My friend got the top most marks in the written exam of a recently conducted NLU PhD exam. He said his interview went well. However he did not find a place in the final list. Later on, he found out that all the candidates selected had either done their LLB or LLM from the same institute.

Is there such preference or nepotism in NLUs for selection of PhDs ? Why then give chance to outsiders when they only want to select their own alumni?

Yes, favoritism and bias do exist, chiefly because of there being no policy for this sort of thing in any of the NLUs. The teachers tend to prefer the students whom they have taught before. Those on the panel might have even advised their students about the best way to present the proposal to maximize their chances etc.