is an expert opinion, and courts should not substitute their own assessment for the CRA's professional judgment merely because another assessment might be possible.

The court stated in substance that interference would be appropriate where the rating opinion is shown to be perverse, arbitrary or mala fide. The court ultimately found ICRA's reasoning sufficiently supported by relevant factors and declined to invalidate the rating.

Importance

This case establishes an important balance:

Professional rating judgment → judicial restraint

but

Arbitrary/mala fide/perverse rating → possible judicial intervention.

10. Investor Loss and Causation

One of the most difficult aspects of CRA liability is proving:

The rating caused the investor's loss.

Suppose:

• CRA gives AAA rating;
• investor buys bonds;
• issuer subsequently becomes insolvent.

The investor must still establish the legal basis for holding the CRA responsible.

Questions include:

1. Did the CRA owe the investor a duty?
2. Was the rating negligently or fraudulently prepared?
3. Was the investor entitled to rely upon it?
4. Was the rating a substantial cause of the investment?
5. Would the investor have invested without the rating?
6. Was the loss too remote?
7. Was the loss caused by subsequent market developments?

These issues make investor damages claims significantly more complicated than regulatory proceedings by SEBI.

11. Important Case Laws

1. Jindal Power Ltd. v. ICRA Ltd.

2020 SCC OnLine Del 790

Principle

Courts should ordinarily respect a CRA's expert assessment unless the rating is shown to be:

• arbitrary;
• perverse;
• mala fide;
• unsupported by relevant considerations.

The case is the most directly relevant Indian judicial authority concerning a challenge to a CRA's rating itself.

2. CARE Ratings Ltd. v. SEBI

Securities Appellate Tribunal, 9 June 2021

CARE Ratings was subjected to a ₹1 crore monetary penalty concerning ratings of Reliance Communications Ltd.

The proceedings concerned alleged violations of Regulation 15(1) and Clauses 3 and 8 of the CRA Code of Conduct.

Principle

The case illustrates that a CRA can incur regulatory liability for deficiencies in the rating process, even though the issue is not simply whether the final rating proved correct or incorrect.

It reinforces the importance of:

• professional diligence;
• proper monitoring;
• rating methodology;
• compliance with regulatory standards.

3. Brickwork Ratings India Pvt. Ltd. v. SEBI

SAT, 21 March 2022

SEBI imposed a monetary penalty of ₹1 crore on Brickwork Ratings after inspection identified deficiencies, including concerns regarding its surveillance mechanism.

The proceedings involved alleged failures concerning the monitoring of repayment schedules and other material events affecting creditworthiness.

Principle

A CRA's responsibility is continuing, not merely limited to the original rating exercise.

Effective surveillance is essential because the creditworthiness of an issuer may change after the initial rating.

4. Brickwork Ratings India Pvt. Ltd. v. SEBI

SAT, 6 June 2023

This proceeding concerned SEBI's cancellation of Brickwork's certificate of registration as a CRA.

The regulatory action was taken under the SEBI Act and Intermediaries Regulations following findings concerning serious regulatory deficiencies.

The matter also reached the Supreme Court in proceedings concerning SEBI and Brickwork Ratings.

Principle

CRA liability can extend beyond monetary penalties.

Where regulatory failures are sufficiently serious, consequences may include:

• suspension;
• cancellation of registration;
• other regulatory restrictions.

This demonstrates the importance of CRA regulation as a form of market-protection liability.

5. CRISIL Ltd. — SEBI Settlement Proceedings

SEBI Settlement Order, 31 January 2018

SEBI proceedings concerning CRISIL involved alleged violations of the SEBI (Credit Rating Agencies) Regulations, 1999.

The matter was resolved through SEBI's settlement mechanism, with CRISIL paying settlement charges of ₹28,36,875 without admitting or denying the findings.

Principle

The case demonstrates that CRA regulatory liability can arise through SEBI enforcement and settlement proceedings, independently of a private damages action.

6. Abu Dhabi Commercial Bank v. Morgan Stanley & Co.

651 F. Supp. 2d 155 (S.D.N.Y. 2009)

This is an important comparative US authority.

Institutional investors brought claims arising from losses on structured investment vehicles and sued, among others, Moody's and Standard & Poor's.

The claims included:

• fraud;
• negligent misrepresentation;
• negligence;
• breach of fiduciary duty;
• unjust enrichment;
• aiding and abetting.

The court allowed some claims against the rating agencies to proceed while dismissing others, illustrating that rating agencies are not categorically immune from liability.

Importance

The case demonstrates that the legal treatment of ratings can depend upon:

• the nature of the representation;
• sophistication of the investor;
• reliance;
• alleged fraudulent conduct;
• applicable statutory protections.

12. Regulatory Liability vs Civil Liability

This distinction is extremely important.

13. Standard of Judicial Review

Courts should not normally behave as if they were competing rating agencies.

