Due diligence, consents/NOC, Charge creation before listing coupled with mandatory listing deadline may be daunting compliance
FCS Vinita Nair | Senior Partner, Vinod Kothari & Company
When the going gets tough, the tough gets going; however, this may not hold good for issuers and debenture trustees (DT) in case of secured debentures intended to be issued and listed on or after January 1, 2021. SEBI, vide Circular dated November 3, 2020 (‘November 3 Circular’), has rolled out norms on several aspects of security creation and due diligence of asset cover in furtherance to the recent amendment made in ILDS Regulations and DT Regulations w.e.f. October 8, 2020. Among other things, the November 3 Circular requires creation of security interest before listing, and if one combines it with the standardization of timeline for listing of securities issued on private placement basis (effective from December 1, 2020) which requires application for listing to be made within 4 trading days of closure of issue, issuers will be fighting for breath in making listing applications on allotment. Additionally, DTs have been loaded with the responsibility of giving two certifications giving their affirmation of due diligence, mainly dealing with security cover creation and maintenance. One forms part of the disclosure document, another is to be submitted along with the listing application.
The inspiration for the changes is not difficult to understand – some of the recent defaults with financial sector issuers saw violations of asset cover norms and potential overlaps in assets for multiple issuances. However, it will be curious to see whether the revised norms will be easy to comply, given the fact that most of the issuances in India are from the financial sector, and the assets in all such cases are a fluid pool of receivables.
The November Circular deals with following:
- Documents/ Consents required at the time of entering into DT agreement;
- Due diligence by DT for creation of security;
- Disclosures in the offer document (OD) or Private Placement Memorandum (PPM)/ Information Memorandum (IM) and filing of OD or PPM/ IM by the Issuer
- Creation and registration of charge in relation to security by Issuer.
Thereafter, on November 13, 2020 SEBI issued circular on Monitoring and Disclosures by DT (November 12 Circular) that is effective from quarter ended on December 31, 2020 for listed debt securities. The November 12 Circular deals with following:
- Monitoring of ‘security created’ / ‘assets on which charge is created’;
- Action to be taken in case of breach of covenants or terms of issue;
- Disclosure on website by DT;
- Reporting of regulatory compliance
This article discusses the impact that the both the aforesaid circulars will have on issue of secured debentures. The November Circular is applicable in case of public issue as well as private placement of debt securities. Having said this, it is well known fact that the market in India is essentially a market for private placements, mostly bespoke, mostly secured on loans and receivables.
Information to be provided at the time of entering DT Agreement
DT Agreement is entered into by the issuer with the DT in accordance with Regulation 13 of DT Regulations before the opening of the subscription list for issue of debentures. The agreement mainly contains an undertaking in relation to compliance with applicable law for allotment till redemption of debentures and the time limit within which the security shall be created. However, the November 3 Circular mandates furnishing of following documents by the issuer at the time of entering into DT Agreement. Additionally, the terms and conditions with respect to exercising due diligence shall also be included in the debenture trustee agreement.
The detailed list to be furnished is given in Annexure 1. Basis the nature of security, the DT is required to submit details periodically to the stock exchange as per November 12 Circular. Certain critical issues are discussed hereunder.
- In case of security created on moveable/ immoveable property, the issuer is required to give copy of evidence of registration with Sub-registrar, Registrar of Companies, Central Registry of Securitization Asset Reconstruction and Security Interest (CERSAI) etc even prior to issuance of debentures. [Para 4.1 of November 3 Circular].
- Further, in case of encumbered assets, Consent/ No-objection certificate (NOC) from existing charge holders. [Para 4.3(b) of November 3 Circular]. In several cases, issuers have common DT for all issuances and the charge is created in favour of DT. There should be suitable carve out or exemption in those cases as the DT cannot be furnishing Consent/ NOC to itself.
- In case of negative lien created by issuer, Consent/NOC is required to be obtained from existing unsecured lenders [Para 4.3(c) of November 3 Circular]. By definition, if the creditor is unsecured, there is no question of the creditor having any right over any asset. Hence, the question of any consent of unsecured lenders does not arise. In case of negative lien, the issuer agrees to keep the agreed quantum of assets free from encumbrance, therefore, the requirement of seeking consent/NOC is not justified.
- In case of corporate guarantee, the guarantor is required to furnish audited financial statements (not older than 6 months from the date of debenture trustee agreement) giving details of all contingent liabilities [Para 4.3(c) of November 3 Circular]. The issuers intending to list debt securities are permitted to submit limited reviewed financial results and not necessarily audited financial statements. However, the guarantor is required to furnish latest audited financial statements.
