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SEBI prescribes stricter regime for Proxy advisors

corplaw@vinodkothari.com

SEBI has on 03rd August, 2020, issued procedural guidelines for Proxy Advisors nearly a year after the Report of the Working Group on Proxy Advisors was published. Read our analysis on the same below. Read more

Update: PSCs get another year to comply with MPS requirements

Ankit Vashishth, Executive

Vinod Kothari and Company; corplaw@vinodkothari.com

To prevent concentration of shares in the hands of a few market players and to ensure a sound and healthy public float to stave off any manipulation or perpetration of other unethical activities in the securities market, it is imperative that the shareholding of listed companies is not blocked by promoters and certain percentage of free float is available for trading by the public.  Regulation 19A of the Securities Contracts (Regulation) Rules, 1957 mandates all listed companies to maintain a Minimum Public Shareholding (‘MPS’) of 25%. Further, to comply with the said requirement, SEBI vide its circulars dated November 30, 2015[1] and February 22, 2018[2] prescribed the manner for achieving MPS.

The timeline for achieving MPS varies for listed public sector companies and listed companies. With regard to the listed public sector companies, the deadline to meet the MPS was 2 years from the commencement of the Securities Contracts (Regulation) (Second Amendment) Rules, 2018[3]  which expired on 2nd August, 2020.

Considering the unfavorable market conditions and difficulty in meeting the MPS requirement during the outbreak of the pandemic, the Ministry of Finance has vide its notification dated July 31, 2020[4] has extended the time period by 1 year i.e. till August 2, 2021 for listed public sector companies.

Initiation of MPS for PSCs

MPS requirements for listed public sector companies initiated in the year 2010[5], when these companies were given a timeline of 3 years to comply with 10% MPS requirements.

Later, as per prevalent market conditions the Central Govt. in August, 2014[6] increased this threshold to 25% and these companies were given a timeline of 3 years to comply with MPS requirement which was subsequently increased to 4 years in July, 2017[7]. Considering the difficulty faced by such companies in diluting their shareholding, the Central Govt. in August 2018[8], allowed a fresh timeline of 2 years i.e. upto August 2, 2020 to such companies to comply with such requirements.

Current Scenario

PSUs constitute around 7.22% of the capital market in India and according to the shareholding data provided by bsepsu.com[9] there are a total of 64 listed CPSEs in India out of which 26 of them have less than 25% public shareholding. This list is dominated by companies which include Hindustan Aeronautics Ltd, General Insurance Corporation of India, Indian Railway Catering & Tourism Corporation Ltd, New India Assurance Company Ltd and counting. There are even such companies in which more than 90% of the shareholding is alone held by the government.

Central Government in Dec, 2019[10] gave ‘in-principle’ approval for strategic disinvestment of 33 CPSEs including subsidiaries, units and Joint Ventures with sale of majority stake of Government of India and transfer of management control. Also, companies like Rites Limited[11] and Coal India Limited[12] in recent times have tried to meet MPS requirements via Offer for Sale.

Due to Covid-19 pandemic, the stock market has already crashed and is now showing small signs of revival. Where listed companies are unable to comply with normal regulatory requirements in this current environment which are constant and urgent in nature, the extension in its 4th attempt to the PSCs will save them from the badge of non-compliance.

Read our similar write ups:

http://vinodkothari.com/2017/09/sebis-yet-another-move-to-ensure-minimum-public-shareholding/

http://vinodkothari.com/2018/02/sebi-qualifies-qip-for-achieving-mps/

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] https://www.sebi.gov.in/legal/circulars/nov-2015/manner-of-achieving-minimum-public-shareholding_31141.html

[2] https://www.sebi.gov.in/legal/circulars/feb-2018/manner-of-achieving-minimum-public-shareholding_37953.html

[3] http://www.egazette.nic.in/WriteReadData/2018/188171.pdf

[4] http://egazette.nic.in/WriteReadData/2020/220809.pdf

[5] http://egazette.nic.in/WriteReadData/2010/E_440_2011_011.pdf

[6] https://www.sebi.gov.in/legal/rules/aug-2014/notification-securities-contracts-regulation-second-amendment-rules-2014_28373.html

[7]  https://www.sebi.gov.in/legal/rules/jul-2017/securities-contracts-regulation-third-amendment-rules-2017-w-e-f-july-3-2017-_35291.html

[8] http://www.egazette.nic.in/WriteReadData/2018/188171.pdf

[9] http://www.bsepsu.com/gov-policy-hp.asp

[10] https://pib.gov.in/Pressreleaseshare.aspx?PRID=1594731

[11] https://rites.com/upload/misc/Balancesheet/INTIMATION-FOR-RITES-EMPLOYEE-OFS.pdf

