By Abhirup Ghosh, firstname.lastname@example.org
& Nikita Snehil, email@example.com
Proper flow of funds within an organisation can be termed as the lifeline of the organization. In the course of the operation, each and every organization stands in need of money over and above their capital. Therefore, in order to meet the financial needs, they are bound to depend on external sources for funding. The source of funds would typically depend on the purpose and duration for which the fund is required.
Say for instance, if the Company requires funds for making a capital expenditure it would go for long term finance like term loans or external commercial borrowings. However, if the company requires funding to meet its working capital needs, it would go for short term financing sources like working capital loans or overdraft facility from banks.
Apart from the tenure or purpose of fund raising there is one more factor which also affects the choice of funding source and that is the borrowing cost. Eventually, over the years, this factor has become the most important of all.
Companies try various kind of fund raising techniques to achieve the lowest borrowing cost and in this regard it is very important to take note of the regulatory aspects of raising funds. In this article we intend we will discuss the various legal and regulatory issues relating to the issuance of the securities or fund raising and borrowing costs.
Meaning of borrowing cost
Before we delve into further details, let us first understand what constitutes to be borrowing cost. In general, Borrowing Cost means the interest and other costs incurred by an organization in relation to the borrowing of funds. However, the same has also been defined in Accounting Standard 16 in the following manner:
‘3.1 Borrowing costs are interest and other costs incurred by an enterprise in connection with the borrowing of funds.’
4. Borrowing costs may include:
(a) interest and commitment charges on bank borrowings and other short-term and long-term borrowings;
(b) amortisation of discounts or premiums relating to borrowings;
(c) amortisation of ancillary costs incurred in connection with the arrangement of borrowings;
(d) finance charges in respect of assets acquired under finance leases or under other similar arrangements; and
(e) exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs’.
To sum up, Borrowing Costs are the expenses incurred by the organization in borrowing the funds.
Modes of Borrowings
Next, with respect to modes of borrowing, the modes of funding can be distinguished majorly between long term borrowing and short term borrowing.
A. Modes of Short Term Borrowings and the cost involved in raising the same:
1. Temporary loans like loans repayable on demand, cash credit facilities and overdraft arrangements
A loan is repayable on demand when:
(a) there is no time for repayment specified (and hence, the obligation to repay on demand is implied by law); or
(b) the parties actually express the obligation to repay on demand or request (i.e., the same is an express term).
Therefore, a loan with no repayment terms, or loan agreement with no repayment date, is a loan repayable on demand. The borrowing company is required to pay the loan along with the interest amount determined by the lender. Example of a demand loan can be the overdraft facilities provided by the Banks.
An overdraft is an arrangement by which a company is allowed to draw more than what is to the credit of its account at the bank. The charges for overdraft facility has to be paid by the company to the Bank, when such facility is utilised.
Cash credit is an arrangement by which a company borrows from its bankers up to a certain limit against a bond of credit by one or more securities or some other security. The company is charged interest on the amount actually utilized and not on the limit sanctioned.
2. Commercial Papers (CPs)
Commercial Papers are unsecured money market instrument which can be issued either in the form of a promissory note or in a dematerialised form through any of the depositories approved by and registered with SEBI. Further, commercial papers are instruments issued by the company, so as to fulfil the short-term fund requirement and have easy liquidity in the market with less compliance burden.
However, before issuing commercial paper, the eligible issuers must obtain the credit rating for the issuance of commercial paper from any one of the SEBI registered Credit Rating Agencies.
Raising finance through issuance of these would not qualify to be deposits for the purpose of Companies Act as the term deposits exclude any money received by issuing money market instruments.
3. Working capital loans
A working capital loan is a loan that has the purpose of financing the everyday operations of a company. Working capital loans are not used to buy long-term assets or investments and are instead used to finance the day to day expenses such as to buy inventory, cover payroll, wages, etc. The lender charges interest for lending the working capital loans.
4. Issuance of NCDs with less than one year maturity
Companies having a tangible net worth as per the latest audited balance sheet, of not less than Rs.4 crore can issue Non-Convertible Debentures (NCDs) of maturity less than one year. The eligible corporate intending to issue NCDs is required to obtain credit rating for issuance of the NCDs from one of the rating agencies specified by RBI and the companies are even required to ensure at the time of issuance of NCDs that the rating so obtained is current and has not fallen due for review. Therefore, raising such funds shall require fulfilment of eligibility criteria and expenses for credit rating.
Like commercial papers, these are also money market instruments. Therefore, raising of finance through issuance of NCDs would not be treated as money market instrument for the purpose of Companies Act.
5. Letter of Credit
A Letter of Credit (L/C) is a letter from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount. Here the banks act as disinterested third parties and they release funds only after certain conditions are met. Banks issue letters of credit when a company applies for the same and has the assets or credit to get approved.
6. Trade Credit
A trade credit is an agreement or understanding between agents engaged in business with each other, it allows the exchange of goods and services without any immediate exchange of money. When the seller of goods or service allows the buyer to pay for the goods or service at a later date, the seller is said to extend credit to the buyer. This is a type of instrument where no cost is involved. Sometime, the payment terms may also offer discount as an incentive for early payment.
B. Modes of Long Term Borrowings and the cost involved in raising the same:
1. Loan from Bankers
Long-term loans are a type of business financing in which the maturity date of the loan extends past a year and can even last for as long as 20 years (e.g. commercial property loans). This is used mainly to finance long-term projects such as business expansion, franchising, purchase of property, plant, and equipment and other fixed assets. Companies may also avail loan from Bankers on the basis of their credibility. The company has to pay interest on the full amount of the loan sanctioned by the bank, irrespective of the amount utilised by the company. The longer the tenure extends, the more amount of interest money has to be paid in total.
