Over a period of the last one month or so, two developments have taken place that have caused anxiety to thousands of non-banking financial companies (“NBFCs”) or those otherwise engaged mainly or partly in business of finance. Many NBFCs are engaged in activities that directly or indirectly affect listed companies and their Promoters. These are acting as investment holding companies for Promoters, trading and investing in securities markets generally, lending to investors in stock markets, carrying on activities related to securities markets such as intermediaries which at times may result in their becoming NBFCs. Hence, these developments are highlighted in a column, essentially focussing on the aspect of securities laws.
One development is that, in a seeming reversal of policy, the Reserve Bank of India has written to tens of thousands of companies asking them whether they are NBFCs and, if yes, why have they not registered as such. The other development is a set of amendments relating to issue of debentures that affect the manner in which NBFCs raise finance and worse, affect finance already raised.
“Are you an unregistered NBFC?” – notices to thousands of companies by Reserve Bank of India
Over the last week, the Reserve Bank of India has sent notices to thousands – tens of thousands perhaps companies asking them whether they are NBFCs. And, if yes, why they have not registered.
This is worrying because if a Company is an NBFC and has not registered, it entails serious consequences for the Company and its concerned directors/ officers. For example, the law provides for minimum and mandatory punishment of one year for nonregistration as NBFC.
The other thing is that the definition of NBFC itself is confusing and contradictory. On the one hand, there is a qualitative definition that treats the principal business as the determining factor when the Company is an NBFC. On the other hand, in certain circulars/press notes, the Reserve Bank of India has provided for quantitative method/formula for determining what is an NBFC. The nature of activities included as finance activities is also broad but subject to different interpretations. Even relatively minor terms like “financial assets” are subject to varying interpretations. For example, is fixed deposit in bank a “financial asset”?
It does not help that the Reserve Bank of India has expressly declared that it is the sole and final judge (subject to “consultation with the Central Government”) to decide whether a Company is an NBFC or not. It also does not help that there is no appellate tribunal to appeal against decisions of the Reserve Bank of India.
Further, even the Reserve Bank of India and law makers are sending mixed signals. In perhaps undue haste, the law makers make a drastic and unduly broad law in 1997. It required any and every company engaged in specified finance activities as principal business to register as NBFC first, even if it intended to use own funds for its business and not accept any public deposits. There is no minimum size of companies that are exempt from registration. In fact, there is a minimum entry barrier of Rs. 2 crore of net-owned funds for registration. Hence, even the smallest and largest of companies are subject to registration. The registration process is not a simple process of filing some documents. It is a prolonged affair involving detailed scrutiny of antecedents even for small companies operating with own funds. Several times, initiatives were taken to rationalise these provisions. About two years back, one group of companies – Core Investment Companies – were exempted from registration but subject to certain restrictions and requirements. Further, just last year, an expert Committee recommended that companies below certain size (Rs. 1,000 crore of assets under certain circumstances) should not be required to be registered. That would have excluded most medium sized and small companies. Indeed a few months back, the Reserve Bank of India even issued draft guidelines proposing to give effect to this, though final guidelines have not been issued.
And now these notices have been sent. The process of responding and disposal will be prolonged and time consuming for the companies, their auditors and of course, the Reserve Bank of India itself. As stated above, determining whether a Company is an NBFC or not is subject to qualitative and/or quantitative criteria.
There are other concerns too. The consequences of non-registration are not just the stringent punishment of imprisonment for non-registration and fine. The question is what would happen of consequential non-compliances. A registered NBFC is required to follow several directions, particularly relating to Prudential Norms. It is possible that these would not have been followed.
The onus of reporting whether a Company is NBFC or not is on their auditors too by specific Directions addressed to them. Non-compliance by them would be subject to fine, in some cases prosecution and also reference to the Institute of Chartered Accountants of India.
It is possible that one reason for this step is the recent uncovering of numerous companies in West Bengal and elsewhere having raised thousands of crores from the public, a large part of which may be lost. The recent Sahara case is also a likely reason.
The coming days would thus be anxious days for these companies – and others who have not yet received such notices.
Restrictions on issue debentures by NBFCs
On 27th June 2013, RBI made amendments and issued certain Guidelines relating to issue of debentures by NBFC as an “excluded” means of raising finance. A followup circular making certain clarificatory amendments was issued on 2nd July 2013. Essentially, the amended law that debentures will be excluded only if they are either compulsorily convertible or fully secured. There are some related changes too. But first, some background.
