Revised Section 42: What’s in the name!

By CS Vinita Nair (corplaw@vinodkothari.com)

Section 42 has been substituted by way of section 10 of Companies (Amendment) Act, 2017[1]. Draft rules amending Rule 14 of Companies (Prospectus and Allotment of Securities) Rules, 2014 have been issued for public comments[2].

Erstwhile section 42 dealt with ‘Offer or invitation for subscription of securities on private placement’. Substituted section 42 has been titled as ‘Issue of shares on private placement basis’. This leads to a general perception that revised section 42 shall not apply to issue of non-convertible debentures on a private placement basis. It will only apply in case of issue on preferential basis considering corresponding amendment in section 62 (1) (c)[3].

Relevance of marginal note

It is a well settled view that marginal note cannot control/ limit the provisions of the section. In case of Chandroji Rao vs Commissioner of Income-Tax, M.P[4] Hon’ble Supreme Court explained that the marginal heading cannot control the interpretation of the words of the section particularly when the language of the section is clear and unambiguous. There are several other rulings of Hon’ble Supreme Court reiterating the aforesaid interpretation.

Modes of issuance of securities under Companies Act

Chapter III of Act, 2013 deals with prospectus and allotment of securities. Part I deals with public offer and Part II deals with private placement. Section 23 (1) provides the manner in which a public company may issue securities viz.;

  1. by way of public issue by complying with provisions of Part I; or
  2. through private placement by complying with provisions of Part II; or
  3. through rights issue or a bonus issue in accordance with section 62 (1) (a) and section 63 respectively.

Section 23 (2) provides the manner in which private company may issue securities viz.;

  1. by way of rights issue or a bonus issue in accordance with section 62 (1) (a) and section 63 respectively;
  2. through private placement by complying with provisions of Part II.

Private placement under Act, 2013

‘Private Placement’ has been explained in section 42 to mean any offer or invitation to subscribe or issue of securities to a select group of persons by a company (other than by way of public offer) through private placement offer-cum-application, which satisfies the conditions specified in the section.

While the marginal note refers to issue of shares, the meaning of private placement clearly refers to ‘securities’. Given the intent under section 23 (1) and (2), it is clear and unambiguous that any private placement of securities will be subject to compliance of provisions of section 42. It cannot be interpreted that ‘securities’ referred in Section 42 refers to the expression, “shares or other securities” explained in Rule 13 of Companies (Share Capital and Debentures) Rules, 2014.

Discussion in CLC Report[5] on issue of debentures by private placement

“3.8 At the moment, in case of non-convertible debentures a prior special resolution only once in a year has been prescribed. The Committee recommends that since Non-Convertible Debentures are pure borrowings and do not form part of equity capital, the proviso to Rule 14(2)(a) may be amended to prescribe that the relevant board resolution under Section 179(3)(c) would be adequate in case the offer under Section 42 is for debentures up to the borrowing limits permissible for Board under section 180(1)(c) of the Act. This would also align the requirements with that of section 180(1)(c). It was, however, felt that the said Board resolution should clearly mention (in the body of the resolution) that the offer of debentures being approved by Board is through private placement under Section 42 and certain other minimum details as may be prescribed in the rules be provided in the Board resolution. Private companies (who have been given exemption from Section 117(3)(g) through section 462 notification) should either be required to file board resolutions under Section 179(3)(c) or pass a special resolution.”

As stated above, the intent was only to exempt the requirement of seeking shareholder’s sanction if the company had already obtained approval of shareholders u/s 180 (1) (c). Apart from this, compliance of entire section is required to be ensured.

Conclusion

Companies should be careful and not interpret that section 42 shall not apply to private placement of debentures. Otherwise, the company, its promoters and directors shall expose themselves to huge amount of penalty.


[1] Yet to be enforced.

[2] http://www.mca.gov.in/Ministry/pdf/DraftCompaniesProspectusSecuritiesRules2018_15022018.pdf

[3] (c) to any persons, if it is authorised by a special resolution, whether or not those persons include the persons referred to in clause (a) or clause (b), either for cash or for a consideration other than cash, if the price of such shares is determined by the valuation report of a registered valuer subject to such conditions as may be prescribedof a registered valuer, subject to the compliance with the applicable provisions of Chapter III and any other conditions as may be prescribed.

