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Shareholder scrutiny for payout under Listing Regulations to directors

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– Understanding the capping rationale

Pammy Jaiswal | Partner

Shaifali Sharma | Assistant Manager

Vinod Kothari and Company; corplaw@vinodkothari.com

Background

The remuneration payable to the directors of a public company is regulated by the provisions of Section 197 read with Schedule V of the Companies Act, 2013 (Act). It provides a ceiling on the maximum remuneration that can be paid to the directors both in aggregate as well categorically, including Whole-time Director, Managing Director and the Manager.

Any payment to such directors within the said limits has to be approved by the shareholders by way of an ordinary resolution. Payment of remuneration in excess of the limits requires approval of the shareholders by way of a special resolution.

There were no specific provisions prescribed under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) on maximum remuneration payable to directors of listed entities until SEBI, on the basis of recommendation of Kotak Committee on Corporate Governance, amended the Listing Regulations to put a ceiling on remuneration payable to executive promoter directors and non-executive directors.

This article tries to critically analyze the intent and deduce the interpretation of the aforesaid capping under the Listing Regulations.

Absolute versus relative limits- reading between the lines

Regulation 17 (6) (e) of the Listing Regulations reads as under:

“The fees or compensation payable to executive directors who are promoters or members of the promoter group, shall be subject to the approval of the shareholders by special resolution in general meeting, if-

(i) the annual remuneration payable to such executive director exceeds rupees 5 crore or 2.5 per cent of the net profits of the listed entity, whichever is higher; or

(ii) where there is more than one such director, the aggregate annual remuneration to such directors exceeds 5 per cent of the net profits of the listed entity:

Provided that the approval of the shareholders under this provision shall be valid only till the expiry of the term of such director.

Explanation: For the purposes of this clause, net profits shall be calculated as per section 198 of the Companies Act, 2013.

On the very first reading of Regulation 17 (6) (e), we understand that in case the listed company has one executive promoter director, it can pay upto 2.5% of the net profits or INR 5 crore, whichever is higher, without passing a special resolution.

In case of more than one such director in the company, the relative limit of 2.5% is doubled to 5% of the net profits, however, the absolute limit of INR 5 crore has not been mentioned under sub-clause (ii) of the said sub-regulation.

This makes it all the more important for us to read between the lines and interpret the meaning as intended by the law-makers. As mentioned, the first sub-clause provides both a relative and an absolute limit for the purpose of securing shareholder scrutiny. In fact, the said clause clearly mentions that higher of the relative or absolute limit has to be considered while determining the need to approach the shareholders.

Accordingly, it may seem to be an incorrect reading if companies consider only the relative limit for the second sub-clause. In such a scenario, companies may end up considering a far lower limit than INR 5 crores which the law makers have already fixed for one promoter executive director in the first sub clause.

Approval requirements under the Act viz-a-viz requirements under Listing Regulations

 

A. Payment of remuneration to executive promoter directors of a listed public company

As per the Report[1] of the Kotak Committee constituted by SEBI, several cases of disproportionate payments made to executive promoter directors as compared to other executive directors were noted and therefore, the Committee with the view to improve the standards on Corporate Governance, suggested that this issue should be subjected to greater shareholder scrutiny. Accordingly, the amendment carved a parallel way for obtaining shareholder’s approval if the total remuneration paid to executive promoter director exceeds the prescribed limits.

The above recommendation has already come into effect from April 01, 2019 and therefore the listed entities, in addition to the threshold limits prescribed u/s 197 of the Act, have to adhere to the ceiling laid down u/r 17(6)(e) of the Listing Regulations.

Below is the comparison of the threshold limits prescribed under Act and Listing Regulations for payment of remuneration to executive promoter director, in excess of which shareholders’ approval by special resolution shall be required:

Special Resolution required if: Under the Companies Act, 2013 Under SEBI Listing Regulations
Remuneration payable to a single executive director* Exceeds 5% of the net profits of the company Exceeds Rs. 5 crore (absolute limit) or 2.5% of the net profit (relative limit), whichever is higher
Remuneration payable to all executive director* Exceeds 10% of the net profits of the company Exceeds 5% of the net profits of the company

* Listing Regulations caps the limit for executive directors who are promoters or members of promoter group

From above, it is evident that the Act allows public listed companies to pay remuneration to its executive directors upto 5% or 10% of its net profits, as the case may be, (without passing special resolution) which is double the relative thresholds prescribed under Listing Regulations i.e. 2.5% or 5% of the net profits.

Illustrations:

Illustration 1 –Payment within the limits laid down under the Act and also Listing Regulations

Type of shareholder approval required – Ordinary resolution under the Act

Illustration 2-Payment exceeds Listing Regulations limits but is within limits of the Act

Let us take a numerical example for this case:

Situation Permissible remuneration to a single executive promoter director Permissible aggregate remuneration to more than 1 executive promoter directors
Act LISTING REGULATIONS Act LISTING REGULATIONS
Company has profits of 10 crore

 

 ·    5% of NP

 

 

 

 

0.5 crore

 Higher of

·    2.5% of NP; or

·    5 crore

 

5 crores

 ·    10% of NP

 

 

 

 

1 crore

 ·    5% of NP

 

 

 

 

0.5 crore

 
Remarks:

In case of single executive promoter director: 

  • Permissible remuneration under Listing Regulations  (5 crore) is much higher than amount (0.5 crores) under the Act. In such cases, there is a clear cut conflict between the two legislations. On one hand where Listing Regulations  allows payment upto INR 5 crores to one such director (which in this case constitutes 50% of the NP), the company in question will be required to pass SR under the Act.
  • Accordingly, providing for a higher payout amongst the relative and absolute limit, in the first sub-clause does not seem to achieve the intent of SEBI to increase the Corporate Governance standards by scrutinizing disproportionate payments to this category.

In case of more than 1 executive promoter director:

  • As soon as we move to second situation, the amount available for payment of remuneration stands reduced drastically. The permissible remuneration under Listing Regulations will be INR 0.5 crore whereas, the Act allows payment upto INR 1 crore.

Illustration 3 – Payment exceeds the limits under the Act and automatically exceeds the limits under Listing Regulations (not considering the absolute limit)

Here the case is simple, SR is required to be passed.

Illustration 4 – Company has inadequate profits for the purpose of section 197 read with Schedule V of the Act

In case the minimum remuneration approved falls within the limits provided against the effective capital – OR is sufficient, however, for the purpose of Listing Regulations, SR will be required. In this case, Listing Regulations are stricter as it does not envisage inadequacy of profits and amounts that can be paid in case inadequacy.

However, if the minimum remuneration approved exceeds the limits provided against the effective capital, SR is required under the Act and such payment can be made only for three financial years with certain other disclosure requirements.

Having said that, it is important to note that once SR under the Act has been passed for payment of remuneration either in cases of adequate or inadequateprofits, there does not seem to be any need to pass another SR under Listing Regulations  for breach of the limits set therein.

 

B. Payment of remuneration to non-executive directors of a listed public company

The Kotak Committee on corporate governance further observed that certain non-executive directors (NEDs) (generally promoter directors) are receiving disproportionate remuneration from the total pool available for all other NEDs and recommended that if remuneration of a single NED exceeds 50% of the pool being distributed to the NEDs as a whole, shareholder approval should be required.

SEBI, in line with the above proposal and the requirement for special resolution for executive promoter directors, amended Listing Regulations and inserted following clause (ca) to Regulation 17(6):

“The approval of shareholders by special resolution shall be obtained every year, in which the annual remuneration payable to a single non-executive director exceeds fifty per cent of the total annual remuneration payable to all non-executive directors, giving details of the remuneration thereof”

The above amendment has also come into effect from April 01, 2019 and therefore, requires an action on the part of the listed entities to pass SR for such disproportionate payment to any one of its NED.

Some companies have already passed an SR in the AGM held for the financial year 2018-19 while other companies are preparing to pass the same in this year. The reason behind such two school of thoughts is based on the following reasons:

  1. Remuneration to a single NED for the FY 2018-19, which is basically profit linked commission, has been paid after 1st April, 2019. Some companies which have already taken the SR in the AGM held for the FY 2018-2019 have done so considering the payment being done post the advent of the aforesaid amendment.
  2. Remuneration to a single NED for the FY 2019- 2020 will be taken to the shareholders if it exceeds the limits. Here the companies which did not approach its shareholders in the AGM held for the FY 2018-2019 is based on the understanding that this amendment has come into force from 1st April, 2019 which means the same is to be complied with for the remuneration payable for FY 2019-2020. Therefore, according to the second school of thought, no SR is required for the disproportionate payment made in FY 2019-2020 for the FY 2018-2019[2].

Concluding Remarks

While the amendment of capping the limits for payout to executive promoter directors does not seem to meet the intent of the law makers, the amendment for passing SR for disproportionate payout to a single NED seems to be much more justified.

It was rightly mentioned in the Kotak Committee report that in future SEBI could review the status of the amendment relating to payout to executive promoter directors based on experience gained. As per the discussions above, it is imperative to draw attention firstly to the absence of the absolute limits in the second sub-clause of this sub-Regulation and even though the same is read with by inserting the same, it may seem to be futile for sole reason of SRs already passed by the companies under the Act. Further, clarity is needed for requirement to seek approval for payment of minimum remuneration in case of inadequacy of profits.

Since, MCA had already prescribed the limits and procedures under the Act for managerial remuneration, SEBI may relook at the capping scrutinylaid down for executive promoter directors and possible could align the same with the provisions of the Act. The intent is not to simply seek special resolution for every item of managerial remuneration as abundant caution.

