Banking & Finance

Report of the Insolvency Law Committee: The New Way Forward

Report of the Insolvency Law Committee: The New Way Forward

On November 16, 2017, the Government of India constituted a committee to undertake a comprehensive review of the Insolvency and Bankruptcy Code, 2016 (‘IBC’) in light of the experiences of various stakeholders during the past year. The Ministry of Corporate Affairs (‘MCA’) constituted the Insolvency Law Committee (‘ILC’) which comprises representatives from across the industry. Bahram N Vakil, a founding partner of AZB & Partners (‘Firm’) and a member of the Bankruptcy Law Reform Committee (the committee entrusted with drafting of the IBC in 2015) is one of the members of the ILC.

The MCA released ILC’s report on April 3, 2018 (‘Report’). The Report proposes various amendments to the IBC and the rules and regulations thereunder. The Parliament is likely to consider the Report in the near future to make the relevant legislative changes. Some of the major changes proposed by the Report are as below:

  • Homebuyers upgraded 

The IBC does not explicitly categorise homebuyers who have paid advances towards completion of real estate projects as financial or operational creditors in the corporate insolvency resolution process (‘CIRP’) of the real estate developer.The ILC took the view that advances paid by homebuyers are effectively used by real estate developers as working capital to finance the completion of projects thereby giving it the commercial effect of a borrowing and has proposed that homebuyers be treated as financial creditors. Note that their secured status depends on the nature of their contract with the developer and the bank providing the home loan. The ILC has also proposed that a large block of creditors be allowed to participate in meetings of the committee of creditors (‘CoC’) through an authorised representative.

  • Interest clock on interim finance extended

Under the IBC, interim finance and any interest on it is classified as insolvency resolution process cost which receives the highest priority on any payout under a resolution plan. However, in the event of liquidation, though the principal amount of interim finance still retains its highest priority, the interest stops accruing from the date of the liquidation order.The ILC felt that the clog on accrual of interest in liquidation was affecting liquidity and raising the coupon on interim finance. The ILC has proposed that interest on interim finance shall continue to accrue for up to one year from the liquidation commencement date. Note that the Insolvency and Bankruptcy Board of India (‘IBBI’) has already made necessary changes to this effect in the IBBI (Liquidation Process) Regulations, 2016.

  • Disqualification for bidders – revisited again

Section 29A of the IBC was introduced to address concerns that persons who by their conduct had contributed to the financial distress of the corporate debtor or are otherwise deemed not to be fit and proper to gain control over distressed assets, should be disqualified from being resolution applicants. However, the market felt that the range of disqualifications and the affected persons was too large. To address this issue, the ILC has made several proposals, some of which are set out below:

i.  Section 29A of the IBC lays down eligibility criteria vis-à-vis the resolution applicant as well as any person acting jointly or in concert with the applicant. The term ‘acting jointly or in concert’ is not defined in the IBC and causes market participants to rely on the definition contained in the Securities and Exchange Board of India (‘SEBI’) (Substantial Acquisition of Shares and Takeovers) Regulations, 2011. This results in inclusion of an extremely broad range of persons, including even those who are involved in the resolution plan in an ancillary way. The ILC proposes to restrict the eligibility test only to the applicant and its connected persons. Additionally, any person acting with a common objective of acquiring voting rights or control over the company would also have to pass the eligibility test.

ii. Section 29A(c) of the IBC bars persons who have been in control of a non-performing asset (‘NPA’) for more than one year. However, this provision effectively disqualified several ‘pure play’ financial investors who are in the business of investing in companies across the credit spectrum. For instance, asset reconstruction companies, private equity and distressed debt funds are quite likely to have some distressed assets in their portfolios. The ILC has proposed that the test under Section 29A(c) of the IBC should not apply to such pure play financial entities.

 iii.  Section 29(A)(d) of the IBC bars persons who have been convicted of a criminal offence punishable with imprisonment for more than two years. This disqualification was thought to be very expansive and would disqualify applicants for offences, the commission of which have no nexus to the ability of the person to run the corporate debtor successfully. The ILC has proposed that the nature of offences, the commission of which will incur the disqualification should be economic in nature and a schedule listing such specific crimes be provided. Additionally, the disqualification should also not apply in case a stay against the conviction has been obtained from a higher court.

iv. Section 29A(h) of the IBC disqualifies persons who have executed an enforceable guarantee in favour of a corporate debtor currently undergoing CIRP. The ILC felt that the scope of the disqualification is overreaching since it bars guarantors solely on account of issuing an enforceable guarantee. The ILC has proposed that the disqualification should only apply against guarantors against whom the underlying guarantee has been invoked by the creditor and remains unpaid.