[4] 1971 SCR (1) 422

[5] Company Law Committee Report – February, 2016

RBI’s Ombudsman storm- Tough road ahead for NBFCs

By Saloni Mathur & Mayank Agarwal (finserv@vinodkothari.com)

 

Introduction

In the wake of rising discrepancies and deficiencies witnessed in the implementation of NBFCs general services, the Reserve Bank of India(“RBI”) came up with The Ombudsman Scheme for Non-Banking Financial Companies, 2018 (hereinafter referred to as the “Scheme”)[1] to address and target any complaint by any party aggrieved by any discrepancy in the service obligation of the NBFC.

The intent behind this scheme is to alleviate any laxity in the service delivery mechanism of the NBFC such that any party aggrieved may turn to a system for Ombudsman for a quick and ready solution and seek for any redress regarding any issue concerned with it.

The Scheme shall come into effect and force from February 23, 2018.

Applicability of the Scheme

The Scheme lucidly lays down the applicability of the provisions to the following class of NBFCs:

NBFCs, as defined in Section 45-I(f) of the Reserve Bank of India Act, 1934 and registered with the RBI under Section 45-IA of the Reserve Bank of India Act, 1934 which:

  • are authorised to accept deposits; or
  • have customer interface, with assets size of one billion rupees or above, as on the date of the audited balance sheet of the previous financial year, or of any such asset size as the RBI may prescribe.

Though the scheme presently is applicable to all the deposit taking NBFCs, it is however proposed to operationalise the scheme for the remaining identified categories of the NBFCs in the later stage. Hence currently, the scheme does not reflect any obligation on the part of the non-deposit taking NBFCs with asset size of one billion rupees and above to comply with the requirements of various provisions of the scheme.

Non-Applicability of the Scheme

The Non-banking Financial Company – Infrastructure Finance Company (NBFC-IFC), Core Investment Company (CIC), Infrastructure Debt Fund – Non-banking Financial Company (NBFC-IDF) and an NBFC under liquidation, are excluded from the ambit of the Scheme.

Ombudsman

The RBI is of the view that one or more officers in the rank of not less than General Manager shall be called the Ombudsman to carry out the functions entrusted by or under this Scheme. The territorial jurisdictions of the Ombudsman cover four metro centres viz. Chennai, Kolkata, Mumbai and New Delhi for handling complaints from different zones.

Grounds for complaint

The Scheme specifies various grounds for complaints as per which the customer may approach the Ombudsman, they can be further classified and rearranged as follows:

  1. Financial deficiencies
    1. Non-presentation or excessive delay in submitting post-dated cheques provided by the customers;
    2. Failure to provide in writing, the terms and conditions relating to loans disbursed;
    3. Failure to provide the aforesaid written document, including any changes made to the terms, if any, in vernacular language or a language as requested by the customer;
    4. Failure or excessive delay in furnishing the securities documents to the borrower upon repayments of all dues;
    5. Non-compliance with RBI regulations in any regard;
  1. Operational deficiencies:
    1. Non-presentation or excessive delay in submitting post-dated cheques provided by the customers;
    2. Failure to provide in writing, the terms and conditions relating to loans disbursed;
    3. Failure to provide the aforesaid written document, including any changes made to the terms, if any, in vernacular language or a language as requested by the customer;
    4. Failure or excessive delay in furnishing the securities documents to the borrower upon repayments of all dues;
    5. Non-compliance with RBI regulations in any regard;
  1. Contractual deficiencies:
    1. Non-insertion of repossession clauses in loan agreement or contracts which are not legally enforceable;
    2. Unclear terms in contracts or loan agreements relating to the following:
      • Notice period before taking possession of security;
      • circumstances under which the notice period can be waived;
      • the procedure for taking possession of the security;
      • a provision regarding final chance to be given to the borrower for repayment of loan before the sale/ auction of the security;
      • the procedure for giving repossession to the borrower and
      • the procedure for sale/ auction of the security;

While the directions do specify at length the grounds for filing of compliant, they also specify certain conditions which must be satisfied before filing of a complaint. One of the most notable conditions is the fact that the complainant, before approaching the Ombudsman, must approach the NBFC. In case the NBFC is of no help to the complainant, only then can he/she seek remedy from the Ombudsman. A detailed flowchart covering the possible scenarios for the aforesaid case has been shown below.

