Securitisation- Should India be moving to the next stage of development?

STAMP DUTY IMPLICATIONS ON E-AGREEMENTS

– Ishika Agrawal (corplaw@vinodkothari.com)

I.        Introduction

The way businesses are done, has evolved with the evolution of technology. Now-a-days, business transactions and business contracts are mostly executed electronically in order to save time and expenses. However, this also raises concerns on enforceability of e-agreements in courts and the stamp duty implications on such agreements. In this article, we have tried to broadly discuss the acceptance of e- agreements as evidence in courts and the stamp duty implications on such agreements.

II.     Whether E-agreement is to be stamped?

In India, stamp duty is levied under Indian Stamp Act, 1899 [1](“Stamp Act”) as well as various legislation enacted by different States in India for the levy of stamp duty[2]. Every instrument under which rights are created or transferred needs to be stamped under the specific stamp duty legislation. There is no specific provision in the Stamp Act that specifically deals with electronic records and/or the stamp duty payable on execution thereof.

Section 3 of Stamp Act is the charging section which provides for the levy of stamp duty on specified instruments upon their execution. Relevant provision of section 3 is reproduced below:

3. Instruments chargeable with duty- Subject to the provisions of this Act and the exemptions contained in Schedule I, the following instruments shall be chargeable with duty of the amount indicated in that Schedule as the proper duty therefore respectively, that is to say—

(a) every instrument mentioned in that Schedule which, not having been previously executed by any person, is executed in India on or after the first day of July, 1899;

(b) every bill of exchange payable otherwise than on demand or promissory note drawn or made out of India on or after that day and accepted or paid, or presented for acceptance or payment, or endorsed, transferred or otherwise negotiated, in India; and

(c) every instrument (other than a bill of exchange, or promissory note) mentioned in that Schedule, which, not having been previously executed by any person, is executed out of India on or after that day, relates to any property situate, or to any matter or thing done or to be done, in India and is received in India.

As per the above provision, broadly, two things are required for chargeability of stamp duty:

  • There must be an instrument as mentioned in the schedule I of Stamp Act.
  • The instrument must be executed.

What is Instrument?

The word ‘instrument’ is defined in section 2(14) of Stamp Act. There has been certain ambiguousness in the interpretation of definition of Instrument. Recent amendments have been made in the Stamp Act by Finance Act, 2019 which will come in force from 1st April, 2020.

Prior to the amendment, section 2(14) read as:

2(14) “Instrument includes every document by which any right or liability is, or purports to be, created, transferred, limited, extended, extinguished or recorded”.

However, after the amendment, the scope of the definition given in section 2(14) has been widened by the inclusion of clause (b) and clause (c) which states that:

(14) “instrument” includes—

(a) every document, by which any right or liability is, or purports to be, created, transferred, limited, extended, extinguished or recorded;

(b) a document, electronic or otherwise, created for a transaction in a stock exchange or depository by which any right or liability is, or purports to be, created, transferred, limited, extended, extinguished or recorded; and

(c) any other document mentioned in Schedule I,

but does not include such instruments as may be specified by the Government, by notification in the Official Gazette;

The aforesaid amendment is only with respect to the electronic document created for a transaction in a stock exchange or depository, but (a) of the aforesaid section is unaltered. Therefore, it may appear that the term “document” in clause (a) does not include electronic documents – however, such interpretation will not be in spirit of law. The Information Technology Act has already accorded legal recognition to electronic records. Therefore, the word “document” shall be read so as to include electronic documents as well.

Apart from the Indian Stamp Act, many states have their own legislation w.r.t. stamp duty. Majority of state specific stamp duty laws also do not specifically include electronic records within their ambit, however, some state stamp duty laws do refer to electronic records. For instance, Section 2(l) of the Maharashtra Stamp Act, 1958 [3] defining instrument, specifically refers to electronic records. It states that:

instrument includes every document by which any right or liability is, or purports to be, created, transferred, limited, extended, extinguished or recorded, but does not include a bill of exchange, cheque, promissory note, bill of lading, letter of credit, policy of insurance, transfer of share, debenture, proxy and receipt;

Explanation. – The term “document” also includes any electronic record as defined in clause (t) of sub-section (1) of section 2 of the Information Technology Act, 2000.”

This makes clear that, Maharashtra Stamp Act imposes stamp duty on electronic agreements as well. This justifies that even electronic agreements come under the scope of Stamp Act, thus need to be stamped.

What is execution?