  • Curious case of guarantors’ liability – now resolved

Section 14 of the IBC imposes a stay on any recovery action against the corporate debtor and the enforcement of any security interest created by a corporate debtor over its assets during the CIRP period. However, a few recent judicial pronouncements have suggested that the moratorium in an ongoing CIRP will also stay enforcement of guarantees or security interest from promoters and group companies of the corporate debtor since it is not feasible to determine the liability of the relevant third party until the CIRP is concluded.The committee felt that the scope of the moratorium is very clear and should not be interpreted broadly. The intent of law could not have been to deprive creditors of contractually negotiated remedies against third parties as long as the corporate debtor’s assets remain unaffected. The ILC proposes that an explanation be added to Section 14 of the IBC to clarify that the moratorium does not apply to any recovery action that does not impact the assets of the corporate debtor.

  • CoC voting thresholds reduced

The IBC provides that all decisions by the CoC be taken by vote of 75% of the CoC, by value. The ILC felt that effectively granting minority lenders constituting 25% of the CoC a veto right to any proposed resolution plan could cause many companies to be liquidated. To ensure that there is a higher likelihood of resolving a distressed company as a going concern under the IBC, the ILC has proposed that the voting threshold for important matters during the CIRP including voting on resolution plans be reduced to 66% of the CoC. Additionally, for other routine decisions that the CoC is required to take during the CIRP, the voting threshold should be reduced to 51% to assist the resolution professional in ease of conducting day to day operations.

  • IBC trigger threshold now ten times    

To keep debt recovery actions from small operational creditors at bay, the ILC recommended that the minimum amount to trigger the IBC be raised to Rs. 10 lakh (approx. US$ 15,000). This may reduce pressure on the NCLT – as statistics suggest that many small creditors used the IBC to coerce recovery. But what of the small creditor? Back to the long queues in the debt recovery tribunals? Perhaps small creditors can accumulate their debt and then trigger IBC.

  • In and out with ninety percent

Currently, once an IBC case is admitted, the law does not permit withdrawal of the same without the consent of all creditors. This is consistent with the philosophy that this is a collective and representative process for all creditors and settlement with the ‘filing creditor’ should not permit withdrawal. The Supreme Court has thought otherwise and has permitted withdrawal post admission. The ILC reiterated the aforesaid philosophy but saw merit in permitting withdrawal post admission if 90% of the committee of creditors deem fit. Would this have been of use in the Binani Cement saga?

  • Regulatory approvals window

An immediate issue for acquirers in the IBC process is obtaining governmental and regulatory consents, dispensations and permits. Should the bidders bear this risk or the CoC live with the uncertainty? Today, negotiations resolve this tug-of-war to some extent while bidders draft their resolution plans treating the NCLT as a single window clearance. The ILC observed that single window clearance was not the intent of the IBC. This is a critical observation for bidders. Some solutions were debated but a comprehensive solution remained elusive. Instead, the ILC has recommended that a requirement be placed to obtain consents, dispensations and permits within a maximum of one year. It’s unclear how this will impact the fine balance currently trying to be achieved in practice by bidders.

  • Competition approval fast tracked

 In a welcome development, the ILC has been informed that the Competition Commission of India will clear notifications for combinations arising out of the IBC within 30 days, with an extension of 30 days for exceptional cases. This is already being borne out in practice and echoes the collaborative effort being taken by Indian regulators to make the IBC work.

  • Liquidation waterfall and priority of security

Concerns had been raised that the language in the IBC liquidation waterfall may override inter se ranking of security amongst creditors; i.e., in liquidation, a secured creditor with a first charge over an asset may receive the same amount as another with a second charge over such asset. After reviewing the language, related laws and relevant case law, the ILC felt confident that any such interpretation would be incorrect and valid subordination agreements should not be disregarded by the IBC and so no change has been proposed.

  • MSME promoters get a breather

Micro, small and medium enterprises are thought to be the bed rock of the Indian economy. When such companies go through the IBC process, keeping their incumbent promoters out of the bidding process has raised concerns of mass liquidation of such companies leading to potentially significant job losses. The ILC has recommended that promoters of such companies be permitted to bid for their companies in the IBC process (despite Section 29A disqualifications) unless they are willful defaulters. In balancing the opposing forces involved, this seems to be the socially appropriate decision.

