Vinod Kothari Consultants P Ltd (email@example.com)
The partial credit enhancement (PCE) Scheme of the Government, for purchase by public sector banks (PSBs) of NBFC/HFC pools, has been discussed in our earlier write-ups, which can be viewed here and here.
This document briefly puts the potential approach of the rating agencies for rating of the pools for the purpose of qualifying for the Scheme.
Brief nature of the transaction:
- The transaction may be summarised as transfer of a pool to a PSB, wherein the NBFC retains a subordinated piece, such that the senior piece held by the PSB gets a AA rating. Thus, within the common pool of assets, there is a senior/junior structure, with the NBFC retaining the junior tranche.
- The transaction is a structured finance transaction, by way of credit-enhanced, bilateral assignment. It is quite similar to a securitisation transaction, minus the presence of SPVs or issuance of any “securities”.
- The NBFC will continue to be servicer, and will continue to charge servicing fees as agreed.
- The objective to reach a AA rating of the pool/portion of the pool that is sold to the PSB.
- Hence, the principles for sizing of credit enhancement, counterparty (servicer) risk, etc. should be the same as in case of securitisation.
- The coupon rate for the senior tranche may be mutually negotiated. Given the fact that after 2 years, the GoI guarantee will be removed, the parties may agree for a stepped-up rate if the pool continues after 2 years. Obviously, the extent of subordinated share held by the NBFC will have to be increased substantially, to provide increased comfort to the PSB. Excess spread, that is, the excess of actual interest earned over the servicing fees and the coupon may be released to the seller.
- The payout of the principal/interest to the two tranches (senior and junior), and utilisation of the excess spread, etc. may be worked out so as to meet the rating objective, provide for stepped-up level of enhancement, and yet maintain the economic viability of the transaction.
- Bankruptcy remoteness is easier in the present case, as pool is sold from the NBFC to the PSB, by way of a non-recourse transfer. Of course, there should be no retention of buyback option, etc., or other factors that vitiate a true sale.
- Technically, there is no need for a trustee. However, whether the parties need to keep a third party for ensuring surveillance over the transaction, in form of a monitoring agency, may be decided between the parties.
Brief characteristics of the Pool
- For any meaningful statistical analysis, the pool should be a homogenous pool.
- Surely, the pool is a static pool.
- The pool has attained seasoning, as the loans must have been originated by 31st March, 2019.
- In our view, pools having short maturities (say personal loans, short-term loans, etc.) will not be suitable for the transaction, since the guarantee and the guarantee fee are on annually declining basis.
The data required for the analysis will be same as data required for securitisation of a static pool.
- Between the NBFC and the PSB, there will be standard assignment documentation.
- Between the Bank and the GoI:
- Declaration that requirements of Chapter 11 of the GFR have been satisfied.
- Guarantee documentation as per format given by GOI
Vinod Kothari (firstname.lastname@example.org)
The so-called partial credit enhancement (PCE) for purchase of NBFC/HFC pools by public sector banks (PSBs) may, if meaningfully implemented, be a win-win for all. The three primary players in the PCE scheme are NBFCs/HFCs (let us collectively called them Originators), the purchasing PSBs, and the Government of India (GoI). The Scheme has the potential to infuse liquidity into NBFCs while at the same time giving them advantage in terms of financing costs, allow PSBs to earn spreads while enjoying the benefit of sovereign guarantee, and allow the GoI to earn a spread of 25 bps virtually carrying no risks at all. This brief write-ups seeks to make this point.
The details of the Scheme with our elaborate questions and answers have been provided elsewhere.
Broadly, the way we envisage the Scheme working is as follows:
- An Originator assimilates a pool of loans, and does tranching/credit enhancements to bring a senior tranche to a level of AA rating. Usually, tranching is associated with securitisation, but there is no reason why tranching cannot be done in case of bilateral transactions such as the one envisaged here. The most common form of tranching is subordination. Other structured finance devices such as turbo amortisation, sequential payment structure, provisions for redirecting the excess spread to pay off the principal on senior tranche, etc., may be deployed as required.
- Thus, say, on a pool of Rs 100 crores, the NBFC does so much subordination by way of a junior tranche as to bring the senior tranche to a AA level. The size of subordination may be worked, crudely, by X (usually 3 to 4) multiples of expected losses, or by a proper probability distribution model so as to bring the confidence level of the size of subordination being enough to absorb losses to acceptable AA probability of default. For instance, let us think of this level amounting to 8% (this percentage, needless to say, will depend on the expected losses of respective pools).
- Thus, the NBFC sells the pool of Rs 100 crores to PSB, retaining a subordinated 8% share in the same. Bankruptcy remoteness is achieved by true sale of the entire Rs 100 crore pool, with a subordinated share of 8% therein. In bilateral transactions, there is no need to use a trustee; to the extent of the Originator’s subordinated share, the PSB is deemed to be holding the assets in trust for the Originator. Simultaneously, the Originator also retains excess spread over the agreed Coupon Rate with the bank (as discussed below).
- Assuming that the fair value (computation of fair value will largely a no-brainer, as the PSB retains principal, and interest only to the extent of its agreed coupon, with the excess spread flowing back to the Originator) comes to the same as the participation of the PSB – 92% or Rs 92 crores, the PSB pays the same to the Originator.
- PSB now goes to the GoI and gets the purchase guaranteed by the latter. So, the GoI has guaranteed a purchase of Rs 92 crores, taking a first loss risk of 10% therein, that is, upto Rs 9.20 crores. Notably, for the pool as a whole, the GoI’s share of Rs 9.20 crores becomes a second loss position. However, considering that the GoI is guaranteeing the PSB, the support may technically be called first loss support, with the Originator-level support of Rs 10 crores being separate and independent.
- However, it is clear that the sharing of risks between the 3 – the Originator, the GoI and the Bank will be as follows:
- Losses upto first Rs 8 crores will be taken out of the NBFC’s first loss piece, thereby, implying no risk transfer at all.
- Losses in excess of Rs 8 crores, but upto a total of Rs 17.20 crores (the GoI guarantee is limited to Rs 9.20 crores), will be taken by GoI.
- It is only when the loss exceeds Rs 17.20 crores that there is a question of the PSB being hit by losses.
- Thus, during the period of the guarantee, the PSB is protected to the extent of 17.2%. Note that first loss piece at the Originator level has been sized up to attain a AA rating. That will mean, higher the risk of the pool, the first loss piece at Originator level will go up to protect the bank.
- The PSB, therefore, has dual protection – to the extent of AA rating, from the Originator (or a third party with/without the Originator, as we discuss below), and for the next 10%, from the sovereign.
- Now comes the critical question – what will be the coupon rates that the PSB may expect on the pool.
- The pool effectively has a sovereign protection. While the protection may seem partial, but it is a tranched protection, and for a AA-rated pool, a 10% thickness of first loss protection is actually far higher than required for the highest degree of safety. What makes the protection even stronger is that the size of the guarantee is fixed at the start of the transaction or start of the financial year, even though the pool continues to amortise, thereby increasing the effective thickness.
- Assume risk free rate is R, and the spreads for AAA rated ABS are R +100 bps. Assume that the spreads for AA-rated ABS is R+150 bps.
- Given the sovereign protection, the PSB should be able to price the transaction certainly at less than R +100 bps, because sovereign guarantee is certainly safer than AAA. In fact, it should effectively move close to R, but given the other pool risks (prepayment risks, irregular cashflows), one may expect pricing above R.
- For the NBFC, the actual cost is the coupon expected by the PSB, plus 25bps paid for the guarantee.
- So as long as the coupon rate of the pool for the NBFC is lower than R+75 bps, it is an advantage over a AAA ABS placement. It is to be noted that the NBFC is actually exposing regulatory and economic capital only for the upto-AA risk that it holds.
Win-win for all
If the structure works as above, it is a win-win for all:
- For the GoI, it is a neat income of 25 bps while virtually taking no real risks. There are 2 strong reasons for this – first, there is a first loss protection by the Originator, to qualify the pool for a AA rating. Secondly, the guarantee is limited only for 2 years. For any pool, first of all, the probability of losses breaching a AA-barrier itself will be close to 1% (meaning, 99% of the cases, the credit support at AA level will be sufficient). This becomes even more emphatic, if we consider the fact that the guarantee will be removed after 2 years. The losses may pile up above the Originator’s protection, but very unlikely that this will happen over 2 years.
- For the PSB, while getting the benefit of a sovereign guarantee, and therefore, effectively, investing in something which is better than AAA, the PSB may target a spread close to AAA.
- For the NBFC, it is getting a net advantage in terms of funding cost. Even if the pricing moves close to AAA ABS spreads, the NBFC stands to gain as the regulatory capital eaten up is only what is required for a AA-support.
The overall benefits for the system are immense. There is release of liquidity from the banking system to the economy. Depending on the type of pools Originators will be selling, there may be asset creation in form of home loans, or working capital loans (LAP loans may effectively be that), or loans for transport vehicles. If the GoI objective of buying pools upto Rs 100000 crores gets materialised, as much funding moves from banks to NBFCs, which is obviously already deployed in form of assets. The GoI makes an income of Rs 250 crores for effectively no risk.
