Rule 3 Electricity Rules 2005 | Dynamic 'Unitary Qualifying Ratio' Ultra Vires Supreme Court Precedent: Karnataka HC

The Karnataka High Court has struck down a procedural order issued by the Karnataka Electricity Regulatory Commission (KERC) that introduced a dynamic Unitary Qualifying Ratio (UQR) for verifying captive status of generating plants. The Court held that the impugned order, which linked proportionality to total actual consumption rather than the statutory qualifying thresholds, was ultra vires Rule 3 of the Electricity Rules, 2005 and contrary to the binding precedent in Dakshin Gujarat Vij Company Limited v. Gayatri Shakti Paper and Board Limited. The judgment underscores that regulatory authorities cannot rewrite statutory qualifications through procedural orders, particularly when such orders depart from the legal framework established by the Supreme Court.

Background & Facts

The Dispute

The dispute revolves around the Karnataka Electricity Regulatory Commission’s (KERC) order dated 28.03.2025, which prescribed a Procedure for Data Collection, Scrutiny, and Verification of Captive Status for generating plants and captive users within Karnataka. The petitioners, comprising captive power producers, renewable energy generators, and industrial consumers, challenged Clause 6.7 of the impugned order, which introduced a proportionality test and a dynamic UQR formula for group captive users. The petitioners argued that this methodology was contrary to Section 9 of the Electricity Act, 2003, Rule 3 of the Electricity Rules, 2005, and the Supreme Court’s judgment in Dakshin Gujarat.

Key Facts

• Definition of Captive Generating Plant: Under Section 2(8) of the Electricity Act, 2003, a captive generating plant (CGP) is one set up primarily for the user’s own consumption, including plants set up by cooperative societies or associations of persons.
• Statutory Requirements: Rule 3 of the Electricity Rules, 2005 prescribes two key thresholds for qualifying as a CGP:
  • Minimum 26% ownership by the captive user(s).
  • Minimum 51% aggregate captive consumption of the electricity generated, determined on an annual basis.
• Proportionality Principle: The second proviso to Rule 3(1)(a) mandates that in cases of association of persons, captive users must consume electricity in proportion to their ownership, with a permissible variation of ±10%. The Supreme Court in Dakshin Gujarat interpreted this as a Unitary Qualifying Ratio (UQR) of 1.96% (51% ÷ 26%), meaning every 1% ownership must correspond to 1.96% captive consumption.
• Impugned Order: KERC’s Clause 6.7 introduced a dynamic UQR formula where:
  • UQR = Y ÷ X, where:
    • Y = Percentage of total actual captive consumption.
    • X = Percentage of total ownership of captive users in the CGP.
  • This formula resulted in a fluctuating UQR, unlike the fixed 1.96% recognized in Dakshin Gujarat.

The Parties

Petitioners

1. Writ Petition No. 13316/2025:

   • Distributed Solar Power Association (through its authorized representative Faiza Zia), representing distributed solar power producers and captive users.
   • Key Contention: The impugned order adversely affects the captive status and surcharge exemptions available to members under the Electricity Act, 2003.

2. Writ Petition No. 14646/2025:

   • JSW Energy Limited, a company engaged in power generation and operation of captive generating plants.
   • Key Contention: The impugned order is without jurisdiction, violates natural justice, and rewrites Rule 3 through a procedural framework.

3. Writ Petition No. 26022/2025:

   • Sembcorp Green Infra Private Limited and its group companies (Green Infra Wind Power Generation Ltd, Green Infra Clean Solar Energy Ltd, Green Infra Solar Power Projects Ltd, and Green Infra Clean Wind Power Ltd), engaged in power generation and operation of captive generating plants.
   • Key Contention: The impugned order is contrary to Rule 3 and the law declared in Dakshin Gujarat.

4. Writ Petition No. 30238/2025:

   • JSW Steel Limited, a captive user and beneficiary of captive power arrangements.
   • Key Contention: The impugned order introduces a new substantive qualification mechanism not contemplated under Rule 3.

Impleading Applicants

1. Orient Cement Limited: Supported the petitioners, arguing that the impugned order is contrary to the Electricity Act, 2003, Rule 3, and Dakshin Gujarat.
2. BESCOM (Bangalore Electricity Supply Company Limited): Supported the impugned order, contending that strict verification of captive status is necessary to prevent misuse of statutory exemptions from Cross Subsidiary Surcharge (CSS) and Additional Surcharge (ASC) under Section 42(2) of the Electricity Act, 2003.

Respondents

1. Karnataka Electricity Regulatory Commission (KERC): Defended the impugned order, arguing that it merely operationalizes Rule 3 and prevents “gaming” by insignificant shareholders consuming disproportionate electricity.
2. Central Electricity Authority (CEA): Contended that Rule 3(3) empowers CEA to frame procedures for interstate captive projects, but does not oust KERC’s jurisdiction over intrastate projects.