  • Limitation now uncomplicated

Lenders benefited from judicial decisions which indicated that the Indian limitation legislation did not apply to an application under the IBC (although doctrine of laches might still apply). But this was yet to be confirmed by the Supreme Court, which had declined to comment on this issue in one matter. The ILC has recommended that limitation should apply to IBC applications other than those made by a corporate debtor itself.

  • No man’s land now occupied

 A resolution plan is approved by the CoC and submitted to the NCLT for confirmation. At this stage, the role of the resolution professional ends and the CoC ceases to exist. But the NCLT order may take weeks or months. Who runs the company during this time and what duties, powers and protections apply to such person? The ILC has recommended that the resolution professional be statutorily required to continue during this period, presumably with the same duties, powers and protections as during the CIRP.

For queries, please email bahram.n.vakil@azbpartners.com, ashwin.ramanathan@azbpartners.com, piyush.mishra@azbpartners.com, nilang.desai@azbpartners.com or suharsh.sinha@azbpartners.com. Bahram N Vakil, one of the founding partners of the Firm, leads the Restructuring and IBC Practice Group at the Firm. Ashwin Ramanathan, Piyush Mishra and Nilang Desai are partners and Suharsh Sinha is a senior associate in the Restructuring and IBC Practice Group at the Firm.

 

 

 

 

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Major Amendments introduced to the Insolvency and Bankruptcy Code

Major Amendments introduced to the Insolvency and Bankruptcy Code

The President of India promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 (‘Ordinance’), which has become effective from June 6, 2018. Pursuant to the Ordinance, many of the amendments suggested by the Insolvency Law Committee (‘ILC’), which included our founding partner Mr. Bahram N Vakil, have now been implemented. The major changes introduced by the Ordinance have been summarised below:

  • Homebuyers Upgraded as ‘Financial Creditors’

Prior to the Ordinance, the Insolvency and Bankruptcy Code, 2016 (‘IBC’) did not recognise persons who had paid advances towards completion of real estate projects as either ‘financial creditors’ or ‘operational creditors’. The Ordinance now provides that any amount raised from an allottee under a real estate project shall be considered a financial debt under the IBC. Since the number of such allottees could be numerous and their participation in a committee of creditors (‘CoC’) could be unwieldy, the Ordinance provides that allottees may appoint authorised representatives to attend CoC meetings on their behalf, with prior instructions on voting matters.

  • Amendments to Eligibility Criteria for a Resolution Applicant

Section 29A sets out ineligibility criteria for potential bidders in a corporate insolvency resolution process (“CIRP”). The ambit of Section 29A may have been in some instances too wide and could have unintentionally disqualified some sophisticated bidders on technical grounds. The Ordinance has, therefore, introduced the following amendments to Section 29A :

i.   Section 29A(c): NPA Related disqualification

(a)     Section 29A(c) provides that persons controlling accounts which have remained non-performing assets (‘NPA’) in excess of one year are barred from acting as resolution applicants in an ongoing CIRP. However, no clarification had been provided on whether the one-year period would be determined from: (i) insolvency commencement date of the corporate debtor; or (ii) the time at which the bid was submitted in the ongoing corporate insolvency resolution process (‘CIRP’) of the corporate debtor. The Ordinance has clarified that the relevant date should be the latter.

(b)   The Ordinance provides that the disqualification under Section 29A(c) shall not apply to a ‘financial entity’ (scope of which is discussed under Paragraph iii below).

(c)   Successful resolution applicants acquiring companies under the CIRP end up being in control or management of accounts which have turned NPA. Such acquirers would, as a result, fall foul of Section 29A(c) and would be estopped from making any further bids for any other company undergoing CIRP. In order to rectify this anomaly, the Ordinance provides for a grace period of three years in favour of a resolution applicant, calculated from the date of acquisition of such corporate debtors with NPAs during which the acquirer will not be disqualified from bidding for other companies undergoing CIRP. A similar carve-out has also been granted under Section 29(A)(g) of the IBC, to successful bidders, who have acquired companies in CIRP where certain avoidable transactions may be been undertaken by the previous promoters or officers.

ii.  Section 29A(d): Disqualification on account of Criminal Convictions

(a)     Section 29A(d) of the IBC disqualified a resolution applicant if it or any of its ‘connected persons’ had been convicted for an offence punishable with imprisonment for two years or more. It was argued that there must be a rational nexus between the underlying offence and the ability of the bidder to successfully restructure the corporate debtor.