[12] https://www.coalindia.in/DesktopModules/DocumentList/documents/10112018182944.pdf

Amendments in SEBI (PIT) Regulations, 2015: From April, 2019 to July, 2020

corplaw@vinodkothari.com

Watch our Youtube video for the subject: https://www.youtube.com/watch?v=Ly3KaQblJBE

 

Shareholder scrutiny for payout under Listing Regulations to directors

– 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

SEBI prescribes norms for structured digital database, system driven disclosures & CoC violations

CS Vinita Nair, Senior Partner | Vinod Kothari & Company

July 23, 2020

Link to gazette notification: http://egazette.nic.in/WriteReadData/2020/220574.pdf

Effective date: July 17, 2020

Background

SEBI in the Board meeting held on June 25, 2020 (‘SEBI BM’) discussed amendments in PIT Regulations on Structured Digital Database, continual disclosures and amendments in the Code of Conduct (CoC).

This article discusses the position prior to amendment, relevant discussion at SEBI BM and actionable post amendment.

Structured Digital Database (SDD-1)

Prior to the amendment

Reg 3(5) of the regulations provided maintenance of SDD-1 with names of persons with whom UPSI was shared and PAN/ any other identifier of the person (where PAN was not available). SDD was required to be maintained with adequate internal controls and checks such as time stamping and audit trails to ensure non-tampering of the database.

The regulation indicated that just the listed entity is required to maintain the same. However, SEBI clarified in the guidance note, pursuant to an insertion made on July 5, 2019, that the requirement to maintain SDD-1 was applicable to listed companies, and intermediaries and fiduciaries who handle UPSI of a listed company in the course of business operations.

Discussion in SEBI BM

As per the agenda of the SEBI BM It was proposed to specify following in relation to SDD:

  • Nature of UPSI;
  • Details of persons or entities who have shared;
  • Period of preservation of SDD-1;
  • Prohibiting entities from outsourcing the same.

Post amendment

  • SDD-1 is required to be maintained by the Board of directors or heads of organization of every person required to handle UPSI;
  • SDD-1 shall additionally contain the name of the person sharing the UPSI.
    • So the names of person sharing and the one with whom the same is shared will be recorded along with PAN/ any other identifier of the person (where PAN was not available).
  • SDD-1 shall be maintained internally and not be outsourced.
  • SDD-1 to be preserved for a period of 8 years after completion of relevant transactions or even longer in case of pending proceedings.

System Driven Disclosures (SDD-2)

Prior to the amendment

Continual disclosures under Reg 7 (2) (b) was required to be made by the promoters, member of promoter group and designated persons to the stock exchanges within two trading days of receipt of the disclosure or becoming aware of such information. System driven disclosure was implemented vide SEBI Circular dated May 28, 2018 only for The CEO and upto two levels below CEO of a company and all directors. The database was submitted to the depositories along with PAN of the individuals.

Discussion in SEBI BM

Investigation of delay or non-compliance due to manual submissions takes up considerable time and effort and clogs the system. In order to eliminate it was proposed to automate the process of filing such disclosures by way of SDD-2 thereby enabling timely and fair disclosure without intervention of entities involved. SEBI will be issued detailed circular on the same to the market participants.

Post amendment

Reg 7 (2) (c) inserted to provide enabling power for issue of format and manner of submitting SDD-2.

Exemption from trading window restrictions

Prior to the amendment

Trading window restriction was not applicable on transactions specified in proviso to Reg 4 (1), in respect of pledge for a bonafide purpose and transactions undertaken in accordance with respective SEBI Regulations such as acquisition by conversion of warrants or debentures, subscribing to rights issue, further public issue, preferential allotment or tendering of shares in a buy-back offer, open offer, delisting offer.

Discussion in SEBI BM

Offer for sale was not included in the said list despite SEBI having laid detailed procedure for the same.

Post amendment

Enabling clause inserted to include the transactions which are undertaken through such other mechanism as may be specified by the Board from time to time. SEBI vide Circular dated July 23, 2020 provided that trading window restriction shall not apply in case of rights entitlement and Offer for Sale.

Crediting the amount for CoC non-compliance to IPEF

Prior to the amendment

Only profits from contra trade were disgorged and credited to Investor Protection and Education Fund (IPEF) administered by SEBI. The listed entity had the option to take disciplinary action including by way of recovery, clawback.

Discussion in SEBI BM

The listed entity could take action against person violating the CoC by way of disciplinary actions viz. wage cut, collecting of certain amount etc. There was no uniform approach w.r.t. utilization of amounts levied by the listed entities/ intermediaries/ fiduciaries for other violations of CoC viz. trades during window closure, trade without pre-clearance etc.