Other reading materials on the similar topic:

  1. ‘FAQs on SEBI (Listing Obligations and Disclosure Requirements) (Amendment) Regulations, 2018’ can be viewed here
  2. Presentation on ‘Appointment & Remuneration of Managerial Personnel & KMPs’ can be viewed here
  3. ‘Managerial Remuneration: A five decades old control cedes’ can be viewed here
  4. ‘Remunerating NEDs and IDs in low-profit or no-profit years’ can be viewed here
  5. Our other articles on various topics can be read at: http://vinodkothari.com/

Email id for further queries: corplaw@vinodkotahri.com

Our website: www.vinodkothari.com

Our Youtube Channel: https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

 

[1]https://www.sebi.gov.in/reports/reports/oct-2017/report-of-the-committee-on-corporate-governance_36177.html

[2]Read our related article on the topic, here

Impleadment of company necessary element under section 138/141 of NI Act

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CS Megha Saraf and Qasim Saif, Vinod Kothari and Company

corplaw@vinodkothari.com

 

A company is an artificial person acting through its management, specifically its board of directors. Also, a company is a separate legal entity that is to say, that a company has a separate legal standing and owns its assets and is liable for its debts. Though both these principles are well settled in corporate laws across the globe, from time to time there arises conflict on the matter that whether director should be held liable for the acts that he did as an office-holder in company or the company should be held solely liable. This conflict has been addressed in various cases and also under the Companies Act, 2013 (“Act, 2013).

In a recent ruling, Bhupendra Suryawanshi v/s Sai Traders[1], the Madhya Pradesh High Court held the company “vicariously liable” for the dishonour of cheque issued on behalf of company by its chairman as the foremost criteria for impleading a person signing on behalf of that company.

The article discusses the said judgment in light of the relevant provisions and other judicial precedents.

Brief facts of the case

In the instant case, the Petitioner (Chairman of Company X) had borrowed a particular sum from the Respondent. In order to make payment, the Petitioner had issued a cheque for the amount. Later, when the cheque was presented in the bank for clearance, the said cheque was dishonoured by the bank on account of “Stop Payment”.

The Respondent had filed a case in court of Judicial Magistrate of First Class, impleading only the Petitioner but not the Company, which was later on appealed in the High Court. The Petitioner had contended that as the Company is not impleaded, the case is liable to be quashed. Whereas, the Respondent was of the view that since, the Petitioner has borrowed the money from the Respondent for his own business purpose, there was no need to implead the Company as an accused.

Observations by the MP HC and other judicial pronouncements

On the perusal of facts, legal text and representation made by the parties, the HC observed as follows-

  • On reading of the provisions, it is apparent that Section 141 of NI Act deals with the offences committed by the companies and says that if an offence is committed by a company under Section 138 of the Act, every person, at the time, the offence was committed, was in-charge and responsible to the company in the conduct of the business of the company, is liable along with the company to be proceeded against and punished accordingly.
  • In the case of Aneeta Hada v. Godfather Travels & Tours (P) Ltd.[2] the Supreme Court has held that there cannot be any vicarious liability unless there is prosecution against the company.
  • In the case of M.S. Pharmaceuticals Corporation Ltd v/s Neeta Bhalla & Anr[3], National Small Industries Corporation Ltd v/s Harmeed Singh Paintal & Anr[4], and K.K. Ahuja v/s V.K. Vora & Anr[5], the Supreme Court had explained the necessity of specific averment in the complaint regarding the company and that director/ managing director/ joint managing director/ other employees of the company cannot be prosecuted under Section 138 of the NI Act unless the company is impleaded as an accused.

Therefore, in the instant case, since the demand notice was served only on the petitioner/accused and there was no demand notice against the company, it held that without arraying the company as an accused in the complaint case, the petitioner cannot be prosecuted for an offence and subsequently allowed the case.

Our Comments

Section 138 read with Section 141 of the Negotiable Instruments Act, 1881 (“NI Act”) provides that where any cheque is drawn by any person on an account maintained by him with a banker and if it is returned back by the banker due to:

  • Insufficient balance to honour the cheque;
  • The cheque value exceeds the amount arranged for payment from the account;

such person is deemed to have committed an offence and is punishable with an imprisonment or fine or with both.

However, before charging a person with such offence, it is required that the following three conditions are fulfilled:

  • the cheque is presented to the bank within 6 months from the date on which it is drawn or within the period of its validity, whichever is earlier;
  • the payee or the holder in due course of the cheque, as the case may be, makes a demand for the payment of the said amount of money by giving a notice; in writing, to the drawer of the cheque, within 30 days of the receipt of information by him from the bank regarding the return of the cheque as unpaid; and
  • the drawer of such cheque fails to make the payment of the said amount of money to the payee or, as the case may be, to the holder in due course of the cheque, within 15 days of the receipt of the said notice.

It is only if the abovementioned conditions are present, the person drawing such cheque can be held liable.

While the aforesaid provides for the reason for charging such person to such offence, it is also pertinent to note the applicability of Section 141 to such case. Section 141 of the NI Act provides for “offences by companies”. Several judicial pronouncements had already quashed cases due to no averment against the company before alleging a person who was acting on behalf of such company, thereby clearly providing the extension of Section 141, to the company first before moving ahead and charging the person-in-charge and holding good the concept of “vicarious liability”.

The MP High Court Order thus relied on Aneeta Hada Vs. Godfather Travels and Tours Private Ltd., and S.M.S. Pharmaceuticals Ltd. Vs. Neeta Bhalla and Another and is in sync with the observations of SC.

Decriminalisation of offence committed u/s 141 of the NI Act– is it desirable?

Aside, it may be pertinent to note that the Department of Financial Services had recently issued a Suggestion Paper[6] and had laid down certain provisions of 19 Acts for de-criminalisation of offences which were open for public comments. One of the provisions include Section 138 of the NI Act. Several Supreme Court judgements such as M/s. Dalmia Cement (Bharat) Ltd. v. M/s. Galaxy Traders and Agencies Ltd[7] and Indian Bank Association and others v. Union of India[8], have already recognised the essence and intent of the section and deliberated on the nature of default involved in the matter. It is pertinent to note that as per the 213th report of the Law Commission[9]; almost 20 percent of the pending litigation relates to cheque dishonour disputes.

In India, contractual relationships are a common way of doing business. The whole purpose of issuing a cheque is to make payment ultimately, and if the person knows that even if he is unable to make the payment, no strict legal action can be taken against him, a cheque will lose its value as a negotiable instrument as there is no promise of getting the payment. Hence, it might not be a feasible idea to decriminalise the section.

Our other Articles on this subject may be viewed at:

  1. Dishonour of PDCs may not be an offence u/s 138 of NI Act- click here
  2. Bounced cheque: SC ruling makes prosecution easier- click here

To read our articles, on other subjects, click here

To subscribe to our YouTube channel, click here

 

[1] https://mphc.gov.in/upload/jabalpur/MPHCJB/2020/MCRC/735/MCRC_735_2020_FinalOrder_09-Jun-2020.pdf

[2] http://www.supremecourtcases.com/index2.php?option=com_content&itemid=99999999&do_pdf=1&id=24430

[3] https://indiankanoon.org/doc/775638/

[4] https://indiankanoon.org/doc/832836/

[5] https://indiankanoon.org/doc/1957018/

[6] https://financialservices.gov.in/sites/default/files/Decriminalization%20-%20Public%20Comments.pdf

[7] https://indiankanoon.org/doc/60864/

[8] https://indiankanoon.org/doc/105912122/

[9] http://lawcommissionofindia.nic.in/reports/report213.pdf

MCA widens CSR for defence personnel

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Measures for the CAPF and CMPF veterans and dependants now a part of CSR activity

Ankit Vashishth, Executive, Vinod Kothari and Company; corplaw@vinodkothari.com

Introduction

Schedule VII of the Companies Act, 2013 (‘Act’) currently includes measures taken for the armed forces veterans, war widows and their dependants as one of the CSR activities. The Ministry of Corporate Affairs (“MCA”) vide its Notification[1] dated 23rd June, 2020 has included contribution made towards the benefit of Central Armed Police Forces (CAPF) and Central Para Military Forces (CPMF) veterans and their dependents including widows, within the ambit of CSR.

MCA has issued several notifications either to clarify or broaden the ambit of Schedule VII. This Notification is yet another step taken by the MCA for widening the scope of CSR activities to include CAPF and CMPF veterans and their dependants and war widows.

This note tries to provide a quick coverage on the said amendment.

Difference between Armed Forces and CAPF/CPMF

Armed Forces CAPF CPMF
The term “armed forces” basically means – Indian Armed Forces which are the military forces of the Republic of India. It comprises three professional uniformed services :

1.   The Indian Army

2.   The Indian Navy

3.   The Indian Air Force

 CAPF (Central Armed Police Force)[2]  consists of :

1.         Assam Rifles (AR);

2.         Border Security Force (BSF);

3.         Central Industrial Security    Force (CISF);

4.         Central Reserve Police Force (CRPF);

5.         Indo Tibetan Border Police (ITBP);

6.         National Security Guard (NSG); and

7.       Sashastra Seema Bal (SSB)

 The nomenclature CAPF will be used uniformly for CPMF as per the Office Memorandum [3]issued by the Ministry of Home Affairs issued on March 18, 2011

Current CSR spending pattern and changes expected due to the amendment

The current pattern for CSR spending for armed forces veterans, war widows and their dependants include contributions to several funds like:

  1. Armed Forces Flag Day Fund (AFFDF)[4]
  2. Army Wives Welfare Association (AWWA)[5]
  3. The Army Welfare Fund Battle Casualties[6]

Apart from donating to these funds, companies have also provided financial relief to the martyr’s families and have conducted workshops for the children of war widows as a part of their CSR projects.

Further, in addition to the above, contribution to “National Defence Fund” which is used for the welfare of the members of the Armed Forces (including Para Military Forces) should be eligible for being a CSR activity.

As a result of the enhanced scope for CSR spending for CAPF/ CAMF, contribution to the fund “Bharat Ke Veer Corpus Fund”[7], which was previously not eligible for CSR considering the fact that it specifically benefits CAPF, will now be covered as per the amendment. Accordingly, any contribution to this fund will now qualify as a CSR activity.