(b)   This sub-section has been amended to provide that: (i) conviction for two years or more is a bar only if the offence relates to certain statutes prescribed in the newly introduced Twelfth Schedule to the IBC; and (ii) conviction for seven years or more would be a bar irrespective of which statute the offence fell under.

(c)   A list of twenty-five laws is specifically mentioned in the Twelfth Schedule covering areas such as money laundering, foreign exchange, pollution control norms, tax, anti-corruption and securities market regulations. The Twelfth Schedule only covers Indian statutes and an interpretation may be taken that similar violation by the bidder or its connected persons under foreign laws may not attract the disqualification. However, the disqualification relating to conviction for seven years or more would apply under Indian as well as foreign laws.

(d)   The Ordinance provides that the bar under Section 29A(d) will not apply if more than two years have elapsed from the date of release from imprisonment (rather than a bar in perpetuity).

iii.  Explanation to Section 29A(i) : Reducing the Scope of ‘Connected Person’

(a)     Part (iii) of the definition of ‘connected person’ under Section 29A(i) of the IBC, is extremely broad and includes the holding company, subsidiary company, associate company or any related party of the proposed acquirer, its promoters, the acquirer’s board as well as the proposed management of the corporate debtor or its promoters. By virtue of their business model, it was inevitable that several pure play financial entities would have connected persons through their investee companies in India or abroad which suffered from the disqualifications (especially relating to NPAs) listed in Section 29A. The IBC was amended late last year to create a carve-out from part (iii) of the definition for scheduled banks, asset reconstruction companies and alternate investment funds registered with the Securities and Exchange Board of India (‘SEBI’) – however this exemption did not benefit foreign private equity players, venture capital and distressed assets funds.

(b)   Pursuant to the Ordinance, relaxation has now been provided to foreign financial investors. The definition of ‘financial entities’ now includes the following additional classes of entities: (i) any entity regulated by a foreign central bank or any other financial sector regulator of a jurisdiction outside India; and (ii) any investment vehicle, registered foreign institutional investor, registered foreign portfolio investor or a foreign venture capital investor as defined in regulation 2 of the Foreign Exchange Management (Transfer of Issue of Security by a Person Resident Outside India) Regulations, 2017.

iv.  Section 29A(d): Disqualification on account of Criminal Convictions

(a)     The impact of Section 29A of the IBC was such that in many cases, it would force a change of control of the erstwhile promoter under a resolution plan or in liquidation. There was a concern that there may not be enough interest from third party buyers in companies under IBC, which are of a comparatively smaller size. A ‘one size fits all’ approach could hamper recoveries where there is little scope for turnaround of smaller companies unless the promoters submit a resolution plan. Recognizing this, the Ordinance provides for limited exemptions from the provisions of Section 29A of the IBC for Micro, Small and Medium Sector Enterprises (‘MSMEs’).

(b)   However, the statutory thresholds for recognizing MSMEs under the Micro, Small and Medium Enterprises Development Act, 2006 (‘MSME Act’) are low. For instance, for companies engaged in manufacturing, the thresholds for classification as MSMEs are investment in plant and machinery ranging from less than INR 25,00,000 (approximately USD 37,000) to INR 10,00,00,000 (approximately USD 1.5 million). The Central Government had approved an amendment to the MSME Act on February 7, 2018 providing that the thresholds in the MSME Act be redefined. The proposal is to re-align the definition of MSMEs on the basis of annual turnover ranging from less than INR 5,00,00,000 (approximately USD 750,000) to INR 250,00,00,000 (approximately USD 37 million). Once the proposed amendment to MSME Act is notified, it will provide significant relief to promoters of a large number of small companies facing financial distress.

  • Withdrawal of an Ongoing CIRP Proceeding

Once an application filed under the IBC is admitted, it can either lead to a successful resolution plan or liquidation. Under the IBC, a company undergoing the CIRP process did not have the power to arrive at a settlement or compromise by which the ongoing CIRP proceedings could be withdrawn. However, in a few cases, the courts had gone beyond the purview of the IBC and allowed settlement of the claims of a creditor, bilaterally leading to withdrawal of the matter.