Procedural History

• 2023: KERC published draft Regulations under Section 181 of the Electricity Act, 2003 for verification of captive status.
• 2024: KERC published revised draft Regulations inviting public objections.
• 28.03.2025: KERC issued the impugned order (Annexure-A), introducing Clause 6.7 and the dynamic UQR formula without fresh consultations.
• 12.06.2025: Writ Petition No. 13316/2025 filed challenging the impugned order.
• Subsequent Filings: W.P. Nos. 14646/2025, 26022/2025, and 30238/2025 were filed by other petitioners raising similar challenges.
• 08.04.2026: The matters were heard and reserved for orders.
• 12.06.2026: Judgment pronounced, allowing the writ petitions and quashing the impugned order.

Relief Sought

The petitioners sought:

• Quashing of the impugned order dated 28.03.2025 (Annexure-A) to the extent it prescribes the proportionality test and dynamic UQR for group captive users.
• Declaration that the impugned order is ultra vires Rule 3 of the Electricity Rules, 2005 and the Supreme Court’s judgment in Dakshin Gujarat.
• Direction to KERC to reconsider the matter and frame a procedure consistent with Rule 3 and Dakshin Gujarat, after following due consultative process.
• Stay on coercive action against the petitioners pending reconsideration.

The Legal Issue

The central legal questions before the Court were:

1. Whether the impugned order dated 28.03.2025, prescribing the test of proportionality for group active users, is contrary to Rule 3 of the Electricity Rules, 2005 and the law declared by the Supreme Court in Dakshin Gujarat?
2. Whether KERC could prescribe a dynamic UQR based on total actual captive consumption and total ownership, contrary to the proportionality formula recognized by the Supreme Court in paragraph No. 43 of Dakshin Gujarat?
3. Whether the impugned order travels beyond the scope of Rule 3 and introduces a new substantive qualification mechanism not contemplated under the Rules?

Arguments Presented

For the Petitioners

1. Ultra Vires Rule 3 and Dakshin Gujarat: The impugned order, particularly Clause 6.7, is contrary to Rule 3 and the Supreme Court’s judgment in Dakshin Gujarat. The UQR recognized in Dakshin Gujarat is derived from 51% ÷ 26% = 1.96%, and the Court specifically rejected using total actual consumption as the benchmark. The impugned order introduces a dynamic UQR based on total actual consumption, which is not contemplated by Rule 3 or the Supreme Court’s judgment.

2. Lack of Jurisdiction: Rule 3(3) empowers the Central Electricity Authority (CEA) to frame procedures for interstate captive projects, but does not authorize KERC to independently adopt a verification mechanism for intrastate projects. KERC has no substantive power under Sections 9, 86, or 181 of the Electricity Act, 2003 to redefine captive qualification norms.

3. Violation of Natural Justice: The impugned order was issued without fresh public notice, consultations, or hearings, violating Section 86(3) of the Electricity Act, 2003 and principles of natural justice. The draft regulations published in 2023 and 2024 did not include the dynamic UQR methodology introduced in the impugned order.

4. Retrospective Operation: The impugned order retrospectively applies the new methodology to the financial year 2024-25, though the procedure itself was issued subsequently. This retrospective operation is impermissible and prejudices captive generators and users.

5. Excessive Delegation: The impugned order introduces a new substantive condition not contemplated by Rule 3 or the Supreme Court’s judgment, effectively rewriting the Rule through a procedural order.

For the Respondents

1. Operationalization of Rule 3: The impugned order merely operationalizes Rule 3 and does not introduce any new substantive condition. Rule 3 contains:

   • Two group-level thresholds: Minimum 26% ownership and minimum 51% aggregate captive consumption.
   • An additional proportionality requirement for association of persons, mandating consumption in proportion to ownership within ±10% variation.

2. Prevention of Gaming: The second proviso to Rule 3(1)(a) mandates proportionality to prevent “gaming” by insignificant shareholders consuming disproportionate electricity. The dynamic UQR is necessary to ensure compliance with this proportionality requirement and prevent misuse of surcharge exemptions.

3. Supreme Court’s Recognition of Proportionality: The respondents relied on paragraph Nos. 43 to 47 of Dakshin Gujarat, where the Supreme Court recognized:

   • Proportionality principle.
   • Annual determination of captive status.
   • Anti-gaming principles.
   • Weighted average ownership in cases of changes during the financial year.
   • Continuous compliance throughout the financial year.

   The respondents argued that 1.96% is merely an illustrative baseline and not a rigid universal formula. The dynamic UQR is a mathematical expression of proportionality already embedded in Rule 3.