High Level Committee on CSR

MCA had constituted[8] a High Level Committee (HLC) on CSR in February, 2015 under the Chairmanship of Secretary (Corporate Affairs) to review the existing CSR framework and formulate a coherent policy on CSR and further make recommendations on strengthening the CSR ecosystem, including monitoring implementation and evaluation of outcomes. Later, the HLC on CSR was re-constituted[9] in November, 2018. The scope of HLC was widened to include recommendation of guidelines for enforcement of CSR provisions. Though the Report discussed on amending Schedule VII in line with promoting sports, senior citizens’ welfare, welfare of differently abled persons, disaster management, and heritage, however, it did not consider widening the clause relating to the scope of armed forces in the Schedule.

Further, as evident from the data given in the HLC Committee Report[10], CSR expenditure made on armed force veterans, war widows/ dependents have seen an upward trend over the years, however it forms a very small proportion of the total CSR expenditure made.

Concluding Remarks

The service spirit of CAPF is no less than that of the Indian Army. Acknowledging this fact MCA has brought this amendment. While all the areas for CSR are extremely important for the overall socio-economic welfare and development, the measures taken for the benefit of veterans and dependants of the armed forces and CAPF/ CPMF is an extremely noble activity.

Link to our other articles:

CSR: A ‘Corporate Social Responsibility’ or a ‘Corporate Social Compulsion’?

http://vinodkothari.com/2019/08/csr-a-corporate-social-responsibility-or-a-corporate-social-compulsion/

Proposed changes in CSR Rules

http://vinodkothari.com/2020/03/proposed-changes-in-csr-rules/

FAQs on Corporate Social Responsibility

http://vinodkothari.com/2019/11/faqs-on-corporate-social-responsibility/

Read our other articles on Corplaw : http://vinodkothari.com/category/corporate-laws/

Link to our Youtube Channel : https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

 

[1] http://egazette.nic.in/WriteReadData/2020/220133.pdf

[2] https://www.mha.gov.in/about-us/central-armed-police-forces

[3] Office Memorandum can be viewed here

[4] http://ksb.gov.in/armed-forces-flag-day-fund.htm

[5] https://awwa.org.in/contribution-under-csr-awwa

[6] The Army Welfare Fund Battle Causalities

[7] https://www.bharatkeveer.gov.in/about

[8] https://www.mca.gov.in/Ministry/pdf/General_Circular_01_2015.pdf

[9] https://www.mca.gov.in/Ministry/pdf/OfficeOrderCommitteeOnCorporate_26112018.pdf

[10] https://www.mca.gov.in/Ministry/pdf/CSRHLC_13092019.pdf

 

 

A Guide to Disclosure on COVID-19 related impacts

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| SEBI seeks transparency from listed entities in times of COVID crises

Shaifali Sharma | Vinod Kothari and Company

corplaw@vinodkothari.com

Introduction

The impact of COVID-19 on companies is evolving rapidly not only in India but all over the world. In times of increased volatility and uncertainty in the capital market, detailed information regarding any material impact on the company’s business will not only assist the investors in making informed investment decisions but will also be fundamental formarket integrity and functioning.

Pursuant to the requirements of Listing Regulations, many listed entities have made disclosures, primarily intimating shutdown of operations owing to the pandemic and the resultant lockdowns. However, such probable information may be relatively less relevant and investors are more interested to know where these companies stand today, what are their estimated future impacts, strategiesadopted by these companies for addressing the effects of COVID-19, etc.

Given the information gaps in the market, SEBI, highlighting the importance of timely and adequate disclosures to investors and other stakeholders, issued an advisory[1]on May 20, 2020 (‘Advisory’), asking all the listed entities to evaluate the impact of COVID-19 on their business, performance and financials, both qualitatively and quantitatively, and disseminated the same to the stock exchange.

This article discuss in detail the disclosure requirements under Listing Regulations and provides a quick guide for the listed entities in evaluating and disclosing impact of pandemic on their business.

Existing disclosure norms under Listing Regulations on impact of COVID-19

The existing requirements prescribed under Listing Regulations in relation to the disclosure of impact of COVID-19 on listed entities are summarized below.The same is applicable to the following entities:

  • companies listed with specified securities i.e. equity shares and convertible securities
  • companies listed with Non-convertible Debt Securities (NCDs) and/or Non-Convertible Redeemable Preference Shares (NCRPSs)
Entities having specified securities listed Entities having NCDs/NCRPS listed
What is the disclosure requirements prescribed under Listing Regulations?
The events can be divided into two broad categories a. Deemed Material Events and b. Material Events based on application of materiality criteria as provided in Regulation 30(4).

In the first category, the events specified in Para A of Part A of Schedule III get covered and requires mandatorily disclosure on the occurrence and in the second category, events under Para B are disclosed based on the application of the guidelines for materiality prescribed under sub-regulation (4) of Regulation 30.

 Unlike Regulation 30, Regulation 51 does not provide for any test of materiality.

Part B of Schedule III requires disclosure of all information either,

  • having bearing on the performance/ operation of the listed entity; or
  • is price sensitive; or
  • shall affect the payment of  interest/ dividend on NCDs/ NCRPSs; or
  • shall affect the  redemption of NCDs/ NCRPSs.
Whether disclosure on COVID impact required by Listing Regulations?
Yes.

Disclosure w.r.t. disruption of operations of any one or more units or division of a listed entity due to natural calamity (earthquake, flood, fire etc.), force majeure or events such as strikes, lockouts etc. falls under second category.

Therefore, disruption of operations due to COVID-19 is required only if the same is considered material after applying the materiality guidelines.

 Yes.

Since disruption caused by COVID may be said to have the aforesaid effects.
What are the actionables as per Listing Regulations?
In terms of sub- regulation (5) of Regulation 30, the Board of Directors (BoD) is required to authorize one or more KMPs for the purpose of determining materiality. Therefore, such authorized KMP(s) shall determine if the impact of COVID on company’s operations is material based on the criteria prescribed under sub-regulation (4) and the policy framed by company for said purpose.

On determination of the materiality, the same shall be disclosed to stock exchange and also host the disclosure on company’s website.

 For this category of companies, the law does not provide for the similar requirements as provided for companieshaving specified securities listed eg. framing of policy, determination of materiality by Board authorized person etc. Therefore, the disruption caused by COVID-19 shall be intimated to the stock exchanges(s) as per Regulation 51 of the Listing Regulations.

In this case, disclosure on website is not mandatory; however, company may do so for better reach of information to investors and stakeholders.
When is the disclosure required?
Regulation 30 provides for disclosure as soon as reasonably possible, but not later than 24 hours from the occurrence of the event. The guidance on when an event is said to have occurred has been provided in SEBI Circular[2] dated September 09, 2015. In terms of the said Circular, the same would depend upon the timing when the listed entity became aware of the event/information or as soon as, an officer of the entity has, or ought to have reasonably come into possession of the information in the course of the performance of his duties. Regulation 51 provides for prompt dissemination i.e. as soon as practically possible and without any delay and that the information shall be given first to the stock exchange(s) before providing the same to any third party.
What all disclosures have been suggested by SEBI vide its Circular dated September 09, 2015?
As per SEBI circular dated September 09, 2015, companies shall disclose:

At the time of occurrence of disruption:

  • expected quantum of loss/ damage caused at the time of occurrence of the event;
  • whether loss/damage covered by insurance or not including amount
  • estimated impact on the production/operations
  • factory/unit where  the  lock  out  takes  place  with reasons

Regularly, till complete normalcy is restored

  • Insurance   amount   claimed   and   realized   by   the   listed   entity   for   the loss/damage;
  • actual amount of damage caused
  • details of steps taken to restore normalcy and impact on production/operations, financials of the entity
 Though the said Circular refers to only Regulation 30, however, the same requirements should apply to this category of companies also which should additionally disclose the impact on servicing of interest/ dividend/ redemption etc.

Similar disclosure requirement are prescribed for entities which has listed its Indian Depository Receipts, Securitized Debt Instruments and Security Receipts where all information which is price sensitive or having bearing on the performance/ operation of the listed entity and other material event as prescribed under Chapter VII, VIII, VIIIA read with Schedule III of the Listing Regulations shall be disclosed

Disclosure requirements as per SEBI Advisory

As mentioned earlier, SEBI Advisory is an addition to the above requirements of Listing Regulations. Though, one may argue that the Advisory is recommendatory in nature and it does not mandate the companies to make the disclosure, however, in our view, the same is not a mere recommendation. Keeping this in mind, the probable questions that one can have with respect to SEBI Advisory have been captured below:

What is the intention of the SEBI behind issuing such Advisory?

As mentioned in the SEBI Advisory, the outbreak of COVID-19 pandemic and the consequent nationwide lockdown has lead to distortions in the market due to the gaps in information available about the operations of a listed entity and therefore, it is important for a listed entity to ensure that all available information about the impact of pandemic on the company and its operations is communicated in a timely and cogent manner to its investors and stakeholders.

These disclosures ensure transparency and will provide investors an opportunity to make an accurate assessment of the company. So, the idea behind the disclosures is to give an equal access to the information to all the stakeholders at large.

Which all entities are covered by SEBI Advisory?

Due to the COVID-19, a global pandemic, all kinds of businesses are impacted in one way or another. Unlike the Listing Regulations, SEBI Advisory does not differentiate the disclosure requirements for the companies listed with specified securities and companies listed with NCDs/NCRPS, and the Advisory is applicable to all the listed entities.

Whether the requirements of Advisory are mandatory for listed entities?

Considering the purpose of making fair and timely disclosure of any material impact on the companies, the disclosures as mentioned in the Advisory shall be treated as mandatory in nature.

Whether disclosure required if the thresholds as set out in company’s materiality policy are not met?

The materiality of an event is generally measured in terms of thresholds laid down by the companies in their ‘policy for determination of materiality’ however, such criteria should not be considered as an absolute test to determine the materiality of an event like COVID pandemic

In times of the ongoing crises, investors would be interested to know all the inside information about the impact of pandemic on the company’s business operations, financial results, future strategies, etc. i.e. every qualitative or quantitative factors.