The Ordinance clarifies that withdrawal of a CIRP proceeding will be permissible if 90% of the CoC approves it. However, such withdrawal will be permissible only prior to the resolution professional formally inviting resolution plans from interested bidders.

  • CoC voting thresholds reduced

The IBC provided that all decisions by the CoC be taken by a vote of 75% of the CoC by value. The Ordinance has reduced the voting threshold from 75% to 66% for major decisions such as: (i) applying for an extension for the CIRP period from 180 to 270 days; (ii) replacement of an interim resolution professional or resolution professional; and (iii) approving a resolution plan. For other routine decisions, the voting threshold has been reduced to 51%.

  • Role of shareholders of the corporate debtor in approving resolution plans

The consent of shareholders of the corporate debtor is generally required for significant corporate actions. The Ministry of Corporate Affairs (‘MCA’) released a clarification last year to the effect that approval of shareholders of the company for any corporate action in the resolution plan (otherwise required under any law) is deemed to have been given on its approval by the NCLT. The Ordinance specifically amends the IBC to incorporate the clarification proposed by the MCA.

  • Resolution professional responsible for ongoing legal compliances by the corporate debtor

Under Section 17 of the IBC, on insolvency commencement date, the board of the company is suspended and an insolvency professional takes control over management control. However, several laws including many provisions of the Companies Act, 2013, regulations issued by SEBI, Factories Act, impose obligations on the board of the company. The Ordinance clarifies that insolvency professionals shall be responsible for complying with the requirements under all applicable laws on behalf of the corporate debtor.

  • Participation of ‘related party’ financial creditors in the CoC

The IBC provided that financial creditors which were related to the corporate debtor would not be allowed to participate, attend or vote in CoC meetings. Financial institutions which had converted their debt into substantial equity stakes in the corporate debtor under any previous restructuring, were deemed ‘related’ to the corporate debtor and were thereby precluded from attending or voting in CoC meetings. The Ordinance provides an exemption from this prohibition for such financial creditors provided they are regulated by a financial sector regulator.

  • Grace period for fulfilling statutory obligations

A critical issue for acquirers in the IBC process is obtaining governmental and regulatory consents, dispensations and permits. Currently, acquirers tend to draft their resolution plans treating National Company Law Tribunal (‘NCLT’) as a single window clearance for all such approvals. But this approach is susceptible to legal challenge. The Ordinance provides for a one year grace period for the successful resolution applicant to fulfill various statutory obligations required under various laws to implement the resolution plan.

  • Issue of guarantors’ liability resolved

Section 14 of the IBC imposes a stay on any recovery action against the corporate debtor and the enforcement of any security interest created by a corporate debtor over its assets during the CIRP period. However, in a few cases, courts had taken the view that the moratorium in an ongoing CIRP will also stay enforcement of guarantees or security interest from promoters and group companies of the corporate debtor. The Ordinance states that the moratorium under Section 14 will not apply to the enforcement of guarantees granted by promoter guarantors or other group companies which are not undergoing a CIRP.

  • Further regulations to govern the bidding process

In most CIRP proceedings, the CoC formulates a process memorandum which governs the timelines for receiving bids, procedure for rebidding, grounds for rejection of bids etc. Such provisions and their application have been subject to several legal challenges at the NCLT by unsuccessful bidders. In a press release accompanying the Ordinance, the government has indicated that the regulations will govern issues such as non entertainment of late bids, bar on negotiations with late bidders and a standardised process for maximization of value of the corporate debtor.

  • Triggering CIRP by a company voluntarily

The IBC provided that a company may initiate its own CIRP and that the persons eligible to initiate a voluntary CIRP were: (i) the corporate debtor itself; (ii) a shareholder of the company specifically authorised to do so under the articles; (iii) director and key employees; and (iv) the chief financial officer. The Ordinance now makes a special resolution of shareholders mandatory for filing for its CIRP. It remains to be seen if a special resolution will be possible in closely held companies where promoters have a dominant stake. But directors and officers will need to be mindful of provisions in the IBC which impose civil and criminal sanctions on erstwhile directors and officers of the company for wrongful trading.

  • Limitation Act to apply to IBC

Lenders have benefited from judicial decisions which indicated that the Indian limitation legislation did not apply to an application under the IBC (although the doctrine of laches might still apply). However this has not been confirmed by the Supreme Court till date, as it had declined to comment on this issue. The Ordinance now provides that the law of limitation will apply to IBC applications.

