Entity versus Enterprise: Dealing with Insolvency of Corporate Groups

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By Vinod Kothari & Sikha Bansal
(resolve@vinodkothari.com)

Present-day businesses sweep across multiple entities, such that the “enterprise” consisting of multiple entities, often in multiple jurisdictions, is referred to as a “group”. While accounting standards and securities market regulators have moved on to the concept of “business groups”, the ghost of the 19th century ruling in Salomon v. Salomon & Co continues to hover over corporate laws and, consequentially, over insolvency laws too. Read more →

Post-Admission Withdrawal of Insolvency Proceedings- Balancing Between Creditors’ Supremacy and Adjudicators’ Discretion

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-By Richa Saraf

(richa@vinodkothari.com); (resolve@vinodkothari.com)

Initiation of insolvency proceedings, whether by creditors or by the debtor himself, may be compared with the Brahmastra: as the latter cannot be retracted without killing the target, the former, once admitted, cannot be withdrawn. However, after all, any insolvency resolution process is a case of a mutual contract between the creditors and the debtor – with requisite majority of creditors, it gets the seal of approval of the Adjudicating Authority and becomes a “statutory contract”. Resolution is, therefore, a consensus in substance. Isn’t it possible for the creditors to reach to a consensus with the debtor outside of the insolvency resolution process, and thus, recall the proceedings? In banking parlance, can there be a one-time-settlement (OTS) after admission of insolvency proceedings? Read more →

Brand usage and royalty payments get a new dimension under Listing Regulations

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By Abhirup Ghosh & Smriti Wadehra (abhirup@vinodkothari.com) (smriti@vinodkothari.com)

Introduction

Usage of common brand is a common practice that we notice among companies which are part of large conglomerates. Often the brands created by one single entity of a group are used by its related parties, however, these transactions are often structured with differential pricing terms i.e. either these transactions are not charged at all or are overpriced.

Therefore, in order to increase transparency and regulate to these transactions, a Committee on Corporate Governance constituted by the SEBI under the chairmanship of Uday Kotak has proposed disclosure requirements this kind of transactions.
In this article we will primarily discuss the proposal made by the Committee threadbare. Additionally, we will also discuss the impact of indirect taxes on such transactions.

Brand usage and Royalty as per Listing Regulations

The erstwhile provisions of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) did not provide anything for royalties or brand usage paid to related parties. However, a SEBI constituted committee under the chairmanship of Mr. Uday Kotak on 2nd June, 2018 provided a report on corporate governance with certain recommendations for implementation. One of the recommendations was to insert provision pertaining to payments made for brand and royalty to related parties.

As noted above, often the transactions involving usage of brands and royalty payments are structured with differential pricing terms. The Committee has noted the importance of brand usage and it also brought the importance of disclosing the terms relating to payments against these brand usages, considering the role it plays in driving the sales or margin.

In this regard, the Committee suggested that where royalty payout levels are high and exceed 5% of consolidated revenues, the terms of conditions of such royalty must require shareholder approval and should be regarded as material related party transactions. The Listing Regulations currently prescribe a materiality limit at ten percent of annual consolidated turnover of the Company. Therefore, the Committee prescribed a stricter limit for brand usage and royalty i.e. 5% instead of the existing limit which is 5% of consolidated turnover.

SEBI applied its discretion to make the provision stricter and subsequently, made the following insertion in the Listing Regulations:

“23(IA) Notwithstanding the above, with effect from July 01, 2019 a transaction involving payments made to a related party with respect to brand usage or royalty shall be considered material if the transaction(s) to be entered into individually or taken together with previous transactions during a financial year, exceed two percent of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.”
On reading the aforesaid provisions and basis our discussion, we understand that from 1st July, 2019 transactions involving payments made to a related party with respect to brand usage or royalty shall be considered material if the transaction(s) to be entered into individually or taken together with previous transactions during a financial year, exceed two percent of the annual consolidated turnover of the listed entity as per the last audited financial statements of the listed entity.

It is pertinent to note that all transactions entered with related party for brand usage and royalty shall always be regarded as related party transactions. However, the trigger point of qualifying such transactions as material related party transaction is when the quantum of payout exceeds two percent of the annual consolidated turnover of the listed entity.