The framework of law for raising of finance by NBFCs and even non-NBFCs is quite broadly worded. The intention is to regulate and restrict any form of raising of monies by NBFCs. But there are specific exclusions. If monies are raised in any of these excluded forms, they are not regulated/restricted (though some general/indirect restrictions may apply). For example, money raised from shareholders by a private limited company is excluded.
Another exclusion, important for several NBFCs, was raising monies in the form of debentures. Debentures generally are not excluded unless they have one of two features. Either they are optionally convertible. Or they are fully secured in the specified manner by mortgage of immovable or other property, etc.
In this context, the Reserve Bank of India has made two changes.
Firstly, they have stated that convertible debentures would be excluded only if they are compulsorily convertible. Thus, optionally convertible debentures would no longer be excluded.
The reason is perhaps not far to see. Optionally convertible debentures do have the feature of being quasi equity in the sense that there is potential of conversion into equity shares. But there is potential and perhaps actual and rampant misuse also. The Sahara case involved the use of optionally convertible debentures. This was also reported to be the case in several other cases.
Question is whether this change will apply only to future issue of convertible debentures or will it affect existing optionally convertible debentures. It would appear that, considering the wording of the relevant provisions, directions, etc., the restrictions would apply to new issues of debentures or renewal of existing debentures.
The second amendment relates to so-called “private placements”. However, instead of amending the Public Deposits Directions relating to NBFC, separate Guidelines have been issued. The term “private placement” has been defined as:-
“private placement means non-public offering of NCDs by NBFCs to such number of select subscribers and such subscription amounts, as may be specified by the Reserve Bank from time to time.”
Certain provisions are made in the Guidelines for issue of such Non- convertible Debentures (NCDs). Firstly, they have to be fully secured. Creation of such security has to be completed within one month and till that time, the proceeds of NCDs should be kept in an escrow account.
Each applicant should acquire at least Rs. 25 lakh worth of NCDs and in excess of that in multiples of Rs. 10 lakh.
It is provided that private placement, once initiated, has to be completed within six months. It was also provided that there should be a gap of six months between two private placements. However, this requirement regarding the gap has been put into abeyance till further notice.
Each private placement should be not more than 49 subscribers, who are to be named upfront. This is obviously to plug the loophole in section 67 of the Companies Act, 1956, which too requires offer by private placement that cannot be to more than 49 subscribers. However, that section has an exemption for NBFCs and thus these Guidelines cover NBFCs by a similar provision and thus bridging this gap.
Once again, it appears that the Sahara and other cases may be at the back of mind to this amendment. The covering letter to the Guidelines states, “It has however been observed that NBFCs have lately been raising resources from the retail public on a large scale, through private placement, especially by issue of debentures.”.
Another term – “public issue” – has been defined as:-
“Public issue” means an invitation by an NBFC to public to subscribe to the securities offered through a prospectus.
Curiously, the original circular issuing the Guidelines provided that private placement would cover only those issues where approval u/s. 81(1A) of the Companies Act, 1956. That would effectively imply issues by public limited companies. The latter circular changed the definition and now all “non-public” issues are covered. It would appear that, taking a conservative view, even private limited companies are covered though it is not clear whether this was the real intention.
An interesting question would be whether these Guidelines relating to private placement would also apply to issue of compulsorily convertible debentures. There is no specific exclusion. The conclusion, which appears to be inconsistent with the scheme, may be that they should apply to compulsorily convertible debentures too. This would lead to the absurd situation that compulsorily convertible debentures should be fully secured too. While, from the clause in the Directions, it appears that, for being excluded, the debentures can be either compulsorily convertible or fully secured. It is submitted that the Guidelines should apply only to non-convertible debentures. Thus, either the debentures should be fully secured or compulsorily convertible.
Conclusion
The law relating to the so-called NBFCs almost scream for a rehaul. It appears that the real concern of the regulator is NBFCs raising excessive monies without safeguards. There are adequate provisions to prevent, detect and punish such offenders. A blanket ban on all so-called NBFCs, whose definition is extremely wide, is counter productive and restrictive. The recent illegal raising of monies and the current amendments has hardly any connection. It is high time the Reserve Bank of India implements the draft Guidelines and gives relief to thousands, perhaps lakhs of companies and individuals seeking to carry out finance business in small or medium size, without having any intention to raise deposits from the public.