In fact, if the GoI gains experience with the Scheme, there may be very good reason for lowering the rating threshold to A level, particularly in case of home loans.
Capital treatment, rating methodologies and other preparations
To make the Scheme really achieve its objectives, there are several preparations that may have to come soon enough:
- Rating agencies have to develop methodologies for rating this bilateral pool transfer. Effectively, this is nothing but a structured pool transfer, akin to securitisation. Hence, rating methodologies used for securitisation may either be applied as they are, or tweaked to apply to the transfers under the Scheme.
- Very importantly, the RBI may have to clarify that the AA risk retention by Originators under the Scheme will lead to regulatory capital requirement only upto the risk retained by the NBFC. This should be quite easy for the RBI to do – because there are guidelines for securitisation already, and the Scheme has all features of securitisation, minus the fact that there is no SPV or issuance of “securities” as such.
Whoever takes the first transaction to market will have to obviously do a lot of educating – PSBs, rating agencies, law firms, SIDBI, and of course, DFS. However, the exercise is worth it, and it may not take 6 months as envisaged for the GoI to reach the target of Rs 1 lakh crores.
Abhirup Ghosh (email@example.com)
The Finance Minister, during the Union Budget 2019-20, promised to introduce a partial credit guarantee scheme so as to extend relief to the NBFC during the on-going liquidity crisis. The proposal laid down in the budget was a very broad statement and were subject to several speculations. At last on 13th August, 2019, the Ministry of Finance came out with a press release to announce the notification in this regard dated 10th August, 2019, laying down specifics of the scheme.
The scheme will be known by “Partial Credit Guarantee offered by Government of India (GoI) to Public Sector Banks (PSBs) for purchasing high-rated pooled assets from financially sound Non-Banking Financial Companies (NBFCs)/Housing Finance Companies (HFCs)”, however, for the purpose of this write-up we will use the word “Scheme” for reference.
The Scheme is intended to address temporary asset liability mismatch of solvent HFCs/ NBFCs, owing to the ongoing liquidity crisis in the non-banking financial sector, without having to resort to distress sale of their assets.
In this regard, we intend to discuss the various requirements under the Scheme and analyse its probable impact on the financial sector.
The Scheme has been notified with effect from 10th August, 2019 and will remain open for 6 months from or until the period by which the maximum commitment by the Government in the Scheme is fulfilled, whichever is earlier.
Under the Scheme, the Government has promised to extend first loss guarantee for purchase of assets by PSBs aggregating to ₹ 1 lakh crore. The Government will provide first loss guarantee of 10% of the assets purchased by the purchasing bank.
The Scheme is applicable for assignment of assets in the course of direct assignment to PSBs only. It is not applicable on securitisation transactions.
Also, as we know that in case of direct assignment transactions, the originators are required to retain a certain portion of the asset for the purpose of minimum retention requirement; this Scheme however, applies only to the purchasing bank’s share of assets and not on the originators retained portion. Therefore, if due to default, the originator incurs any losses, the same will not be compensated by virtue of this scheme.
The Scheme lays down criteria to check the eligibility of sellers to avail benefits under this Scheme, and the same are follows:
- NBFCs registered with the RBI, except Micro Financial Institutions or Core Investment Companies.
- HFCs registered with the NHB.
- The NBFC/ HFC must have been able to maintain the minimum regulatory capital as on 31st March, 2019, that is –
- For NBFCs – 15%
- For HFCs – 12%
- The net NPA of the NBFC/HFC must not have exceeded 6% as on 31st March, 2019
- The NBFC/ HFC must have reported net profit in at least one out of the last two preceding financial years, that is, FY 2017-18 and FY 2018-19.
- The NBFC/ HFC must not have been reported as a Special Mention Account (SMA) by any bank during year prior to 1st August, 2018.
Some observations on the eligibility criteria are:
- Asset size of NBFCs for availing benefits under the Scheme: The Scheme does not provide for any asset size requirement for an NBFC to be qualified for this Scheme, however, one of the requirement is that the financial institution must have maintained the minimum regulatory capital requirement as on 31st March, 2019. Here it is important to note that requirement to maintain regulatory capital, that is capital risk adequacy ratio (CRAR), applies only to systemically important NBFCs.
Only those NBFCs whose asset size exceeds Rs. 500 crores singly or jointly with assets of other NBFCs in the group are treated as systemically important NBFCs. Therefore, it is safe to assume that the benefits under this Scheme can be availed only by those NBFCs which – a) are required to maintained CRAR, and b) have maintained the required amount of capital as on 31st March, 2019, subject to the fulfilment of other conditions.
- Financial health of originator after 1st August, 2018 – The eligibility criteria for sellers state that the financial institution must not have been reported as SMA by any bank any time during 1 year prior to 1st August, 2018, the apparent question that arises here is what happens if the originator moves into SMA status after the said date. If we go by the letters of the Scheme, if a financial institution satisfies the condition before 1st August, 2018 but becomes SMA thereafter, it will still be eligible as per the Scheme. This makes the situation a little awkward as the whole intention of the Scheme was to facilitate financially sound financial institutions. This seems to be an error on the part of the Government, and it surely must not have meant to situations such as the one discussed above. We can hopefully expect an amendment in this regard from the Government.
Pool of assets satisfying the following conditions can be assigned under the Scheme:
- The asset must have been originated on or before 31st March, 2019.
- The asset must be classified as standard in the books of the NBFC/ HFC as on the date of the sale.
- The pool of assets should have a minimum rating of “AA” or equivalent at fair value without the credit guarantee from the Government.
- Each account under the pooled assets should have been fully disbursed and security charge should have been created in favour of the originating NBFCs/ HFCs.
- NBFCs/HFCs can sell up to a maximum of 20% of their standard assets as on 31.3.2019 subject to a cap of Rs. 5,000 crore at fair value. Any additional amount above the cap of Rs. 5,000 crore will be considered on pro ratabasis, subject to availability of headroom.
- The individual asset size in the pool must not exceed Rs. 5 crore.
- The following types of loans are not eligible for assignment for the purposes of this Scheme:
- Revolving credit facilities;
- Assets purchased from other entities; and
- Assets with bullet repayment of both principal and interest
Our observations on the eligibility criteria are as follows:
- Rating of the pool: The Scheme states that the pools assigned should be highly rated, that is, should have ratings of AA or equivalent prior to the guarantee. Technically, pool of assets are not rated, it is the security which is rated based on the risks and rewards of the underlying pools. Therefore, it is to be seen how things will unfold. Also, desired rating in the present case is quite high; if an originator is able to secure such a high rating, it might not require the assistance under this Scheme in the first place. And, the fact that the originators will have to pay guarantee commission of 25 bps. Therefore, only where the originators are able to secure a significantly lower cost from the banks for a higher rating, that would also cover the commission paid, will this Scheme be viable; let alone be the challenges of achieving an AA rating of the pool.
- Cut-off date of loan origination to be 31st March, 2019: As per the RBI Guidelines on Securitisation and Direct Assignment, the originators have to comply with minimum holding requirements. The said requirement suggests that an asset can be sold off only if it has remained in the books of the originator for at least 6 months. This Scheme has come into force with effect from 10th August, 2019 and will remain open for 6 months from the commencement.
Considering that already 5 months since the cut-off date has already passed, even if we were to assume that the loan is originated on the cut-off date itself, it would mean that closer to the end of the tenure of the Scheme, the loan will be 11 months seasoning. Such high seasoning requirements might not be motivational enough for the originators to avail this Scheme.
- Maximum cap on sell down of receivables: The Scheme has put a maximum cap on the amount of assets that can be assigned and that is an amount equal to 20% of the outstanding standard assets as on 31st March, 2019, however, the same is capped to Rs. 5000 crores.
It is pertinent to note that the Scheme also allows additional sell down of loans by the originators, beyond the maximum cap, however, the same shall depend on the available headroom and based on decisions of the Government.
Invocation of guarantee and guarantee commission
As already stated earlier, in order to avail benefits under this Scheme, the originator will have to incur a fee of 25 basis points on the amount guaranteed by the Government. However, the payment of the same shall have to be routed through the purchasing bank.
Invocation of guarantee
The guarantee can be invoked any time during the first 24 months from the date of assignment, if the interest/ principal has remained overdue for a period of more than 90 days.
Consequent upon a default, the purchasing bank can invoke the guarantee and recover its entire exposure from the Government. It can continue to recover its losses from the Government, until the upper cap of 10% of the total portfolio is reached. However, the purchasing bank will not be able to recover the losses if – (a) the pooled assets are bought back by the concerned NBFCs/HFCs or (b) sold by the purchasing bank to other entities.
The claims of the purchasing bank will be settled with 5 working days from the date of claim by the Government.
However, if the purchasing bank, by any means, recovers the amount subsequent to the invocation of the guarantee, it will have to refund the amount recovered or the amount received against the guarantee to the Government within 5 working days from the date of recovery. Where the amount recovered is more than amount of received as guarantee, the excess collection will be retained by the purchasing bank.
