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

June 25, 2020/0 Comments/in Corporate Laws, SEBI /by Vinod Kothari Consultants

Henil Shah | Executive

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:

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

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 3/4^th 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: https://vinodkothari.com/2020/04/sebis-proposal-to-aid-financially-stressed-companies/

Prudential Framework for Resolution of Stress Assets: New Dispensation for dealing with NPAs: https://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!

June 4, 2020/0 Comments/in Capital Markets, Corporate Laws, SEBI /by Vinod Kothari Consultants

Timothy Lopes, Executive, Vinod Kothari Consultants

finserv@vinodkothari.com

– with updates as on 30-07-2022

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 19^th 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 1^st 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;
3^rd 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.

Developments taken place since the WG report

Subsequent to the Working Group Report published on 1^st June, 2020, several developments have taken place relating to a framework for SSE. A Technical Group on SSE was constituted by SEBI on 21^st September, 2020 which submitted its report on 6^th May, 2021[1].

The key recommendations of the Technical Group (which built upon the recommendations of the WG) included recommendations relating to eligibility of social enterprise for SSE, on-boarding of NPOs and FPEs, various instruments available for NPOs and FPEs, offer document content for social enterprises, social venture funds, capacity building fund, social auditors, information repositories and disclosures on SSE.

Our article on the recommendations of the Technical Group can be viewed here.

Public comments were invited and received on the report of the Technical Group. Subsequent to this, SEBI in its Board meeting dated 28^th September, 2021, discussed the agenda relating ‘Framework for Social Stock Exchange’[2] which was considered and approved and amendments to several regulations were proposed. Further, SEBI in its Board meeting dated 15^th February, 2022, discussed the agenda relating to ‘Regulatory Framework for Social Stock Exchanges’[3] which was also considered and approved.

On 15^th July, 2022[4], the Central Government in exercise of the powers conferred by sub-clause (iia) of clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (‘SCR Act’) declared “zero coupon zero principal instruments” as “securities” for the purpose of the SCR Act.

Further, pursuant to these developments, on 25^th July, 2022, SEBI has amended the following regulations to lay down a framework for SSE –

Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015[5];
Securities and Exchange Board of India (Alternative Investment Funds), 2012[6];
Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018[7].

Amendments to other Acts (as proposed in the Working Group and Technical Group reports) that fall outside the purview of SEBI, such as the Companies Act, 2013, Income Tax Act, 1961, etc. are yet to be made.

[1] https://www.sebi.gov.in/reports-and-statistics/reports/may-2021/technical-group-report-on-social-stock-exchange_50071.html

[2] https://www.sebi.gov.in/sebi_data/meetingfiles/oct-2021/1633606607609_1.pdf

[3] https://www.sebi.gov.in/sebi_data/meetingfiles/feb-2022/1645691296343_1.pdf

[4] https://www.sebi.gov.in/legal/gazette-notification/jul-2022/declaration-of-zero-coupon-zero-principal-instruments-as-securities-under-the-securities-contracts-regulation-act-1956_60875.html

[5] https://www.sebi.gov.in/legal/regulations/jul-2022/securities-and-exchange-board-of-india-listing-obligations-and-disclosure-requirements-fifth-amendment-regulations-2022_61169.html

[6] https://www.sebi.gov.in/legal/regulations/jul-2022/securities-and-exchange-board-of-india-alternative-investment-funds-third-amendment-regulations-2022_61156.html

[7] https://www.sebi.gov.in/legal/regulations/jul-2022/securities-and-exchange-board-of-india-issue-of-capital-and-disclosure-requirements-third-amendment-regulations-2022_61171.html

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

May 20, 2020/0 Comments/in Corporate Laws, Covid-19, SEBI, SEBI and listing-related compliances - Covid-19 /by Vinod Kothari Consultants

Munmi Phukon & Ambika Mehrotra

corplaw@vinodkothari.com

Introduction

The Securities and Exchange Board of India (SEBI) has issued an Advisory on 20^th 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.