Since every person is doing an assessment of the impact of the crisis, it is intuitive to say that the management of the companies must also have done some assessment. Considering that the idea is to provide general and equal access to the information to all the stakeholders at large, the management must disclose every positive/negative/neutral impact of the crises on the company, irrespective of the fact that it qualifies the prescribed materiality threshold or not.

What if there no impact on the business caused by the pandemic? Whether the same is also required to be disclosed?

In our view, not getting affected by the pandemic at the time when the entire world is otherwise getting affected is also material. Therefore, the disclosure shall have to be made.

Further, it is not always necessary that the pandemic will have to have a negative impact e.g. decrease in sales volume. For example, companies in pharmaceutical sector or in the sector of manufacturing of essential items such as, mask, sanitizer etc. will have a boost in sales, thereby carrying a positive impact on them.

Whether Board meeting is required to be conducted in this regard? Or will the company be required to wait till the Board decision to make the disclosure?

While an internal assessment is required at the management level, however, a Board meeting is not mandatory to be conducted. Yes, the estimates already made may be changed at a later stage which may be disclosed at that stage again.

Is it ok to say for the management to take a position that they have not analyzed the impact of the crisis?

Considering the current risk and challenges as a result of COVID-19, it is very unlikely to say that companies have not done any internal assessment to determine the current and potential impact on the company’s financial and business operations.

What are the steps involved in making the disclosure?

Step 1: Evaluate the impact of the pandemic on the business, performance and financial

Before making any disclosure to the stock exchange(s), the management of the company must properly assess the impact of COVID-19 on its business, performance and financials, both qualitative and quantitative impact.

Step 2: Dissemination of impact of pandemic to stock exchange

The following information shall be disseminated to the stock exchange:

  1. Impact of the pandemic on the business;
  2. Ability to maintain operations including factories/ units/ office spaces functioning and closed down;
  3. Schedule, if any for restarting the operations;
  4. Steps taken to ensure smooth functioning of the operations;
  5. Estimation of future impact on the operations;
  6. Details of impact on the listed entity’s
    • capital and financial resources;
    • profitability;
    • liquidity position;
    • ability to service debt and other financing arrangements;
    • assets;
    • internal financial reporting and control;
    • supply chain
    • demand for its products/services;
  7. Existing contracts/agreements where non-fulfilment of the obligations byany party will have significant impact on the listed entity’s business;
  8. Any other information as the entity may determine to be relevant and material;

While making the above disclosure to stock exchanges, entities shall also adopt the principle of disclosure and transparency prescribed under Regulation 4(2)(e) of the Listing Regulations.

Who is responsible to evaluate and make disclosures to the stock exchange(s)? What is the role of the Board in the process of assessment and/or disclosure?

  1. Responsibility of KMP(s) as per Listing Regulations

Pursuant to Regulation 30 of the Listing Regulations, the KMP(s), as may be authorized by the Board, is responsible to determine the materiality of the impact of pandemic on the company based on the on the guidelines for materiality and the materiality policy of the company and disclose the same to the stock exchange

  1. Role of Board in the assessment of other material qualitative and quantitative impacts

Considering the language of the Advisory issued by SEBI, in addition to the KMPs authorized to test the materiality, the Board will also have a role in determining the COVID impact as the same requires disclosure in which management intervention may be necessary, e.g. future plans for business continuity, capability of running the business smoothly, material changes expected during the year, impact of the financial position etc.

However, as discussed above, a Board level discussion is not a prerequisite of making the disclosure.

Is there any timeline prescribed for making disclosers to the stock exchange(s)?

There is no specific timeline provided in the Advisory for making disclosures, however, in the present situation, the disclosure is required to be made as soon as an assessment is done on the probable impact by the management.

Whether the disclosures a one-time requirement for the listed entities?

Since the operations of the company will recommence soon, question arises if the companies should continue with its assessment and disclosure process. As stated in Advisory, to have continuous information about the impact of COVID-19, listed entities may provide regularupdates, as and when there are material developments. Further, since the disclosures will be made based on estimates, any changein those estimates or the actual position shall also be disclosed in regular intervals.

Therefore, disclosure is required not only at the time of occurrence but also on a continuous basis till the normalcy of the situation.

Whether impact on an unlisted subsidiary company shall also be disclosed? 

To get an overall view of company’s performance, we always evaluate consolidated figures. Sometimes, company’s standalone performance is strong as compared to its performance at consolidated level. Accordingly, if the pandemic’s impact on unlisted subsidiary is such that it is having a material impact at the group level, the same shall be disclosed to the stock exchange.

Whether effects of COVID-19 be also reported in Financial Results?

In the coming days, companies will be disclosing their quarterly and yearly financial results. This time, however, investors will be interested inknowing the impact of COVID-19 on the company’s financial positions. Therefore, while submitting financial statements under Regulation 33 of the Listing Regulations, companies should mention about the impact of the CoVID-19 pandemic on their financial statements.

What will be the consequences for not complying with the SEBI Advisory?

Since no separate penal provisions are prescribed under the Advisory, non- compliance of the same may not lead to any penal consequences.

What is the global position as regards disclosure of COVID impact?

Market regulators worldwide have taken various steps to ensure transparency related to the impacts of the pandemic on the listed companies. In United States, the Securities Exchange Commission has issued guidance[3] regarding disclosure and other securities law obligations that companies should consider w.r.t the COVID-19 and related business and market disruptions. Similarly, for listed companies and auditors in Hong Kong, the Securities and Futures Commission and the Stock Exchange of Hong Kong Limited issued a joint press release[4] in relation to the disclosure requirements in response to the COVID-19 outbreak

Our write-up giving an insightful analysis on the said SEBI advisory drawing an inference from the global perspective can be viewed here

What kind of information be disclosed to the stock exchange?

The table below is a quick guide for the listed entities in determining and disclosing the impact of COVID-19 on their businesses:

 

Sr. No. Subject of Assessment and Disclosure Broad Contents (Illustrative list)

 
I.                     Current status (both financial and operating status)

 
  • Status of closure and reopening of branches/units/ stores in different parts
  • Areas in which the company is operating
  • Current liquidity position
  • Impact on productions, sales, profits, stock prices, credit rating, assets, etc.
  • Internal financial reporting and control
  • Impact in capital and financial resources
  • Current trading and outlook
  • Impact on working staff
  • Layoffs during the period
  • Areas of business most impacted
  • Status of business in other countries (say China)
  • Delay of important projects
  • Suspension of dividends
  • Impact of Government imposed measure/restrictions (e.g. for logistic companies, border closures may impact ability to operate)

 
II.                  Steps taken to address effects of COVID Steps taken to:

  • reduce business/operating cost or cost cutting measures adopted
  • conserve cash and ensure liquidity
  • secure safety of employeesensure business continuity
  • address the immediate impact and ensure future positioning
III.               Future operational and financial status (estimates)
  • Estimation of future impact on the operations
  • Estimated trends in demand for its products/services
  • Expected financial resource needsFuture expectations of financial and operating conditions
  • Any material impairment (e.g. impairment of goodwill)
  • Forecasts for the year
  • Material changes expected during the year
  • Business continuity plans
  • Future operating/ financial long-terms or short-term  strategies to address future risk/challenges
  • Other forward-looking disclosures
IV.               Company Specific Focusing on the sectors in which the company deals in, the impact of crises varies from company to company and shall be assessed accordingly. For example:

  • Closure of unit/factory/company
  • Breach of contract significantly impacting the company’s business

 

The above list is illustrative but not exhaustive and each company will need to carefully assess COVID-19’s impact and related material disclosure obligations.  

Concluding Remarks

In light of the effects and uncertainties created by COVID-19, disclosure about shutdowns and safety measures against COVID will not help the investors in making an informed assessment about the company’s financial position. Timely and adequate information about company’s current operational and financial status with future plans to address the effects of COVID-19 will better equip the investors to make an investment decision. Therefore, the Advisory should not be considered as a mere recommendation of SEBI as a transparent communication by the companies will allow the investors and other stakeholders to evaluate current and expected impact of COVID-19 on company’s businesses, financial and operating conditions and future estimated performance.

[1]https://www.sebi.gov.in/legal/circulars/may-2020/advisory-on-disclosure-of-material-impact-of-covid-19-pandemic-on-listed-entities-under-sebi-listing-obligations-and-disclosure-requirements-regulations-2015_46688.html

[2]https://www.sebi.gov.in/legal/circulars/sep-2015/continuous-disclosure-requirements-for-listed-entities-regulation-30-of-securities-and-exchange-board-of-india-listing-obligations-and-disclosure-requirements-regulations-2015_30634.html

[3] https://www.sec.gov/corpfin/coronavirus-covid-19

[4] https://www.hkex.com.hk/-/media/HKEX-Market/Listing/Rules-and-Guidance/Other-Resources/Listed-Issuers/Joint-Statement-with-SFC/20200204news.pdf

Other reading materials on the similar topic:

  1. ‘Listed company disclosures of impact of the Covid Crisis: Learning from global experience’ can be viewed here
  2. ‘Resources on virtual AGMs’ can be viewed here
  3. ‘COVID-19 – Incorporated Responses | Regulatory measures in view of COVID-19’ can be viewed here
  4. Our other articles on various topics can be read at: http://vinodkothari.com/

Email id for further queries: corplaw@vinodkothari.com

Our website: www.vinodkothari.com

Our Youtube Channel: https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

RBI grants additional 3 months to FPIs under Voluntary Retention Route

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Shaifali Sharma | Vinod Kothari and Company

corplaw@vinodkothari.com

In March, 2019, the RBI with an objective to attract long-term and stable FPI investments into debt markets in India introduced a scheme called the ‘Voluntary Retention Route’ (VRR)[1]. Investments through this route are in addition to the FPI General Investment limits, provided FPIs voluntarily commit to retain a minimum of 75% of its allocated investments (called the Committed Portfolio Size or CPS) for a minimum period of 3 years (retention period).However, such 75% of CPS shall be invested within 3 months from the date of allotment of investment limits. Recognizing the disruption posed by the COVID-19 pandemic, RBI vide circular dated May 22, 2020[2], has granted additional 3-months relaxation to FPIs for making the required investments. The circular further addresses the questions as to which all FPIs are covered under this relaxation and how the retention period will be determined.

