NBFCs get another chance to reinstate NOF

By Falak Dutta, (finserv@vinodkothari.com)

Since the Sarada scam in 2015, the Reserve Bank of India (RBI) had been on high alert and had been subsequently tightening regulations for NBFCs, micro-finance firms and such other companies which provide informal banking services. As of December 2015, over 56 NBFC licenses were cancelled[1]. However, recently in light of the uncertain credit environment (recall DHFL and IF&LS) among other reasons, RBI has cancelled around 400 licenses [2]in 2018 primarily due to a shortfall in Net Owned Funds (NOF)[3] among other reasons. The joint entry of the Central Govt. regulators and RBI to calm the volatility in the markets on September 21st, 2018 after an intra-day fall of over 1000 points amid default concerns of DHFL warrants concern. Had it been two isolated incidents the regulators and Union government would have been unlikely to step in. The RBI & SEBI issued a joint statement on September saying they were prepared to step in if market volatility warrants such a situation. This suggests a situation which is more than what meets the eye.

Coming back to NBFCs, over half of the cancelled NBFC licenses in 2018 could be attributed to shortfall in NOFs. NOF is described in Section 45 IA of the RBI Act, 1934. It defines NOF as:

1) “Net owned fund” means–

(a) The aggregate of the paid-up equity capital and free reserves as disclosed in the latest

Balance sheet of the company after deducting therefrom–

(i) Accumulated balance of loss;

(ii) Deferred revenue expenditure; and

(iii) Other intangible assets; and

(b) Further reduced by the amounts representing–

(1) Investments of such company in shares of–

(i) Its subsidiaries;

(ii) Companies in the same group;

(iii) All other non-banking financial companies; and

(2) The book value of debentures, bonds, outstanding loans and advances

(including hire-purchase and lease finance) made to, and deposits with,–

(i) Subsidiaries of such company; and

(ii) Companies in the same group, to the extent such amount exceeds ten per cent of (a) above.

At present, the threshold amount that has to be maintained is stipulated at 2 crore, from the previous minimum of 25 lakhs. Previously, to meet this requirement of Rs. 25 lakh a time period of three years was given. During this tenure, NBFCs were allowed to carry on business irrespective of them not meeting business conditions. Moreover, this period could be extended by a further 3 years, which should not exceed 6 years in aggregate. However, this can only be done after stating the reason in writing and this extension is in complete discretion of the RBI. The failure to maintain this threshold amount within the stipulated time had led to this spurge of license cancellations in 2018.

However, the Madras High Court judgement dated 29-1-2019 came as a big relief to over 2000 NBFCs whose license had been cancelled due a delay in fulfilling the shortfall.



The regulations

On 27-3-2015 the RBI by notification No. DNBR.007/CGM(CDS)-2015 specified two hundred lakhs rupees as the NOF required for an NBFC to commence or carry on the business. It further stated that an NBFC holding a CoR and having less than two hundred lakh rupees may continue to carry on the business, if such a company achieves the NOF of one hundred lakh rupees before 1-04-2016 and two hundred lakhs of rupees before 1-04-2017.

The Petitioner’s claim

The petition was filed by 4 NBFCs namely Nahar Finance & Leasing Ltd., Lodha Finance India Ltd., Valluvar Development Finance Pvt. Ltd. and Senthil Finance Pvt. Ltd. for the cancellation of CoR[5] against the RBI. The petitioners claim that they had been complying with all the statutory regulations and regularly filing various returns and furnishing the required information to the Registrar of Companies. These petitions were in response to the RBI issued Show Cause Notices to the petitioners proposing to cancel the CoR and initiate penal action. The said SCNs were responded to by the petitioners contending that they had NOF of Rs.104.50 lakhs, Rs.34.19 lakhs, Rs.79.50 lakhs and Rs.135 lakhs respectively, as on 31.03.2017.

Valluvar Development Finance also sent a reply stating that they had achieved the required NOF on 23-10-2017, attaching a certificate from the Statutory Auditor to support its claim. The other petitioners however submitted that due to significant change in the economy including the policies of the Govt. of India during the fiscal years 2016-17 and 2017-18 like de-monetization and implementation of Goods & Services Tax, the entire working of the finance sector was impaired and as such sought extension of time till 31-03-2019 to comply with the requirements.

Now despite seeking extension of time, having given explanations to the SCNs, the CoRs were cancelled without an opportunity for the NBFCs to be heard.


The Decision

It was argued that there is a remedy provided against the cancellation of the CoRs, the petitioners had chosen to invoke Article 226 contending violation of the principles of justice. The proviso to Section 45-IA(6) relates to the contentions in regards to cancellation of the CoRs.

“45-IA. Requirement of registration and net owned fund –

(3) Notwithstanding anything contained in sub-section (1), a non-banking financial company in existence on the commencement of the Reserve Bank of India (Amendment) Act, 1997 and having a net owned fund of less than twenty five lakhs rupees may, for the purpose of enabling such company to fulfill the requirement of the net owned fund, continue to carry on the business of a non-banking financial institution–

(i) for a period of three years from such commencement; or

(ii) for such further period as the Bank may, after recording the reasons in writing for so doing, extend,

subject to the condition that such company shall, within three months of fulfilling the requirement of the net owned fund, inform the Bank about such fulfillment:

Provided further that before making any order of cancellation of certificate of registration, such company shall be given a reasonable opportunity of being heard.