Also, a clawback is generally a contractual agreement between the employee and the employer in which the employee agrees to return previously paid or vested remuneration to the employer under certain circumstances. However, every employment agreement may not have a “clawback” clause or provision. Whereas, disgorgement as an equitable remedy, aimed at depriving the wrongdoer of his ill-gotten gains. It was suggested to substitute ‘clawback’ with ‘disgorgement’.

Post amendment

Any amount collected for violation of CoC shall also be remitted to SEBI for credit to the IPEF. The word ‘clawback’ has been deleted in Schedule B and Schedule C. SEBI vide Circular dated July 23, 2020 has provided that such amounts shall be credited to the IPEF through the online mode or by way of a demand draft (DD) in favour of the Board (i.e. SEBI – IPEF) payable at Mumbai. The bank account details of SEBI – IPEF for online transfer is given below:

Informing violation of PIT Regulations to Stock Exchange

Prior to the amendment

Violation of PIT Regulations was required to be informed to SEBI. SEBI vide Circular dated July 19, 2019 prescribed format for standardized reporting of violations under CoC.

Discussion in SEBI BM

The intimations received from listed companies/ intermediaries/fiduciaries were maintained in non IT based environment. To ensure that such intimations were captured electronically in an IT based environment to create a data repository, which could be used for conducting examination of cases or for any other data analysis, in future, it was recommended to file intimations with the stock exchanges.

Post amendment

The violations will be required to be reported to the stock exchanges in the form and manner as may be prescribed by SEBI. SEBI vide Circular dated July 23, 2020 prescribed the format in supersession of July, 2019 circular.

Whether the intimations filed with the stock exchanges will be publicly available, is not clear.

Comparison of formats

The format is broadly similar to that prescribed in July, 2019, however, has following modifications:

Particulars

July, 2020 Circular July, 2019 Circular

Remarks 

Details of DP Whether the DP is promoter or belongs to promoter group Whether the DP is promoter /promoter group/ holding CXO level position (e.g. CEO, CFO, CTO etc). The details highlighted is anyways provided under Designation of DP and Functional role of DP. This seemed repetition.
Details of transaction No of shares traded and value (Rs.) (Date- wise) No of shares traded (which includes pledge) and value (Rs.) (Date- wise). The legislative note under definition of ‘trading’ in the Regulations clarify that trade includes pledge.
Details of violations Details of violations observed under Code of Conduct. Details of violations observed under SEBI (PIT) Regulations, 2015. Reference aligned with Para 12 of Schedule B of the Regulations.
Amount collected for CoC violation ·       Mode of transfer to IPEF (Online/ DD)

·       Details of the transfer.

No such field. It seems that the amount is to be first transferred and thereafter, reporting is to be done as payment details is required to be furnished.

Actionables for the listed entities/ intermediaries/fiduciaries

SDD-1

Maintenance of SDD-1 to be ensured with details of persons sharing the UPSI.  SDD to be preserved for minimum 8 years from completion of relevant transactions. Internal control manual/ SOP, if any, will be required to be updated to capture the amendment.

SDD-1 may be maintained by Compliance Officer or may be maintained by various functional heads who are in possession of UPSI and share the same for legitimate purpose. The Compliance Officer should have access to the same as that is required for deciding of pre-clearance for the trades by DPs.

SDD-2

Reporting continual disclosure in SDD-2 after the format is prescribed by SEBI. In case SEBI decides to implement SDD-2 in the manner it implemented in 2018, the listed entity will be required to furnish name and PAN details of promoter, member of promoter group and all designated persons to the depository.

CoC

The CoC will be required to be amended to capture the amendments by removing reference of clawback provision and specifying to deposit amounts collected for violation to IPEF.

Violation of the regulations and of CoC to be reported to the stock exchange instead of SEBI by listed entity/ intermediary/ fiduciary in the format provided by SEBI vide circulated dated July 23, 2020.

 

SEBI’s measures towards resuscitation of financially “stressed” companies

Henil Shah | Executive

corplaw@vinodkothari.com

Introduction & Background

In layman’s term, a company with falling share prices, inability to pay off its obligations is said to be a company with financial distress. In most of the times, it is seen that the conventional means of fund raising such as borrowings, issuance of debt securities etc. do not work for such companies due to their ongoing stressed status even though generating cash is the foremost priority for them to fund their operations. Additionally, insolvency/ bankruptcy also becomes a matter of concern which may be caused due to the lack of funding and the resultant disruption in operation.