This article intends to discuss the features of the VRR scheme and the implications of RBI’s circular in brief.

What is ‘Voluntary Retention Route’?

RBI, to motivate long term investments in Indian debt markets, launched a new channel of investment for FPIs on March 01, 2019[3] (subsequently the scheme was amended on May 24, 2019[4]), free from the macro-prudential and other regulatory norms applicable to FPI investment in debt markets and providing operational flexibility to manage investments by FPIs. Under this route, FPIs voluntarily commit to retain a required minimum percentage of their investments for a period of at least 3 years.

The VRR scheme was further amended on January 23, 2020[5], widening its scope and provides certain relaxations to FPIs.

Key features of the VRR Scheme:

  1. The FPI is required to retain a minimum of 75% of its Committed Portfolio Size for a minimum period of 3 years.
  2. The allotment of the investment amount would be through tap or auctions. FPIs (including its related FPIs) shall be allotted an investment limit maximum upto 50% of the amount offered for each allotment, in case there is a demand for more than 100% of amount offered.
  3. FPIs may, at their discretion, transfer their investments made under the General Investment Limit, if any, to the VRR scheme.
  4. FPIs may apply for investment limits online to Clearing Corporation of India Ltd. (CCIL) through their respective custodians.
  5. Investment under this route shall be capped at Rs. 1,50,000/- crores (erstwhile 75,000 crores) or higher, which shall be allocated among the following types of securities, as may be decided by the RBI from time to time.
    1. ‘VRR-Corp’: Voluntary Retention Route for FPI investment in Corporate Debt Instruments.
    2. ‘VRR-Govt’: Voluntary Retention Route for FPI investment in Government Securities.
    3. ‘VRR-Combined’: Voluntary Retention Route for FPI investment in instruments eligible under both VRR-Govt and VRR-Corp.
  6. Relaxation from (a) minimum residual maturity requirement, (b) Concentration limit, (c) Single/Group investor-wise limits in corporate bonds as stipulated in RBI Circular dated June 15, 2018[6] where exposure limit of not more than 20% of corporate bond portfolio to a single corporate (including entities related to the corporate) have been dispensed with. However, limit on investments by any FPI, including investments by related FPIs, shall not exceed 50% of any issue of a corporate bond except for investments by Multilateral Financial Institutions and investments by FPIs in Exempted Securities.
  7. FPIs shall open one or more separate Special Non-Resident Rupee (SNRR) account for investment through the Route. All fund flows relating to investment through the VRR shall reflect in such account(s).

What are the eligible instruments for investments?

  1. Any Government Securities i.e., Central Government dated Securities (G-Secs), Treasury Bills (T-bills) as well as State Development Loans (SDLs);
  2. Any instrument listed under Schedule 1 to Foreign Exchange Management (Debt Instruments) Regulations, 2019 other than those specified at 1A(a) and 1A(d) of that schedule; However, pursuant to the recent amendments, investments in Exchange Traded Funds investing only in debt instruments is permitted.
  3. Repo transactions, and reverse repo transactions.

What are the options available to FPIs on the expiry of retention period?

Option 1

 

 Continue investments for an additional identical retention period
 

 

 

Option 2

 

 Liquidate its portfolio and exit; or

 
Shift its investments to the ‘General Investment Limit’, subject to availability of limit under the same; or

 
Hold its investments until its date of maturity or until it is sold, whichever is earlier.

Any FPI wishing to exit its investments, fully or partly, prior to the end of the retention period may do so by selling their investments to another FPI or FPIs.

3-months investment deadline extended in view of COVID-19 disruption

As discussed above, once the allotment of the investment limit has been made, the successful allottees shall invest at least 75% of their CPS within 3 months from the date of allotment. While announcing various measures to ease the financial stress caused by the COVID-19 pandemic, RBI Governor acknowledged the fact that VRR scheme has evinced strong investor participation, with investments exceeding 90% of the limits allotted under the scheme.

Considering the difficulties in investing 75% of allotted limits, it has been decided that an additional 3 months will be allowed to FPIs to fulfill this requirement.

Which all FPIs shall be considered eligible to claim the relaxation?

FPIs that have been allotted investment limits, between January 24, 2020 (the date of reopening of allotment of investment limits) and April 30, 2020 are eligible to claim the relaxation of additional 3 months.

When does the retention period commence? What will be the implication of extension on retention period?

The retention period of 3 years commence from the date of allotment of investment limit and not from date of investments by FPIs. However, post above relaxation granted, the retention period shall be determined as follows:

FPIS

 

 RETENTION PERIOD
*Unqualified FPIs Retention period commence from the date of allotment of investment limit

 
**Qualified FPIs opting relaxation

 

 

 Retention period commence from the date that the FPI invests 75% of CPS
Qualified FPIs not opting relaxation

 

 Retention period commence from the date of allotment of investment limit

*Unqualified FPIs – whose investments limits are not allotted b/w 24.01.2020 and 30.04.2020

**Qualified FPIs to relaxation – whose investments limits not allotted b/w 24.01.2020 and 30.04.2020 

What will be the consequences if the required investment is not made within extended period of 3 months?

Since no separate penal provisions are prescribed under the circular, in terms of VRR Scheme, any violation by FPIs shall be subjected to regulatory action as determined by SEBI. FPIs are permitted, with the approval of the custodian, to regularize minor violations immediately upon notice, and in any case, within 5 working days of the violation. Custodians shall report all non-minor violations as well as minor violations that have not been regularised to SEBI

Concluding Remarks

The COVID-19 disruption has adversely impacted the Indian markets where investors are dealing with the market volatility. Given this, FPIs are pulling out their investments from the Indian markets (both equity and debt). Thus, relaxing investments rules of VRR Scheme during such financial distress, will help the foreign investors manage their investments appropriately.

You may also read our write ups on following topics:

Relaxations to FPIs ahead of Budget, 2020, click here

Recommendations to further liberalise FPI Regulations, click here

RBI removes cap on investment in corporate bonds by FPIs, click here

SEBI brings in liberalised framework for Foreign Portfolio Investors, click here 

For more write ups, kindly visit our website at: http://vinodkothari.com/category/corporate-laws/

To access various web-lectures, webinars and other useful resources useful for the Corporate and Financial sector, visit and subscribe to our Youtube channel: https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

[1]https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11561&Mode=0

[2]https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11896&Mode=0

[3]https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11492&Mode=0

[4]https://www.rbi.org.in/Scripts/BS_CircularIndexDisplay.aspx?Id=11561

[5]https://rbidocs.rbi.org.in/rdocs/notification/PDFs/APDIR19FABE1903188142B9B669952C85D3DCEE.PDF

[6] https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NT199035211F142484DEBA657412BFCB17999.PDF

Introduction to FEMA (NDI) Rules, 2019 and recent amendments

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For relevant questions discussed during the webinar, click here.

COVID- 19 AND DEBENTURE RESTRUCTURING

/3 Comments/in /by

-Munmi Phukon, Pammy Jaiswal and Richa Saraf (corplaw@vinodkothari.com)

ICRA has published a report on 23.04.2020[1], listing out some 328 entities[2] who have availed or sought a payment relief from the lending institutions or investors. The list also includes names of such entities that have received an in-principle approval from investors in their market instruments (like non-convertible debentures)- prior to the original due date- for shifting the original due date ahead, but where a formal approval from the investors was received either after the original due date or is still pending to be received.

Earlier, Securities and Exchange Board of India (SEBI) had, vide circular no. SEBI/ HO/ MIRSD/ CRADT/ CIR/ P/ 2020/53 dated 30.03.2020[3], addressed to the credit rating agencies (CRAs), granted certain relaxation from compliance with certain provisions of the circulars issued under SEBI (Credit Rating Agencies) Regulations, 1999 due to the COVID-19 pandemic. The circular stipulated that appropriate disclosures in this regard shall be made in the press release, seemingly, the report published by ICRA is a part of the disclosure requirement specified by SEBI.

In view of the COVID crisis, companies in large numbers are approaching investors or will be approaching investors for restructuring of the debentures, therefore, it becomes pertinent to discuss- how the restructuring is carried on? whether a meeting of debenture holders will be required to be convened? what will be the consequences if the restructuring is not done? and other related questions. Below we discuss the same.

Force Majeure– An Excuse to Default?

In financial terms, “default” means failure to pay debts, whether principal or interest. Under ISDA Master Agreement[4], failure by the party to make, when due, any payment is listed as an event of default and one of the termination events. However, the ISDA Master Agreement provides that in case of a force majeure event, payments can be deferred. Most of the standard agreements, contain specific clauses pertaining to force majeure, where the party required to perform any contractual obligation is required to intimate the other party as soon as it becomes aware of happening of any force majeure event. While in some cases, due to impossibility of performance, the agreement itself is frustrated; in some other cases, the obligations are merely deferred till the event persists.

Our article “COVID- 19 and The Shut Down: The Impact of Force Majeure” can be accessed from the link: http://vinodkothari.com/2020/03/covid-19-and-the-shut-down-the-impact-of-force-majeure/

Consequences of default- Rights available to debenture holders:

A debenture holder has several options available in case of default: (a) insolvency proceedings; (b) enforcement of security interest; (c) proceedings for recovery of debt due. Below we discuss the same:

– Right to call for meeting of debenture holders: Rule 18 (4) of the Companies (Share Capital and Debentures) Rules, 2014 stipulates that the meeting of all the debenture holders shall be convened by the debenture trustee on:

  • requisition in writing signed by debenture holders holding at least 1/10th in value of the debentures for the time being outstanding; or
  • the happening of any event, which constitutes a breach, default or which in the opinion of the debenture trustees affects the interest of the debenture holders.