Other features of the Scheme
- Reporting requirement – The Scheme provides for a real-time reporting mechanism for the purchasing banks to understand the remaining headroom for purchase of such pooled assets. The Department of Financial Services (DFS), Ministry of Finance would obtain the requisite information in a prescribed format from the PSBs and send a copy to the budget division of DEA, however, the manner and format of reporting has not been notified yet.
- Option to buy-back the loans – The Scheme allows the originator to retain an option to buy back its assets after a specified period of 12 months as a repurchase transaction, on a right of first refusal basis. This however, is contradictory to the RBI Guidelines on Direct Assignment, as the same does not allow any option to repurchase the pool in a DA transaction.
- To-do for the NBFCs/ HFCs – In order to avail the benefits under the Scheme, the following actionables have to be undertaken:
- The Asset Liability structure should restructured within three months to have positive ALM in each bucket for the first three months and on cumulative basis for the remaining period;
- At no time during the period for exercise of the option to buy back the assets, should the CRAR go below the regulatory minimum. The promoters shall have to ensure this by infusing equity, where required.
-Kanakprabha Jethani and Julie Mehta
RBI has vide notification dated August 02, 2019 issued a clarification regarding waiver of foreclosure charges/ prepayment penalty on all floating rate term loans sanctioned to individual borrowers, as referred to in paragraph 30(4) of Chapter VI of Master Direction – Non-Banking Financial Company – Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016 and paragraph 30(4) of Chapter V of Master Direction – Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions, 2016.
As per the fair practice code, NBFCs cannot charge foreclosure charges/ pre-payment penalties on all floating rate term loans sanctioned to individual borrowers
RBI has further clarified that NBFCs shall not charge foreclosure charges/ pre-payment penalties on any floating rate term loan sanctioned for purposes other than business to individual borrowers, with or without co-obligant(s).
To understand its implication and for further understanding, please refer to the list of ‘frequently asked questions’ listed below:
- What is pre-payment or foreclosure?
Ans. Prepayment or foreclosure is the repayment of a loan by a borrower, in part or in full ahead of the pre-determined payment schedule.
However, the distinguishing factor is that pre-payment means early payment of scheduled instalments, while foreclosure means early payment of the entire outstanding amount leading to early closure of the loan term. To extend, pre-payment is partial in nature whereas foreclosure is the closure of the loan account before the due-date.
- How do foreclosure charges and pre-payment penalties differ?
Ans. Conceptually, both have the same meaning. The only difference is in the terminology as the charges levied at the time of foreclosure are termed as foreclosure charges and charges levied at the time of pre-payment of an instalment are termed as pre-payment penalties.
- What is a term loan?
Ans. A term loan means a loan for which the term for repayment is pre-determined. This is unlike a demand loan in which the borrower has to repay on demand of repayment by the lender.
- How is a floating rate term loan different from a fixed rate term loan?
Ans. A fixed-rate term loan refers to interest rates that remain locked throughout the loan period, while floating-rate term loan refers to interest rates that are subject to fluctuate owing to certain factors.
- How is floating rate determined?
Ans. Lenders determine the floating rate on the basis of certain base rate. Usually, the floating rate is some percentage points more than the base rate. Base rate is determined by taking into account the cost of funds of the lender.
- Where do we find such floating rate term loans?
Ans. Floating rates are generally found in loans of long-term as the cost of funds is likely to fluctuate in the long run. However, certain medium term loans also have floating interest rate depending upon the agreement between the lender and borrower.
- Can a borrower make pre-payment of a term loan?
Ans. Courts have, in many cases, given judgements stating that in the absence of specific provision in the agreement between the lender and the borrower (Loan Agreement), the borrower has the inherent right to make pre-payment of a loan. This puts light on the principle that ‘every borrower has an inherent right to free himself from the loan’.
In case a lender requires that the loan amount should not be prepaid, such a restriction must be expressly mentioned in the Loan Agreement.
- Can a lender levy foreclosure charges/pre-payment penalty?
Ans. Unlike the provisions relating to pre-payment of loan by the borrower, the provisions for levy of foreclosure charges/pre-payment penalties are largely governed by the terms of the Loan Agreement. A lender can levy only those charges which form part of the Loan Agreement.
If provisions for levy of foreclosure charges/pre-payment penalties are expressly mentioned in the Loan Agreement, the lender can levy such charges/penalty. In absence of such provision, the lender does not have the right to levy such charges/penalty.
Further, for entities regulated by RBI, it is mandatory to mention all kinds of charges and penalties applicable to a loan transaction in the loan application form.
- What happens on prepayment of loan?
Ans. Pre-payment of loan amount by the borrower has dual-impact. One is saving of interest cost and the other is reduction in the loan period. When a borrower pre-pays the loan, huge interest cost is saved, specifically in case of personal loans, where the interest rates are quite high.
- Why are borrowers charged in event of pre-payment?
Ans. Lenders pre-determine a schedule in terms of the specified term of a loan, including the repayment schedule, and the interest expectation. An early prepayment disrupts this schedule and also means that the borrower has to pay lesser interest (since interest is calculated from the time the loan is disbursed, till it is repaid).
Pre-payment charges are used as a client retention tool to discourage borrowers to move to other lenders, who may offer better interest for transferring the outstanding amount. It puts a limitation to the number of choices a customer can have due to market competition.
To compensate for such loss, pre-payment charges exist.
- What is the rate at which pre-payment charges are imposed?
Ans. The rate is determined by the opportunity cost foregone due to pre-payment/foreclosure. The future cash flows are discounted at a relatively lower rate and accordingly imposed. The rate differs from bank to bank depending on their relevant factors and policies. For example: several banks charge early repayment penalties up to 2-3% of the principal amount outstanding.
- How do banks benefit from the pre-payment penalties?
Ans. The prepayment penalty is not charged with the motive to generate revenue, but to recover costs incurred due to mismatch in assets and liabilities. It is believed that when long-term loans are offered to borrowers, lending facility raises long-term deposits to match their assets and liabilities on their balance sheet. So when the loans are pre-paid with respect to their scheduled payments, lenders continue to have long-term deposits on their books, leading to a mismatch
- What are the other factors that need to be kept in mind for pre-payment or foreclosure of loan?
Ans. The applicable rate at which penalty shall be charged is a major factor as it should not result in higher cost to the borrower. Other factors include the process of undergoing pre-payment/foreclosure, lock-in period associated with the option, documentation etc.
- What has been clarified?
Ans. Earlier, the FPC provided that NBFCs shall not charge foreclosure charges/prepayment penalties from individuals on floating rate term loans.
The clarification that has been provided by the RBI is that the foreclosure charges/prepayment penalties shall not be charged floating rate term loans, provided to individuals for purposes other than business i.e. personal purposes loans
- On whom will this restriction be applicable?
Ans. The change shall be applicable to all kinds of NBFCs, including systemically important as well as non-systemically important NBFCs who are into business of lending to individuals. However, NBFCs engaged in lending to non-individuals only are not required to comply with this requirement.
- What kinds of loans will be covered?
Ans. All floating rate term loans provided to individuals for purposes other than business shall be covered under the said restriction.
- How will the lender define that loan is for purposes other than business?
Ans. Before extending loans, documentation and background checks are performed. This process includes specification of the purpose for which the loan is taken. This gives a clear picture of the nature of the agreement and helps distinguish between business purpose and personal purposes.
- Why is this restriction on floating rate term loans only and not on fixed rate terms loans?
Ans. Fixed rate loans involve no fluctuations in interest rates in the entire loan term. Thus in case of pre-payment, the interest foregone can be computed and realised to evaluate pre-payment penalties to be imposed.
While floating rate loans involve fluctuations based on the underlying benchmark and thus interest foregone cannot be estimated. There lies no confirmation of the lender being in the loss position. There is no way to realise interest rate sulking or hiking. Thus there is no basis on which overall loss might be estimated. In response to this situation, restrictions are on floating rate term loans and not on fixed rate term loans.
- Are there any other entities under similar restriction?
Ans. RBI has put restrictions, similar to this, on banks and Housing Finance Companies as well. Banks are not permitted to charge foreclosure charges / pre-payment penalties on home loans / all floating rate term loans, for purposes other than business, sanctioned to individual borrowers. HFCs are not permitted to charge foreclosure charges/ pre-payment penalties in case of foreclosure of floating interest rate housing loans or housing loans on fixed interest rate basis which are pre-closed by the borrowers out of their own sources.
- When does this clarification come to effect?
Ans. It is noteworthy that this is a clarification (and not a separate provision) issued by the RBI in respect of a provision which is already a part of RBI Master Directions for NBFCs. Therefore, this clarification is deemed to be in effect from the date the corresponding provision was issued by the RBI by way of a notification i.e. August 01, 2014.
- What is the borrower’s perspective?
Ans. Borrower’s may choose to pre-pay due to their personal obligations/burden, or if they obtain their funds which were earlier stuck, or by borrowing from a cheaper source to repay. This waive off of penalty charges, might be a sign of relief to them as they would get out of the obligation of an existing loan arrangement by paying off early and save the compounding interests and explore from the other options available in the market.