SEBI’s Primary Market Advisory Committee (PMAC) deliberated on the topic and came out with a Consultation Paper dated April 22, 2020[1] providing for the proposed measures for resuscitation of the stressed companies. The changes so proposed were w.r.t certain amendments under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations) and SEBI (Substantial Acquisitions of Shares and Takeovers) Regulations, 2011 (SAST Regulations). Based on the public comments, SEBI vide Notifications dated June 23, 2020 has prescribed the final text of the amendments under the ICDR Regulations[2] and SAST Regulations[3]

The article covers a brief synopsis and the relevant impact/ actionable pursuant to the said amendments.

Rationale behind the proposed changes

Preferential issue seems to be one of the most sought options of fund raising by the companies due to the administrative as well as regulatory convenience it carries. Further, knowing the probable investors ready to invest in the company makes a preferential issue one of the most commonly used ways for raising funds.

For a listed company, under a preferential issue, the issue price has to be determined as per the pricing provisions of Chapter V of ICDR Regulations. The ICDR Regulations provides the pricing mechanism for both frequently traded shares and infrequently traded shares.

In case of frequently trades shares, the price shall be determined as per the provisions of Regulation 164(1) (a) & (b) of the ICDR Regulations which are as follows.

Even though a preferential issue may be a convenient way of fund raising for a well performed company, the same may not be the case for a company with financial distress for the following reasons:

1.      Onerous pricing mechanism

Considering the continuous falling prices of the shares over a period of 26 weeks due to the company being in stress, the determination of the price as per the pricing mechanism provided in Regulation 164(1) (a) becomes too onerous for the investor. Further, the price under Regulation 164(1) (a) is much higher than that as determined as per Regulation 164(1) (b). Hence, the pricing mechanism acts as a major deterrent for the investors from subscribing to the shares offered under the preferential issue.

2.      Exemptions only to 5 QIBs restricting investor pool

Though the ICDR Regulations allow issuance to QIBs at a price determined as per regulation 164(1) (b) however, the same is restricted to only 5 QIBs and is not applicable to the investors other than QIBs thereby restricting the investor pool.

3.      Open offer obligations for the acquirer

Another roadblock which the issuers tend to face is from the view point of the investors i.e. an incoming investor who has an impending burden on complying with an open offer obligation in case where the subscription to the preferential offer leads to the triggering of the open offer obligations under SAST Regulations. In view of the procedural requirements and the huge costs involved, making an open offer discourages the investors seeking to have a substantial stake in the company in order to take control and thereby reverse the stress.

As per the extant provisions, the acquisition pursuant to a resolution plan approved under the Insolvency and Bankruptcy Code, 2016 is exempted from meeting the open offer obligations but no such exemption has been provided in case for acquisition in the financially distressed entity which are not under any resolution plan.

Rescue mechanism brought through the amendments

Insertion of regulation 164A in ICDR Regulations

The newly inserted provisions incorporate the changes that were proposed by PMAC into the existing regulations as discussed below:

When to consider a company at ‘stress’?

For a company to be classified as financially stressed and issue equity share in pursuance of regulation 164A of ICDR regulations it has meet certain conditions. Below is a comparative presentation between the text of the Consultation Paper and the final text of the Regulations. Further, any two of the three conditions shall have to be satisfied for considering a company as stressed.

PMCA Recommendations Final text of the Regulations Remarks
A listed company which has made disclosure of defaults on payment of interest/ principal amount of loans from banks/ financial institutions and listed and unlisted debt securities for 2 consequent quarters in terms of the SEBI Circular dated November 21, 2019[4] issued in this regard.

 

The issuer has disclosed the default relating to the payment of interest/ repayment of principal amount on loans from banks/ financial institutions/ NBFCs- ND-SI and NBFCs-D and/ or listed on unlisted debt securities in terms of SEBI circular dated November 21, 2019 and such default is continuing for a period of at least 90 days after occurrence of such default.

 

The amendment regulation in slight contrast to the PMAC recommendations provided shorter timeline for calculating continuity of the default.

 

Further, even though NBFCs-ND-SI and NBFCs- D already get covered under the definition of Financial Institution provided under RBI Act, they have been specifically covered under the list of creditors.

Existence of Inter-Creditor agreement in terms of Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019[5] (RBI Directions)

 

Same as PMCA Recommendations Inter-Credit agreement as provided in the RBI Directions stands for the agreement executed among all the lenders of a defaulting borrower, providing for ground rules for finalisation and implementation of resolution plan in respect to the borrower.
Credit rating of the listed instruments of the company has been downgraded to “D”. The credit rating of the financial instruments (listed or unlisted), credit instruments/ borrowings (listed or unlisted) of the listed company has been downgraded to “D” The final text of the amendments, in addition to the listed instruments, also brings unlisted instruments and as well as borrowings under its purview.