Whether provisions applicable for payments received for Brand usage and royalties?

While the provision talks about royalty payments to be treated as material related party transactions, but what remains to be answered is whether royalty receipts would also be considered as material related party transactions.

Please note that provisions of the amendment clearly provides:
“xxx
involving payments made to a related party with respect to brand usage or royalty
xxx”

Therefore, the applicability of the provisions appears to apply only in case of payments made to related party for brand usage and royalty. However, this does not seems to be the intent of law. Every transaction has two parties, in the present case, the two parties are the receiver and the giver. It does not seem rationally correct to include one side of the coin within the ambit of the law while keeping the other side out. Therefore, ideally receipt of royalty must also be treated as material related party transaction for the purpose of Regulation 23(IA) of the Listing Regulations.

Meaning of “Royalty”

Despite insertion of a new regulation dealing with royalty payments, the Listing Regulations do not define the term royalty. The meaning of the term, however, can be borrowed from the Income Tax Act, 1961 which provides for an elaborate definition. Section 9(1) of Income Tax Act, 1961 reads as:
XXX

“royalty” means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head “Capital gains”) for—

(i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property ;
(ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property;
(iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property ;
(iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill ;
(iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB;
(v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films ; or
(vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v).
XXX

Explanation 5.—For the removal of doubts, it is hereby clarified that the royalty includes and has always included consideration in respect of any right, property or information, whether or not—
(a) the possession or control of such right, property or information is with the payer;
(b) such right, property or information is used directly by the payer;
(c) the location of such right, property or information is in India.

Therefore, as per the aforesaid provisions, consideration for transfer of rights (including granting of a licence) in respect of a trade mark or similar property or for use of a trademark or transfer of rights (including granting of a licence) in respect of any copyright, literary, artistic or scientific work, falls under the definition of ‘Royalty’ under the IT Act. Accordingly, any transaction with the related party for the aforesaid activities shall be regarded as related party transaction for usage of royalty.

Similarly, the term ‘brand usage’ has not been defined under the Listing Regulations. In this regard, reference may be drawn from section 2(zb) of the Trade Marks Act, 1999 which identifies brand as a trade mark or label which is an intellectual property right. Accordingly, any transactions of brand usage by related party shall be regarded as related party transaction.

Impact of GST laws on brand usage transactions

After the introduction of regulation 23(1A) it is very clear the companies will have to structure the brand usage transactions properly and pricing policy of the same shall have be relooked at, however, one must not forget the potential impact GST laws can have on these transactions.
Rule 28 of Central Goods and Services Tax (CGST) Rules, 2017 states that all transactions between related persons must be carried out on arm’s length basis and should be priced at open market value. This applies to all transactions between related parties, needless to say even brand usage transactions will also be covered under this.

Therefore, if going forward the parties decide to execute the transactions without any consideration, in order to escape the provisions of regulation 23(1A), the same shall be subjected to rule 28 which provides for computation of notional value and GST will have to paid on the notional value.
However, rule 28 provides for an exception which states that if an invoice is raised by the supplier with GST on it and the recipient of the supply is eligible to claim input tax credit on the value of services, then the value quoted in the invoice shall be deemed to be the open market value of the goods or services.
Therefore, to ensure that notional value taxation does not apply, the parties must refrain from structuring transactions with nil consideration. However, if the same involves royalty payments of more than 2% of the consolidated turnover, it will have to comply with regulation 23(1A).Therefore, the companies must be mindful of both these provisions while structuring this kind of transactions henceforth.

Conclusion

While the Committee does not intend to stop brand usages in the country, all it wants to establish is a fair and transparent practise of charging royalty payments for the usage of brands. Accordingly, listed companies have to be more careful before charging for brand usages, as the same have come under the radar of materiality and have to be reported. Further, considering the tax implications, the structuring of such kind of transaction shall be important. To summarise, the Listing Regulations have introduced a new dimension to payments made for brand usages and royalties.

Extension of Ombudsman Scheme to remaining class of notified NBFCs

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By Dibisha Mishra (dibisha@vinodkothari.com)

Updated as on April 26, 2019

Introduction

Reserve Bank of India (RBI), in its Statement on Development and Regulatory Policies[1] dated April 04, 2019, stated its intention to extend the same to the remaining notified classes of NBFCs as well, by the end of April, 2019.