(7) A company aggrieved by the order of rejection of application for registration or cancellation of certificate of registration may prefer an appeal, within a period of thirty days from the date on which such order of rejection or cancellation is communicated to it, to the Central Government and the decision of the Central Government where an appeal has been preferred to it, or of the Bank where no appeal has been preferred, shall be final:

Provided that before making any order of rejection of appeal, such company shall be given a reasonable opportunity of being heard.

The decision was taken on two grounds. First, the statute specifically provides for an opportunity of personal hearing besides calling for an explanation. The amended provision is very particular that opportunity of being personally heard is mandatory, as the very amendment relates to finance companies, which are already carrying on business also. Not affording this opportunity would cripple the business of the petitioners.

Second, the amended section provides NBFCs sufficient time to enhance their NOF by carrying on business and comply with the notifications. For the aforesaid reasons, the orders by the RBI requires interference. Resultantly, the respondents (RBI authorities) are directed to restore the CoR of the petitioners and also extend the time given to the petitioners.



This was a landmark hearing in the case of NBFCs as they had been under increasing pressure as of recent times. Many NBFCs can now apply for restoration of their licenses and might already have. The case doesn’t just stand the case for NOF conflicts but will also ring in the minds of regulators in the future, compelling greater caution and concern. The last statement of the judgement stands apt here. The brief sentence read,” Consequently connected miscellaneous petitions are closed.”

[1] https://economictimes.indiatimes.com/news/economy/finance/rbi-cancels-license-of-56-nbfcs-bajaj-finserv-gives-away-license/articleshow/50045835.cms?from=mdr

[2] https://www.businessinsider.in/indias-central-bank-has-scrapped-the-licenses-of-nearly-400-nbfcs-so-far-this-year/articleshow/65698193.cms

[3] https://www.firstpost.com/business/ilfs-dhfl-shocks-may-be-temporary-triggers-but-the-bad-news-for-indian-financial-markets-do-not-end-there-5248071.html

[4] https://enterslice.com/learning/wp-content/uploads/2019/02/Madras-high-court-Judgement-on-NBFC-License-Cancellation.pdf

[5] Certificate of Registration

Brand usage and royalty payments get a new dimension under Listing Regulations

By Abhirup Ghosh & Smriti Wadehra (abhirup@vinodkothari.com) (smriti@vinodkothari.com)


Usage of common brand is a common practice that we notice among companies which are part of large conglomerates. Often the brands created by one single entity of a group are used by its related parties, however, these transactions are often structured with differential pricing terms i.e. either these transactions are not charged at all or are overpriced.

Therefore, in order to increase transparency and regulate to these transactions, a Committee on Corporate Governance constituted by the SEBI under the chairmanship of Uday Kotak has proposed disclosure requirements this kind of transactions.
In this article we will primarily discuss the proposal made by the Committee threadbare. Additionally, we will also discuss the impact of indirect taxes on such transactions.

Brand usage and Royalty as per Listing Regulations

The erstwhile provisions of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) did not provide anything for royalties or brand usage paid to related parties. However, a SEBI constituted committee under the chairmanship of Mr. Uday Kotak on 2nd June, 2018 provided a report on corporate governance with certain recommendations for implementation. One of the recommendations was to insert provision pertaining to payments made for brand and royalty to related parties.

As noted above, often the transactions involving usage of brands and royalty payments are structured with differential pricing terms. The Committee has noted the importance of brand usage and it also brought the importance of disclosing the terms relating to payments against these brand usages, considering the role it plays in driving the sales or margin.

In this regard, the Committee suggested that where royalty payout levels are high and exceed 5% of consolidated revenues, the terms of conditions of such royalty must require shareholder approval and should be regarded as material related party transactions. The Listing Regulations currently prescribe a materiality limit at ten percent of annual consolidated turnover of the Company. Therefore, the Committee prescribed a stricter limit for brand usage and royalty i.e. 5% instead of the existing limit which is 5% of consolidated turnover.

SEBI applied its discretion to make the provision stricter and subsequently, made the following insertion in the Listing Regulations:

“23(IA) Notwithstanding the above, with effect from July 01, 2019 a transaction involving payments made to a related party with respect to brand usage or royalty shall be considered material if the transaction(s) to be entered into individually or taken together with previous transactions during a financial year, exceed two percent of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.”
On reading the aforesaid provisions and basis our discussion, we understand that from 1st July, 2019 transactions involving payments made to a related party with respect to brand usage or royalty shall be considered material if the transaction(s) to be entered into individually or taken together with previous transactions during a financial year, exceed two percent of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.

It is pertinent to note that all transactions entered with related party for brand usage and royalty shall always be regarded as related party transactions. However, the trigger point of qualifying such transactions as material related party transaction is when the quantum of payout exceeds two percent of the annual consolidated turnover of the listed entity.