 

This Scheme also specifies certain other conditions which must be satisfied before seeking redressal from the ombudsman and they are:

  1. Any compliant which has already been covered by the Ombudsman in previous proceedings or the proceeding for which an order has been passed or is ongoing in any court, tribunal or arbitrator or any other forum, cannot again be raised by a different complainant
  2. The complaint must be meaningful in nature
  3. the complainant has filed along with the complaint, copies of the documents, if any, which he intends to rely upon, and a declaration that the complaint is maintainable.
  4. the complaint is made before the expiry of the period of limitation prescribed under the Indian Limitation Act, 1963 for such claims.

Additionally, the Ombudsman may decide to reject a complaint, at the time of inception or during the process as well in the following cases:

  1. The complaint does not satisfy the grounds of complaint, as mentioned above;
  2. The complainant is seeking monetary compensation that is higher than what the Scheme limits;
  3. The complaint requires excessive deliberation and diligence on part of the Ombudsman and hence, is not appropriate for adjudication of such complaint;
  4. The complaint is not made with a sufficient cause;
  5. The complainant is callous while the case is ongoing;
  6. The Ombudsman adjudges that there is no loss, physical or financial, suffered by the complainant.

Process for filing Complaint under the Ombudsman Regime

 

Settlement of complaint

Consequent to receiving of a complaint, the primary road of action for the Ombudsman remains to arrive at an amicable solution, which means a Settlement.  A complaint will be adjudged to be settled when any of the following scenarios are satisfied:

  • Where the grievance raised by the complainant has been resolved by the NBFC with the intervention of the Ombudsman; or
  • The complainant is satisfied with the process and extent of resolution provided by the Ombudsman based on mediation and conciliation provided by the NBFC
  • When the Ombudsman adjudges that the NBFC has complied with the respective laws and the same has been informed to the complainant. In case the complainant fails to raise an objection to the same within the time frame provided, the same will be adjudged to be settled.

In cases where it is deemed practical to do so, the Ombudsman shall intimate the concerned NBFC and forward all requisite documents with the view of reaching an understanding. The Ombudsman shall consider documents and declarations from both the concerned parties and in case a decision cannot be arrived at, a meeting may be arranged between the two. In case a settlement has been reached through such meeting, the proceedings of the meeting must be signed by both parties concluding the same.

Award by the Ombudsman

If the complaint is not settled by agreement, the Ombudsman shall pass an Award where it will either allow or reject a complaint. While doing so it shall take into account all the relevant evidence placed before him, the RBI circulars and Directions as prescribed from time to time, and shall state the reasons for passing such an award.

The Ombudsman shall prescribe certain conditions of specific performance on the part of the NBFCs if it allows the complaint and also direct the NBFCs for the payment of any compensation. The complainant shall also submit to the NBFC and the Ombudsman concerned within a period of 30 days, a letter of acceptance of the Award in full and final settlement of his claim.

The NBFC shall unless it has preferred an appeal within one month from the date of receipt by it of the acceptance in writing of the Award by the complainant comply with the Award and intimate compliance to the complainant and the Ombudsman.

Appeal before the Appellate Authority

Any person aggrieved by the award may within 30 days of the receipt of the communication of Award or rejection of the complaint, prefer an appeal before the Appellate Authority. An appeal by an NBFC may be filed within 30 days from the date on which the NBFC receives letter of acceptance of the Award from the complainant.

Appeal may be filed by the NBFC only with the previous sanction of the chairman or the Managing director/Chief Executive Officer or any other officer of equal rank.