Pricing of preferential issue of shares of companies having stressed assets

Unlike the current pricing requirements as provided in Regulations 164(1) (a) & (b) of ICDR Regulations for a preferential issue, the price of the shares to be issued by a stressed company as aforesaid shall be a price which shall not be less than the average  of  the  weekly  high  and  low  of  the volume  weighted  average  prices  of  the  related  equity  shares quoted  on  a  recognised  stock  exchange  during  the  two  weeks preceding the relevant date. Therefore, the price as determined under Regulations 164(1) (a) & (b) of ICDR Regulations shall not be considered.

Negative list of proposed investors

The following person(s) shall not be eligible to participate in the preferential issue under Regulation 164:

  1. Persons/entities part of promoter or promoter group will not be eligible to participate in the preferential issue;
  2. Undischarged insolvent in terms of Insolvency and bankruptcy Code, 2016 (IBC, 2016);
  3. Wilful defaulter as per RBI guidelines issued under the Banking Regulations Act, 1949;
  4. A person disqualified to act as director as per Companies Act, 2013
  5. Person debarred from trading in securities or accessing securities market by SEBI and period of debarment has not been over
  6. Person declared as fugitive economic offender
  7. Person is convicted of offence punishable with imprisonment
    1. For a period of 2 years or more under any as specified under 12th schedule of IBC, 2016
    2. 7 years or more under any law for time being in force

and a period of 2 years has not been subsisted from his release form imprisonment.

  1. Person who has executed a guarantee in favour of a lender of the issuer and such guarantee has been invoked by the lender and remains unpaid in full or part.

Approval from shareholders falling under ‘public’ category

For companies with identifiable promoters

The amendments provides for an approval for the preferential issue by the majority of the shareholders in the ‘public’ category. The ‘public’ category of shareholders does not include promoter shareholders and also any proposed allottee who is already a holder of specified securities of the issuer. Therefore, the same is said to be an approval with majority of the minority.

For companies with identifiable promoters

For companies with no identifiable promoters, the resolution shall have to be passed by 3/4th majority. Though in this case, there is no specific mention in the Regulation as regards the eligibility of voting by the proposed allottees being a security holder in the issuer, the same should apply here also.

Contents of explanatory statement annexed with the notice of shareholder’s meeting

The proposed use of the issue proceeds shall be mentioned in the explanatory statement sent for the purpose of the shareholders resolution. This requirement is already in existence as the provisions of regulation 163 of ICDR Regulations and Rule 13 of the Companies (Share Capital and Debenture) Rules, 2014 do provide for mandatorily mentioning object for which the preferential issue is being made in the explanatory statement of the notice.

Restriction on use of proceeds

Additionally it’s restricted to use the issue proceeds for the purpose of repayment of loans from promoters/ promoter group/ group companies effectively deterring the companies to raise funds to pay-off its promoters.

Appointment of public financial institution or schedule commercial bank as monitoring agency:

As per the amendments, it shall be mandatory for the issuer company to appoint a monitoring agency whoc shall be responsible to submit report on quarterly basis to the issuer until 95% of the proceeds are utilised in the format as specified in Schedule XI ICDR Regulations. All though there is no requirement of appointing a monitoring agency as per the provisions of chapter V (Preferential Issue) requirement of ICDR Regulations, the concept of the monitoring agency is not new as several chapters of the regulations provide for appointment and functions to be performed by the monitoring agency in case where offer size exceeds a predefined limit.  However the considering issue by a financially stressed company there is no monetary limit set for the purpose of appointment of monitoring agency.

Responsibilities of Board of Directors

The board of directors and the management of the issuer shall be required to provide their comments on the findings in the report of monitoring agency and disseminate the same within 45 days of end quarter by publishing it on the website of the company as well as submitting the same with the stock exchange(s) were equity shares of the company are listed.

Responsibilities of Audit Committee

Additionally the audit committee of the issuer is entrusted with responsibility to monitor the utilization of the proceeds. This is nothing new the same already falls under the responsibility of the audit committee as laid in the SEBI (Listing Obligations and Disclosure Requirements), 2015.

Further, the audit committee of the company shall also be required to certify about the meeting of all conditions at the time of dispatch of notice and at the time of allotment.

Responsibilities of statutory auditors

The amendments require the statutory auditor also to certify about the meeting of all conditions at the time of dispatch of notice and at the time of allotment.

Lock in period

The allotment shall be lock-in for a period of 3 years from the date of trading approval.

Amendments to SAST Regulations

On same lines as mentioned in the Consultations Paper, SEBI has vide its amendments under the SAST Regulations inserted regulation 10 (2B) of SAST Regulations thereby granting immunity from open offer obligations to the investors under the preferential issue in compliance with regulation 164A of ICDR Regulations. Irrespective of the fact that equity shares are frequently traded or not.