– Right to make an application before NCLT: Section 71(10) of the Companies Act, 2013 provides that on failure of the company to redeem the debentures on the date of their maturity or failure to pay interest on the debentures when it is due, an application may be filed by any or all of the debenture holders or debenture trustee, seeking redemption of the debentures forthwith on payment of principal and interest due thereon.

– Application under IBC: Section 5(7) of IBC defines a “financial creditor” to mean any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to, and Section 5(8) of IBC defines “financial debt” as a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument. Thus, debenture holders are treated as financial creditors for the purpose of IBC and may exercise all the rights as available to a financial creditor.

As per Section 6 of IBC-“Where any corporate debtor commits a default, a financial creditor, an operational creditor or the corporate debtor itself may initiate corporate insolvency resolution process in respect of such corporate debtor in the manner as provided under this Chapter”.  Accordingly, the debenture holders (whether secured or not) may apply for initiation of corporate insolvency resolution process against the company under Section 7 of IBC. In fact the Central Government has, vide notification no. S.O. 1091(E) dated 27th February, 2019, notified that such right may also be exercised by the debenture holder, through a debenture trustee.

– Right to enforce security interest: The right of foreclosure is a counter-part of right of redemption. Just like a company has a right of redeeming the security after payment of debt amount, a secured debenture holder has a right of foreclosure or sale in case of default in redemption. In the case of Baroda Rayon Corporation Limited vs. ICICI Limited[5] and in Canara Bank vs. Apple Finance Limited[6], Bombay High Court upheld the right of the debenture trustee to sell off the properties of the company for the benefit of the debenture holders.

Here, it is pertinent to understand how the debenture holders shall exercise the right of foreclosure. The law distinguishes between security interests based on the nature of the collateral. For instance, in case of security interests on immovable properties, Chapter IV of Transfer of Property Act, 1882 applies.  Further, the security interest, in case of secured debentures, can be enforced in the following manner: (a) In case the debenture holder is a bank/ financial institution, as per the provisions of Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002; and (b) In case the debenture holder is not a bank/ financial institution, as per the common law procedures.

– Other remedies: Any default in the terms of the debentures is a breach of contract, and the debenture holder may sue the company for breach of contract as per the provisions of Contract Act, 1872, and further seek for compensation as per the terms of the debenture, or in absence of specific term in the agreement, compensation may be claimed as per the provisions of Section 73 of the Contract Act, 1872.

Issues cropping up due to COVID- 19 and the resolution thereof:

In view of the COVID pandemic one of the issue that was arising was that the issuers of debt instruments who were not able to fulfil the obligations as per the terms of the debentures or redeem the same on the maturity date were running to courts for seeking interlocutory reliefs, seeking to restrain the debenture holders from exercising any rights against the defaulting issuer. In the case of Indiabulls Housing Finance Ltd. vs. SEBI[7], the petitioner prayed for an ad interim direction to restrain any coercive action against it, with respect to the repayment to be made by it to its non-convertible debenture holders. In the said case, granting the prayer, the Hon’ble Delhi High Court directed maintenance of status quo with respect to the repayments to be made by the petitioner to the NCD holders.

Further, there was a lack of clarity on how rating and valuation of a security would be revised in view of the default or the restructuring? Therefore, SEBI has issued the following circulars:

  • SEBI, vide a circular no. SEBI/ HO/ MIRSD/ CRADT/ CIR/ P/ 2020/53 dated March 30, 2020[8], granted certain relaxation from compliance with certain provisions of the circulars issued under SEBI (Credit Rating Agencies) Regulations, 1999 due to the COVID-19 pandemic.

With respect to recognition of default, the circular stipulates that CRAs recognize default  based  on  the guidance issued  vide  SEBI circular dated May 3, 2010[9] and November 1, 2016[10], however, based on its assessment, if the CRA is of the view that the delay  in  payment  of  interest/principle  has  arisen  solely  due  to  the  lockdown  conditions   creating   temporary   operational   challenges   in   servicing   debt, including due to procedural delays in approval of moratorium on loans by the  lending institutions, CRAs may not consider the same as a default event and/or  recognize default.

  • Further, SEBI has, vide its circular no. SEBI/HO/IMD/DF3/CIR/P/2020/70 dated 23.04.2020[11], reviewed certain provisions of  the  circular  dated  09.2019[12] issued under  SEBI  (Mutual  Funds)  Regulations,  1996. In the circular, SEBI has stipulated that based  on  assessment,  if  the valuation  agencies appointed  by Association of Mutual Funds in India are of the view that the delay in payment of interest/principal or extension of  maturity of  a  security  by  the  issuer has  arisen  solely  due  to  COVID-19 pandemic  lockdown  creating   temporary   operational   challenges   in   servicing   debt, then valuation  agencies may  not  consider  the  same as  a  default for the  purpose of valuation of money market or debt securities held by mutual funds.

Restructuring Process and the Formalities associated thereto:

In the context of COVID, the restructuring of debentures shall mean nothing but deferral of the date of redemption. The terms of the debentures, including the maturity date, etc is specified in the terms of issuance. The terms of issuance also provides how the variation in terms can be effectuated. Therefore, it is pertinent that to make any changes in terms of debentures, the relevant clauses in the issuance terms are considered.

In terms of Reg. 59 (2) of the SEBI LODR Regulations, 2015, any material modification to the structure of debentures in terms of coupon redemption etc. are required to approved by the Board of Directors and the debenture trustee (DT). Further, in terms of Reg. 59(1), prior approval of the stock exchange(s) shall also be required for such material modification which shall be given by the stock exchange(s) only after obtaining the approval of the Board and the DT.

In addition to the approval as aforesaid, in terms of Regulation 15(2)(b) of SEBI DT Regulations, DT is required to call a meeting of the debenture holders on happening of any event which in the opinion of the DT affects the interest of the holders. Similar provision is there in the Companies (Share Capital and Debenture) Rules, 2014 also [sub- rule (4) of Rule 18].

Unlike the requirements of obtaining shareholders’ consent by way of special/ ordinary resolution for various matters including variation of rights thereof, there is no explicit provision  for obtaining of a consent of the debenture holders for restructuring of the debentures under the Companies Act, 2013 (‘CA 13’). However, the provisions of SS 2 being, mutatis mutandis, applicable to a meeting of debenture holders also, all the provisions w.r.t convening/ conducting of general meeting such as, sending of notice, explanatory statement etc. as applicable to general meetings shall apply to the meeting of debenture holders.

However, looking at the current crisis situation, where calling of a physical meeting is not possible, and issuers will be required to hold the meeting of the debenture holders, in case consent by e-mail is not possible due to the large number of debenture holders, through video conferencing mode. The modalities for participation (like voting, two-way communication, recording, etc.) and other compliances related of sending of notices etc. may be in the manner clarified by the MCA Circular dated 13.04.2020[13].

In a nutshell, the procedural requirements to be followed for restructuring of debentures shall be as provided hereunder.

S. No

 

 Relevant Provisions Actionable/ Compliance Remarks
1. Regulation 50 (3) of LODR Regulations Prior intimation to the stock exchange (SE) for the meeting board of directors, at which the restructuring is proposed to be considered.

 

 2 working days in before the board meeting.

 

(excl. date of intimation and date of meeting)
2. Sec. 173 of CA 13 BM to be convened by the Company for proposed restructuring including the revised terms subject to approval of the stock exchanges and the debenture holders.

 

 Through VC considering the COVID 19 Guidelines issued by the Govt. Our FAQs in this regard may be found at : https://www.google.com/url?q=http://vinodkothari.com/2020/03/board-meetings-during-shutdown/&sa=D&source=hangouts&ust=1587820272757000&usg=AFQjCNEictCwK_-LNnlH7oiB1GMmdRzO6w

 
3. Regulation 59(2)(a) of LODR Regulations

 

 Obtain approval of the DT Before applying to SEs.
4. Regulation 59 of the Listing Regulations Seek prior approval from the stock exchange

 

 After taking the consent of the board of directors and DT.

 
5. Regulation 15(2) of DT Regulations, 1993 Separate meeting of debenture holders to be called for deferment in repayment due to liquidity crunch in the hour of crisis.

 

 The meeting may be called by the company itself or through the DT.

Since the scope of SS 2 issued by ICSI includes meetings of debenture holders also, the company will have to observe the requirements of SS 2 in convening the meeting of debenture holders. However, considering the current crisis situation, such meeting may be convened through VC facility as clarified by MCA Circular dated 13th April, 2020. Our FAQs in this regard may be found at http://vinodkothari.com/2020/04/general-meetings-by-video-conferencing-recognising-the-inevitable/

 
6. Regulation 51 (2) of the Listing Regulations Intimation to the stock exchanges being an action that shall affect payment of interest or redemption of NCDs

 

 

 ASAP but not later than 24 hours of Board decision.

 Documentation Requirements:

In usual circumstances, if any variation is carried out in the debenture terms, the parties enter into an addendum, amending the clauses contained in the debenture subscription agreement (and also, in the trust deed/ security documents, if required), however, given the current scenario and the lock down, it is not possible for parties to sign and execute the agreements. Since the restructuring already has the approval of the majority debenture holders, it is deemed that the resolution “overrides the terms of issuance”. Thus, in our view, the resolution passed by the debenture holders approving the restructuring should suffice, and modification in the agreements may not be required.

[1] https://www.icra.in/Rationale/ShowRationaleReport/?Id=94320

[2] The rating agency has stated that the list is not a comprehensive one, as information about some rated entities are not readily available as of now, and separate disclosures will be made w.r.t. such entities.