- What will happen after such clarification?
Ans. Prior to this clarification, the provision seemed to be providing a safe shelter to individual borrowers where they could foreclose or pre-pay any loan taken by them. Sometimes, the borrowers misused this facility by availing funds at a lower cost from some other lender to pre-pay the loans of higher interest rate. This resulted in disruptions in the forecasts of lenders, sometimes also resulting in loss to the lender.
This clarification limits the benefit of pre-payment to loans of personal nature only which are not availed very frequently by a borrower and are generally prepaid when borrowers have genuine savings or capital inflows.
In India, every state has its own law on tenancy matters. The matters, which are not covered by state legislations are governed by the Transfer of Property Act, 1882 (“TPA”), which is central legislation dealing with the matters between tenants and landlords. However, it covers transaction between tenant and landowner in the form of a lease. Codified legislation dealing exclusively on rent related matters in the real estate market has been long ignored in India. Lack of an exclusive legal framework hampered the growth of rental housing segment and resulted in low investments in the rental housing sector. The draft Model Tenancy Act, 2015 was an effort made earlier to codify the law on tenancy. but majority of states never implemented the same. In Union Budget 2019, it was proposed that in order to promote rental housing, new tenancy laws will be formulated to remove the archaic laws currently in use. In furtherance to the said proposition, Ministry of Housing and Urban Affairs (MHUA) released the draft Model Tenancy Act, 2019 (“MTA”) on July 10, 2019, which aims to regulate rental housing by a market-oriented approach while balancing interests of landowner and tenant at the same time. The article points out current problems of rental housing in India along with the issue that how MTA is going to compensate for these problems. It also presents an overview of MTA and loopholes present in it.
2. Need for rental housing
Housing is one of the basic necessities of life. The rapid pace of urbanization in India has resulted in severe shortage of housing. People go for rental housing because low-income or people are not ready to build their own house.In spite of government’s prime consideration to affordable housing, many poor households live in congested conditions, which indicates that housing is unaffordable for a large section of population, be it ownership or rental.
The Draft National Urban Rental Housing Policy, 2015 (“the Policy”) pointed out that there is a huge housing shortage in urban areas and on the other hand, there are massive stocks of vacant houses.Possible reasons ascertained for vacant houses could be low rental yield, fear of repossession, lack of incentives etc. The Policy defines rental housing as a property occupied by someone other than the owner, for which the tenant pays a periodic mutually agreed rent to the owner. The policy suggested that if these vacant houses are made available for rental housing, then some, if not most of the urban housing shortage, could be addressed. Hence, the need for rental housing can be understoodunder the following heads-
- An alternative to eliminate the problem of housing shortage in view of ever-increasing population of India.
- Prevention of future growth of slums by providing affordable housing to all.
- Rental housing could be turned as a steady source of income for the landlords, making investment in rental market attractive.
3. Current problems of rental housing in India
Rental housing is a subject on which States have exclusive right to legislate. It is a state subject as mentioned under item 18 in List II of Seventh Schedule of the Constitution of India. Although, Central Government can guide the states as we have a quasi-federal structure in India, therefore, Central Government has power to make model law on rent control or tenancy.
At present, nearly every state has its own law governing matters relating to rental housing in their jurisdiction in the name of Rent Control Laws. However, these rent control laws are not adequate to satisfy the need for rental housing in true sense. Because, issues, such as lack of affordable housing, lack of investment in rental housing etc., are still present in the country.
The problems of rental housing in India, as present under different existing rent control laws, can be encapsulated as follow:
- Fixation of standard rent:
Existing rent control laws provide for standard rent or fair rent, which is calculated on the basis of cost of construction involved, when the premise was built and does not include present market value of the premise as a consideration to determine standard rent. This proves to be major disincentive for landlords and investors, who want to invest in rental market as it will give very low rate of return.
- Overstaying problem of tenants:
Existing rent control laws do not provide for any remedy for when tenants do not vacant the rent premises even after termination of the tenancy period. Therefore, landlords often fear that they might lose control on their premises and had to go long litigation process for recovering their premises.
- Reduced liquidity for landlords:
Freeze of availability of rental housing is evident in light of the long litigation proceedings relating to recovery of rental premises by the landlord or proceedings relating to eviction of tenants. When the proceedings are undergoing, it is difficult to rent out the premises which are lis pendens in court of law and thereby it reduces liquidity for landlords in the market.
- Security deposit:
From the point of view of tenants, it is unfair to give limitless amount to the landlords in the name of security deposit or pugree. Existing rent control laws do not provide for any upper cap as far as security deposit is concerned and tenants have to suffer in the hands of landlords, who demand lump sum amount as much as they want at the beginning of tenancy period. Because of this practice, poor households choose to live in slum areas as they cannot afford to give arbitrary amount of security deposit, which leads to lack of affordable housing in the Country.
- Landlord’s right to evict the tenant on false grounds:
It has been seen in many cases that landlords file false cases to evict tenants on the ground of non-payment of rent because most of the existing rent control laws do no mandate receipt of rent to be given by the landlord.
- Lease under Transfer of Property Act, 1882:
Section 105 of the aforesaid Act defines lease as “a lease of immoveable property is a transfer of a right to enjoy such property, made for a certain time, express or implied, or in perpetuity, in consideration of a price paid or promised, or of money, a share of crops, service or any other thing of value, to be rendered periodically or on specified occasions to the transferor by the transferee, who accepts the transfer on such terms. The transferor is called the lessor, the transferee is called the lessee, the price is called the premium, and the money, share, service or other thing to be so rendered is called the rent.” It is to be noted that in case of a lease agreement, terms of the same cannot be changed until the expiry of the lease period unlike tenancy agreement. In practice, landlords often opt for tenancy agreement under rent control laws where they can execute tenancy on a month-to-month basis and can alter its terms.. However, in areas with high vacancy rate of rental premises, landlords choose for lease agreement under Section 105 and thereby make the use of rent control laws fatal. In addition, TPA and rent control laws do not mandate a written agreement to be executed, which is another problem to enforce the rights of either party to the oral agreement and leads to never-ending litigation proceedings in case of disputes.
- Leave and License Contract:
Apart from rent control laws and lease under the TPA, people often use leave and license contract as given under the Indian Easements Act, 1882. Section 52 of the said Act defines license as- “where one person grants to another, or to a definite number of other persons, a right to do, or continue to do, in or upon the immovable property of the grantor, something which would, in the absence of such right, be unlawful, and such right does not amount to an easement or an interest in the property, the right is called a license.” Hence, the licensor gives the license to the licensee to use the property, which includes usage same as applicable to rental market without transferring a specific interest in the immovable property. Thus, to execute a landlord-tenant relationship, there exist different contracts under the different names and different procedures, the ambiguities of which can be used by the landlord or tenant to influence the law as per their needs.
4. Overview of MTA
MTA has been drafted with a view to balance the interests of the landowner and tenant and to provide for speedy dispute redressal by establishing adjudicatory bodies under MTA. It also tries to create an accountable and transparent environment for renting the premises and promotes sustainable ecosystem to various segments of society including migrants, professionals, workers, students and urban poor. To understand what MTA proposes for tenants and landlords, a brief overview has been presented here under the following heads-
4.1 Institutional framework – regulatory and judicial bodies-
Section 29 of MTA provides for the appointment of Rent Authority to be an officer who is
not below the rank of Deputy Collector. Rent Authority exercises same power as vested in Rent Court in the following matters-
- Upload details of tenancy agreement on a digital platform in the local vernacular or state language in the form prescribed and provide a unique identification number to the parties;
- Fix or revise the rent on an application by the landowner or tenant;
- Investigate the case and pass an order in case of deposit of rent by the tenant with the rent authority, if the landowner does not accept the rent;
- Allow the tenant, if requested, to vacate the premises if it becomes uninhabitable in absence of repairs by the landlord.
- Conduct an inquiry and allow compensation or levy penalty in case of an application made to it by the landlord or tenant if any person cuts-off or withholds any essential supply or service in the premises occupied by the tenant or the landowner.
Rent Court and Rent Tribunal-
Section 32 and 33 provides for the constitution of Rent Court and Rent Tribunal respectively. Section 34 gives exclusive jurisdiction to Rent Court and Rent Authority to hear and decide the applications relating to disputes between landowner and tenant and matters connected with and ancillary thereto. For speedy disposal of cases, Rent Court or Rent Tribunal has to dispose the case within 60 days from the date of receipt of the application or appeal and shall record the reasons in writing in case of disposal of case exceeds 60 days period.Appeal from the orders of the Rent Court lies to the Rent Tribunal. In addition, order of Rent Court or Rent Tribunal shall be executable by as a decree of a civil court.Following reliefs can be given by the Rent Court:
- Delivery of possession of the premises to the party in whose favor the decision is made;
- Attachment of bank account of the losing party for the satisfaction of the amount to be paid;
- Appoint any advocate or any other competent person including officers of the Rent Court or local administration or local body for the execution of the order.