Conclusion

Considering the stressed status of the company, it is believed that aligning the pricing requirement with that of pricing requirement in case of preferential issue to QIBs, shall effectively increase the pool of investors. Similarly, the proposed exemption from making of an open offer shall lessen the additional burden on an incoming investor to comply with the stringent requirements thereby attracting investors to put in money in such companies.

Accordingly, SEBI’s intention behind the changes may be said to be a welcome move as it will definitely help the financially stressed companies to revive.

Link to our other articles:

SEBI’s proposal to aid financially “stressed” companies: http://vinodkothari.com/2020/04/sebis-proposal-to-aid-financially-stressed-companies/

Prudential Framework for Resolution of Stress Assets: New Dispensation for dealing with NPAs: http://vinodkothari.com/2019/06/fresa/

[1] https://www.sebi.gov.in/reports-and-statistics/reports/apr-2020/consultation-paper-preferential-issue-in-companies-having-stressed-assets_46542.html

[2] http://egazette.nic.in/WriteReadData/2020/220093.pdf

[3] http://egazette.nic.in/WriteReadData/2020/220094.pdf

[4] https://www.sebi.gov.in/legal/circulars/nov-2019/disclosures-by-listed-entities-of-defaults-on-payment-of-interest-repayment-of-principal-amount-on-loans-from-banks-financial-institutions-and-unlisted-debt-securities_45036.html

[5] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0

New CSR avenues, innovative bonds and much more in the Social Stock Exchange package!

Timothy Lopes, Executive, Vinod Kothari Consultants

finserv@vinodkothari.com

In the Union Budget of 2019-2020 the Hon’ble Finance Minister proposed “to initiate steps towards creating an electronic fund raising platform – a Social Stock Exchange (‘SSE’) – under the regulatory ambit of Securities and Exchange Board of India (‘SEBI’) for listing social enterprises and voluntary organizations working for the realization of a social welfare objective so that they can raise capital as equity, debt or as units like a mutual fund.”

A Working Group was subsequently formed on 19th September, 2019 to recommend possible structures and mechanisms for the SSE. We have tried to analyse and examine what the framework would look like based on global SSEs already prevalent in a separate write up.

On 1st June, 2020, the Working Group on Social Stock Exchange published its report for public comments. In this write up we intend to analyse the recommendations made by the working group along with its impact.

The idea of a Social Stock Exchange

Social enterprises in India exist in large numbers and in several legal forms, for e.g. trusts, societies, section 8 companies, companies, partnership firms, sole proprietorships, etc. Further, a social enterprise can be either a For-Profit Enterprise (‘FPE’) or a Non-Profit Enterprise (‘NPO’). The ultimate objective of these enterprises is to create a social impact by carrying out philanthropic or sustainable development activities.

Certain gaps exist for social enterprises in terms of funding, having a common repository able to track these entities and their performance. The sources of funding for social enterprises have been philanthropic funding, CSR, impact investing, government agencies, etc.

 

Funding is important in terms of the effectiveness of NPOs in creating an impact. The funding, however, is contingent upon demonstration of impact or outcomes.

Here comes the idea and role of a social stock exchange. An SSE proposed to be set up is intended to fill the gaps not only in terms of funding, but also to put in place a comprehensive framework that creates standards for measuring and reporting social impact.

Who is eligible to be listed on the SSE?

The SSE is intended for listing of social enterprises, whether for-profit or non-profit. Listing would unlock the funds from donors, philanthropists, CSR spenders and other foundations into social enterprises.

There is no new legal form recommended by the working group which a social enterprise will have to establish in order to get listed. Rather, the existing legal forms (trusts, societies, section 8 companies, etc.) will enable a NPO or FPE to get listed through more than one mode.

Is there any minimum criteria for listing on the SSE?

In case of NPOs, the minimum reporting standards recommended to be implemented, require the NPO to report that it has received donations/contributions of at least INR 10,00,000 in the last financial year.

Further, in case of FPEs, it must have received funding from any one or more of the impact investors who are members of the Impact Investors Council. Certain eligibility conditions for equity listings would also apply in case of FPEs, as per the SEBI’s Issue of Capital, Disclosure Requirements (ICDR).

The working group has requested SEBI to look into the following aspects of eligibility and recalibrate the existing thresholds in the ICDR:

  • Minimum Net Worth;
  • Average Operating Profit;
  • Prior Holding by QIBs, and;
  • Criteria for Accredited Investor (if a role for such investors is envisaged).

Listing, compliance and penalty provisions must be aptly stringent to prevent any misuse of SSE platform by FPEs.