Section 2(12) of Stamp Act defines the terms “executed” and “execution”, which is also widened by the recent amendment[4] to take into account, attribution of electronic records. It states that:

“2(12).Executed and execution”- executed and execution used with reference to instruments, mean signed and signature and includes attribution of electronic record within the meaning of section 11 of the Information Technology Act, 2000.”

Thus the execution means putting signature on the instrument by the party to the agreement. Attribution[5] of electronic record will also be treated as execution. It can be concluded from the above definition that, the specific instrument would attract payment of stamp duty upon their execution i.e. when it is signed or bears a signature, even if the execution takes place electronically.

III.   Time and Manner of Stamping

As discussed, an e-agreement is required to be stamped according to State specific stamp laws. Section 3 of the Indian Stamp Act and the stamp legislation of several other States in India specify that an instrument to be chargeable with stamp duty must be “executed”.

Section 17 of Stamp Act stipulates when an instrument has to be stamped. It states that:

17. Instruments executed in India- All instruments chargeable with duty and executed by any person in India shall be stamped before or at the time of execution.

Thus, the stamp duty is to be paid before or at the time of executing the e- agreement and cannot be paid after execution.

However, one may also refer to section 17 of the Maharashtra Stamp Act which allow payment of stamp duty on the next working day following the day of execution.

There are some of the e-agreements such as click wrap agreements where execution does not takes place by the customer. Click-wrap agreements are the agreements where the customer accepts the terms and conditions of the contract by clicking on “OK” or “I agree” or such other similar terms. In case of such e-agreements, while the agreement can be said to be executed by the originator (by way of attribution), there is no signature of the customer which means such agreement does not get executed. Since, execution does not takes place, such agreements need not be stamped. However, another view can be derived that in such click wrap agreements there is acknowledgement of receipt of the electronic record by the customer. Such “acknowledgment” of receipt of electronic record u/s 12 of IT Act may be treated as deemed “execution” [6] by the customer. However, there are no clear provisions in the Stamp Act dealing with eligibility of stamp duty to click-wrap agreements.

As regards the manner of stamping, same can be done in three ways:-

  1. E-stamping: Some states like Maharashtra provides specific provisions for e-stamping. In such case, both the party can digitally sign the document and get it stamped electronically on the same day. For instance, Maharashtra E-Registration and E-Filing Rules, 2013[7] facilitates online payment of stamp duty and registration fees. Rule 10 of the said rules states that:

Rule 10. For online registration, Stamp duty and registration fees shall be paid online to Government of Maharashtra through Government Receipt Accounting System (GRAS) (Virtual Treasury) by electronic transfer of funds or any other mode of payment prescribed by the Government.

Further, as per Rule 3 of The Maharashtra ePayment of Stamp Duty and Refund Rules 2014[8], the stamp duty required to be paid under the act, may be paid online into the Virtual Treasury through Government Revenue and Accounting System (GRAS).

  1. Franking: There is also the concept of franking in some of the states, in which case, document may be printed and stamped by the way of franking before the parties have affixed their signature. For instance, in case of Maharashtra Stamp Act, 1958, section 2(k) which defines “Impressed stamp” also includes impression by franking machine.
  2. Physical Stamping: Where the facility of e-stamping or franking is not available, a print of the e-agreement may be taken and the same may then be adequately stamped with adhesive stamps or impressed stamps before or on the date of execution by the parties as per section 10 of Indian Stamp Act.

However, the liability to pay stamp duty will be upon either of the party to contract as per the agreement entered between them. In the absence of any such agreement, liability to pay stamp duty shall be upon such person as may be determined under section 29 of the Indian Stamp Act.

IV.   Consequences of Non- stamping

Non-payment of stamp duty in respect of documents would attract similar consequences for both physical instruments as well as electronic instruments, unless specific consequences have been prescribed for electronically executed instruments under the respective stamp duty laws.

Inadmissibility as an evidence:

In terms of the Indian Stamp Act and most State stamp duty laws, instruments which are chargeable with stamp duty are inadmissible as evidence in case appropriate stamp duty has not been paid. Section 35 of Indian Stamp Act deals with the consequences of non-stamping of documents. It states that:

  1. Instruments not duly stamped inadmissible in evidence, etc.-No instrument chargeable with duty shall be admitted in evidence for any purpose by any person having by law or consent of parties authority to receive evidence, or shall be acted upon, registered or authenticated by any such person or by any public officer, unless such instrument is duly stamped.

However, the inappropriately stamped instruments may be admissible as evidence upon payment of applicable duty, along with prescribed penalty.

Other Liability:

Every person who executes or signs, otherwise than as a witness, any instruments which is not duly stamped but the same was chargeable with stamp duty, can be held liable for monetary fines. In case of an intentional evasion of stamp duty, criminal liability can also be imposed.