SEBI’s relaxation inspired by MCA circulars

May 13, 2020/0 Comments/in Corporate Laws, Covid-19, SEBI, SEBI and listing-related compliances - Covid-19, UPDATES /by Vinod Kothari Consultants

Link to the circular (12.05.2020)

Transfer of shares to family trusts without complying with SAST requirements

May 6, 2020/0 Comments/in Corporate Laws, SEBI /by Vinod Kothari Consultants

Corporate Law Updates – April, 2020

May 2, 2020/0 Comments/in Corporate Law Updates, Corporate Laws, Publications, UPDATES /by Vinod Kothari Consultants

SEBI’s proposal to aid financially “stressed” companies

April 28, 2020/0 Comments/in Corporate Laws, SEBI /by Vinod Kothari Consultants

-Proposal for relaxation in pricing norms for preferential issue and making an open offer

Henil Shah | Executive

corplaw@vinodkothari.com

Introduction

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. It’s safe to say that for such a company, one of the foremost priority is to secure a source of funds in order to fund their operations to upturn its economic conditions thereby avoiding Insolvency/Bankruptcy. Keeping the same view in mind, the Securities and Exchange Board of India (‘SEBI’) deliberated the matter to its Primary Market Advisory Committee (‘PMAC’), which identified the following key issues to be addressed in order to assist the financially stressed companies to raise funds:

Criteria for determining a company as stressed
Determination of a reasonable price for preferential allotment
Exemptions from open offer obligations under the SAST Regulations

Based on the recommendations given by PMAC, SEBI on April 22, 2020 released a Consultation paper “Pricing of preferential issues and exemption from open offer for acquisitions in companies having stressed assets”[1] seeking public comments till May 13, 2020.

Rationale behind the proposed changes

One of the key modes of raising funds by a company especially a financially distressed company is by way of preferential issue of equity shares or convertible instruments. Knowing the probable investors ready to invest in the company makes 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 SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“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.

i. 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.

ii. Exemptions only to 5 QIBs restricting investor pool

iii. 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 SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011(‘SAST Regulations’).

Therefore, where the listed entity is already under distress and suffering from a financial crisis, huge open offer obligations and the cost involved therein discourage the probable investors from taking any controlling interest in such entity.

Rescue mechanism by way of proposed changes

What will be regarded as “stressed”?

It is proposed that only such listed companies which meet any 2 (two) of the following 3 (three) conditions will be determined as a “stressed” company and shall be able to avail the benefits while making an offer under preferential issue once the proposed changes come alive.

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[2] issued in this regard;

Default for the purpose of the above circular shall mean non –payment of interest or principal in full on the pre-agreed due date. Provided in case of revolving facilities default shall be considered when outstanding balance remains continuously in excess of the sanctioned limit or drawing power, whichever is lower for more than 30 days.

Existence of Inter-Creditor agreement in terms of Reserve Bank of India (Prudential Framework for Resolution of Stressed assets) Directions 2019[3];

Inter-credit agreement in terms of the RBI directions stands for 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”.

Proposal for relaxed pricing norms under the ICDR Regulations:

Unlike the current pricing requirements as provided in Regulations 164(1) (a) & (b) 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.

Exemptions proposed under the SAST Regulations

Where due to the subscription of shares offered under preferential issue by a financially stressed company triggers open offer obligations as per SAST Regulations, the same shall be exempted.

Additional conditions for availing the exemptions

The Consultation Paper also provides for an additional set of requirements to be complied in case were the benefits of the proposed exemptions are to be availed.

Persons/entities that are not part of the promoter or promoter group will not be eligible to participate in the preferential issue.
Obtaining of shareholders’ consent for the exemption to make an open offer by the proposed investors along with the proposal of preferential issue. The shareholders’ approval shall be an approval of majority of minority excluding the promoters and promoter group and any proposed allottee that already hold securities in the issuer.
Disclosure of the proposed use of the proceeds of such preferential issue in the explanatory statement. This requirement is nothing new 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.
Appointment of a monitoring agency. 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.
Mandatory lock in requirements of shares issued on preferential basis for 3 years which is same as provided in chapter V (Preferential issue) requirement of ICDR Regulations.