The Jindal Power principle is therefore significant:

Court normally asks:

• Was there a rational basis?
• Were relevant factors considered?
• Was the CRA acting within its regulatory framework?
• Was the methodology irrational?
• Was there bad faith?
• Was material information deliberately ignored?

Court normally does not ask:

“Would I personally have given AAA instead of BBB?”

That would improperly replace professional financial judgment with judicial judgment.

14. Defences Available to a CRA

A CRA may rely upon several arguments.

1. Rating is an expert opinion

An incorrect prediction is not automatically negligence.

2. No guarantee of repayment

A rating indicates credit risk; it does not insure investors against default.

3. Reliance on issuer information

CRAs frequently depend upon information supplied by issuers and other sources, although they must still exercise appropriate diligence.

4. No duty to individual investor

In some claims, the CRA may argue that no sufficiently proximate legal duty was owed to the particular claimant.

5. Lack of causation

The CRA may argue that the loss resulted from:

• issuer fraud;
• market collapse;
• economic conditions;
• subsequent events;
• investor's independent decision.

6. Contributory/comparative fault

Depending upon the applicable law, an investor's own conduct may affect recovery.

15. When Liability Becomes Stronger

A claim becomes considerably stronger where evidence shows:

Material information available

↓

CRA knew or should reasonably have discovered it

↓

CRA ignored/suppressed it

↓

Rating was materially misleading

↓

Investors reasonably relied upon it

↓

Loss resulted

This is very different from:

Reasonable analysis

↓

Unexpected economic event

↓

Issuer defaults

In the second situation, liability is much harder to establish.

16. CRA Liability and Systemic Financial Risk

Credit ratings are particularly important for:

• banks;
• mutual funds;
• pension funds;
• insurance companies;
• institutional investors;
• debt markets;
• securitisation;
• infrastructure finance.

An inflated rating can therefore produce systemic consequences.

For example:

Incorrect AAA rating → institutional investment → widespread exposure → issuer default → financial losses.

Consequently, CRA regulation is not merely about protecting one investor. It is also intended to preserve market confidence and integrity.

17. Modern Areas of CRA Liability

Emerging liability issues include:

A. ESG ratings

Green and sustainability-linked debt creates questions concerning the reliability of environmental assessments.

B. AI-based credit analysis

If artificial intelligence is used to generate or assist ratings, questions arise concerning:

• algorithmic bias;
• data quality;
• explainability;
• model risk;
• human supervision.

C. Cybersecurity

Manipulated issuer data could produce an incorrect rating.

D. Structured finance

Complex securities make rating methodology and assumptions especially important.

E. Sovereign ratings

Errors in sovereign-risk assessments can have consequences extending beyond individual issuers.

F. Crypto and digital assets

As digital-asset debt products develop, questions may arise concerning whether conventional rating methodologies adequately capture:

• volatility;
• liquidity;
• smart-contract risk;
• technological risk;
• regulatory risk.

18. Remedies

Depending on the circumstances, possible remedies include:

Regulatory remedies

• monetary penalty;
• directions;
• suspension;
• cancellation of registration;
• compliance requirements;
• corrective measures.

Civil remedies

• damages;
• injunction;
• declaration;
• contractual remedies;
• restitution/account of profits where legally appropriate.

Investor remedies

Investors may additionally pursue claims against:

• issuers;
• directors;
• arrangers;
• intermediaries;
• trustees;
• other responsible persons,

depending on the facts.

19. Key Principles from the Case Law

The principal principles can be summarised as follows:

1. A credit rating is primarily an expert opinion.
2. An incorrect rating alone does not automatically create liability.
3. Due diligence is mandatory.
4. Professional independence is essential.
5. CRAs have continuing surveillance responsibilities.
6. Regulatory breaches can result in substantial penalties.
7. Serious violations may lead to cancellation of registration.
8. Fraudulent or knowingly misleading ratings can attract stronger civil liability.
9. Investor claims require careful proof of duty, reliance, causation and loss.
10. Courts generally avoid substituting their own financial judgment for a CRA's reasonable expert assessment.

20. Conclusion

Credit Rating Agency Liability Claims occupy an important position at the intersection of securities regulation, financial law, negligence, contract, corporate governance and investor protection.

The Indian framework places significant responsibilities upon CRAs through the SEBI CRA Regulations, particularly concerning due diligence, independent professional judgment, adequate research, monitoring, review and disclosure.

The most important Indian judicial authority is Jindal Power Ltd. v. ICRA Ltd., which demonstrates that courts will generally respect a genuine expert rating but can intervene where the opinion is shown to be arbitrary, perverse or mala fide.

The CARE Ratings and Brickwork Ratings proceedings demonstrate the separate and powerful role of SEBI/SAT regulatory liability, particularly for failures in surveillance, professional diligence and compliance.

Thus, the central legal principle is:

A CRA is not an insurer against investment loss, but it is accountable for performing its professional and regulatory functions with due diligence, independence, objectivity and integrity.