4.2 Scope of coverage-
MTA applies to any premises, which is, let separately for residence or commercial or educational use except industrial use. However, MTA does not provide what constitutes residence/commercial/educational/industrial use. Besides, MTA does not apply to the following premises–
- Hotel, lodging house, dharamshala or inn etc.;
- Premises owned or promoted by-
- The Central/ State/ UT Government, or
- Local Authority, or
- Government undertaking or enterprise, or
- Statutory body, or
- Cantonment board;
- Premises owned by a company, university or organization given on rent to its employees as part of service contract;
- Premises owned by owned by religious or charitable institutions as may be specified by notification;
- Premises owned by owned by any trust registered under the Public Trust Act of the State;
- Premises owned by owned by Wakfs registered under the Wakf Act, 1995;
- Any other building specifically exempted in public interest through notification.
However, if the owner of any of the premises mentioned under in (b) to (g) wishes a tenancy agreement to be regulated under MTA, then he can inform the same to the Rent Authority.
4.3 Protection of landlord-
As stated above the prime object of the MTA is to eliminate the fear among landlords regarding repossession of their premises and increase the growth of investment in rental sector of the market. Keeping this view, MTA proposes to give protection to landlord in following manner-
- Subletting of rented premises cannot be effected without prior consent of landlord in
- writing along with disclosure of all details of sub-letting to landlord by the tenant. .
- Landlord is allowed to make deduction from security deposit amount for any liability of the tenant.
- Landlord is allowed to deduct the amount from the security deposit or can ask the amount payable from the tenant, in case the tenant refuses to carry out scheduled or agreed repairs in the premises.
- Landlord can file an application to the Rent Authority against the tenant in case of cut-off or withhold of any essential supply or service in the premises by the tenant.
- Landlord can evict the tenant on an application made to the Rent Court on any of the grounds mentioned under Section 21. These grounds are-
- Failure of agreement on rent payable;
- Failure of tenant to pay the arrears of rent in full and other charges payable unless the payment of the same within 1 month of notice being served on the tenant;
- Tenant has parted with the possession of whole or any part of the premises without obtaining the written consent of the landlord;
- Tenant has continued misuse of the premises even after receipt of notice from the landowner to stop such misuse;
- The premises are required by the landlord for carrying out any repairs, additions, alterations etc., which cannot be carried out without the premises being vacated unless re-entry of tenant has been pre-agreed between the parties;
- The premises or any part thereof are required by the landlord for carrying out any repairs, additions, alterations etc. for change of its use as a consequence of change of land use by the competent authority;
- Tenant has given written notice to vacate the premises and in consequence of that notice, the landlord has contracted to sell the accommodation or has taken any other step, as a result of which his interests would seriously suffer if he is not put in possession of that accommodation.
- In case of overstay of the tenant beyond tenancy period, the landlord is entitled to get compensation of double of the monthly rent for 2 months and 4 times of the monthly rent.
- Landlord can make any construction or improvement to the rented premises after permission of the Rent Court obtained in this behalf.
- Landlord is allowed to fix or revise the rent payable by the tenant, provided the same should be agreed by the tenant in the tenancy agreement.
4.4 Protection of tenant-
MTA has not only given protection to landlords but balances the interests of the tenants as well. With this view, MTA proposes to give protection to landlord in the following manner-
- In the event of death of the tenant, his/her successors will have the same rights and obligations as agreed in tenancy agreement for the remaining period of the tenancy.
- Rent cannot be increased during the tenancy period, unless the amount of increase or method for increase is expressly set out in the Tenancy Agreement.
- Tenant is entitled to get refund of the security deposit amount at the time of vacating the premises after deduction of amount of liability, if any.
- Tenant is entitled to get a written acknowledgment rent receipt by the landlord.
- Where the landlord refuses to accept the rent, tenant may deposit it with the Rent Authority.
- Tenant is allowed to deduct the amount from periodic rent, in case the landlord refuses to carry out the scheduled or agreed repairs in the premises.
- Where the premises becomes uninhabitable and landlord refuses for repairs, thenthetenant has the right to vacate the premises after giving 15 days notice in writing to the landlord or with the permission of the Rent Authority, in case the.
- Tenant can file an application to the Rent Authority against the landlord in case of cut-off or withhold of any essential supply or service in the premises by the landlord.
- Tenant is entitled to get refund of such an advance amount and interest, in case of default, after deduction of rent and other charges in case of eviction proceedings initiated by the landlord under Section 21.
- Tenant may give up possession of the premises on giving a one-month prior notice or notice as required under the tenancy agreement to the landlord.
5. How will the MTA help rental housing issue?
MTA recommends eradicating the existing rental housing problems by incorporating needful provisions. MTA has recognized the problems in existing rent control laws in its preamble as lack of growth of rental housing segment and lack of the landlords renting out their vacant premises. For better understanding of these needful provisions in MTA, a comparison of key provisions of existing rent control laws and MTA has been produced in Annexure A. In conclusion, the table suggests that MTA provides for market-oriented approach by leaving the fixation of rent amount on parties, who may fix or revise it considering current market value of the premises and thereby increasing the possibilities of high rate of return to the investors in the rental housing market. On the other hand, to remove the fear of the landlords of losing possession of the premises has been taken care by MTA by giving a remedy in form of compensation to the landlord.
6. What do the state governments have to do?
As mentioned above, housing is a state subject and States have exclusive right to legislate upon it. MTA proposes only a model on how the issues relating to rental housing as existed under current laws relating to tenancy can be eliminated. It is completely on the states to adopt or not adopt MTA in their state. For better functioning of the rental housing in the state and to resolve the issues as point out above, state should adopt MTA. Moreover, States are free to make amendments in the proposed provisions in MTA while incorporating the same in their states.
7. What incentives will the state governments have for enacting the MTA?
MTA only proposes a model and States are under no obligation to enact MTA in their respective jurisdictions. Therefore, what the states will get for enacting MTA is equally an important question to consider. Section 46 of MTA provides that if any difficulty arises in giving effect to the provisions MTA, the State/UT Government may, by order, not inconsistent with the provisions MTA, remove the difficulty. Hence, any State enacting MTA is empowered to remove difficulty or amend the provision in their jurisdiction, if there arises any difficulty in implementation of the MTA.
Moreover, housing is one of the basic needs of life and raising the standard of living of its people is one of the primary duties of State as enshrined under the Article 47 of the Constitution of India. Therefore, States shall make every endeavor to resolve the issue of affordable housing in the best manner possible and MTA serves this objective well.
8. Drawbacks of the MTA
Despite all the good attempts made in the provisions of MTA to remove the current problems relating to rental housing, MTA shortfalls on following grounds:
- Moreover, the term ‘Landlord’ covers ‘Lessor’ and the term ‘Tenant’ covers ‘Lessee’ in its definitions, but the MTA nowhere provides that it will override the provisions relating to Lease under the Transfer of Property Act, 1882. Therefore, usage of the term lessor/lessee would create conflict in practice since application of the Transfer of Property Act, 1882 is not clarified under the MTA .
- Lodging house and hotels are kept outside the scope of MTA. Therefore, application of the MTA to premises providing paying guest facilities is not clear.
- MTA provides for prospective application and gives no redress to tenancies, which are already in existence, prior to the commencement of MTA. Hence, position regarding existing tenancies is left untouched.
- Successor-in-interest has not been included in the definition of the term ‘tenant’ under Section 2 (m) of the MTA. However, Section 6 provides for successors of the tenant to come into the shoes of tenant in case of his/her death. This provision creates anomaly that after death of tenant, his/her successor-in-interest may deny acceptance of tenancy agreement on the ground that he/she is not covered within the definition of the term ‘tenant’.
- The term ‘rent’ is not defined under the Act, because of which, the form of rent payable is not clear, i.e. whether it has to be necessarily in cash or kind or crops or services rendered.
- The MTA does not address the situation in case of failure to execute tenancy agreement, failure to obtain consent of landowner for subletting, failure to refund security deposit at the time of taking over vacant possession of the premises by the landlord, failure to observe obligations imposed on parties. Although specific establishment of adjudicatory bodies has been provided under the MTA but the same results in increase of litigation matters before judicial bodies established under the MTA.
- MTA is open to be adopted by the States and does not necessarily impose application of its provisions to State.
- MTAdoes not talk about weak bargaining power of tenants and allows parties to agree on rent amount, which may cause prejudice to weaker sections of the society.
- MTA does not talk about over-riding effect of MTA on existing laws on tenancy, lease under the TPA, license under the Indian Easements Act, 1882 to uphold the objectives of the MTA.
MTA is a welcoming step in rental matters relating to any premises. Establishment of the adjudicating authorities is going to lessen the burden on lower courts in the country in the matters relating to tenancy. However, application of the MTA would be interesting to see as to how many states actually implement MTA because it is only a model and not mandatory for states to adopt it.