Quick Actionable by NBFCs pursuant to the scheme

The Scheme though is currently applicable to only deposit taking NBFCs, however the intent is to gradually extend it to other NBFCs as well. Following is a set of actionable required on the part of the NBFCs:

Display salient features of the scheme for Public Knowledge

  • The purpose of the scheme and the contact details of the Ombudsman to whom the complaints are to be made by the aggrieved party to be displayed prominently in all the offices and branches.
  • The NBFCs covered by the Scheme shall ensure that a copy of the Scheme is available with the designated officer of the company for perusal in the office premises, if anyone desires to do so, and notice about the availability of the Scheme with such designated officer shall be displayed and shall place a copy of the Scheme on their websites.

Appointment of nodal officers

To appoint Nodal Officers at their Head/ Registered/ Regional/ Zonal Offices who shall be responsible for representing the company and furnishing information to the Ombudsman in respect of complaints filed against the NBFC.

Information to all offices of Ombudsman

Inform all the Offices of the Ombudsman about the appointment of nodal officers. Wherever more than one zone/ region of a NBFC is falling within the jurisdiction of an Ombudsman, one of the Nodal Officers shall be designated as the ‘Principal Nodal Officer’ for such zones or regions.

Obligations of the NBFCs pursuant to the Scheme

Providing information

Provide information to the Ombudsman when there is a call for any to decide upon any complaint filed, and furnish all certified copies and documents as required from time to time.

Specific performance

Where the Ombudsman decides to allow the compliant, it is required to do specific performance of its obligations in addition to or otherwise, the amount, if any to be paid by it to the complainant by way of compensation for any loss suffered by the complainant arising directly out of the act or the omission of the NBFC.

Implementation/Enforcement of Award

It shall be the obligation of the NBFC concerned to implement the settlement arrived with the complainant or the Award passed by the Ombudsman when it becomes final and send a report in this regard to the Reserve Bank of India within 15 days of the award becoming final.

Penalty

NBFC’s are required to pay an amount which is more than the actual loss suffered by the complainant as a direct consequence of the act, omission, or commission of the NBFC, or one million rupees whichever is lower.

Compensation for any harassment

NBFCs are  also required to pay compensation as a requirement of the Reward passed by the Ombudsman not exceeding one hundred thousand rupees to the complainant, taking into account the loss of time, expenses incurred, harassment and mental anguish suffered by the complainant.

Conclusion

In a nutshell, this will increase the responsibility of the NBFCs while dealing with the customers and other stakeholders and ensure that proper redressal is provided by them to the aggrieved party so as to avoid scrutiny of the Ombudsman.


[1] https://rbidocs.rbi.org.in/rdocs/Content/PDFs/NBFC23022018.pdf

Presentation on corporate structuring and regulatory framework

Ministry of Finance approves amendment in Chit Funds’ law

By Mayank Agarwal (finserv@vinodkothari.com)

The Ministry of Finance (“MoF”) has introduced The Chit Funds (Amendment) Bill, 2018 (“Bill”) on 20th February, 2018,[1] bringing in some noteworthy changes to the Chit Funds Act, 1982 (“Act”).

The Rs. 500 billion Chit Fund industry has had its fair share of ups & downs in the country.[2] While the sector emerged as a prominent alternative to established financial institutions in the country during its early years due to cheaper rates and easier access to funds, however, it has gradually lost its charm.

The Chit Funds law, which was introduced in 1982, as a counteractive measure of the Sanchaita scam in 1978, was itself subject to abusive use in the later part of 2000s as a number of chit fund related scams came to fore, notably, the Sharada scam and the Rose Valley scam.

The chit funds industry has had to travel a tumultuous path, be it the systemic breakdowns due to the scams or government reforms like demonetisation and introduction of GST. All of these took the investors away from the industry.

Given the fact that the poor and lower-middle income sector of the country still rely heavily on chit funds to mobilise their hard earned money, the MoF has brought in the Bill in order to alleviate concerns relating to its downfall and encourage systematic growth within this sector. The amendments aim at alleviating some concerns associated with this already vanishing industry and aims to increase financial inclusion by bring the down-trodden and unbanked sectors of the society within the financial fold.

In this write-up we have enlisted the amendments brought in by the Bill, its implication and the aim behind bringing in such modifications.