4. Incidental Jurisdiction of KERC: Rule 3(3) does not oust KERC’s jurisdiction. The State Commission determines captive status while examining surcharge exemption under Section 42(2) and therefore possesses incidental and ancillary jurisdiction to prescribe verification methodology.

5. Alternative Remedy: The petitioners have an alternative effective remedy before the Appellate Tribunal for Electricity (APTEL) under Section 111 of the Electricity Act, 2003. The impugned order is merely procedural and does not require prior publication under Section 181(3). No final determination disqualifying the petitioners has been made, and no surcharge liability has crystallized.

The Court's Analysis

The Court undertook a detailed examination of Rule 3 of the Electricity Rules, 2005, the Supreme Court’s judgment in Dakshin Gujarat, and the impugned order to determine the legality of the dynamic UQR prescribed by KERC.

Statutory Framework and Supreme Court’s Interpretation

Section 2(8) of the Electricity Act, 2003: “‘Captive generating plant’ means a power plant set up by any person to generate electricity primarily for his own use and includes a power plant set up by any co-operative society or association of persons for generating electricity primarily for use of members of such cooperative society or association.”

Rule 3 of the Electricity Rules, 2005: “(1) No power plant shall qualify as a ‘captive generating plant’ under section 9 read with clause (8) of section 2 of the Act unless- (a) in case of a power plant - (i) not less than twenty six percent of the ownership is held by the captive user(s), (ii) not less than fifty one percent of the aggregate electricity generated in such plant, determined on an annual basis, is consumed for the captive use: Provided that in case of power plant set up by registered cooperative society, the conditions mentioned under paragraphs at (i) and (ii) above shall be satisfied collectively by the members of the cooperative society: Provided further that in case of association of persons, the captive user(s) shall hold not less than twenty six percent of the ownership of the plant in aggregate and such captive user(s) shall consume not less than fifty one percent of the electricity generated, determined on an annual basis, in proportion to their shares in ownership of the power plant within a variation not exceeding ten percent.”

The Supreme Court in Dakshin Gujarat interpreted Rule 3 and recognized the proportionality principle for association of persons. The Court held:

Paragraph 43 of Dakshin Gujarat: “The last portion of the second proviso to Rule 3(1)(a) of the Rules, that is, the proportionality principle, specifies an unitary qualifying ratio. The unitary qualifying ratio is the consumption requirement divided by the shareholding requirement, that is, 51% divided by 26%. This means that the owner of every 1% shareholding of the CGP should have minimum consumption of 1.96% of the electricity generated by the CGP, with a variation of ±10% being permissible. Therefore, the unitary qualifying ratio has to be within a range of 1.764% to 2.156%. In other words, we do not take into consideration 100% of the electricity generated. Instead, we apply the shareholding requirement, which should not be less than 26% in aggregate, to the electricity consumed, which should not be less than 51%, and thereby compute whether the ownership criteria and the proportionate consumption criteria is satisfied. Benefit of variation by 10% either way is to be given.”

The Supreme Court clarified that the benchmark for proportionality is the qualifying captive consumption requirement (51%) and not total actual generation or consumption. The UQR of 1.96% is derived from 51% ÷ 26%, and this ratio must be maintained with a ±10% variation.

Impugned Order: Departure from Statutory Framework

The impugned order introduced Clause 6.7, which prescribed a dynamic UQR formula as follows:

Clause 6.7 of the Impugned Order: “(i) The test of proportional consumption in case of the Group Captive Users except Cooperative Society, shall be on actual energy consumption by Captive Users, determined on an annual basis and in proportion to the shares in ownership of the power plant within a variation not exceeding ten percent. In order to calculate the proportionate energy consumption requirement of Captive Users a term called Unitary Qualifying Ratio (UQR) is used, which is the ratio of percentage of total consumption by Captive Users (Y) and the percentage of total ownership of Captive Users in the CGP (X). Thus, UQR=Y/X. (ii) The proportional consumption requirement by a Captive User in a CGP, except the Co-operative Society, shall be calculated on the basis of following formula: Proportionate consumption of a Captive User = UQR * Percentage ownership of that Captive User. Variation of ± 10 % in the Proportionate consumption of a Captive User is allowed.”

The Court observed that under Clause 6.7, the UQR is calculated as Y ÷ X, where:

• Y = Percentage of total actual captive consumption.
• X = Percentage of total ownership of captive users in the CGP.

This methodology departs from the Supreme Court’s judgment in two critical respects:

1. Benchmark for Proportionality: The Supreme Court’s UQR of 1.96% is derived from the qualifying thresholds (51% ÷ 26%), whereas the impugned order uses total actual consumption as the benchmark.
2. Dynamic vs. Fixed UQR: The Supreme Court’s UQR is fixed (1.96%), subject to ±10% variation, while the impugned order introduces a fluctuating UQR that changes based on total actual consumption and ownership.