Whether provisions applicable for payments received for Brand usage and royalties?

While the provision talks about royalty payments to be treated as material related party transactions, but what remains to be answered is whether royalty receipts would also be considered as material related party transactions.

Please note that provisions of the amendment clearly provides:
involving payments made to a related party with respect to brand usage or royalty

Therefore, the applicability of the provisions appears to apply only in case of payments made to related party for brand usage and royalty. However, this does not seems to be the intent of law. Every transaction has two parties, in the present case, the two parties are the receiver and the giver. It does not seem rationally correct to include one side of the coin within the ambit of the law while keeping the other side out. Therefore, ideally receipt of royalty must also be treated as material related party transaction for the purpose of Regulation 23(IA) of the Listing Regulations.

Meaning of “Royalty”

Despite insertion of a new regulation dealing with royalty payments, the Listing Regulations do not define the term royalty. The meaning of the term, however, can be borrowed from the Income Tax Act, 1961 which provides for an elaborate definition. Section 9(1) of Income Tax Act, 1961 reads as:

“royalty” means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head “Capital gains”) for—

(i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property ;
(ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property;
(iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property ;
(iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill ;
(iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB;
(v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films ; or
(vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v).

Explanation 5.—For the removal of doubts, it is hereby clarified that the royalty includes and has always included consideration in respect of any right, property or information, whether or not—
(a) the possession or control of such right, property or information is with the payer;
(b) such right, property or information is used directly by the payer;
(c) the location of such right, property or information is in India.

Therefore, as per the aforesaid provisions, consideration for transfer of rights (including granting of a licence) in respect of a trade mark or similar property or for use of a trademark or transfer of rights (including granting of a licence) in respect of any copyright, literary, artistic or scientific work, falls under the definition of ‘Royalty’ under the IT Act. Accordingly, any transaction with the related party for the aforesaid activities shall be regarded as related party transaction for usage of royalty.

Similarly, the term ‘brand usage’ has not been defined under the Listing Regulations. In this regard, reference may be drawn from section 2(zb) of the Trade Marks Act, 1999 which identifies brand as a trade mark or label which is an intellectual property right. Accordingly, any transactions of brand usage by related party shall be regarded as related party transaction.

Impact of GST laws on brand usage transactions

After the introduction of regulation 23(1A) it is very clear the companies will have to structure the brand usage transactions properly and pricing policy of the same shall have be relooked at, however, one must not forget the potential impact GST laws can have on these transactions.
Rule 28 of Central Goods and Services Tax (CGST) Rules, 2017 states that all transactions between related persons must be carried out on arm’s length basis and should be priced at open market value. This applies to all transactions between related parties, needless to say even brand usage transactions will also be covered under this.

Therefore, if going forward the parties decide to execute the transactions without any consideration, in order to escape the provisions of regulation 23(1A), the same shall be subjected to rule 28 which provides for computation of notional value and GST will have to paid on the notional value.
However, rule 28 provides for an exception which states that if an invoice is raised by the supplier with GST on it and the recipient of the supply is eligible to claim input tax credit on the value of services, then the value quoted in the invoice shall be deemed to be the open market value of the goods or services.
Therefore, to ensure that notional value taxation does not apply, the parties must refrain from structuring transactions with nil consideration. However, if the same involves royalty payments of more than 2% of the consolidated turnover, it will have to comply with regulation 23(1A).Therefore, the companies must be mindful of both these provisions while structuring this kind of transactions henceforth.


While the Committee does not intend to stop brand usages in the country, all it wants to establish is a fair and transparent practise of charging royalty payments for the usage of brands. Accordingly, listed companies have to be more careful before charging for brand usages, as the same have come under the radar of materiality and have to be reported. Further, considering the tax implications, the structuring of such kind of transaction shall be important. To summarise, the Listing Regulations have introduced a new dimension to payments made for brand usages and royalties.

Adjudication of penalties under SEBI: SC ruling gives controlled discretion to Adjudicating Officer

-Ruling of Bhavesh Pabari overrules Roofit Industries

By Smriti Wadehra (smriti@vinodkothari.com)

A three member Bench of the SC recently overruled its earlier decision in Roofit Industries Ltd vs SEBI, and provided a controlled discretion to the Adjudicating Officer in fixing penalties for offences under the SEBI Act as well Securities Contract Regulation Act (SCRA) as a result of  the ruling, the Adjudicating Officer shall not be constrained by the minimum extent of penalty laid in SEBI Act and may, where circumstances so warrant, either waive off the penalty completely or may assign a penalty less than the so called minimum. Thus, the adjudication of penalties may be expected to be more commensurate with the gravity of the offence, than was so far possible primarily due to the position arising out of Roofit ruling. Read more

SEBI proposes to restructure the issuance of shares with DVRs

By Nikita Snehil and Shaifali Sharma | corplaw@vinodkothari.com

Vinod Kothari & Company

The basic principle behind the issuance of shares with differential voting rights, commonly known as ‘DVRs’ in India and dual class shares or ‘DCS’ in the international context, is to enable the companies to raise capital without dilution of control and decision-making power in company. In promoter/ founder led companies where promoters/ founders are instrumental in the success of the company, such structures enable them to retain decision-making powers and rights vis-a-vis other shareholders either through retaining shares with superior voting rights or issuance of shares with lower or fractional voting rights to public investors.