Submission of periodic reports by DT to Stock Exchange (SE)
As per November 12 Circular, the DT is required to submit following to the SE for every issuer.
|Periodicity||Nature of submission||Timeline||Format||Remarks|
||Within 60 days from end of each quarter||Annexure A to November 12 Circular||
|Half yearly||Net worth certificate of guarantor (in case of personal guarantee)||Within 60 days from end of each half year||NA|
||Within 75 days from end of each financial year.||NA|
Enabling provision in DTD
As per November 12 Circular, the DT is required to incorporate the terms and conditions of periodical monitoring in the DTD pursuant to which the issuer will be liable to share information to enable DT to submit details to the stock exchange as provided in table above. For existing debt securities, issuers and DT shall enter into supplemental/amended debenture trust deed within 120 days from November 12 2020 incorporating the changes in the DTD. In case, a listed entity has more than one DT for its listed debt securities, then DTs may choose a common agency for preparation of asset cover certificate.
Due diligence by DT for creation of security
The due diligence may be carried out by the DTs by itself or through its advisers or experts. The DT, by itself or through its appointed agencies viz. chartered accountant firm, registered valuer, legal counsel etc., is required to prepare one or more reports viz. valuation report, ROC search report, title search report/ appraisal report, asset cover certificate, any other report/ certificate as applicable etc. The DT is also required to independently assess that the assets for creation of security are adequate for the proposed issue of debt securities. DTs are required to maintain records and documents pertaining to due diligence exercised for a minimum period of 5 years from redemption of the debt securities.
List of documents to be verified during due diligence and the format of due diligence certificate in given as Annexure 2. Certain issues in relation to the same is discussed hereunder:
- There is no clarity on who is to bear the cost of due diligence. If the same is to be borne by the issuer, the issue expense will increase. The issuer will be required to provide due diligence certificates obtained from DT, one at the time of filing the OD or PPM/IM and another at the time of filing the listing application.
- In case of creation of further charge on assets, the DT is required to intimate to existing charge holders via email about the proposal to create further charge on assets by Issuer seeking their comments/ objections, if any, to be communicated to the DT within next 5 working days. [Para 6.1 (b) (ii) of November 3 Circular]. Further, information about the consents is required to be furnished in the OD or PPM/IM.
In several cases, issuers have common DT for all issuances and the charge is created in favour of DT. There should be suitable carve out or exemption in those cases as the DT cannot be intimating and seeking its own comments/objections.
In case of private placement, where the issue opens, closes and debentures are allotted on same day, the process will have to be commenced much before opening of offer, given the requirement to wait for 5 working days.
Disclosure in OD or PPM/IM by issuer
The issuer is required to disclose following in the OD or PPM/IM:
- “Debt securities shall be considered as secured only if the charged asset is registered with Sub-registrar and Registrar of Companies or CERSAI or Depository etc., as applicable, or is independently verifiable by the debenture trustee.”
- Terms and conditions of DT agreement including fees charged by debenture trustees(s), details of security to be created and process of due diligence carried out by the debenture trustee;
- Due diligence certificate (To be furnished at the time of filing OD or PPM/IM)
Creation of security
The November 3 Circular mandates creation of charge prior to listing. Due diligence certificate confirming execution of DTD and creation of charge is required to be furnished along with listing application.
The November 3 Circular, further mandates registration of charge within 30 days of creation. Failure to register the charge within 30 days of creation (as opposed to 120 days permitted under Act, 2013) will be considered as breach of covenants/terms of the issue by the Issuer.
What will be the consequence of breach of covenant? Whether it will deemed as an event of default requiring redemption? In our view, this may not be required. As per November 12 Circular, in case of breach of covenants or terms of the issue by listed entity, the DT shall take steps as outlined in para 6.1 and 6.3 of SEBI Circular SEBI/HO/MIRSD/CRADT/CIR/P/2020/203 dated October 13, 2020 (October Circular). Para 6.1 and 6.3 of the October Circular mandates DT to send notice to investors within 3 days of event of default and convene meeting of the investors within 30 days of the event of default. The DT shall thereafter take necessary action as decided in the meeting of holders of debt securities in this regard. One needs to ascertain if meeting of debenture holders is relevant for delay in creation of charge.
As evident from the format of certificate given at the time of listing, the DTD is required to be executed before listing (as opposed to 3 months from the date of closure of an issue or an offer under ILDS Regulations and CA, 2013)
Disclosure on website by DT
The consultation paper provided for certain mandatory disclosures to be made by DT on the website. The November 12 Circular provides list of disclosures to be made along with the format prescribed in Annexure B thereto.