Conclusion

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

Our write up on prudential framework for resolution for stressed assets can be accessed at:

https://vinodkothari.com/2019/06/fresa/

Our other write ups can be accessed at: https://vinodkothari.com/category/corporate-laws/

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

[2] 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

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

Highlights of SEBI’s temporary relaxations for Rights Issue

April 25, 2020/0 Comments/in Corporate Laws, Covid-19, SEBI, SEBI and listing-related compliances - Covid-19, UPDATES /by Vinod Kothari Consultants

Ambika Mehrotra & Ankit Vashishth

corplaw@vinodkothari.com

In line with various other relaxations introduced by the Securities and Exchange Board of India (‘SEBI’), amid the global pandemic, it has now come up with a Circular dated 21^st April, 2020 [1]granting temporary relief under certain provisions of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR regulations’) in respect of Rights Issue. The rights issues opening on or before March 31, 2021 will get benefited from the said Circular.

It goes without saying that during the period of this of economical breakdown, the industrial undertakings are in need of funds for various purposes. In this hour of crisis, SEBI’s move seems to ease out the stringent requirements in the statues which hamper the facility of raising funds by companies especially through rights issue.

The amended provisions broadly serve the intent of having a relatively flexible eligibility criteria for a fast track rights issue and lesser chances of refund of the amount in case of non- receipt of subscription amount.

A snapshot of the relaxations and their impact is enlisted below: –

Eligibility conditions related to Fast Track Rights Issues

Relevant Regulation	Pre- amendment	Post-amendment	Impact Analysis
99(a)	the equity shares of the issuer have been listed on any stock exchange for a period of at least three years immediately preceding the reference date	the equity shares of the issuer have been listed on any stock exchange for a period of at least eighteen months immediately preceding the reference date	Relaxation in the pre-condition with respect to listing of equity shares from 3 years to 18 months.
99(c )	the average market capitalisation of public shareholding of the issuer is at least two hundred and fifty crore rupees	the average market capitalisation of public shareholding of the issuer is at least one hundred crores	Companies with smaller market size i.e. more Rs. 100 crore and above also permitted to enter into Fast Track Issue.
99(f) and its proviso	the issuer has been in compliance with the equity listing agreement or the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, as applicable, for a period of at least three years immediately preceding the reference date: Provided that if the issuer has not complied with the provisions of the listing agrîment or the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, as applicable, relating to composition of board of directors, for any quarter during the last three years immediately preceding the reference date, but is compliant with such provisions at the time of filing of letter of offer, and adequate disclosures are made in the letter of offer about such non-compliances during the three years immediately preceding the reference date, it shall be deemed as compliance with the condition;	the issuer has been in compliance with the equity listing agreement or the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, as applicable, for a period of at least eighteen months immediately preceding the reference date: Provided that if the issuer has not complied with the provisions of the listing agreement or the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, as applicable, relating to composition of board of directors, for any quarter during the last eighteen months immediately preceding the reference date, but is compliant with such provisions at the time of filing of letter of offer, and adequate disclosures are made in the letter of offer about such non-compliances during the three years immediately preceding the reference date, it shall be deemed as compliance with the condition;	The timeline for being in compliance with listing regulations has been reduced from 3 years to 18 months. This is in line with the requirement under Regulation 99(a) wrt listing of equity shares for a period of atleast 18 months instead of 3 years.
99(h)	No show-cause notices have been issued or prosecution proceedings have been initiated by the SEBI and pending against the issuer or its promoters or whole-time directors as on the reference date.	No show-cause notices, excluding under adjudication proceedings, have been issued by the SEBI and pending against the issuer or its promoters or whole-time directors as on the reference date. In cases where against the issuer or its promoters/ directors/ group companies, i. a show cause notice(s) has been issued by the Board in an adjudication proceeding or ii. prosecution proceedings have been initiated by the Board; necessary disclosures in respect of such action (s) along-with its potential adverse impact on the issuer shall be made in the letter of offer.	Regulation 99(h) restricts the company to make fast track rights issue in case there had been any show-cause notices or prosecution proceedings issued/initiated against the company/ its promoters/ WTDs. The temporary relaxation however allows the company to be eligible for rights issue to the extent where adjudication proceedings or prosecution proceedings in respect of the above as well as the group companies are concerned, on making the required disclosures in this regard and its adverse impact, in the letter of offer
99(i)	the issuer or promoter or promoter group or director of the issuer has not settled any alleged violation of securities laws through the consent or settlement mechanism with the Board during three years immediately preceding the reference date;	The issuer or promoter or promoter group or director of the issuer has fulfilled the settlement terms or adhered to directions of the settlement order(s) in cases where it has settled any alleged violation of securities laws through the consent or settlement mechanism with the Board.	Prior to the relaxation, any violation in the securities laws by the issuer/ promoter/ promoter group/ director made the issuer ineligible. This however has now been relaxed to permit the issue in case the above violators, having violated the securities laws at anytime during the past have fulfilled the settlement terms or followed the directions under the settlement order(s)
99(j)	The equity shares of the issuer have not been suspended from trading as a disciplinary measure during last 3 years immediately preceding the reference date.	The equity shares of the issuer have not been suspended from trading as a disciplinary measure during last 18 months immediately preceding the reference date.	In line with Regulation 99(a) and (f)
99(m)	There are no audit qualifications on the audited accounts of the issuer in respect of those financial years for which such accounts are disclosed in the letter of offer	For audit qualifications, if any, in respect of any of the financial years for which accounts are disclosed in the letter of offer, the issuer shall provide the restated financial statements adjusting for the impact of the audit qualifications. Further, that for the qualifications wherein impact on the financials cannot be ascertained the same shall be disclosed appropriately in the letter of offer.	Prior to the Circular, any qualification in the audit report led to ineligibility. This condition has now been re-framed to make the companies eligible on providing the restated financial statements adjusting for the impact of the audit qualifications or providing clarifications in case such impact cannot be ascertained