Comparison of Existing Rent Control Laws and MTA:
The author has tried to analyze some of the major existing rent control lawsin comparison with the MTA. The same has reproduced in a table form below:
|Point of difference||Existing Laws||MTA||Comments|
|Purpose of the Act||1. Control of rent and protection of tenant from payment of rent more than the standard rent, and
2. Protection of tenants from eviction,
|It provides not only for protection of tenants but also provides for protection of landowners.||Most of the existing rent control laws are tenant-centric; whereas MTA balances the interests of landowner and tenant.|
|Exemption||Premises belonging to the Government are exempted but no specific provision is present regarding exemption of religious or charitable premises and premises owned by a university except Maharashtra Rent Control Act, 1999.||MTA exempts any premises owned by the Government, religious or charitable institutions, and premises owned by a company, university or organization given on rent to its employees as part of service contract.||MTA applies to all kind of government occupied premises and publicly used premises unlike existing rent control laws.
|Definition of ‘Landlord’||If the premises were let to a tenant then landlord means a person who-
1. is receiving, or is entitled to receive the rent of any premises, or
2. trustee, guardian or receiver, who is receiving or is entitled to receive rent, on behalf of, or for the benefit of, any other person who cannot enter into a contract (such as minor, person with unsound mind etc.).
|If the premises were let to a tenant then landlord (Landowner/Lessor) means a person who–
1. is receiving, or is entitled to receivethe rent of any premises,and
2. includes successor-in-interest,
3. trustee, guardian or receiver, who is receiving or is entitled to receive rent, on behalf of, or for the benefit of, any other person who cannot enter into a contract (such as minor, person with unsound mind etc.).
|MTA covers Lessor within the term ‘Landlord’ and includes successor-in-interest unlike existing rent control laws.
|Definition of ‘Premises’||Premises mean any building or part of a building rented out, and includes-
1. Gardens, garages or outhouses, any furnituresupplied by the landlord,
2. any fittings affixedto such building.
However, premises do not include hotel, lodging house.
|Premises mean any building or part of a itrented out for the purpose of residence or commercial or educational use, (except for industrial use) and includes–
1. the garden, garage or closed parking area, grounds and out-houses, appertaining to such building or part of the building,
2. any fitting to such building or part of the building for the more beneficial enjoyment thereof,
However, premises do not include hotel, lodging house, dharamshala or inn etc.
|State RCAs do not explicitly exclude industrial use, unlike MTA and do not specifically recognize a particular purpose of use of building to be cover within the term ‘premises’.|
|Definition of ‘Tenant’||Some of the rent control laws do not provide definition of term ‘tenant’. And others include tenant as a person-
1. who is paying the rent, or
2. deemed tenant, or
4. member of tenant’s family in case of death of tenant.
|Tenant/Lesseemeans a person–
1. by whom the rent is payable, or
2. on whose behalf the rent is payable, and
3. includes a sub-tenant,and
4. any person continuing in possession after the termination of his tenancy whether before or after the commencement of this Act.
However, tenant does not include any person against whom any order or decree for eviction has made.
|MTA does not include successor-in-interest within the definition of tenant.|
|Standard rent||Standard rent means a rent fixed by the Controller under rent control laws.||No provision is made.||MTA does not provide for the definition of the term ‘rent’.|
|Tenancy agreement||It was not necessary and tenancy can be affected even without entering into tenancy agreement.||It means a written agreement executed by the landowner and the tenant. Moreover, it is mandatorycondition for a tenancy to come into effect.||MTA making the tenancy agreement mandatory unlike existing rent control laws.|
|Sub-letting||No provision regarding prior written consent of landlord for sub-letting by tenant.||Prior written consent of the landowner is madecompulsory.||More stringent provision.|
|Fixation of rent||Rent fixed (standard rent) based on the value of land andcost of construction when built.||The rent is the amount agreed between the landowner and the tenant as per the terms of the tenancy agreement.||Standard rent or fair rent concept has removed in MTA.|
|Increase in rent||It is unilateral by the landlord with the approval of the controller.||Revision of rent between the landowner and the tenant shall be as per the terms set out in the Tenancy Agreementor on a prior 3 months notice to the tenant.||Mutually agreed increase in rent is provided under MTA unlike rent control laws.|
|Temporary recovery of possession||The landlord is entitled to get possession of the building, if bona fide, it is required by him to carry out repairs, alterations or additions, which cannot be carried out without the building being vacated, after which the building will again be offered to the tenant.
|Rent Court may on an application made to it, make the order that the landlord is entitled to get possession of the premises or any part thereof on account of any repairs or rebuilding or additions or alterations or demolition, which cannot be carried out without the premises being vacated, provided that such re-possession has to be mutually agreed to between the landowner and the tenant and the new tenancy agreement has to submitted with the Rent Authority.||More requirements that are stringent have been put on the parties under MTA.|
|Deposit of rent||Many of state rent control lawsdo not provide for deposit of rent lawfully payable to the landlord in respect of the building, before the authority as may be prescribed.||Explicit provision provided for deposit of rent with the Rent Authority where the landowner does not accept the rent or refuses to give a receipt or if landowner does not accept the rent.||Transparency and accountability enabled provision.|
|Overstay of tenant||No deterrent provision, therefore landlords fear to give their houses on rent, which in turn reduces the supply of renting houses in the market.||It provides for compensation i.e. four times the rent, to the landlord.||MTA provides Remedy in favour of landlord.|
|Rent Receipt on payment of rent||No provision.||Every tenant is entitled to get a written receiptfrom the landowner for the amount paid to him.||Tenant friendly provision to eliminate abuse against tenants.|
|Security deposits||No explicit provision existed for security deposits/ pugree in addition to rent.||MTA provides for 2 months’ rent in residential property, 1-month rent in non-residential property as security deposit.||MTA provides elimination of abuse against tenants.|
|Inheritance of tenancy||Order of inheritance has provided in most of the state RCAs.||No order of successors has given in MTA.||MTA introduces more wide import in case of inheritance of tenancy.|
|Structural alteration to the rent premises||Rent control laws provide for structural alteration without consent of tenant and increase rent.||MTA provides for structural alteration to rent premises only if the same is provided in the agreementwith the tenant and increase the rent.||Tenant friendly provision to eliminate abuse against tenants.|
|Adjudicatory Authority||Controller or Civil Courts||Rent Authority, Rent Court, Rent Tribunal||Specific adjudicatory bodies introduced in MTA for speedy disposal of rent related matters.|
Draft National Urban Rental Housing Policy, 2015, p 10.
Id. At p 5.
 Section 4 (4), MTA, 2019.
 Section 10, MTA, 2019.
 Section 14 (2), MTA, 2019.
 Section 15 (5), MTA, 2019.
 Section 20, MTA, 2019.
 Section 35 (2), MTA, 2019.
 Section 37, MTA, 2019.
 Section 36 (7), MTA, 2019.
 Section 38 (1), MTA, 2019.
 Section 2 (e), MTA, 2019.
 Section 3, MTA, 2019.
 Section 7, MTA, 2019.
 Section 11 (2), MTA, 2019.
 Section 15 (3), MTA, 2019.
 Section 20, MTA, 2019.
 Section 22, MTA, 2019.
 Section 25, MTA, 2019.
 Section 8 & 9, MTA, 2019.
 Section 6, MTA, 2019.
 Section 9 (4), MTA, 2019.
 Section 11 (2), MTA, 2019.
 Section 13 (2), MTA, 2019.
 Section 14, MTA, 2019.
 Section 15 (4), MTA, 2019.
 Section 15 (5), MTA, 2019.
 Section 20, MTA, 2019.
 Section 23, MTA, 2019.
 Section 28, MTA, 2019.
 Section 8, MTA, 2019.
 Section 22, MTA, 2019.
 Section 46, MTA, 2019.
Maharashtra Rent Control Act, 1999; Delhi Rent Control Act, 1958; Andhra Pradesh Buildings (Lease, Rent and Eviction) Control (Amendment) Act, 1960; The West Bengal Premises Tenancy Act, 1997.
 Section 3, Maharashtra Rent Control Act, 1999.
 Section 3, MTA, 2019.
 Section 2(b), MTA, 2019.
 Section 2(e), MTA, 2019.
 Section 2(m), MTA, 2019.
 Section 2(a), MTA, 2019.
 Section 4, MTA, 2019.
 Section 7 (1), MTA, 2019.
 Section 8, MTA, 2019.
 Section 9, MTA, 2019.
 Section 9 (6), MTA, 2019.
 Section 14 (1), MTA, 2019.
 Section 22, MTA, 2019.
 Section 13 (2), MTA, 2019.
 Section 11, MTA, 2019.
 Section 6, MTA, 2019.
 Section 9 (6), MTA, 2019.
 Chapter VI & VII, MTA, 2019.
Julie Mehta (firstname.lastname@example.org)
Who thought hiring was even an option to enjoy the luxury of having to use a car. But with the world undergoing a paradigm shift, it untapped its energies into providing and establishing better services for its customers, leasing has paved its way into existence. Most of the industries have adopted this concept and structured their services accordingly in order to provide the best they can to their customers, but that requires huge understanding of their needs. A commoner would always be awed by the immensely developing technology and the environment around them but limited resources makes them take a step back from the thought of availing such services. The market had its solution as hiring and renting came into picture. This has ensured dreams do come true.