|Disclosure prescribed in Consultation Paper||Disclosure required to be made as per November 12 Circular||Periodicity and Timeline||Information to be furnished as per the format prescribed|
|Quarterly Compliance Reports received from the issuers||Monitoring of Asset cover certificate and Quarterly compliance report of the listed entity||Quarterly basis. Within 60 days of end of each quarter.||
|Compliance status on the receipt of asset cover from the issuers, maintenance of various funds by the issuers||Covered above|
|Defaults by the company||Status of information regarding any default by listed entity and action taken by debenture trustee||Annually. Within 75 days of end of financial year.||Details of default, date of intimating and sending notice to debenture holders, results of voting, date of meeting, date of enforcement, date of other actions viz. joining ICA, appointment of nominee director etc to be furnished.|
|Status of the proceedings of the cases under default||Covered above|
|Compliance status of each covenant-issue wise on a half yearly basis||Status of information regarding breach of covenants/terms of the issue, if any action taken by debenture trustee||Half yearly basis. Within 60 days of end of each half year.||Details of covenants/ terms of issue breached during HY, details of security to be enforced, date of actual breach, detecting the breach and date of intimation to debenture holders, SE, SEBI etc to be provided.|
|–||Revision in Credit ratings||Continuous basis within T+1 day from receipt of information||Details of immediate previous credit rating and revised credit rating, along with hyperlink of the press release of the CRA to be furnished.|
|–||Status of payment of interest/ principal by the listed entity||Continuous basis within T+1 day from receipt of information||Status of Payment (Default / Delayed / Non-Cooperation, No Information etc. to be furnished along with date of information given to SE and CRA by DT and other actions taken by DT.|
|–||Details of Debenture issues handled by debenture trustee and their status||Half yearly basis. Within 60 days of end of each half year.||Details of issues accepted during HY, issues fully redeemed during HY, issues outstanding during HY and cumulative issue handled during HY to be furnished.|
|–||Complaints received by debenture trustee(s) including default cases||Half yearly basis. Within 60 days of end of each half year.||Details of complaints pending prior to, received during, resolved during and pending at the end of half year to be furnished.|
|Status regarding maintenance of accounts maintained under supervision of debenture trustee||Annually. Within 75 days of end of financial year.||Details of maintenance of DRR, DRF, recovery expense fund, Accounts/ funds in case of municipal debt securities to be provided.|
|Monitoring of Utilization Certificate||Annually. Within 75 days of end of financial year.||Information about utilisation certificate furnished on quarterly basis while monitoring asset cover.|
Tough time ahead
As per SEBI Circular dated October 5, 2020 effective for issuance made on or after December 1, 2020, listing of private placement will be required to be done within 4 trading days from closure of issue, failing which, the issuer will not be able to utilize issue proceeds of its subsequent two privately placed issuance until final listing approval is received from stock exchanges and penalty will be separately payable. Given the procedural compliances given in the November Circular, it will be challenging for the issuer as well as DT to achieve the timeline.
While, SEBI has rolled out stringent norms for issue and listing of secured debentures, one will have to see how equipped the DTs are to carry out the due diligence and ensure adherence by issuer to these stringent timelines, given the quantum of secured debt issuance done by various issuers. Additional compliances imposed on the DT in terms of November 12 Circular will further add actionables for the DT and also on the issuers as the said information will be required to be furnished by the issuer. Disclosures regarding performance of the DTs, as was proposed in the consultation paper, has not been enforced yet.
In view of increased complexity in issuance of secured debentures, Corporates may consider opting for unsecured debt issuances. Further, Issuers and DTs will have to pull up socks to comply with several actionables lined up this New Year.
|Sr. No.||Nature of securities extended by Issuer||Information/Documents required to be furnished to Debenture Trustee|
|1.||Movable property and Immovable property||
|3.||Encumbered assets||Following consents along-with their validity as on date of their submission:
|4.||Personal guarantee or any other document/ letter with similar intent||
|5.||Corporate guarantee or any other document/ letter with similar intent||
|6.||Securities such as equity shares etc.||
|7.||Any other form of security||
Table 1: Information/Documents required to be furnished to Debenture Trustee
The due diligence w.r.t. creation of security shall inter-alia include the following:
|Nature of Security and things required to be verified by DT||Manner of verification|
|1. Assets provided by the issuer for creation of security are:
a. free from any encumbrances; or
b. necessary permissions or consents has been obtained from existing charge holders
|1. Verify from Registrar of Companies, Sub-registrar, CERSAI, IU or other sources where charge is registered/disclosed as per terms.
2. In case where existing charge holders have given a conditional consent/ permission to the issuer to create further charge on the asset, DT will be required to verify following:
a. Verify whether such conditional consent/ permission given to issuer by existing charge holders is valid as per terms of transaction documents;
b. Intimate to existing charge holders via email about the proposal to create further charge on assets by Issuer seeking their comments/ objections, if any, to be communicated to the DT within next 5 working days.
|2. Personal guarantee, corporate guarantee and any other guarantees/form of security.||Verify from relevant filings made on websites of MCA, Stock Exchange(s), CIBIL, IU etc. and obtain appraisal report, necessary financial certificates viz. from the statutory auditor in case of corporate guarantee, certificate from Chartered Accountant in case of personal guarantee, as applicable, of the guarantor/ issuer.|
Table 2: Due diligence by DT at the time of creation of security
Contents of due diligence certificate
|To be furnished at the time of filing OD or PPM/IM||To be furnished at the time of filing listing application|
Table 3: Contents of Due diligence certificate to be furnished by DT
 SEBI (Issue and Listing of Debt Securities) Regulations, 2008
 SEBI (Debenture Trustees) Regulations, 1993
Other reading materials on the similar topic:
- ‘SEBI responds to payment defaults by empowering Debenture Trustees’ can be read here
- Our other articles on various topics can be read at: http://vinodkothari.com/
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