Relaxation with respect to Minimum Subscription:

Relevant Regulation

Pre- amendment

Post-amendment

Remarks

86(1)

The minimum subscription to be received in the issue shall be at least ninety per cent. of the offer through the offer document.

The minimum subscription to be received in the issue shall be at least seventy five percent of the offer through the offer document.

Provided that if the issue is subscribed between 75% to 90%, issue will be considered successful subject to the condition that out of the funds raised atleast 75% of the issue size shall be utilized for the objects of the issue other than general corporate purpose.

The minimum subscription amount has been reduced from 90% to 75%.

However, the Circular seems to put another restriction on the utilization of atleast 75% of the funds for the objects of the issue other than general corporate purpose if the actual subscription goes beyond 75% but within 90% of the offer.

Minimum threshold for not filing draft letter of offer

Relevant Regulation	Pre- amendment	Post-amendment	Remarks
Applicability of the Regulations: 3(b)	rights issue by a listed issuer; where the aggregate value of the issue is ten crore rupees or more;	rights issue by a listed issuer; where the aggregate value of the issue is twenty-five crores or more;	The conditions prescribed in Chapter III of ICDR Regulations shall not apply in case of Rights Issue carrying an issue size of less than Rs. 25 crores.
Proviso to Reg. 3	Provided that in case of rights issue of size less than ten crore rupees, the issuer shall prepare the letter of offer in accordance with requirements as specified in these regulations and file the same with the Board for information and dissemination on the Board’s website.	Provided that in case of rights issue of size less than twenty-five crore rupees, the issuer shall prepare the letter of offer in accordance with requirements as specified in these regulations and file the same with the Board for information and dissemination on the Board’s website.	The change is made considering the revised limit of applicability of the Regulations for a rights issue.
60	Unless otherwise provided in this Chapter, an issuer offering specified securities of aggregate value of ten crore rupees or more, through a rights issue shall satisfy the conditions of this Chapter	Unless otherwise provided in this Chapter, an issuer offering specified securities of aggregate value twenty-five crore rupees or more, through a rights issue shall satisfy the conditions of this Chapter.	The change is made considering the revised limit of applicability of the Regulations for a rights issue.

One-time Relaxation on opening of issue

In addition to the above Circular, SEBI has also issued another circular on the same date i.e. April 21, 2019[2] for granting one-time relaxation on the basis of the representations received from various stakeholders with respect to the opening of issue period within 12 months from the date of issuance of the observations by SEBI, for an Initial Public Offer (IPO), Further Public Offer (FPO) or Rights Issue as per Regulation 44, 140 and 85 respectively of the ICDR Regulations, expiring during this period of lockdown i.e. between March 1, 2020 and September 30, 2020 to be extended by 6 months, from the date of expiry of the above-mentioned observations received from SEBI.

However, the extension to this issue opening period shall be granted on obtaining an undertaking from lead manager of the issue confirming compliance with Schedule XVI of the ICDR Regulations with respect to the nature of changes in the offer document which require filing of updated offer document, while submitting the updated offer document to SEBI.