V.      Conclusion

When all the applicable laws are taken and interpreted in conjunction with one another, it can be understood that, e-agreements being a valid agreements are also liable for stamp duty on execution. However, the same levy will be as per the respective State laws. Where the State legislation provides for the facility of e-stamping, the same shall be availed in order to move towards the goal of paperless economy. Whereas, some States are yet to recognize the importance and validity of e-agreements and e-stamping. It is looked forward on the part of state as well as central government to make specific provisions for e-agreements and e-stamping in order to save time and money and to provide an ease for doing business.

Our write-up on the legal validity of e-agreements can be viewed here.

[1] https://indiacode.nic.in/bitstream/123456789/2331/1/a1899____2.pdf

[2] The Central Government and the State Government (s) have been empowered under the Union List and the State list (respectively) to levy stamp duty on instruments specified therein.

[3] http://igrmaharashtra.gov.in/SB_PUBLICATION/DATA/acts/THE_MAHARASHTRA_STAMP_ACT-2016-revised_sections.pdf

[4] The amendment was brought by the Finance Act, 2019, which by Notification of Ministry of Finance dated 8th January, 2020 are to be effective from the 1st day of April, 2020”

[5] Section 11 of the IT Act provides for attribution of electronic record as follows –

“11. Attribution of electronic records.–An electronic record shall be attributed to the originator–

(a) if it was sent by the originator himself;

(b) by a person who had the authority to act on behalf of the originator in respect of that electronic record; or

(c) by an information system programmed by or on behalf of the originator to operate automatically.”

[6] For instance, Article 7 of the UNCITRAL Model Law on E-Commerce states that where the law requires a signature of a person, that requirement is met in relation to a data message if a method is used to identify that person and to indicate that person’s approval of the information contained in the data message; and that method is as reliable as was appropriate for the purpose for which the data message was generated or communicated, in the light of all the circumstances, including any relevant agreement. This way of putting “signature” is not explicitly recognized in relevant Acts, however, the Courts may take a liberal view in this regard.

[7] http://igrmaharashtra.gov.in/SB_PUBLICATION/DATA/rules/Registration/Maharashtra%20%20e-Registration%20&e-Filing%20Rules,%202013%20.pdf

[8] http://igrmaharashtra.gov.in/SB_PUBLICATION/DATA/rules/STAMPS/4_e-Payment_Rules.pdf

Marketplace lending: Legal issues around “true lender” and “valid when made” doctrines

-Vinod Kothari (vinod@vinodkothari.com)

 

Marketplace lending, P2P lending, or Fintech credit, has been growing fast in many countries, including the USA. It is estimated to have reached about $ 24 billion in 2019[1] in the USA.

However, there are some interesting legal issues that seem to be arising.  The issues seem to be emanating from the fact that P2P platforms essentially do pairing of borrowers and lenders. In the US practice, it is also commonplace to find an intermediary bank that houses the loans for a few days, before the loan is taken up by the “peer” or crowd-sourced lender.

USA, like many other countries, has usury laws. However, usury laws are not applicable in case of banks. This comes from sec 85 of National Bank Act, and sec. 27 (a) of the Federal Deposit Insurance Act.

In P2P structure, the loan on the platform may first have been originated by a bank, and then assigned to the buyer. If the loan carries an interest rate, which is substantially high, and such high interest rate loan is taken by the “peer lender”, will it be in breach of the usury laws, assuming the rate of interest is excessive?

One of the examples of recent legal issues in this regard is Rent-Rite Superkegs West, Ltd., v. World Business Lenders, LLC, 2019 WL 2179688[2]. In this case, a loan of $ 50000 was made to a corporation by a local bank, at an interest rate of 120.86% pa. The loan-note was subsequently assigned to a finance company. Upon bankruptcy of the borrower, the bankruptcy court refused to declare the loan as usurious, based on a time-tested doctrine that has been prevailing in US courts over the years – called valid-when-granted doctrine.

Valid-when-granted doctrine

The valid-when-granted doctrine holds that if a loan is valid when it is originally granted, it cannot become invalid because of subsequent assignment. Several rulings in the past have supported this doctrine: e.g., Munn v. Comm’n Co., 15 Johns. 44, 55 (N.Y. Sup. Ct. 1818); Tuttle v. Clark, 4 Conn. 153, 157 (1822); Knights v. Putnam, 20 Mass. (3 Pick.) 184, 185 (1825)

However, there is a ruling that stands out, which is 2015 ruling of the Second Circuit court in Madden v. Midland Funding, LLC  (786 F.3d 246). In Madden, there was an assignment of a credit card debt to a non-banking entity, who charged interest higher than permitted by state law. The court held that the relaxation from interest rate restrictions applicable to the originating bank could not be claimed by the non-banking assignee.