What is a social enterprise? Is the term defined?

Social enterprises broadly fall under two forms – A For-Profit Enterprise and a Non-Profit Enterprise.

For-Profit Enterprise – A FPE generally has a business model made to earn profits but does so with the intent of creating a social impact. An example would be creating innovative and environmental friendly products. FPEs are generally in the form of Companies.

Non-Profit Enterprise – NPOs have the intention of creating a social impact for the better good without expecting any return on investment. These are generally in the form of trusts, societies and Section 8 companies. These entities cannot issue equity. The exception to this is a section 8 company which can issue equity shares, however, there can be no dividend payment.

The working group defines a social enterprise as a class or category of enterprises that are engaging in the business of “creating positive social impact”. However, the group does not recommend a legal/regulatory definition but recommends a minimum reporting standard that brings out this aspect clearly, by requiring all social enterprises, whether they are FPEs or NPOs, to state an intent to create positive social impact, to describe the nature of the impact they wish to create, and to report the impact that they have created. There will be an additional requirement for FPEs to conform to the assessment mechanism to be developed by SEBI.

Therefore, an enterprise is “social” not by virtue of satisfying a legal definition but by virtue of committing to the minimum reporting standard.

Since there would be no legal definition to classify as a social enterprise, a careful screening process would be required in order to enable only genuine social enterprises to list on the exchange.

Who are the possible participants of the SSE?

What are the instruments that can be listed? What are the other funding structures? What is the criteria for listing?

In case of Section 8 companies, there is no restriction on issue of shares or debt. However, there is no dividend payment allowed on equity shares. Further, there is no real regulatory hurdle in listing shares or debt instruments of Section 8 companies. However, so far listing of Section 8 companies is a non-existent concept, as these avenues have not been utilized by Section 8 companies apparently due to their inherent inability to provide financial return on investments.

The working group recognises that trusts and societies are not body corporates under the Companies Act, and hence, in the present legal framework, any bonds or debentures issued by them cannot qualify as securities under the Securities Contracts (Regulation) Act 1956 (SCRA).

In this regard the working group suggests introducing a new “Zero Coupon Zero Principal” Bond to be issued by these entities. The features and other specifics of these bonds are discussed further on in this write up.

Further, it is recommended that FPEs can list their equity on the SSE subject to certain eligibility conditions for equity listings as per the SEBI’s Issue of Capital, Disclosure Requirements (ICDR) and social impact reporting.

Funding structures and other instruments are discussed further on in the write up.

What are the minimum reporting standards?

One of the important pre-requisites to listing on the SSE is to commit to the minimum reporting standards prescribed. The working group has laid down minimum reporting standards for the immediate term to be implemented as soon as the SSE goes live. The minimum reporting standards broadly cover the areas shown in the figure below –

The details of the minimum reporting standard are stated in Annexure 2 to the working group report. The working group states in its report that over time, the reporting requirements can begin to incorporate more rigour in a graded and deliberate manner.

Overall, it seems as though the reporting framework at the present stage is sufficient to measure performance and identify truly genuine social enterprises. The framework sets a benchmark for reporting by NPOs and FPEs and will provide the requisite comfort to investors.

Innovative bonds and funding structures

The SSE’s role is clearly not limited to only listing of securities and trading therein. The working group has recommended several innovative funding mechanisms for NPOs that may or even may not end up in creation of a listable security. Following are the highlights of the proposed structures –

1. Zero coupon zero principal bonds –

The exact modalities of this instrument are yet to be worked out by SEBI.

2. Mutual Fund Structure –

  • Under this structure, a conventional closed-ended fund structure is proposed wherein the Mutual Fund acts as the intermediary and aggregates capital from various individual and institutional investors to invest in market-based instruments;
  • The returns generated out of such fund is will be channelled to the NPOs who in turn will utilise the funds for its stated project;
  • The principal component will be repaid back to the investors, while the returns would be considered as donations made by them;
  • There could also be a specific tax benefit arising out of this structure;
  • The other benefit of this structure is that the role of the intermediary can be played by existing AMCs.

3. The Social/ Development Impact Bond/ Lending Partner Structure –

These bonds are unique in a way that they returns on the bonds are linked to the success of the project being funded. This is similar to a structured finance framework involving the following –

  • Risk Investors/ Lenders (Banks/ NBFCs) – Provide the initial capital investment for the project;
  • Intermediary – Acts as the intermediating body between all parties. The intermediary will pass on the funds to the NPO;
  • NPO (Implementing Agency) – will use the funds for achieving the social outcomes promised;
  • 3rd party evaluator – An independent evaluator who will measure and validate the outcomes of the project;
  • Outcome Funder – Based on the third party evaluation the outcome funders will pay the Principal and Interest to the risk investors/ lending partners in case the outcome of the project is successful. In case the outcome is not successful the outcome funders have the option to not pay the risk investors/ lending partners.