Amendment to Section 2(b) and 11(1): Use of the words “Fraternity Funds”

In addition to the words “chit”, “chit fund”, “chitty” or “kuri”, any business involved in running chit fund schemes must incorporate “Fraternity Funds” along with its name in order to express its inherent nature as a chit fund company and to distinguish it from a “Prize Chit”, which is illegal in nature and banned.

Amendment to Section 16(2) and Section 17: Presence of at least 2 subscribers

While presence of at least 2 subscribers to the fund was a must during the draw of chit (as per Section 16(2)) and during the time of preparation of minutes of the draw (as per Section 17), the Bill relaxes such requirements and permits the presence of 2 subscribers through video conference, which must be duly recorded by the foreman of the scheme. Further, their signatures to the minutes can be obtained within a period of 2 days from the preparation of the minutes.

Amendment to Section 21(b): Foreman’s commission

One of the most significant reforms proposed in the Bill are the increase in the foreman’s commission from the earlier ceiling of 5% to 7%. Such reform comes against the backdrop of increasing costs and overheads associated with running a chit fund, while the commissions have remained stagnant.

This is going to encourage more and more people to come forward with such schemes. However, it would also reduce the amount disbursed to the bidder post deduction of commission and hence, leave him financially dis-advantaged.

Amendment to Section 85(b): Removal of ceiling

Section 85(b) of the Act mandates that any chit fund running solely or two or more chit funds being run by the same foreman shall be exempted from the provisions of the Act provided the aggregate amount of the same does not exceed 100 rupees.

Given the fact that such meagre amount holds no relevance in today’s age, the Bill has abolished the same and granted freedom to State governments to levy a ceiling as per their choice and increase the same at regular intervals.

Right to Lien

A new provision that has been brought in by the Bill is the right to lien for dues from subscribers that has been granted to the foreman so as to allow set-off to the chit company in cases when a subscriber, who has already drawn funds, defaults.

This provision is significant as it reduces credit risk associated with such schemes. Not only does it protect the interests of other subscribers to the scheme, it also safeguards the chit company in cases of default.

Industry response to the amendments

The chit fund industry has not been entirely enthused by the proposal brought in by the Bill. The sector was already left choking when GST implementation led to a hefty jump in tax from the previous rate of 10.5% to 12%. Despite representation from the All India Association of Chit Funds (AIACF), apex body of chit fund companies in the country, the rates were not reduced and brought on par with those of other NBFCs.

Now, the Bill has also ignored the request of the association. Given the fact that the ratio of number of unregulated players to regulated ones is 100:1, the association had hoped implementation of proposals that are in line with the theme of bringing more and more players within the regulatory ambit. Relaxation of security amount from 100% to 50% of the chit value was another major plea of the industry, however, the Bill ignores the same as well.

Conclusion- A step too-little

While the Bill aims at easing compliance burden and regulatory restrictions on this fading industry, it is a step too-little too-late. Although the increase in commission fees and relaxation of physical presence of 2 subscribers is a welcome move, it is not enough to provide impetus to the industry and fails to tackle the major problem of a vast number of unorganised players.

Leaving myriad questions unanswered, AIACF says that the Bill totally ignores the pleas made by the association and has done nothing to convert un-organised sector into organised and bring them within the regulatory ambit.


[1] http://www.pib.nic.in/PressReleseDetail.aspx?PRID=1521038

[2] http://www.business-standard.com/article/economy-policy/chit-funds-sore-about-amendment-bill-say-it-won-t-safeguard-public-money-118022000685_1.html

Crucial Step taken by MCA to remove the curtain on SBOs

By Pammy Jaiswal & Richa Gupta (corplaw@vinodkothari.com)

 

Introduction

Over the past few years, regulatory changes have conspired to re-define and re-examine the corporate structures in order to have an efficient and transparent environment to work in. A very recent and crucial step taken by MCA is with regard to revamping the provisions of section 89 and 90 of the Companies (Amendment) Act, 2017 (‘Amendment Act’). As all the stakeholders were waiting for the clarity to come in by way of rules in this connection, MCA has on 15th February, 2018 come out with the Companies (Beneficial Interest and Significant Beneficial Interest) Rules, 2018[1] (hereinafter called as “ Draft SBO Rules’’).