[3]https://www.sebi.gov.in/legal/circulars/mar-2020/relaxation-from-compliance-with-certain-provisions-of-the-circulars-issued-under-sebi-credit-rating-agencies-regulations-1999-due-to-the-covid-19-pandemic-and-moratorium-permitted-by-rbi-_46449.html

[4] https://www.sec.gov/Archives/edgar/data/1065696/000119312511118050/dex101.html

[5] 2002 (2) BomCR 608, (2002) 2 BOMLR 915, 2003 113 CompCas 466 Bom, 2002 (2) MhLj 322

[6] AIR 2008 Bom 16, (2007) 77 SCL 92 Bom

[7]https://images.assettype.com/barandbench/2020-04/6ec54849-0188-4fe3-a841-88c2861124d5/Indiabulls_vs_SEBI.pdf

[8]https://www.sebi.gov.in/legal/circulars/mar-2020/relaxation-from-compliance-with-certain-provisions-of-the-circulars-issued-under-sebi-credit-rating-agencies-regulations-1999-due-to-the-covid-19-pandemic-and-moratorium-permitted-by-rbi-_46449.html

[9] https://www.sebi.gov.in/legal/circulars/may-2010/guidelines-for-credit-rating-agencies_1467.html

[10]https://www.sebi.gov.in/legal/circulars/nov-2016/enhanced-standards-for-credit-rating-agencies-cras-_33585.html

[11]https://www.sebi.gov.in/legal/circulars/apr-2020/review-of-provisions-of-the-circular-dated-september-24-2019-issued-under-sebi-mutual-funds-regulations-1996-due-to-the-covid-19-pandemic-and-moratorium-permitted-by-rbi_46549.html

[12] https://www.sebi.gov.in/legal/circulars/sep-2019/valuation-of-money-market-and-debt-securities_44383.html

[13] http://www.mca.gov.in/Ministry/pdf/Circular17_13042020.pdf

 

Please click below for youtube presentation on the above topic:

 

Our other content related to COVID-19 disruption may be referred here: http://vinodkothari.com/covid-19-incorporated-responses/

Our other articles relating to restructuring on account of COVID-19 disruption may also be viewed here:

Consensual restructuring of debt obligations, due to COVID disruption, not to be taken as default, clarifies SEBI

Restructuring of debt securities not to be treated as default, clarifies SEBI

Our presentation can be viewed here – https://vinodkothari.com/2021/09/structuring-of-debt-instruments/

Extended meaning of “encumbrance” on promoter holdings in listed entities

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-SEBI’s Order in Yes Bank promoters indicates long arm of the provision 

Munmi Phukon | Partner | Vinod Kothari & Company

corplaw@vinodkothari.com

Introduction

While structuring of instruments like debentures, parties resort to various covenants in order to protect the interests of the investors and also to reflect the intent and purpose of the parties more specifically. One fairly commonplace practice with promoters of Indian listed companies to raise funds on the strength of their shareholding in their companies. It is often observed that, in structuring such transactions, companies find innovative ways of creating pseudo security interests on shares. Therefore, a careful analysis of the documentation entered into by the parties is required to conclude whether the covenants amount to creation of an encumbrance or not.

SEBI has recently dealt with such a case[1], in which SEBI throws some light on what could constitute an encumbrance for the purpose of SEBI (SAST) Regulations, 2011 (Regulations). SEBI considered the covenants mentioned in the debenture trust deed (DTD) executed by the promoter entities of the listed entity at the time of issuance of NCDs and held the promoters liable for non-disclosure of the encumbrance created on the shares held in the listed entity.

Legislative intent and purpose of the SAST Regulations

SAST Regulations are considered to be a social welfare legislation. The aim and intent of the Regulations is to protect the interest of the investors and ensuring market integrity. That is why, the Regulations recognise the importance of event based and periodic disclosures, specifically by the promoters of the entity, through Regulation 29 to 31 thereof. It has always been seen as a measure for ensuring better corporate governance which in turn enables the regulators and stock exchanges to monitor the transactions of the promoters.

Requirements related to encumbered shares under the Regulations

Transactions involving promoters’ shares are considered crucial in order to ensure transparency as regards the ownership/ control of the target company as well as price discovery of the shares in an informed manner. The genesis of the requirements of such disclosures arose in the beginning of 2009 when SEBI made it mandatory by amending the provisions of the erstwhile Regulations.

Later, similar requirements were provided in the revamped SAST Regulations vide Regulation 31 which requires the promoters to disclose about the shares of the target company encumbered by them on a yearly basis to the stock exchange(s) where the shares of the target company are listed and also to the target company. The promoters have also been mandated, by virtue of an amendment made in the said Regulation, to give declaration to the audit committee of the target company and the stock exchange(s) on a yearly basis about not having any encumbrance.

Further, SEBI vide its Circular dated 7th August, 2019[2] read with its Press Release-PR No.16/2019[3] requires the promoters to disclose to the stock exchange(s) and the target company, the detailed reasons for encumbrance if the combined encumbrance by the promoter along with PACs with him equals or exceeds, a) 50% of their shareholding in the target company; or b) 20% of the total share capital of the target company and also any positive changes therein thereafter within two working days from the creation of such encumbrance.

Furthermore, Regulation 29 requiring disclosure of acquisition/ disposal of shares of the target company by an acquirer on meeting certain threshold, interestingly, also provides that shares taken by way of encumbrance shall be treated as an acquisition, and shares given upon release of encumbrance shall be treated as a disposal and shall also require disclosure. In this context, it is pertinent to note if the pledgee/creditor gets voting rights also or has the right to cause the shareholder to vote as per the instructions of the creditor, the transaction would well amount to acquisition of control and hence, triggering the Regulation 3 as well.

The term ‘encumbrance’ under the Regulations

The term ‘encumbrance’ is defined under Regulation 28(3) of the SAST Regulations. Further, there has been an amendment to the existing definition w.e.f 29th July, 2019 vide SEBI (Substantial Acquisition of Shares and Takeovers) (Second Amendment) Regulations, 2019[4]. Evidently, the text of the existing definition signifies that it is an inclusive explanation and not an exhaustive one keeping the same open to different interpretations.

 

SEBI had tried to clarify the broad definition through its FAQs that, non- disposal undertaking (NDU) will be covered under the purview of ‘encumbrance’. The FAQs also clarified that NDUs may, inter alia, include the following:

“-     not encumbering shares to another party without the prior approval of the party with whom the shares have been encumbered;

  • non-disposal of shares beyond a certain threshold so as to retain control;
  • non-disposal of shares entailing risk of appropriation or invocation by the party with whom the shares have been encumbered or for its benefit.”

As mentioned above, the existing text of the definition has been expanded. As claimed by SEBI itself, the amendments have been made in the context of recent concerns w.r.t. promoter/ companies raising funds from Mutual Funds/ NBFCs through structured obligations, pledge of shares, non- disposal  undertakings,  corporate/  promoter guarantees and various other complex structures,  which reads as below:

“(3) For the purposes of this Chapter, the term “encumbrance” shall include,

  • any restriction on the free and marketable title to shares, by whatever name called, whether executed directly or indirectly;
  • pledge, lien, negative lien, non-disposal undertaking; or
  • any covenant,  transaction,  condition  or  arrangement  in  the  nature  of encumbrance,  by  whatever  name  called,  whether  executed  directly  or indirectly.”

Brief of the SEBI’s Order

The Order of SEBI seems to be an attempt of making an interpretation of certain clauses of the debenture trust deeds (DTDs) entered into by the promoter entities in the context of the then definition of ‘encumbrance’ provided u/r 28(3). SEBI found the following clauses in the DTDs and construed the same as creation of encumbrance on the shares of the listed company:

  • Maintenance of asset cover ratio at all times i.e. maintenance of equity shares held by the promoters in the listed entity, over and above the borrowing of the promoter.
  • In case of breach of the said condition, even though the debentures can be redeemed, however, only with an approval of the debenture holders for such early redemption;
  • The requirement of creation of security in favour of the DTs by way of exclusive pledge of the shares held by the promoter in the listed entity while availing any further borrowing and also with prior notice and giving of right of first refusal to the debenture holders;
  • Maintenance of borrowing cap at all times i.e. borrowing over the value of the shares held in the listed entity and the requirement of obtaining of a consent of the debenture holders in case of sell, disposal or encumbrance of the said shares.

SEBI contended that the covenants related to maintenance of asset cover/ borrowing cap at all times restrict the abilities of the borrowers/ promoters to dispose of the shares of the listed entity held by them. Therefore, the same should be considered as encumbrance for the purpose of Regulation 28(3). Further, the requirement of obtaining prior approval/ consent of the debenture holders before disposing of the shares tantamount to be a non- disposal undertaking as clarified vide the FAQs which include not encumbering shares to another party without prior approval of the party with whom the shares have been encumbered.

Meaning of ‘encumbrance’ in jurisprudence

In two passages in Salmon on Jurisprudence, 12th Edition, at Page 241 under the sub-heading “Rights in re propria and rights in re aliena” the learned author has stated thus:

“Rights may be divided into two kinds, distinguished by the civilians as Jura in re propria[5] and jura in re aliena[6]. The latter may also be conveniently termed encumbrances, if we use that term in its widest permissible sense. A right in re aliena or encumbrance is one which limits or derogates from some more general right belonging to some other person in respect of the same subject -matter. All other are jura in re propria.”

At Page 242 the learned author has observed as follows:

“it is essential to an encumbrance that it should in the technical language of our law, run with, the right encumbered by it. In other words, the document and the servant rights are necessarily concurrent. By time it is meant that an encumbrance must follow the encumbered right into the hands of new owners, so that a change of ownership will not free the right from the burden imposed upon it. If this is not so — if the right is transferable free from the burden — there is no true encumbrance.”

Thus, the true test of an encumbrance is the concurrence of the right with property – that the right attaches to property and travels along with it. Salmon has discussed encumbrances elaborately and mentions 4 types of encumbrances: leases, servitudes, security interests, and trusts. A lease confers a right to use the property. Servitude is a right to the limited use of the property such as the right of way or easements. Security interests (including mortgages) are encumbrances vested in a creditor. A trust is the obligation attached to property to hold it for the benefit of another.