Car has always been a luxury at least in most parts of India because of the fact that India still in its developing stage and there still remains a big gap between the rich and the poor and the middle income families fall nowhere. Indians have been developed with the mind state that not everyone can afford everything and thus one should limit their demands keeping in mind their pocket potential. The concept of hiring and renting is not only limited to houses and properties but with the advent of MNC’s and startup companies, they have widened the scope of bringing in the concept of hiring even furniture, vehicles, electronic equipment’s, etc.
Earlier, the concept of car leasing was only limited to corporate senior executives that was earlier known as ‘corporate leasing’ and was common for the luxury car brands. But slowly it has trickled down and become accessible to commoners and middle income families. Companies like Mahindra & Mahindra made some of its models available for leasing. Following this concept, several other car brands like Hyundai, TATA group and luxury brands like BMW, Mercedes etc. have also opened their doors to providing the lease facilities.
Car leasing and rental is one of the most lucrative and fast growing segment of the automobile sector in India even though it currently represents only 4-5% of the market in terms of absolute number of vehicles, but its future prospects are strong enough.
Factors like increasing popularity of app-cab providers like Ola, Uber, Zoom car cab booking facilities, rapid urbanization, relocation of rural population into cities, adds on to the potential of car leasing in India.
The growth of the market in India is to ensure manifold growth in its CAGR by 15-20% in the coming ten years and further on making hiring of cars simpler eventually with current worth of Rs. 1500 crores. Most car making companies are making 40% of its business from leasing cars. This has largely helped change the mentality of customers and imbibed the fact that ‘why buy when you can lease it’.
Yellow number plates or white number plates?
People remain apprehensive about the color of the number plate they use in the car. While a yellow number plates denotes commercial use, white number represents personal use. People taking cars on lease will of course want white number plates on their cars.
The current legal framework for registration of motor vehicles allow cars taken on lease for personal use to bear white number plates.
In case of a car taken on lease, the lessee is the person having possession of the vehicle and hence, the ‘owner’ as per the Motor Vehicles Act, 1988. Further, since it is the lessee who is actually using the car and the same has not been given on hire or used for any other commercial purpose, the car shall have a white number plate.
Global Status of Car Leasing
Globally, car leasing and hiring has been prevalent and growing for many years now. The analysts have forecasted that in the coming years, the global leasing market is to grow at a CAGR of 13-15%. This is gaining momentum due to the development of new mobility concepts by car leasing companies. For example, telematics was introduced in leased vehicles to monitor their usage on the job, another technological development was the installation of navigation in the leased vehicles making it more convenient for the lessor. People want change and with such facilities where there is an added benefit of not burning the pockets of customers, the lease scheme always works to hire cars on lease and cancel the contract anytime to shift on to better and advanced models of cars.
The new trends dominating the global markets are the introduction of electric vehicle leasing and environment friendly cars that lead to sustainable development in the car manufacturing industries as well in the overall environmental situation. Such facilities encourage people to be more socially responsible and to do their bit towards the betterment of the society and also getting the leasing benefit out of it. Governments across the world are offering subsidies and tax benefits to encourage and boost the penetration of electric vehicles in their fleet. They have also introduced the concept of leasing old cars which helps reduce wastage as well as optimum usage. It is offered at a highly considerate premium and is attractive for low income customers. The global leasing market is fast moving with efficient strategies that ensures further growth too.
Why has Leasing gained popularity in recent times?
GST introduction has come out to be a source of relief in time of distress for the Indian markets and consumers due to the stiff tax system of the country resulting in poor market functioning. With the introduction of ‘Goods and Services Tax’ on July 1, 2017, times have changed for the consumers, dealers as well as manufactures and has helped bring stability and balance in the economy by considering every person and their transaction at par, with the motive to bridge the gap between rich and poor in the long run. Evaluating their benefits below taking into consideration automobile industry:
- To the consumers: The new tax regime has resulted in significant reduction in the tax rates imposed on the end consumers in comparison to the previous tax system.
- To the dealers: The benefit of claiming the tax paid earlier benefits the dealers with the introduction of GST provides an added advantage to the dealers.
- To the manufacturers: In recent times, car manufacturing companies have marked a fall in their sales which has led to dwindling profits. With the increasing exposure to car leasing, manufacturers have found their resort to stabilise their performance. This option induces customers to opt for leasing, thereby ensuring good business to the car manufacturers.
|CAR TYPE||GST RATES||COMPENSATION CESS||TOTAL|
|Small Cars||28%||1% or 3% (depending on capacity)||29% or 31%|
|Sports Utility Vehicles (SUV’s)||28%||22%||50%|
To understand the calculation of Loan EMIs and Lease rentals, we structure an example with the concept of residual model to distinguish the calculations of both the alternatives.
Any loan transaction requires an initial down payment to the seller after which installments follow on monthly/quarterly/annually basis. The down payment creates an extra outflow on part of the buyer on loan along with additional installments. While no down payment is required in case of a lease that makes its overall outflow on the lower side in comparison to a loan.
Plus, in case of a lease transaction, the lessor takes an exposure on the residual value of the asset, this brings down the lease rentals per month.
In the example below, with the assumption of different rates of residual value, we understand that with the every increase in the percentage of residual value, the lease rentals of the operating lease borne by lessee comes down. This implies lower the term of the lease contract, lesser value of the asset is used, and thus lesser are thee lease rentals.
|Details of the Vehicle|
|Rate of GST||45%|
When Residual Value is considered to be 20%
|Operating lease arrangement|
|Add GST on purchase (ITC eligible)||450000.00|
|Expected Residual Value||20%||200000.00|
|Lease Rentals (RV not factored)||₹ 42,593.75|
|Lease Rentals (before passing GST benefit)||₹ 39,718.75|
|Input tax credit percentage||100%|
|Less: GST benefit||₹ 9,375.00|
|Lease Rentals (after passing GST benefit)||₹ 30,343.75|
|Add: GST on rentals||₹ 13,654.69|
|Total inflow||₹ 43,998.44|
|Expected Residual Value||0%||0|
When Residual Value is considered to be 25%
|Expected Residual Value||0%||0|
|Operating lease arrangement|
|Add GST on purchase (ITC eligible)||450000.00|
|Expected Residual Value||25%||250000.00|
|Lease Rentals (RV not factored)||₹ 42,593.75|
|Lease Rentals (before passing GST benefit)||₹ 39,000.00|
|Input tax credit percentage||100%|
|Less: GST benefit||₹ 9,375.00|
|Lease Rentals (after passing GST benefit)||₹ 29,625.00|
|Add: GST on rentals||₹ 13,331.25|
|Total inflow||₹ 42,956.25|
When the Residual Value is considered to be 30%
|Expected Residual Value||0%||0|
|Operating lease arrangement|
|Add GST on purchase (ITC eligible)||450000.00|
|Expected Residual Value||30%||300000.00|
|Lease Rentals (RV not factored)||₹ 42,593.75|
|Lease Rentals (before passing GST benefit)||₹ 38,281.25|
|Input tax credit percentage||100%|
|Less: GST benefit||₹ 9,375.00|
|Lease Rentals (after passing GST benefit)||₹ 28,906.25|
|Add: GST on rentals||₹ 13,007.81|
|Total inflow||₹ 41,914.06|
The major differentiating factors between a lease and a loan is that the former gives the right to use the asset without any upfront down payment, however, in case of the latter, there is an upfront down payment. Leasing works better when the lessor takes exposure on a handsome amount of residual value. Otherwise, it will turn out to be costlier than loan.
In the coming years, the car leasing market in India will be prospering as most car brands have now started to expand their services to even leasing now, which wasn’t prevalent until the last 4-5 years. With this competitive spirit, many more well developed brands would undertake this strategy to enhance customer base. The statistics of no: of cars being sold is going through a falling spree currently and is expected to fall further. But the leasing market will be flourishing on the other hand. It provides the ‘Best of Both Worlds’ to the customers as well as benefits the owner who still retain the ownership of the cars and gain benefit out of it.
By Falak Dutta (email@example.com)
Ruling of Bombay High Court
The Bombay High Court on March 27, 2019, in the case of Edelweiss Financial Services v. Percept Finserve Pvt. Ltd., ruled out an award passed by a sole arbitrator with respect to a share purchase agreement (SPA). The High Court allowed enforcing of a put option clause to be exercised by Edelweiss, the appellant, to sell back the shares it had acquired from Percept Group, the respondent.
Before delving into the proceedings of the aforesaid case, it is important to understand certain basic concepts, to appreciate the ‘option clause’ in the case. An option is a derivative contract which gives the holder the right but not the obligation to buy (call) or sell (put) the underlying within a stipulated time in exchange for a premium. Options are not just traded on exchanges but are also used in debt instruments (eg. callable and puttable bonds), private equity and venture capital investment covenants. Even insurance is a type of option contract where the insured pays monthly premium in exchange of a monetary claim upon the future occurrence of a contingent event (accident, disease, damage to property etc.).