The concept was first recognized under the Companies (Amendment) Act, 2000 followed by similar provisions adopted by the Companies Act, 2013. However, the current practical scenario depicts a different picture, as the provisions of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 does not permit DVRs with higher or superior voting rights. However, subject to certain conditions, DVR shares with lower voting rights are permitted. Till date, only 5 listed companies have used this structure in India. Strict pre-condition and corporate governance norms, unavailability of investors due to lack of awareness are some grounds of company’s reluctance from adopting such idea.

SEBI’s Consultation Paper to restructure the issuance of DVRs

On December 19, 2018, Mr. Ajay Tyagi, Chairman of SEBI, had said in an interview that SEBI has made a sub-committee for reintroducing Differential Voting Rights on shares, which will make recommendation on the same by next month. Post this, SEBI on March 20, 2019, has come out with a Consultation Paper[1] on issuance of shares with Differential Voting Rights. The Consultation Paper provides that the matter of issuance of shares with DVRs was deliberated in the Primary Market Advisory Committee of SEBI (‘Committee’) and a group (‘DVR Group’) was constituted amongst the Committee members to do an in-depth study of the proposal of introduction of shares with DVRs in Indian Scenario.

The Consultation Paper addresses the norms for issuance of shares with DVRs under two categories –

  1. issuance by companies whose equity shares are already listed on stock exchanges;
  2. companies with equity shares not hitherto listed but proposed to be offered to the public.

The basic moto behind allowing shares with differential voting rights is to raise equity without dilution of promoter control i.e., to allow the promoters/ founders to maintain control as they would hold shares with superior voting rights.

Therefore, considering SEBI’s proposed structure, there shall be four categories of companies which can issue DVRs:

  • Equity listed cos – as per this Consultation Paper;
  • Unlisted cos, which are intending to get their equity listed — as per this Consultation Paper;
  • Unlisted cos, not intending to list their equity shares – as per Section 43 of the Companies Act, 2013 (‘Act’) read with Rule 4 of the Companies (Share Capital and Debenture) Rules, 2014;
  • Private Cos — exempted from applicability Section 43 of the Act, if either its memorandum or articles of association so provides- vide notification number G.S.R. 464(E) dated 5th June 2015.

Need for DVRs in India

In order to maintain the current growth phase in India, it is pertinent for the companies to raise capital to sustain this growth. For companies with high leverage or asset light models, they may prefer equity over debt capital. Raising DVRs will reduce the dilution of founder/ promoter stake which would otherwise be a case in capital raised by equity.

The protection of founder/ promoter’s stake/ control is especially relevant for new technology entities which have asset light models, with little or no need for debt financing. However, these entities generally raise funds through equity which dilutes the promoter’s/ founder’s stake, thereby diluting control. Considering the issue, the Consultation Paper states that retaining founder’s interest & control in the business is of great value to all shareholders and the same can be achieved by:

  1. Issue of shares with superior voting rights (‘SR’) to founders and/or
  2. Issue of shares with lower or fractional voting rights (‘FR’) to raise funds from private/ public investors.

International Scenario

The global market has witnessed a mixed response to the concept of DVRs, while many countries have permitted the listing of companies with Dual Class Shares or DCS (internationally used term for DVRs), some countries like UK, Australia, Spain, Germany and China do not permit the Issuers with DCS structure for listing. Singapore and Hong Kong have recently permitted DCS structures with detailed checks and balances. Considering the international scenario, the Consultation Paper has provided a detailed comparison of the issuance & listing of DCS structure in internal jurisdictions, the summary of which is presented below:

  • 700 public companies in the US have DCS structures, predominant listed ones being Google, Facebook, Snapchat, Nike and Alibaba. There is ongoing debate in the SEC about the continuation of DCS[2].
  • Hong Kong and Singapore recently allowed DCS to encourage more new technology firms to list.
  • In the UK[3], DCS structures were used in the 1960s to protect corporations from hostile takeovers or for the Queen to have ‘golden share’, before institutional investors expressed strong opposition to such structures. DSC is presently not allowed in the UK.
  • Over the past decade, a number of European governments have implemented or debated the use of different voting rights.
  • US, Canada, HK, Singapore, Denmark, Spain, Sweden and Italy allow dual-class shares. Germany, Spain, China, Australia disallow listing of shares of companies with DCS structures.

Recommendations of the DVR Group

Ø Pre-conditions

A company would be entitled to issue DVR Shares, subject to following pre-conditions:

  • issue of DVR Shares must have been be authorized in the AoA of the company; and
  • the issue of DVR Shares should be authorized by a special resolution passed at a general meeting of the shareholders.
  • for companies already listed, by way of e-voting as per Companies Act, 2013
  • The notice should mention specific matters, including but not limited to, size of issuance, ratio of the difference in the voting rights, rights as to differential dividends, if any, sunset clause, coattail provisions, etc., as made applicable by SEBI regulations to be notified in this regard.