Madras High Court also in the matter of M. Ratanchand Chordia And Ors. vs Kasim Khaleeli[7] held as below:

“The word “Encumbrances” in regard to a person or an estate denotes a burden which ordinarily consists of debts, obligations and responsibilities. In the sphere of law it connotes a liability attached to the property arising out of a claim or lien subsisting in favour of a person who is not the owner of the property. Thus a mortgage, a charge and vendor’s lien are all instances of encumbrances. The essence of an encumbrance is that it must bear upon the property directly and in-directly and not remotely or circuitously. It is a right in re aliena circumscribing and subtracting from the general proprietary right of another person. An encumbered right, that is a right subject to a limitation, is called servient while the encumbrance itself is designated as dominant.”

An analysis of the meaning of encumbrance

The following important features of encumbrances arise from the discussion above:

  • An encumbrance is a burden attached to property;
  • If it is a burden for the owner, it must be a benefit for the person holding the encumbrance. This also follows from the discussion by Salmond which has taken encumbrances to be jura in re propria, that is, rights over estate of someone else. That is, the burden created by the owner must be such which can operate as a benefit in the hands of the person holding the encumbrance;
  • The burden must necessarily be attached to the asset in question;
  • Since the essence of attachment or concurrence of the burden is that the burden will pass on a person acquiring the property, it necessarily follows that the burden must be on an ascertainable, identifiable property;
  • A mere restraint on sale or negative covenant is not an encumbrance. A leading English case law on whether a negative covenants “runs” with the property is Tulk v Moxhay(1848) 41 ER 1143. This classic ruling holds that a negative covenant is passable to the buyer of the property only where the parties intended the same to pass, and the burden “touches and concerns” the property. Here, a question of intent of parties will come in.

Different forms of quasi security interests on shares

Negative Lien or Negative Pledge

Negative Lien is used in banking parlance for a borrower to undertake not to create any charge on his property without the consent of the lender.

A negative pledge covenant does not give the negative pledgee a security interest or, in general, any other right in the debtor’s property.

It was held in Knott[8] that Negative Pledgee’s remedies are purely contractual and that the covenant confers no right in the property.

The generally accepted view as mentioned before is that the negative pledge does not create a proprietary or security interest and is therefore not registrable. [Tracy Hobbs, The Negative Pledge: A Brief Guide, 8(7) J.I.B.L.269 (1993)]

Springing Lien

A “springing lien” refers to lien granted in the future by a debtor (borrower or lessee) in favor of its creditors whereby the right conferred on the lender springs into a full-fledged lien or pledge either on the happening of certain events, or the discretion of the person holding the pledge.

Whether a so-called springing lien will amount to encumbrance or security interest will depend on intent of parties. If the debtor is free to deal with the subject matter before the trigger events that transform a springing lien into full-fledged lien have taken place, it cannot be said that the lien is an obligation attached to property. Therefore, it will not amount to encumbrance. However, if the lien comes attached with restrictions on sale, it will amount to encumbrance, because the combination of restriction on sale, and automatic attachment of a right on the asset that cannot be sold, in conjunction, will amount to a passable burden on property.

Conclusion

As discussed earlier, an encumbrance carries certain features along with it. A mere restraint on sale or negative covenant is not an encumbrance. Having said so, SEBI’s view in this context may not be in line with the jurisprudence of encumbrance.

However, it is seen that SEBI has been constantly endeavoring to expand the scope of the disclosure requirements, in the wake of various corporate governance failure recently witnessed by the country. SEBI, realizing the recent concerns w.r.t. promoters raising funds through structured obligations, pledge of shares, NDUs and various other complex structures and its impact on the corporate governance structures, had amended the meaning of encumbrance provided in Regulation 28(3). The said amendment has been made to include all such structures including any restriction on the free and marketable title to shares, by whatever name called, whether executed directly or indirectly or any covenant, transaction, condition or arrangement in the nature of encumbrance, by whatever name called, whether executed directly or indirectly.

Considering the amended definition of the term ‘encumbrance’, apparently, SEBI’s intent gets clearer that it wants to include all the possible arrangements/ structures which may carry a potential dilution in the promoter holding. The views held by SEBI are still open for a contest before the Securities Appellate Tribunal.

Read our related articles:

http://vinodkothari.com/wp-content/uploads/2020/04/Article_on_Meaning_of_encumbrance_under_takeover_code.pdf

For more updates, please visit our website.

[1] https://www.sebi.gov.in/enforcement/orders/mar-2020/adjudication-order-in-respect-of-two-entities-in-the-matter-of-yes-bank-ltd-_46477.html

[2] https://www.sebi.gov.in/legal/circulars/aug-2019/disclosure-of-reasons-for-encumbrance-by-promoter-of-listed-companies_43837.html

[3] https://www.sebi.gov.in/media/press-releases/jun-2019/sebi-board-meeting_43417.html

[4] https://www.sebi.gov.in/legal/regulations/jul-2019/securities-and-exchange-board-of-india-substantial-acquisition-of-shares-and-takeovers-second-amendment-regulations-2019_43812.html

[5] Right over one’s own property

[6] Right over someone else’s property

[7] https://indiankanoon.org/doc/548843/

[8] Knott v. Shepherdstown Manufacturing Co. 5 S.E. 266 (W. Va. 1888)

MCA extends timeline for companies following calendar year

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– by Megha Saraf

megha@vinodkothari.com

Updated as on 24th April, 2020

While currently the world is suffering due to the pandemic COVID-19, our regulatory authorities have been continuously providing reliefs/ relaxations to all corporate houses from making various compliances required under the statutory laws. While some of the major relaxations such as conducting extraordinary general meeting of shareholders through VC, making contribution to PM-CARES Fund as a notified CSR expenditure or making compliances under Listing Regulations have already been notified, MCA has come up with yet another Circular[1] granting relaxation from holding AGMs to such companies that follows calendar year as their financial year.

Can there be a different financial year apart from April-March?

Section 2(41) of the Companies Act, 2013 (“Act, 2013”) lays down the definition of “financial year” as, “in relation to any company or body corporate, means the period ending on the 31st day of March every year, and where it has been incorporated on or after the 1st day of January of a year, the period ending on the 31st day of March of the following year, in respect whereof financial statement of the company or body corporate is made up:

Provided that where a company or body corporate, which is a holding company or a subsidiary or associate company of a company incorporated outside India and is required to follow a different financial year for consolidation of its accounts outside India, the Central Government may, on an application made by that company or body corporate in such form and manner as may be prescribed, allow any period as its financial year, whether or not that period is a year:”

XX

There are corporate groups where the structure of shareholding is such, that the holding company is situated outside India and is having Indian subsidiaries. The provisions of law provide that where the relationship between the group is such, that it requires the Indian company to follow a different financial year for the purpose of consolidation of its accounts with the accounts of the company situated outside India, such Indian company can have a different financial year. However, such company needs to apply to the Tribunal for the same.

What is the timeline for holding AGMs?

Section 96 of the Act, 2013 provides that a company is required to hold an AGM within 6 months from the date of closing of the financial year. However, a newly incorporated company can have its first AGM within 9 months of the closure of the financial year.

Are there such companies following a different financial year?

Source[2]: Business Standard: 226 firms to march to a new accounting year

Yes. As per the above graph, there are nearly 226 companies in India that follow a different financial year. Out of the 226 companies, 74 are such companies whose calendar year is the financial year i.e. January- December.

What is the relaxation?

Currently, only companies that follows calendar year as financial year have been granted a 3-months relaxation from holding their AGMs i.e. such companies are allowed to hold their AGMs till 30th September, 2020 instead of June, 2020. Further, the due dates of all other related compliances such as filing of annual returns or financial statements which are required to be done within 60 days/ 30 days as applicable shall be construed accordingly.

What if the company is a listed entity?

Regulation 44(5) of the SEBI (LODR) Regulations, 2015 provides that where the listed entity is within top 100 listed entities based on market capitalization, they have to hold their AGM within 5 months from the closure of the financial year i.e. by August 31, 2020. However, considering the present situation and the need for social distancing, conducting AGMs within such time was becoming a challenge for large corporates. Keeping this in mind, SEBI has granted relief to such entities by extending the requirement by 1 month i.e. till September 30, 2020. However, there was no clarity on what if such entity is a listed entity and follows calendar year as their financial year and is among the top 100 listed entities.

SEBI has now also clarified the same vide its Circular[3] dated 23rd April, 2020 and the present timeline may be summarized as follows:

Sl. No. Type of company Time line under the Companies Act, 2013 Time line under the  SEBI (LODR) Regulations, 2015 Extended timeline
1 Listed company following Apr- Mar as F.Y. Within 6 months from end of FY i.e. 30th September, 2020 Does not provide No extension
2 Listed company following Jan-Dec as F.Y. Within 6 months from end of FY i.e. till 30th June, 2020 Does not provide Extended by 3 months i.e. till 30th September, 2020
3 Listed company following Apr- Mar as F.Y. and amongst top 100 listed entities General provision- Within 6 months from end of FY i.e. 30th September, 2020 Within 5 months from end of FY i.e. till 31st August, 2020 Extended by 1 month i.e. till 30th September, 2020
4 Listed company following Jan- Dec as F.Y. and amongst top 100 listed entities General provision- Within 6 months from end of FY i.e. 30th September, 2020 Within 5 months from end of FY i.e. till 31st May, 2020 Extended till 30th September, 2020 under both laws

 

Therefore, all types of companies can conduct their AGMs till 30th September, 2020.

Our other articles on related subject may be found here.

[1] http://www.mca.gov.in/Ministry/pdf/Circular18_21042020.pdf

[2] https://www.business-standard.com/article/companies/226-firms-to-march-to-a-new-accounting-year-113100300666_1.html

[3] https://www.sebi.gov.in/legal/circulars/apr-2020/relaxation-in-relation-to-regulation-44-5-of-the-sebi-listing-obligations-and-disclosure-requirements-regulations-2015-lodr-on-holding-of-annual-general-meeting-agm-by-top-100-listed-entitie-_46552.html