Conclusion

These temporary relaxations will surely bring in a sigh of relief for the stakeholders including the companies intending to raise funds through rights issue, during this interim period of disruption due the outbreak of COVID-19, considering the stagnancy of operations in the country.

Read our related articles below –

SEBI ICDR Regulations, 2018– Snapshot on changes in rights, bonus, QIP and preferential issue;

Key amendments in relation to Rights, Bonus, QIP and Preferential Issue under SEBI (ICDR) Regulations, 2018;

SEBI (ICDR) Regulations, 2018-Key Amendments;

Covid-19 – Incorporated Responses | Regulatory measures in view of COVID-19.

[1] https://www.sebi.gov.in/legal/circulars/apr-2020/relaxations-from-certain-provisions-of-the-sebi-issue-of-capital-and-disclosure-requirements-regulations-2018-in-respect-of-rights-issue_46537.html

[2] https://www.sebi.gov.in/legal/circulars/apr-2020/one-time-relaxation-with-respect-to-validity-of-sebi-observations_46536.html

COVID- 19 AND DEBENTURE RESTRUCTURING

April 24, 2020/3 Comments/in SEBI /by Vinod Kothari Consultants

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

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

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

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

***Force Majeure*– An Excuse to Default?**

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

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

Consequences of default- Rights available to debenture holders:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Restructuring Process and the Formalities associated thereto:

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

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

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

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

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

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

S. No	Relevant Provisions	Actionable/ Compliance	Remarks
1.	Regulation 50 (3) of LODR Regulations	Prior intimation to the stock exchange (SE) for the meeting board of directors, at which the restructuring is proposed to be considered.	2 working days in before the board meeting. (excl. date of intimation and date of meeting)
2.	Sec. 173 of CA 13	BM to be convened by the Company for proposed restructuring including the revised terms subject to approval of the stock exchanges and the debenture holders.	Through VC considering the COVID 19 Guidelines issued by the Govt. Our FAQs in this regard may be found at : https://www.google.com/url?q=https://vinodkothari.com/2020/03/board-meetings-during-shutdown/&sa=D&source=hangouts&ust=1587820272757000&usg=AFQjCNEictCwK_-LNnlH7oiB1GMmdRzO6w
3.	Regulation 59(2)(a) of LODR Regulations	Obtain approval of the DT	Before applying to SEs.
4.	Regulation 59 of the Listing Regulations	Seek prior approval from the stock exchange	After taking the consent of the board of directors and DT.
5.	Regulation 15(2) of DT Regulations, 1993	Separate meeting of debenture holders to be called for deferment in repayment due to liquidity crunch in the hour of crisis.	The meeting may be called by the company itself or through the DT. Since the scope of SS 2 issued by ICSI includes meetings of debenture holders also, the company will have to observe the requirements of SS 2 in convening the meeting of debenture holders. However, considering the current crisis situation, such meeting may be convened through VC facility as clarified by MCA Circular dated 13^th April, 2020. Our FAQs in this regard may be found at https://vinodkothari.com/2020/04/general-meetings-by-video-conferencing-recognising-the-inevitable/
6.	Regulation 51 (2) of the Listing Regulations	Intimation to the stock exchanges being an action that shall affect payment of interest or redemption of NCDs	ASAP but not later than 24 hours of Board decision.

Documentation Requirements:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Please click below for youtube presentation on the above topic:

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

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

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

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

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

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

April 23, 2020/0 Comments/in Corporate Laws, SEBI /by Vinod Kothari Consultants

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

Munmi Phukon | Partner | Vinod Kothari & Company

corplaw@vinodkothari.com

Introduction

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

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

Legislative intent and purpose of the SAST Regulations

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

Requirements related to encumbered shares under the Regulations

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

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

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

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

The term ‘encumbrance’ under the Regulations

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

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

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

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

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

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

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

Brief of the SEBI’s Order

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

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

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

Meaning of ‘encumbrance’ in jurisprudence

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

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

At Page 242 the learned author has observed as follows:

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

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

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

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

An analysis of the meaning of encumbrance

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

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

Different forms of quasi security interests on shares

Negative Lien or Negative Pledge

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

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

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

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

Springing Lien

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

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

Conclusion

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

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

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

Read our related articles:

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

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

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

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

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

[5] Right over one’s own property

[6] Right over someone else’s property

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

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

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