Ø Requirements for both the categories

Category I: Companies whose equity shares are already listed – issuance of FR Shares;

Category II: Companies whose equity shares are proposed to be listed – issuance of SR shares.



Requirements for Category I Requirements for Category II
Conditions Cos whose shares have been listed on a SE for atleast a year, may issue FR Shares.


Note: listed cos are still not allowed to issue SR Shares.

Unlisted cos may issue SRs, only to promoters.

First issuance of FR/ SR shares

Type of issuance Through a) rights issue; b) bonus issue pro rata to all equity shareholders; or c) a Follow-on Public Offer (“FPO”) of FR shares. An unlisted co. where the promoters hold SR Shares shall be permitted to do an Initial Public Offer (“IPO”) of only ordinary equity shares provided the SR Shares are held by the promoters for more than one year prior to filing of the draft offer document with SEBI.

Subsequent issues of FR Shares once FR Shares are already listed

Type of issuance A company that has already listed FR Shares shall be eligible to do:

a) rights issue; b) bonus issue; c) preferential issue; d) QIP of FR Shares of the same class;


A company whose SR Shares and ordinary equity shares are already listed shall be permitted to issue FR Shares in terms of the applicable provisions for issue of FR Shares by listed companies – which means same as Category I.


Note: Issuance of SR shares not allowed post listing.

Depository Receipts A company whose FR Shares are listed for at least one year shall be eligible to issue depositary receipts where the underlying shares are FR Shares.
Convertible Instruments A company can issue convertible instruments which will convert into FR Shares subject to applicable regulatory considerations.
Voting and other rights The FR shares shall not be treated at par with the ordinary equity shares.


Max ratio


The FR Shares shall not exceed a ratio of 1:10, i.e. one vote as applicable to one Ordinary Equity Share, would be voting entitlement on 10 FR Shares. The ratio can be in full numbers from 1:2 to 1:10.



At any point of time, the co. can only have one class of FR Shares.

The SR Shares shall be treated at par with the ordinary equity shares in every respect except in the case of voting on certain matters.


Max ratio


The SR Shares shall be of a maximum ratio of 10:1, i.e. ten votes for every SR Share held. The ratio can be in whole numbers from 2:1 to 10:1. A ratio once adopted by a company shall remain valid for any subsequent issuances of SR Shares.


A co. can issue only one class of SR Shares.


Any rights or bonus issue by the co. post-listing shall be offered only as ordinary equity shares

to the holders of the SR Shares.


On certain matters to be notified by regulations, the SR Shares would be treated as having only one vote. The initial list of the same is set out in the coattail provisions set out in the Committee Report (the same has been explained later in this Article).


Dividends The company may, at its discretion, decide to pay additional dividend per FR Share compared to dividend paid on ordinary Equity Share, which shall be higher than the dividend per

ordinary Equity Share and the same shall be stated in the terms of the offering. No dividend may be payable on FR Shares for such years where no dividend has been declared by the company for the ordinary equity shares.


Post IPO, the SR shares shall be eligible for the same dividend and other rights as ordinary equity shares, except for superior voting rights.
Minimum Public Shareholding The co. should comply with the req of Securities Contracts (Regulation) Rules, 1957 (“SCRR”) and other applicable regulations formulated in this regard. The co. shall comply with the SCRR and other applicable regulations formulated, for the ordinary equity shares that will be listed.


Post-listing, the voting rights with the promoters through the SR Shares and ordinary equity shares shall not exceed 75% of the total voting rights.

Pricing The pricing of FR shares shall be in accordance with regulatory considerations applicable to

mode of issuance of FR Shares

Face Value The face value of a company’s FR Shares shall be the same as that of its

ordinary equity shares.

The face value of a company’s SR Shares shall be the same as of that of the ordinary equity shares.
Number of FR / SR Shares The number of FR Shares that may be issued by a company shall be subject to

provisions of the Companies Act, 2013 and the rules framed thereunder

A company shall be permitted to issue any number of SR Shares of the same class prior to an IPO, subject to provisions of the Companies Act, 2013.
Lock-in period All SR Shares shall remain under a perpetual lock-in after the IPO.
Pledge of shares Creation of any encumbrance over SR Shares including pledge, lien, negative lien, non-disposal undertaking, etc. shall not be permissible.

In other words, no third-party interest may be created over the SR Shares and any instrument purporting to do so would be void ab initio.

Fasttrack issuance


A company shall be eligible to issue FR Shares in a rights issue or an FPO through the fasttrack method in case it meets the eligibility criteria of fast-track issuances.
Conversion of FR / SR shares


[Also known as ‘Sunset Clause in case of SR Shares]

The FR Shares can be converted into ordinary equity shares only in cases of schemes of


The validity of SR shares is 5 years from the date of listing of ordinary shares. Which means, such shares shall be compulsory converted into ordinary shares on the 5th year anniversary of the listing of such ordinary shares i.e. superior rights will fall under the standard rule of ‘one-share one-vote’. Conversion shall be done in the following manner:


For promoters: at any time prior to the 5th year anniversary of the listing of the Ordinary Shares or such extended period as decided by the shareholders by passing special resolution.