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Amendment to the IBC : Legislating for Moral Hazard with a Broad Brush

Published In:Inter alia- IBC Client Update- November 2017- 1 [ English ]

AMENDMENT TO THE IBC – LEGISLATING FOR MORAL HAZARD WITH A BROAD BRUSH

Earlier today, the President of India promulgated an ordinance making certain amendments to the Insolvency and Bankruptcy Code, 2016 (‘IBC’). This ordinance had been approved by the Union Cabinet of Ministers yesterday.

The key change is the introduction of eligibility criteria for being a ‘resolution applicant’ which leads to the explicit prohibition of certain persons from submitting a resolution plan (and from such persons purchasing assets of a company in liquidation). It is believed that no other restructuring law in the world has provided such restrictive thresholds. The ordinance brings about these changes with immediate effect and these changes also apply for ongoing corporate insolvency resolution processes where the committee of creditors is yet to approve a resolution plan.

An applicant and any person acting jointly with the applicant who meets the following criteria are disqualified from submitting a resolution plan: (i) an undischarged insolvent; (ii) a willful defaulter as per norms laid down by the Reserve Bank of India, (iii) classified as a non performing assets for over one year unless it makes all overdue payments prior to submitting a resolution plan, (iv) convicted of any offence punishable with imprisonment for two years or more, (v) disqualified to act as a director under the Companies Act, 2013, (vi) prohibited by the Securities and Exchange Board of India (SEBI) from trading or accessing the securities market, (vii) indulged in preferential, undervalued or fraudulent transactions (and an order of the NCLT has been passed in this regard), (viii) has executed an enforceable guarantee in favour of a creditor for a company under IBC proceedings or liquidation, (ix) a person connected to the applicant who meets the criteria set out in (i) to (viii) above and (x) has been the subject of disability as per (i) to (ix) under any law outside India.

And ‘connected persons’ means: (i) any person who is a promoter or in the management or control of the resolution applicant, (ii) any person who is to be a promoter or in the management or control of business of the corporate debtor during the implementation of the resolution plan and (iii) holding company, subsidiary company, associate company or related party of a person referred to in (i) and (ii) above.

Over the last few months, there has been considerable discussion amongst various stakeholders as to whether certain persons (especially promoters or owner managers) are less desirable or potentially inappropriate resolution applicants. The IBC did not previously bar anyone from submitting a resolution plan. The Insolvency and Bankruptcy Board of India (‘IBBI’) amended certain regulations just over a couple of weeks ago requiring resolution plans to contain more information about resolution applicants’ negative markers. Those changes meant that the committee of creditors would need to consider that information closely and be careful before approving a resolution plan despite such negative markers.

The disqualification thresholds brought in by the ordinance however, rely on a longer and wider number of negative markers than the IBBI amendments. This ordinance seeks to end the debate, for now, on whether all promoters of stressed companies should be disqualified from bidding for their companies or those promoters whose companies have suffered due to extraneous reasons should not be punished (indeed, all such promoters are now disqualified not only from bidding for their own companies but also any other companies in an insolvency resolution process and from acquiring assets in any liquidation process). Stakeholders are now querying whether in an attempt to prevent moral hazard, this amendment has now created a potential economic hazard: will the lack of strong promoter bids dilute the competitive process between the remaining resolution applicants and so, lower the recovery for lenders?

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Notification of Section 2(87) of the Companies Act, 2013 and the Companies (Restrictions on number of layers) Rules, 2017

Published In:Inter Alia - Quarterly Edition - October 2017 [ English japanese ]

The Ministry of Corporate Affairs (‘MCA’) has, by way of notifications dated September 20, 2017, notified the proviso to Section 2(87) of the Companies Act, 2013 (‘Companies Act’) and the Companies (Restrictions on Number of Layers) Rules, 2017 (‘Layers Restrictions Rules’). Pursuant thereto, no company can have more than two layers of subsidiaries other than (i) banking companies, (ii) non-banking financial companies, (iii) insurance companies, and (iv) Government companies. Existing companies, which currently have more than two layers of subsidiaries, are:

i. required to file a return in Form CRL- 1, disclosing details in relation to such companies, within 150 days from September 20, 2017; and

ii. restricted from having any additional layer of subsidiaries over and above the layers existing on the date of notification of the Layers Restrictions Rules, and will not, in case one or more layers are reduced by it subsequent to the commencement of these rules, have the number of layers beyond the number of layers it has after such reduction or maximum layers allowed under the Layers Restrictions Rules (whichever is more).