The ruling in Madden was deployed in a recent [June 2019] class action suit against JP Morgan Chase/Capital One entities, where the plaintiffs, representing credit card holders, allege that buyers of the credit card receivables (under credit card receivables securitization) cannot charge interest higher than permitted in case of non-banking entities. Plaintiffs have relied upon the “true sale” nature of the transaction, and contend that once the receivables are sold, it is the assignee who needs to be answerable to the restrictions on rate of interest.

While these recent suits pose new challenges to consumer loan securitization as well as marketplace lending, it is felt that much depends on the entity that may be regarded as “true lender”. True lender is that the entity that took the position of predominant economic interest in the loan at the time of origination. Consider, however, the following situations:

  1. In a marketplace lending structure, a bank is providing a warehousing facility. The platform disburses the loan first from the bank’s facility, but soon goes to distribute the loan to the peer lenders. The bank exits as soon as the loan is taken by the peer lenders. Will it be possible to argue that the loan should be eligible for usurious loan carve-out applicable to a bank?
  2. Similarly, assume there is a co-lending structure, where a bank takes a portion of the loan, but a predominant portion is taken by a non-banking lender. Can the co-lenders contend to be out of the purview of interest rate limitations?
  3. Assume that a bank originates the loan, and by design, immediately after origination, assigns the loan to a non-banking entity. The assignee gets a fixed, reasonable rate of return, while the spread with the assignee’s return and the actual high interest rate paid by the borrower is swept by the originating bank.

Identity of the true lender becomes an intrigue in cases like this.

Securitization transactions stand on a different footing as compared to P2P programs. In case of securitization, the loan is originated with no explicit understanding that it will be securitized. There are customary seasoning and holding requirements when the loan is incubated on the balance sheet of the originator. At the time of securitization, whether the loan will get included in the securitization pool depends on whether the loan qualifies to be securitized, based on the selection criteria.

However, in case of most P2P programs, the intent of the platform is evidently to distribute the loan to peer-lenders. The facility from the bank is, at best, a bridging facility, to make it convenient for the platform to complete the disbursement without having to wait for the peer-lenders to take the portions of the loan.

US regulators are trying to nip the controversy, by a rule that Interest on a loan that is permissible under 12 U.S.C. 85 shall not be affected by the sale, assignment, or other transfer of the loan. This is coming from a proposed rule by FDIC /OCC in November, 2019[3].

However, the concerns about the true lender may still continue to engage judicial attention.

Usurious lending laws in other countries

Usurious lending, also known as extortionate credit, is recognised by responsible lending laws as well as insolvency/bankruptcy laws. In the context of consumer protection laws, usurious loans are not regarded as enforceable. In case of insolvency/bankruptcy, the insolvency professional has the right to seek avoidance of a usurious or extortionate credit transaction.

In either case, there are typically carve-outs for regulated financial sector entities. The underlying rationale is that the fairness of lending contracts may be ensured by respective financial sector regulator, who may be imposing fair lending standards, disclosure of true rate of interest, etc. Therefore, judicial intervention may not be required in such cases. However, the issue once again would be – is it justifiable that the carve-out available to regulated financial entities should be available to a P2P lender, where it is predesigned that the loan will get transferred out of the books of the originating financial sector entity?

Conclusion

P2P lending or fintech credit is the fastest growing part of non-banking financial intermediation, sometimes known as shadow banking. A lot of regulatory framework is designed keeping a tightly-regulated bank in mind. However, P2P is itself a case of moving out of banking regulation. Banking laws and regulations cannot be supplanted and applied in case of P2P lending.

Further research

We have been engaged in research in the P2P segment. Our report[4] on P2P market in India describes the basics of P2P lending structures in India and demonstrates development of P2P market in India.

Our other write-ups on P2P lending may also be referred:

 

 

 

[1] https://www.statista.com/outlook/338/109/marketplace-lending–consumer-/united-states#market-revenue

[2] https://www.docketbird.com/court-documents/Rent-Rite-Super-Kegs-West-LTD-v-World-Business-Lenders-LLC/Corrected-Written-Opinion-related-document-s-44-Written-Opinion-48-Order-Dismissing-Adversary-Proceeding/cob-1:2018-ap-01099-00049

[3] https://www.occ.gov/news-issuances/news-releases/2019/nr-occ-2019-132a.pdf

[4] http://vinodkothari.com/2017/10/india-peer-to-peer-lending-report/