For other than promoters: on completion of the 5th year anniversary of the listing of the Ordinary Shares or such extended period of 5 years with the approval of shareholders by way of special resolution in the meeting where all members vote on one-share-one vote basis.


Besides the aforementioned validity of 5 years, the SR shares shall be converted into ordinary shares on the merger or acquisition of the company or sale of such shares by the identified promoters who hold such shares or in the case of demise of the promoter(s).

Extinguishment The FR Shares can be extinguished only through buy-back by the company or reduction of capital in accordance with applicable laws.
Delisting The company can delist the FR Shares in accordance with the SEBI (Delisting of Equity Shares) Regulations, 2009. However, in the event ordinary equity shares of the company are delisted, the company shall be mandatorily required to delist the FR Shares.
Listing and Trading The FR Shares shall be held in dematerialized form. However, FR Shares can be

issued in physical form, if such FR Shares have been issued pursuant to a bonus issue and the underlying shares are held in physical form.


The FR Shares shall be listed and traded on all SEs where ordinary equity shares of the co. are listed with a separate identifier from the ordinary equity shares.

All SR Shares shall be held in dematerialized form and shall be listed on the main board platform of the recognized SEs.

For listing of SR Shares, exemption will be granted from Rule 19(2)(b) of SCRR.


The SR Shares, however, cannot be traded except upon conversion into ordinary equity shares.

Post-Issue Disclosures The shareholding pattern filed by the co. with the SEs shall provide the details of the FR Shares separately and in the format specified by SEBI and the SEs The shareholding pattern to be filed by the co. with the SEs shall provide the details of both ordinary equity shares and SR Shares in the format specified by SEBI and the stock exchanges.
ESOPs A co. can issue ESOPs of FR Shares post the listing of such shares, subject to applicable laws.
Bonus issue by the co. which has issued FR shares If a co. which has issued FR shares, issues bonus shares, then it shall issue to FR shareholders bonus FR shares in the same proportion in which bonus shares are issued on ordinary equity shares.
Applicability of other SEBI Regulations SEBI regulations in respect of buy-back, and takeovers shall apply to FR Shares, subject to such modification as may be required in the context of FR Shares. The FR Shares once listed shall not be delisted on a standalone basis and may be delisted as and when the ordinary equity shares are delisted. SEBI regulations in respect of buy-back, and takeovers shall be applicable to SR Shares, subject to such modification as may be required in the context of SR shares.


Ø ”Coattail”  Provisions for issuance of SR shares

Post-IPO, the SR Shares shall be treated as ordinary equity shares in terms of voting rights (i.e. one SR share-one vote) in the following circumstances:

  1. provisions relating to appointment or removal of independent directors and/or auditor;
  2. in case there is a change in control of the company;
  3. any contract or agreement of the company with any person holding the SR Shares, in excess of the materiality threshold prescribed under Regulation 23 of the SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015;
  4. voluntary winding up of the company;
  5. any material changes in the company’s AoA or MoA, including but not limited to, undertaking variation in the voting rights of the shareholders, changing the principal objects of the company, granting special rights in favour of a particular shareholder or shareholder groups and such other items as may be prescribed by the SEBI;
  6. initiation of a voluntary resolution plan under the Insolvency and Bankruptcy Code, 2016;
  7. extension of the validity of the SR Shares post completion of 5 years from date of listing of ordinary equity shares; and
  8. any other provisions notified by SEBI in this regard from time to time.


The major benefits of DVRs structure highlighted in the DVR Group Report are as follows:

  1. DVRs promote fund raising without diluting control;
  2. In a promoter led companies, DVR structure will enable such promoters to retain control, the decision-making powers and other rights in the company;
  3. DVRs structure acts as defense mechanism for hostile takeover.

The recommendations by DVRs Group seems to extend a hand of opportunity to listed companies and those companies including, newly incorporated companies, who intend to issue DVRs but do not have a consistent track record of distributable profits as stated in the existing ICDR regulations, i.e. 3 years.

The Sunset Clause in case of SR shares shall keep a check on the tenure of the DVRs, however, the provisions requiring companies issuing the DVRs to observe better corporate governance practices is missing in the proposed structure of DVRs. Further, there might be instances where the interest of minority shareholders could be adversely affected by the holder of SR shares, therefore, certain checks and balances to prevent the misuse of the instruments should be imposed by SEBI to protect the interest of the shareholders as well as the genuine issuers.