Changes under section 89 and Draft SBO Rules

The major change in section 89, was defining the term ‘significant beneficial owner’ which in itself is a vital in terms interpreting the whole section. The scope of the section has been made very broad by covering all aspects of pledge, proxy, power of attorney executed in relation to shares. This was much needed to catch hold of those behind the veil.

The Draft SBO Rules in this regard are slightly different from the existing rules. While the erstwhile MGT-4 , MGT-5 and MGT-6  are now renamed as BEN-1, BEN-2 and BEN-3 respectively, the contents of the declaration and return are same, however, BEN-3 will be filed by the company within 30 days of receiving complete declarations from both the registered and beneficial owners. This has been mentioned by way of an explanation and is relevant because, reference to section 403 has been removed from this section as well. Therefore, even if the gap between date of receiving declaration and filing return is beyond a period of 30 days due to incomplete information in the in respective declaration of the registered as well as the beneficial holder, it seems that the law will allow putting the date on which complete information received such persons in BEN-3.

Changes under section 90 and Draft SBO Rules

Section 90 has been completely re-vamped under the Amendment Act. Looking at the language of law, the intent is very clear that the individual significant beneficial owner (‘SBO’) has to come out of his hideaway. The onus is on such SBO and person who may have the knowledge about such SBO to disclose the nature and extent of significant interest. The company on which such SBO has significant influence is required to to do (i) maintain register of the interest declared by individuals and changes therein, (ii) file return of SBO to the RoC in BEN-5 and (iii) to ask for information from such person on whom the company has reason to believe to have information on such SBOs.

While the intent of law is to identify the individual being the SBO, the Draft Rules in this connection have the following ambiguities:

  • BEN-4 (‘declaration by SBO’) contains a filed for writing the particulars of the SBO, which also has place for writing Corporate Identification Number (‘CIN’) of such SBO, being a company. If the intent was to identify corporate SBO, section 89 has a provision to take care of the same. Hence, having such field in BEN-4 seems to be contradictory to the language of section 90.
  • The exemption given vide Rule 8 of the Draft SBO Rules is also not in line with the intent of law. The exemption provides that making declaration and maintaining of register of SBO will not apply where the registered holder is equity listed body corporate or a WoS of such body corporate or a foreign listed company. While we try to understand this exemption, the question that comes in our mind is that are we trying to say that listed body corporates do not have SBOs. Well the answer to this question may or may not be positive. Hence, the idea behind such carve out is vague.

Conclusion

Undoubtedly,  the  Draft SBO Rules’’ were awaited and while they have come out, the same is surely a stepping stone in implementing the changes under section 89 and 90, however, due to some ambiguities in such rules as discussed above, clarity on the grey areas is still required. We are hopeful that MCA will take care of the unclear portions in the said rules when the final version comes to life.


To read our other write-ups on the Companies (Amendment) Act, 2017 – Click here

To read our other resources – Click here


[1] http://www.mca.gov.in/Ministry/pdf/DraftRulesBeneficialOwnership_15022018.pdf

How PNB Rs 11,300 crore scam exposes the biggest flaws in the Indian banking system

When frauds with a similar design happen on a repetitive basis, it becomes a matter of concern. It is regrettable that frauds based on letters of credit, supporting fake transactions of purchases, have happened in the past in the jewellery sector. Banks’ internal controls need to be strengthened. Fraud protection is essentially a duty of the bank. – Vinod Kothari. Read more

PAS-3 for privately placed issuance: “Unless” v/s “until”

CS Vinita Nair, Partner, Vinod Kothari & Company

corplaw@vinodkothari.com

One of the major concerns arising from enforcement of Companies (Amendment) Act, 2017 is ensuring compliance of provisions of substituted Section 42. One of the provisions of Section 42 restricts utilization of monies received from subscribers of the privately placed issue unless allotment is made and the return of allotment is filed with the Registrar in accordance with sub-section (8). This article critically analyses the aforesaid restriction, its consequences and the need to amend the same. Read more