Although banks may not be looking into risky lending, the structure provides incentive to the bank in the form of Priority Sector Lending (PSL) qualification. In order to meet their PSL targets, banks may choose to lend under this structure.

4. Pay-for-success through grants –

This structure is where a new CSR aspect comes in. The working group recommends a structure which is similar to the pay-for-success structures stated earlier however, this required the CSR arm of a Company to select the NPO for implementation of the project. The CSR funds are then kept in an escrow account earmarked for pay-for-success, for a pre-defined time period over which the impact is expected to be created (say 3 years).

The initial capital required by the NPO to achieve the outcomes, will be provided by an interim funding partner (typically a domestic philanthropic organization, and distinct from the third-party evaluator).

If the CSR funder finds that the NPO has achieved the outcomes, then it pays out the CSR capital from the escrow account partly to the interim funding partner (similar to the earlier mentioned pay-for success structures), and partly to the NPO in the form of an accelerator grant up to 10% of the program cost in case the NPO exceeds the pre-defined outcome targets. The grant to the NPO is designed to provide additional support for non-programmatic areas such as research, capacity building, etc.

If the CSR funder finds that the NPO has not achieved the outcomes, then it either rolls over the CSR capital in the escrow account (if the pre-defined time period is not yet over), or routes the CSR capital to items provided under Schedule 7 of the Companies Act such as the PM’s Relief Fund (if the pre-defined time period is over).

An avenue for Corporate Social Responsibility

The implementation of the SSE will provide a new platform, not just for CSR spending but also a trading platform for trading in a “CSR certificates” between corporates with excess CSR expenditure and those with a deficit in a particular year.

Investment in securities listed on the SSE are likely to qualify as CSR expenditure. However, necessary amendments in the Companies Act, 2013 will also be required to permit the same to qualify as CSR expenditure. The working group has made the necessary policy recommendations in its report.

Trading platform for CSR spending –

India is one of the only countries that has mandated CSR spending. In a particular year, a Company may fail to meet its required spending obligations owing to several reasons. The High Level Committee on CSR had recommended the transfer of unspent CSR funds to a separate account and the said amount should be spent within 3 years from the transfer failing which the funds would be transferred to a fund specified in Schedule VII. The necessary provisions were inserted by the Companies (Amendment) Act, 2019, however, the same is yet to be notified.

The working group has proposed a new model that could solve the issue of unspent CSR funds. It is recommended that CSR Certificates [may be negotiable instruments, somewhat similar to Priority Sector Lending Certificates (PSLCs)], be enabled to be bought and sold on a separate trading platform. This will allow Companies which have unspent CSR funds to transfer these funds to those Companies that have spent excess for CSR in a particular year. This in turn motivates Companies to spend more than the minimum required CSR amount in a particular year.

The certificates are recommended to have a validity of 3-5 years but may be used only once. In order to avoid any profit making on excess CSR spends, it is recommended that these transactions must involve only a flat transaction fee that gets charged to the platform and involves actual transfer of funds.

Further, the working group has recommended that If the platform as described above succeeds in facilitating the trading of CSR certificates, the government might then consider licensing private platforms that provide an auction mechanism for the trading of CSR certificates (similar to the RBI’s licenses for Trade Receivables Discounting Systems or TReDS). However, this would require additional clarifications on whether CSR certificates must have the status of negotiable instruments or not and on how companies are to treat any profits from the sale of such certificates.

Conclusion

The recommendations of the working group has given an expanded role to the SSE. The working group also attempted to address the role of the SSE in terms of COVID-19 by proposing the creation of a separate COVID-19 Aid Fund to activate solutions such as pay-for-success bonds which can be used to provide loan guarantees to NBFC-MFIs that wish to extend debt moratoriums to their customers.

Necessary changes in law have also been recommended, while several other tax incentives have been recommended by the working group.

The SSE framework seems to be interesting in the Indian context. Nevertheless, the implementation of the same is yet to be seen.

Listed company disclosures of impact of the Covid Crisis: Learning from global experience

Munmi Phukon & Ambika Mehrotra

corplaw@vinodkothari.com

Introduction

The Securities and Exchange Board of India (SEBI) has issued an Advisory on 20th May, 2020[1] for listed entities  advising them to evaluate the impact of the COVID 19 pandemic on their business and disseminate the same to stock exchanges.

Read more

SEBI’s relaxation inspired by MCA circulars

Link to the circular (12.05.2020)