[1] https://www.sebi.gov.in/reports/reports/mar-2019/consultation-paper-on-issuance-of-shares-with-differential-voting-rights_42432.html

[2] http://www.pionline.com/article/20180216/ONLINE/180219888/sec-commissioner-calls-for-curb-on-dual-class-forever-shares#

[3] https://ecgi.global/sites/default/files/working_papers/documents/SSRN-id2138949.pdf

Guidelines for Review of Loans and Investments by the Audit Committee

Team Vinod Kothari & Company



Securities and Exchange Board of India (Listing Obligations and Disclosure Requirement) Regulations, 2015 (‘Listing Regulations’) as well as Companies Act, 2013 (‘Act, 2013’) specify the role of the audit committee and mandates the audit committee to mandatorily review certain matters. Among the matters to be reviewed by the audit committee, section 177 of the Act, 2013 provides for review of inter-corporate loans and investments. Additionally, under Regulation 18 read with Schedule II and Regulation 24 of the Listing Regulations, the audit committee shall review the utilization of the loans/advances given to subsidiaries which exceed a certain threshold and shall also review the financial statements of its unlisted subsidiary.


The intent of audit committee review is to provide an independent view of the strength, objectivity and transparency of long-term investments made by the company and financial exposures taken by the company into other entities. Additionally, the audit committee may also review whether the loans/investments are still serving the purpose that they were intended to achieve, and whether the health/fair value of the loans and investments has substantially been affected over time. The audit committee’s review may also become the basis for strategic decisions on continuing the said financial exposures.


In case of subsidiaries, they are a part of the extended enterprise led by the holding entity. The holding entity puts in capital and other resources into subsidiaries. The subsidiaries are engaged in specific activities/verticals based on the business model of the enterprise. The subsidiaries may make further downstream investments and thus, create a network, once again, within the larger group objective of the enterprise. However, the review by the audit committee ensures that the subsidiaries are serving the larger group objective that they were designed to serve.


The following is a guideline as to what should be the perspective of the review and the specific areas of concern for such loans and investments which are placed for review/scrutiny before the audit committee; when such review is to be made etc. Further, the perspective and purpose of the audit committee is different while reviewing the loans and investments to its subsidiaries and that given to others.

Relevant provisions of Listing Regulations:


Regulation 24(2):


“The audit committee of the listed entity shall review the financial statements, in particular, the investments made by the unlisted subsidiary.”


Para A of Part C of Schedule II:


“The role of the audit committee shall include the following:

  1. Scrutiny of inter-corporate loans and investments.


  1. reviewing the utilization of loans and/ or advances from/investment by the holding company in the subsidiary exceeding rupees 100 crore or 10% of the asset size of the subsidiary, whichever is lower including existing loans / advances / investments existing as on the date of coming into force of this provision”

Parallel provisions of Companies Act, 2013:


Section 177(4) 

“Every audit committee shall act in accordance with the terms of reference specified in writing by the board which shall, inter alia, include:

(v) Scrutiny of inter-corporate loans and investments;



Clarification on the terms loans, advances and investment


Need to review inter corporate loans and investments by the audit committee:


Inter corporate loans and investments made by the company implies a long term financial exposure. Generally speaking, unless the company is into the business of making investments, the inter-corporate investments are not directional investments; they are strategic in nature. Similarly the inter-corporate loans, except in case of companies engaged in the business of lending, are not intended for reaping interest income. Therefore, the review of these long-term financial exposures to be taken by the audit committee is to ensure that these outlays of funds do not lead to long-term resources of the entity being diverted to a purpose which is not congenial or related to the corporate objective. The objective also includes review of the health and integrity of these loans and investments. Where required, disinvestment calls may also have to be taken based on review by the audit committee.


While the law requires the audit committee to review the inter-corporate loans and investments, there seems to be no reason for excluding the review of guarantees/ securities provided by the company in connection with the loan.


Need to review investments in and made by the unlisted subsidiaries:


The holding company invests in the capital of subsidiaries. While the need for reviewing the investment in subsidiaries does not come from the Companies Act, 2013, the Listing Regulations specifically requires the listed holding company to review the investments of its unlisted subsidiaries. The investments made by the subsidiaries are indirect investments of the holding company itself. Where the subsidiaries are listed entity, the investments made are subject to similar review by their audit committee. However, in case of unlisted subsidiaries, there is less likelihood that the subsidiary will have its own audit committee. Irrespective, the audit committee of the holding listed entity is entrusted with the responsibility of monitoring and reviewing the investments made by such subsidiaries. The audit committee of the holding company has to review such investments to understand if there is any diversion from the objectives of the investment. Further, in case of downward investment by the subsidiary, the audit committee shall review whether the larger objective of the holding company is being served.


Need to review loans given to unlisted subsidiary


The audit committee the holding company is required to review whether the loans granted by it to its subsidiary is being utilized for the approved purpose or not. Any case of diversion of funds has to be brought to the notice of the audit committee since any sort of funding to the subsidiary is always with an intent of expanding or stabilizing the operations of the holding company. Further, the audit committee while reviewing needs to check whether the terms on the loan are reasonably fair and at arm’s length.