Facts of the case
Edelweiss Financial Services Pvt. Ltd. entered into a share purchase agreement (SPA) dated 8, December, 2007 with the Percept Group where it invested in the shares of Percept Group subject to a condition that the latter shall restructure itself as agreed between the parties followed by an IPO. Under the terms of the SPA, the appellant (Edelweiss) purchased 228,374 shares for a consideration of Rs. 20 crores. One of the conditions in the agreement, required Percept to entirely restructure by 31st December, 2007 and to provide proof of such restructuring. Upon failure of compliance by the respondent, the date was further extended to 30 June, 2008 with obligation to provide documentary evidence of completion by 15th, July 2008. Upon non-fulfillment within the extended date, Edelweiss had the option to re-sell the shares to Percept, where Percept was obligated to purchase the shares at a price which gave the appellant an internal rate of return of 10% on the original purchase price.
As was the case, Percept failed to restructure itself within the stipulated time. Subsequently in view of this breach Edelweiss exercised the put option and Percept was required to buy back the shares for a total consideration of Rs. 22 crores. Since the respondent refused to comply the appellant invoked the arbitration clause in the SPA and a sole arbitrator was appointed to adjudicate the dispute. The arbitrator submitted that despite Percept being in breach of the conditions in the SPA, the petitioner’s claim to exercise the put option was illegal and unenforceable, being in conflict with the Securities Contracts regulation Act (SCRA), 1956. The unenforceability was proposed on two grounds. First, for the clause being a forward contract prohibited under Section 16 of SCRA read with SEBI March 2000 notification, which recognizes only spot delivery transactions to be valid. Secondly these clauses were illegal because they contained an option concerning a future purchase of shares and were thus a derivatives contract not traded on a recognized stock exchange and thus were illegal under Section 18 of SCRA, which deals with derivative trading.
Aggrieved by the arbitrator’s order, Edelweiss challenged it before the Bombay High Court under section 34 of the Arbitration & Conciliation Act, 1996.
The Bombay High Court observed the reasoning of the order by the arbitrator and the contentions made by Percept. The said order confirmed the breach caused by Percept, but found the particular clauses of put option in the SPA to be illegal under two grounds as mentioned earlier. The Court divided the judgement along the sections involved.
The first of the arbitrator’s conclusion was found untenable when referred to the judgement in the case of MCX Stock Exchange Ltd. vs. SEBI which deals with such a purchase option as in the present case. The Court observed that the put option clause contained in the SPA cannot be a derivatives contract prohibited by SCRA, because there was no present obligation at all and the obligation arose by reason of a contingency occurring in the future. The contract only came into being upon the following two conditions being met: (i) failure of the condition attributable to Percept (ii) exercise of the option by Edelweiss upon such failure. Whereas a forward contract is an unconditional obligation, the option in the SPA only comes into being when the aforesaid conditions are met. Thus, the arbitrator’s claim of the clause being a forward contract disregards the law stated by the Court in MCX Stock (supra).
Subsequently, respondent (Percept Group) challenged the relevance of the MCX Stock case to the present one. In the MCX Stock Exchange case, upon the exercise of the option the contract would be fulfilled by means of a spot delivery, that is, by immediate settlement. Whereas Edelweiss’s letter by which it exercised the put option required the shares to be re-purchased with immediate effect or before 12 Jan, 2009. This deferral of repurchase upon exercise of the option was not part of the MCX Stock Exchange case’s option clause and hence is not comparable to the present case.
This too was disregarded by the Court on the ground:
“It is submitted that in as much as this exercise of options demands repurchase on or before a future date, it is not a contract excepted by the circular of the SEBI dated 1 March, 2000.
Just because the original vendor of securities is given an option to complete repurchase of securities by a particular date it cannot be said that the contract for repurchase is on any basis other than spot delivery.
There is nothing to suggest that there is any time lag between payment of price and delivery of shares.”
Now, this brings us to the second leg of the arbitrator’s award regarding the illegality and unenforceability of the SPA option on account of breach of Section 18A of SCRA, which deals in derivative trading. The following is an excerpt from Section 18A:
Contracts in derivative. — Notwithstanding anything contained in any other law for the time being in force, contracts in derivative shall be legal and valid if such contracts are—
(a)Traded on a recognized stock exchange;
(b) Settled on the clearing house of the recognized stock exchange. In accordance with the rules and bye-laws of such stock exchange.
The respondent appeals that as the put option was not of a recognized stock exchange, it stands unenforceable and illegal. In response, the court submitted that the contract does contain a put option in securities which the holder may or may not exercise. But the real question is whether such option or its exercise is illegal? The presence of the option does not make it bad or impermissible.
“What the law prohibits is not entering into a call or put option per se; what it prohibits is trading or dealing in such option treating it as a security. Only when it is traded or dealt with, it attracts the embargo of law as a derivative, that is to say, a security derived from an underlying debt or equity instrument.”
There was further cross objections filed by the respondent but it was ruled out under Section 34 of the Arbitration & Conciliation Act, which deals with the application for setting aside arbitral award. Since the provisions of Civil Procedure Code, 1908 are not applicable to the proceedings under Section 34 and the section itself does not make any provision for filing of cross objections, the appeal was ruled out.
This Bombay High Court ruling in favor of Edelweiss provides an important distinction of options, from forward contracts. It highlighted that although both options and forwards are commonly categorized as derivatives, they share an important difference. On one hand, a forward contract contains a contractual obligation to buy or sell, on the other hand, the option gives the holder the right or choice but not the obligation to do the same. Options have always been integral to finance, routinely appearing in corporate covenants and contracts. Options are widely observed in mezzanine financing, private equity, start-up and venture funding among others. Given the Court’s distinction of forwards from options in their very essence and nature, the author believes this ruling is likely to be useful and a point of reference in future derivative litigations.
As a part of the Bi-monthly Monetary Policy on 6th June, 2019, the RBI’s review of Development and Regulatory Policies [https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=47226] proposed to set up a working group to strengthen the regulatory framework for core investment companies (CICs). The RBI states: “Over the years, corporate group structures have become more complex involving multiple layering and leveraging, which has led to greater inter-connectedness to the financial system through their access to public funds. Further, in light of recent developments, there is a need to strengthen the corporate governance framework of CICs. Accordingly, it has been decided to set up a Working Group to review the regulatory guidelines and supervisory framework applicable to CICs.”
Core investment companies are group holding vehicles, which hold equities of operating or financial companies in a business group. These companies also give financial support in form of loans to group companies. However, CICs are barred from dealing with companies outside the group or engaging in any other business operation.
Currently as per the data as on 30th April, 2019, there are only 58 registered CICs in the country. There may be some unregistered CICs as well, since those not having “public funds” do not require registration.
If a CIC is not holding “public funds” (a broad term that includes bank loans, inter-corporate deposits, NCDs, CP, etc.), the CIC is exempt from registration requirement. Presumably such CICs are also excluded from any regulatory sanctions of the RBI as well. However, it is quite common for CICs to access bank loans or have other forms of debt for funding their investments. Such CICs require registration and come under the regulatory framework of the RBI, if their assets are worth Rs 100 crores or more.
Corporate governance norms applicable to systemically important NBFCs are currently not applicable to CICs.
The RBI has observed that CICs are engaged in layering of leverage. This observation is correct, as very often, banks and other lenders might have lent to CICs. The CICs, with borrowed money, use the same for infusing capital at the operating level below, which, once again, becomes the basis for leveraging. Thus, leveraged funds become basis for leverage, thereby creating multiple layers of leverage.
While agreeing with the contention of the RBI, one would like to mention that currently, the regulatory definition of CICs is so stringent that many of the group holding companies qualify as “investment companies” (now, credit and investment companies) and not CICs. There is a need to reduce the qualifying criteria for definition of CICs to 50% of investments in equities of group companies. This would ensure that a large number of “investment companies” will qualify as CICs, based on predominance of their investments, and would be viewed and regulated as such.
Prominent among the registered CICs are entities like Tata Sons, L&T Finance Holdings, JSW Investments, etc. The extension of corporate governance norms to CICs is unlikely to benefit any, but impact all.
The Reserve Bank has accordingly constituted the Working Group to Review Regulatory and Supervisory Framework for Core Investment Companies on 3rd July, 2019 [https://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/PR43DDEE37027375423E989F2C08B3491F4F.PDF]. The Terms of Reference (ToR) of the Working Group are given below:
- To examine the current regulatory framework for CICs in terms of adequacy, efficacy and effectiveness of every component thereof and suggest changes therein.
- To assess the appropriateness of and suggest changes to the current approach of the Reserve Bank of India towards registration of CICs including the practice of multiple CICs being allowed within a group.
- To suggest measures to strengthen corporate governance and disclosure requirements for CICs
- To assess the adequacy of supervisory returns submitted by CICs and suggest changes therein
- To suggest appropriate measures to enhance RBI’s off-sight surveillance and on-site supervision over CICs.
- Any other matter incidental to the above.
As per the press release, the Working Group shall submit its report by October 31, 2019.