Judicial Review of Regulatory Action

The Court held that KERC’s impugned order effectively rewrote Rule 3 by introducing a new substantive condition not contemplated by the statute or the Supreme Court’s judgment. The Court emphasized:

• Rule 3 prescribes minimum qualification thresholds (26% ownership and 51% consumption) and does not contemplate any maximum cap or continuing ceiling on consumption.
• The Supreme Court in Dakshin Gujarat expressly rejected using total actual consumption as the benchmark for proportionality, confining it to the qualifying thresholds.
• The impugned order substitutes the statutory qualifying ratio with a dynamic UQR, which is contrary to the law declared by the Supreme Court.

The Court also noted that the impugned order was issued without fresh consultations or hearings, despite the material departure from the draft regulations published earlier. This violated Section 86(3) of the Electricity Act, 2003 and principles of natural justice.

Jurisdictional Overreach by KERC

The Court rejected KERC’s contention that Rule 3(3) does not oust its jurisdiction. While Rule 3(3) empowers the Central Electricity Authority (CEA) to frame procedures for interstate captive projects, it does not authorize KERC to independently adopt a verification mechanism for intrastate projects that rewrites the statutory qualifications.

The Court held that the impugned order goes beyond mere procedural operationalization of Rule 3 and introduces a new substantive qualification mechanism, which is ultra vires the statutory framework.

The Verdict

The Court allowed the writ petitions and passed the following orders:

1. Quashed the impugned order dated 28.03.2025 (Annexure-A) passed by KERC.
2. Directed KERC to reconsider the matter and frame an appropriate procedure consistent with Rule 3 of the Electricity Rules, 2005 and the law declared by the Supreme Court in Dakshin Gujarat, after following the due consultative process and principles of natural justice.
3. Stayed coercive action against the petitioners pending reconsideration by KERC.

What This Means For Similar Cases

Regulatory Authorities Cannot Rewrite Statutory Qualifications

• Binding Nature of Statutory Thresholds: Regulatory authorities are bound by the statutory thresholds prescribed under Rule 3 and the Supreme Court’s interpretation in Dakshin Gujarat. They cannot introduce new substantive conditions through procedural orders that depart from these thresholds.
• Proportionality Must Align With Qualifying Thresholds: The proportionality test must be applied only to the qualifying thresholds (51% consumption and 26% ownership) and not to total actual consumption. Any methodology that recalculates the UQR dynamically based on total actual consumption is ultra vires Rule 3.

Due Process Is Non-Negotiable

• Consultative Process Is Mandatory: Regulatory authorities must follow due process, including public consultations and hearings, before issuing orders that materially depart from earlier drafts or introduce new methodologies. Failure to do so violates principles of natural justice and renders the order vulnerable to judicial review.
• Retrospective Operation Is Impermissible: Regulatory orders cannot retrospectively apply new methodologies to prior financial years without explicit statutory authorization. Such retrospective operation prejudices stakeholders and is legally unsustainable.

Judicial Review of Delegated Legislation

• Challenge to Jurisdiction and Legality: Writ petitions under Articles 226 and 227 of the Constitution are maintainable to challenge delegated legislation or procedural frameworks that travel beyond statutory authority, even if an alternative remedy exists before specialized tribunals like APTEL.
• Substantive vs. Procedural Orders: While procedural orders may not always require prior publication, orders that introduce new substantive conditions or rewrite statutory qualifications are subject to strict judicial scrutiny.

Practical Implications for Captive Generators and Users

• Clarity on UQR Calculation: Captive generators and users must ensure that the proportionality test is applied only to the qualifying thresholds (51% consumption and 26% ownership). Any verification mechanism that links proportionality to total actual consumption is contrary to law.
• Documentation and Compliance: Captive users should maintain accurate records of ownership shares and consumption patterns to demonstrate compliance with Rule 3 and the Supreme Court’s judgment. In cases of changes in ownership during the financial year, the weighted average method recognized in Dakshin Gujarat should be applied.
• Challenging Ultra Vires Regulations: Stakeholders aggrieved by ultra vires regulatory orders can approach High Courts under writ jurisdiction, particularly when the order rewrites statutory qualifications or violates principles of natural justice.

Anti-Gaming Principles and Surcharge Exemptions

• Prevention of Misuse: While anti-gaming principles are recognized under Rule 3 and Dakshin Gujarat, regulatory authorities cannot introduce new substantive conditions to prevent misuse. Any such attempt must align with the statutory framework and Supreme Court’s interpretation.
• Surcharge Exemptions: Captive generators are exempt from Cross Subsidiary Surcharge (CSS) and Additional Surcharge (ASC) under Section 42(2) of the Electricity Act, 2003. However, this exemption cannot be misused by insignificant shareholders consuming disproportionate electricity. The proportionality test must be applied strictly within the bounds of Rule 3 to prevent such misuse.