Scope of ‘loans’ to be reviewed by audit committee:


The audit committee of the listed entity is required to scrutinize inter-corporate loans availed/ granted by the listed entity. Inter- corporate loans for the purpose of review shall include-


  • Inter-corporate guarantees given by the listed entity;
  • Inter-corporate security provided by the listed entity;
  • Loans with terms and conditions substantially at variance with the loans ordinarily provided;
  • Guarantees with terms and conditions substantially at variance with the guarantees usually provided;
  • Loans other than in the ordinary course of business


Loans/ guarantees which are granted or security provided in the ordinary course of business or to exempted categories need not be reviewed by the audit committee.


Scope of ‘Investments’ to be reviewed by audit committee:


Investments as are assets held by an enterprise for earning income by way of dividends, interest, and rentals, for capital appreciation, or for other benefits to the investing enterprise. Assets held as stock-in-trade are not ‘investments’.


Investments which shall be reviewed by the audit committee of the listed entity will include strategic investments made with the motive to earn yield or regular investment income. Investing the funds reduces the investible funds of the entity, funds available for business and therefore it is necessary to review the same. Investments should not be restricted to investments in securities only. Investment in the assets/property should also be covered within the ambit. Certain investments, as specified here under, need not be included within the ambit:


  • Trade investments made by the listed entity or its unlisted subsidiary;
  • Investments made in the ordinary course of business;
  • Statutory investments made under applicable law;


Specific concerns for review by the audit committee:


The perspective of the audit committee is different while scrutinizing loans and investments of the listed entity as well as while reviewing the investments made in/by the unlisted subsidiary. For this purpose the following points should be included by the audit committee in its review –


1.      Specific concerns for loans to other entities


  • Purpose of loan, how does it serve the business interest of the company;
  • Tenure of loan;
  • Where the company has raised any money by issuing any shares/ debentures, does the giving of the loan amount to utilization of issue proceeds for a purpose other than that disclosed in the offer document;
  • Rate of interest appropriate in view of credit risk of investee;
  • Security interest and liquidity;
  • Whether the loan is being serviced or has become impaired;
  • Whether the quality of the borrower has deteriorated;
  • Whether repayment happens as per stated repayment schedule;
  • Whether there exists a scope for premature repayment;
  • Whether there exists any reason to opt for premature repayment;
  • If loan is not to a related party, how and why the transaction emanate;
  • Whether the loan has been extended on reasonably fair terms and conditions and at arm’s length.

2.      Specific concerns for investment in other entities


  • Purpose of investment, how does it serve the business interest of the company;
  • Whether there has been any diversion in utilizing the investment of the company from the objects and purposes approved by the audit committee;
  • Whether the subsidiary has made any downstream investment and whether such downstream investment is at par with the objectives of the investment of the company
  • Performance of investment – in terms of yield, returns;
  • Likely performance of the investment in future;
  • Liquidity of the investment;
  • Any reason to seek liquidation/ exit from investment.


  1. Specific concerns in case of subsidiaries


While many of the above may not be relevant in case of subsidiaries, the following areas of concern shall be looked into by the audit committee in case of loans and investment made:




  • Whether the loan is being utilized for the purposes approved by the company;
  • Is there any diversion in the end use of the loan;
  • Covenants of the loan, particularly, with a view to ensure that there are no chances of diversion of funds from the purpose for which they are purportedly intended to be provided.




  • Whether there has been any diversion in utilizing the investment of the company from the

objective and purposes approved by the audit committee;

  • Whether the subsidiary has made any downstream investment and whether such downstream investment is at par with the objectives of the investment of the company;
  • Whether the investment made is a fit case for impairment considering the performance of the investee company.

On-going review by audit committee:


As per Regulation 24(2), investments of the unlisted subsidiary shall be reviewed by the audit committee of the holding listed entity at the time of review of financial statements of the unlisted subsidiary. Financial statements are prepared annually; therefore, the review shall be done on an annual basis for the investments made by unlisted subsidiaries during the year.


Further, as per Clause 9 of Para A, Part C of Schedule II to Listing Regulations the loans/ investments of the listed entity shall be subject to scrutiny by its audit committee before making investment/disbursing loans, to the extent possible or after the same have been made.


Furthermore, the holding company also reviews the following in case of its unlisted subsidiary, on an on-going basis:


  • Whether the subsidiary has sufficient accumulated reserves while considering its performance;
  • Whether the dividend policy of the subsidiary is in line with the larger objectives of the holding company;
  • Whether the subsidiary has large amount of surplus lying in its books so as to enable it to plan a buy back.


Format for reporting to the audit committee


There is no specific format for reporting the performance / status report to the audit committee for enabling the committee to review the same. However, the same may be reported in the following manner:


Sr. No Particulars of investment / loan


[Name of the party, date of investment or loan, purpose, tenure, etc.]

Concerns Amount involved Performance / Update
    Whether Secured or unsecured    
What is the yield
Whether liquid or illiquid
Market price of the securities
Whether there is any potential risk associated with the investment /loan
Servicing / repayment schedule
Any change in the credit rating of the investee company


Impact of the amendments in SEBI Regulations and the Companies Act, 2013 on the Policies and Codes of the Companies