The Layers Restriction Rules specify that for computing the number of layers, a layer comprising of one or more wholly owned subsidiary or subsidiaries will not be counted. It has also been clarified that Layers Restrictions Rules do not derogate from the proviso to Section 186(1) of the Companies Act which deals with the layers of investment companies a company may have. These provisions do not restrict any company from acquiring a company outside India with subsidiaries beyond two layers, as per the laws of such foreign country.

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Amendments to Schedule 5 of FEMA 20: Investment in Corporate Debt Securities

Published In:Inter Alia - Quarterly Edition - January 2017 [ English Chinese japanese ]

The Reserve Bank of India (‘RBI’) has, by way of a notification dated October 24, 2016, amended Schedule 5 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (‘FEMA 20’) to permit registered Foreign Institutional Investors and Foreign Portfolio Investors (‘FPIs’) to invest in unlisted non-convertible debentures (‘NCDs’)/bonds issued by an Indian company and securitized debt instruments, including certificates/instruments issued by special purpose vehicles set up for securitization of assets with banks, financial institutions or Non-Banking Financial Companies (‘NBFCs’) as originators, and any listed securitized debt instruments. Additionally, by its circular dated November 17, 2016, the RBI has specified that unlisted corporate debt securities in the form of NCDs/bonds issued by Indian companies would be subject to minimum residual maturity of three years along with an end use-restriction on investments in real estate business, capital market and purchase of land. The RBI has also specified that such investments in unlisted corporate debt securities and securitized debt instruments will be permitted up to an aggregate of Rs. 35,000 crores (approximately US$ 5 billion) within the existing investment limits prescribed for corporate bonds from time to time (presently, Rs. 2,44,323 crore (approximately US$ 35 billion)).

The Securities and Exchange Board of India (‘SEBI’) in its board meeting dated November 23, 2016 (‘SEBI Board Meeting’) approved corresponding amendments to the SEBI (Foreign Portfolio Investors) Regulations, 2014, which are yet to be notified by SEBI.

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Disclosure of Divergence in the Asset Classification and Provisioning by Banks

Published In:Inter Alia - Quarterly Edition - October 2017 [ English Chinese japanese ]

Pursuant to the RBI notification dated April 18, 2017 requiring certain disclosures by banks in cases of divergence in asset classification and provisioning, SEBI, by its circular dated July 18, 2017 mandated banks with listed specified securities (equity shares and convertible securities) to disclose divergences in asset classification and provisioning to the stock exchanges in the prescribed format where:

i.  the additional provisioning requirements assessed by the RBI exceed 15% of the published net profits after tax for the reference period; and/or

ii.  the additional gross non performing assets identified by the RBI exceed 15% of the published incremental gross non performing assets for the reference period.

Such disclosures are required to be made along with the annual financial results filed immediately following communication of such divergence by the RBI to the concerned bank, as an annexure to the disclosures to the annual financial results filed with the stock exchanges in accordance with the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.

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Demonetisation: Withdrawal of Legal Tender of Bank Notes of Denominations 500 and 1000

Published In:Inter Alia - Quarterly Edition - January 2017 [ English Chinese japanese ]

In order to contain the rising incidence of fake notes and black money, the scheme to declare the old currency notes in the denominations of Rs. 500 and Rs. 1000 invalid as legal tender, was introduced by the Government of India (‘GoI’). In this regard, the Ministry of Finance issued a notification dated November 8, 2016, declaring that the bank notes of existing series of denomination of the value of Rs. 500 and Rs. 1000 (‘Bank Notes’) will cease to be legal tender on and from November 9, 2016. The Bank Notes were allowed to be: (i) exchanged for value at RBI Offices till December 30, 2016 and till November 25, 2016 at bank branches/Post Offices, and (ii) deposited at any of the bank branches of commercial banks/Regional Rural Banks/Co-operative banks (only Urban Co-operative Banks and State Co-operative Banks) or at any Head Post Office or Sub-Post Office during the period from November 10, 2016 to December 30, 2016.