Ombudsman Scheme for Non-Banking Financial Companies, 2018 (Scheme) on 23rd February, 2018[2] was introduced with the intent of curbing down the time, costs and complexities involved in complaint redressal mechanism for certain services rendered by non-banking financial companies (NBFC). The salient features of the Scheme worth taking note of has been explained in our previous article.[3] The Scheme covered within its ambit, all NBFCs registered with RBI, who are:

  • authorized to accept deposits; or
  • having customer interface, with assets size of Rs. 100 Crores or above, as on the date of the audited balance sheet of the previous financial year,

(hereinafter referred to as “notified classes of NBFCs”)

However, to start with, the Scheme was made applicable to deposit taking NBFCs only and the idea was to make it applicable on the other notified classes of NBFCs, once the same could gather some traction.

Subsequently, as per RBI’s recent statement in regard to increased applicability, a formal notification in this regard was expected to follow. The aforesaid has finally been notified vide. RBI’s notification dated April 26, 2019[4].

Considering the importance of the matter, in this article we will discuss all that the remaining notified classes of NBFCs must prepare for.

Applicability

As already stated the Scheme is applicable to all notified classes of NBFCs, however, the following classes of companies are excluded from its purview:

  • Non-banking Financial Company – Infrastructure Finance Company (NBFC-IFC);
  • Core Investment Company (CIC);
  • Infrastructure Debt Fund – Non-banking Financial Company (IDF-NBFC); and
  • A company under liquidation.

To do list for newly included entities

Upon notification of Scheme, the newly notified NBFCs will have to immediately take care of the following:

  1. Make the copy of the Scheme available on the website and also with the designated officer of the company for perusal in the office premises.
  2. Display prominently in all its offices and branches:
  • the purpose of the Scheme;
  • the contact details of the Ombudsman to whom the complaint is to be made by the aggrieved customer;
  • notice about the availability of the copy of Scheme with such designated officer.
  1.  Appoint Nodal Officers at Head/ Registered/ Regional/ Zonal Offices and inform all the Offices of the Ombudsman about the same.
  2. Nodal Officers so appointed must be responsible for representing the company and furnishing information to the Ombudsman in respect of complaints filed against the NBFC.
  3. Wherever more than one zone/ region of a NBFC is falling within the jurisdiction of an Ombudsman, designate one of the Nodal Officers as the ‘Principal Nodal Officer’ for such zones or regions

Pre-Conditions for availing the Scheme by an aggrieved customer

A customer aggrieved by the acts of the company or its representatives can make an application under the Scheme, however, the following pre-conditions must be satisfied before making an application:

  1. Complaint must refer to any of the grounds mentioned under Clause 8 of the Scheme.
  2. Customer must have filed a written representation to the respective NBFC regarding the grievance
  3. Concerned NBFC must have rejected the complaint or the complainant must not have received any reply within one month of NBFC receiving the representation or the complainant must not have been satisfied with the reply given to him by the NBFC.
  4. Not more than one year must have elapsed after the complainant received the unsatisfactory reply or where no reply was received, not later than one year and one month have elapsed after the date of representation to NBFC.
  5. The complaint must not be in respect of the same cause of action which was settled or dealt with on merits by the Ombudsman in any previous proceedings whether or not received from the same complainant or along with one or more complainants or one or more of the parties concerned with the cause of action;
  6. The complaint must not pertain to the same cause of action, for which any proceedings before any court, tribunal or arbitrator or any other forum is pending or a decree or Award or order has been passed by any such court, tribunal, arbitrator or forum;
  7. The complaint must not be frivolous or vexatious in nature;
  8. The complaint must fall under the period of limitation prescribed under the Indian Limitation Act, 1963 for such claims; and
  9. The complainant must have filed along with the complaint, copies of the documents, if any, which he intends to rely upon, and a declaration that the complaint is maintainable under Clause 9-A.