2. Issuance of Debentures
A debenture is a securitised loan and is backed by a certificate. It is the most important method of obtaining loan for a longer period by the companies. On the basis of coupon, the debentures can be classified into two categories – coupon bearing [These debentures are issued at face value and the specified rate of interest is earned by the holders of these securities] and zero coupon [These debentures are issued at a discounted price and redeemed at par; and these do not carry any coupon rate.]. Generally, the following types of debentures are issued by the companies:
(a) Compulsorily Convertible debentures (CCDs): These debentures are mandatorily converted into equity shares of the company, as per the terms specified at the time of issue or on the expiry of specified period.
(b) Non-convertible Debentures (NCDs): These debentures do not carry the option of conversion into equity shares and are therefore, redeemed on the expiry of certain specified period. Most commonly, entities issued NCDs for meeting their long term capex requirements.
NCDs issued to corporates or listed or fully secured do not qualify to be deposits for the purpose of Companies Act.
(c) Optionally convertible debentures (OCDs): The investor has an option to convert into shares at the pre-determined price and time.
3. Inter-Corporate Deposits
An Inter-Corporate Deposit (ICD) is an unsecured borrowing by corporates from other corporate entities registered under the Companies Act, 2013 (or the erstwhile Companies Act, 1956). Corporates having surplus funds lend to another corporate in need of funds.
Inter-corporate deposits are exempt from the definition of deposits under Companies Act. Therefore, this is a very widely used mode of finance.
However, the companies shall also consider applicability of the restrictions under section 185 (dealing with loan to directors etc.) and section 186 (dealing with loans and investments by companies) of the Act, 2013 on the lending as well as the borrowing companies.
4. External Commercial Borrowings (ECBs)
ECB is basically debt availed by Indian companies in foreign currency, from a non-resident lender, in accordance with the ECB Framework, issued by the Ministry of Finance. There are no restrictions on the use of such loans, except the items mentioned in the negative list in relation to the end use mentioned by BRI in the ECB framework. Once the RBI and Ministry of Finance approves a loan and its terms, no limitations are placed on interest and principal payments. However, entities are required to report to the RBI through its designated banker every time an interest payment is made.
RBI vide RBI/2017-18/169 A.P. (DIR Series) Circular No.25 dated April 27, 2018 has further liberalised certain norms of the framework. The erstwhile provision had prescribed separate all-in-cost ceilings for different tracks in ECBs which were linked to the maturity period. Now, a uniform all-in-cost ceiling of 450 basis points over the benchmark rate is stipulated irrespective of the maturity period of ECB. Further, the ECB Liability to Equity Ratio for ECB raised from direct foreign equity holder under automatic route has been enhanced to 7:1 (as against 4:1 earlier). Therefore, by liberalising the framework, the Government has broaden the scope of fund raising for the companies.
Further, earlier, proceeds of ECBS could be used only for the purpose of meeting capital expenditures, but vide the aforesaid change, the end use restriction has been liberalised and the ECBs can now be used for the purpose of working capital requirements as well.
Compliance for borrowings by a company under the Companies Act, 2013
The borrowing powers of a company is mentioned in section 179(3) and 180(1)(c) of the Companies Act 2013.
Section 179 (3) (d): The powers to borrow money can only be exercised by the Directors at a duly convened meeting of the board, to borrow moneys. However, the power to borrow money may be delegated by the Board by passing a resolution for such delegation at a duly convened Board Meeting, to any committee of directors, the managing director, the manager or any other principal officer of the company or in the case of a branch office of the company, the principal officer of the branch office.
Section 180 (1) (c): The provisions of this section prohibits the Board of Directors of a company from borrowing a sum which together with the moneys already borrowed by the company, exceeds the aggregate of its paid-up share capital and free reserves, apart from the temporary loans obtained by the company’s bankers in the ordinary course of business unless the company has received the prior approval of the shareholders of the company, through a special resolution in general meeting.
Therefore, the Board may continue borrowing within the limits approved by the shareholders, however, in order to borrow beyond the above-mentioned limit, the Board of Directors will have to obtain prior approval of the shareholders.
Meaning of the term ‘Temporary Loans’ in section 180(1)(C)
As per the explanation provided in section 180(1)(C), the expression “temporary loans”
means loans repayable on demand or within six months from the date of the loan such as short-term, cash credit arrangements, the discounting of bills and the issue of other short-term loans of a seasonal character, but does not include loans raised for the purpose of financial expenditure of a capital nature.
Borrowings by private companies
Private companies are exempted from the entire provisions of section 180 of Act, 2013 vide MCA Notification dated June 5, 2015.
Borrowings by banking companies:
As per the proviso provided in section 180(1)(C), the acceptance of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise, in the ordinary course of its business by a banking company, shall not be deemed to be borrowing of monies by the banking company.
Ultra Vires Borrowings
As per the provision of section 180 (5), where a company borrows in excess of its borrowing limits as approved by the shareholders, then such borrowing in excess of the limit shall not be valid or effectual unless the lender proves that he advances the loan in good faith without knowledge that the limit imposed by the law has been exceeded.
The above mentioned various modes of borrowings provide the various option of fund raising by the companies. The various options of borrowing further depends on the need of the companies and the nature of borrowings. The most relevant part is the basic idea is to identify and explore the avenues to reduce the borrowing costs for companies. Identifying low cost avenues is a joint responsibility of the treasury department and the compliance team, while the treasury team should opt to explore new avenues, the compliance team should see if the same fits into the existing regulatory framework.