Roadmap while availing the Scheme

Once the complainant is satisfied that the aforesaid conditions are satisfied, it will have to take the following route to make the application:

  1. Make a complaint, as per Annex II of the Scheme, to the Ombudsman under whose jurisdiction the concerned NBFC falls. The complaint can be made either by the aggrieved customer himself or by his authorized representative;
  2. Where extra clarification or documents is required from the customer, the same is to be provided;
  3. Ombudsman shall send a copy of the complaint to the branch or registered office of the NBFC named in the complaint, under advice to the designated Nodal Officer (NO);
  4. Ombudsman may require NBFC to provide information or furnish certified copies of any document relating to the complaint which is or is alleged to be in its possession;
  5. Endeavour should be made to promote a settlement of the complaint by agreement between the complainant and the NBFC through conciliation or mediation. He/ she may convene a meeting of NBFC and the complainant together to promote an amicable resolution;
  6. If complaint is still not settled by agreement, Ombudsman shall pass an award of either allowing or rejecting the case after giving both parties an opportunity of being heard;
  7. The Ombudsman shall take into account the evidence being placed, the underlying principles on which the practices, directions, instructions and guidelines issued by the Reserve Bank from time to time and such other factors which in his opinion are relevant to the complaint;
  8. A copy of the Award shall be sent to the complainant and the NBFC free of cost;
  9. An Award shall take effect only when the complainant furnishes to the NBFC and the Ombudsman concerned within a period of 30 days from the date of receipt of copy of the Award, a letter of acceptance of the Award in full and final settlement of his claim;
  10. Unless an appeal is filed, the NBFC shall then comply with the Award and intimate compliance of the same to the complainant and the Ombudsman;
  11. Award or appeal rejection can be appealed against within 30 days of receipt of such communication.

Conclusion

The Ombudsman scheme plays a very important role in the banking system. Considering the growing importance of NBFCs in the country, introduction of this became essential. However, effectiveness of any initiative depends on how well the beneficiaries of the same are informed; same will be the case with this Scheme as well. This Scheme will turn out to be fruitful only if the same borrowers are educated about this. RBI must also take some initiative to achieve that as well

[1] https://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/PR23654E42140EAC6347D1A9D08AF62F5BF2E9.PDF

[2] https://rbidocs.rbi.org.in/rdocs/Content/PDFs/NBFC23022018.pdf

[3] https://vinodkothari.com/2018/02/rbis-ombudsman-storm-tough-road-ahead-for-nbfcs/

[4] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11546&Mode=0

Adjudication of penalties under SEBI: SC ruling gives controlled discretion to Adjudicating Officer

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-Ruling of Bhavesh Pabari overrules Roofit Industries

By Smriti Wadehra (smriti@vinodkothari.com)

A three member Bench of the SC recently overruled its earlier decision in Roofit Industries Ltd vs SEBI, and provided a controlled discretion to the Adjudicating Officer in fixing penalties for offences under the SEBI Act as well Securities Contract Regulation Act (SCRA) as a result of  the ruling, the Adjudicating Officer shall not be constrained by the minimum extent of penalty laid in SEBI Act and may, where circumstances so warrant, either waive off the penalty completely or may assign a penalty less than the so called minimum. Thus, the adjudication of penalties may be expected to be more commensurate with the gravity of the offence, than was so far possible primarily due to the position arising out of Roofit ruling. Read more →

RBI’s 12th February circular: The Last Word Becomes the Lost World

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RBI’s 12th February circular:

The Last Word Becomes the Lost World

Abhirup Ghosh (abhirup@vinodkothari.com)

The 12th February 2018 circular of the Reserve Bank of India (RBI)[1] (Circular), arguably one of the sternest of measures requiring banks to stop ever-greening bad loans, and resolve them once for all, with a hard timeline of 6 months, or mandatorily push the matter into insolvency resolution, was aimed at being the last word, overriding several of the previous measures such as CDR, JLF, SSSS-A, etc. However, with the Supreme Court striking it down, in the case of Dharani Sugars and Chemicals Limited vs Union of India and Ors.[2], the mandate of the RBI in directing banks with how to deal with stressed loans has fallen apart. While the SCI has used very technical grounds to quash the 12th Feb circular, the major question for the RBI is whether it should continue to micro-manage banks’ handling of bad loans, and the major question for the banks is when will they grow up into big boys and stop expecting RBI to tell them how to clean up the mess on their balance sheet. Read more →