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Changes and Clarifications on External Commercial Borrowing

Published In:Inter Alia - Quarterly Edition - January 2017 [ English Chinese japanese ]

i. Clarification on Hedging: The RBI, on November 7, 2016, clarified that: (a) in cases where hedging for external commercial borrowings (‘ECB’) is mandatory, the ECB borrower will be required to cover principal as well as interest of the ECB through financial hedges from the start of each such exposure; (b) the financial hedges should be for a minimum tenor of one year with a periodic rollover and the exposure on account of ECB should not be unhedged; and (c) any natural hedging in lieu of financial hedging, will be considered only to the extent of offsetting projected cash flows/ revenues in matching currency, net of all other projected outflows.

ii. Extension and Conversion: The RBI has, pursuant to its circular dated October 20, 2016, allowed AD Category – I banks to, subject to other conditions:

a. approve requests from borrowers for changes in repayment schedule of an ECB prior to its maturity, provided the average maturity and all-in-cost are in conformity with applicable norms, and subject to there being: (A) no additional cost incurred; (B) lender’s consent for such changes; and (C) satisfaction of reporting requirements; and

b. approve cases of conversion of matured but unpaid ECB into equity.

iii. ECBs for Startups: The RBI has, pursuant to its circular dated October 27, 2016, permitted all startups recognized by the GoI to access borrowings in the form of loans or non-convertible, optionally convertible or partially convertible preference shares under the ECB framework up to a limit of US$ 3 million (approximately Rs. 20.33 crores). The minimum average maturity period of such borrowing is three years for end use in relation to expenditure in connection with the business of the borrower.

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Disclosure by Listed Entities of Defaults on Payment of Interest or Repayment of Principal Amount on Loans

Published In:Inter Alia - Quarterly Edition - October 2017 [ English Chinese japanese ]

SEBI had issued a circular on August 4, 2017 mandating disclosures by listed entities that have defaulted on inter alia, either the payment of interest or the repayment of the principal amount on loans taken from banks or financial institutions, with effect from October 1, 2017. Accordingly, all entities which have listed any specified securities (equity and convertible securities), non-convertible debt securities or non-convertible and redeemable preference shares, are required to disclose any default with respect to, either the payment of interest, or instalment obligation on debt securities (including commercial paper), medium term notes, foreign currency convertible bonds, loans from banks and financial institutions, external commercial borrowings, etc.

However, SEBI, through its press release dated September 29, 2017, has decided to indefinitely defer the implementation of this circular.

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Dishonour of a Post-dated Cheque for Repayment of a Loan Covered by Section 138 of the Negotiable Instruments Act, 1881

Published In:Inter Alia - Quarterly Edition - January 2017 [ English Chinese japanese ]

On September 19, 2016, the SC in Sampelly Satyanarayana Rao v. Indian Renewable Energy Development Agency Limited[1] dealt with the issue of whether the dishonor of post-dated cheques that have been described as ‘security’ in a loan agreement, would attract criminal liability under Section 138 of the Negotiable Instruments Act, 1881 (‘Negotiable Instruments Act’), the penalty for which includes imprisonment for a term upto two years, or a fine, or both.

The SC held that Section 138 of the Negotiable Instruments Act applies only if, on the date of issuance of the cheque, the liability or debt exists or the amount has become legally recoverable, and not otherwise. The SC further held that the issuance of a cheque and admitted signature on such cheque creates a presumption of a legally enforceable debt in favour of the payee, and a mere statement by the accused that the cheques were issued as “security” and not as repayment, would not rebut this presumption.

In the present case, though the word “security” was used, the cheques were towards repayment of installments, which became due under the relevant agreement immediately upon advancement of the loan. Therefore, the dishonor of cheque was for an existing liability and covered under Section 138 of the Negotiable Instruments Act.

[1]     Sampelly Satyanarayana Rao v. Indian Renewable Energy Development Agency Limited, (2016) 10 SCC 458.

 

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Notification of Reserve Bank Commercial Paper Guidelines, 2017

Published In:Inter Alia - Quarterly Edition - October 2017 [ English Chinese japanese ]

The RBI has by a notification dated August 10, 2017 issued the Reserve Bank Commercial Paper Directions, 2017 (‘New CP Directions’) in supersession of the existing directions on the same, which inter alia specifies the following:

i. A commercial paper (‘CP’) will be issued in the form of a promissory note, held in a dematerialized form with a denomination of Rs. 5 lakhs (approx. US$ 7,600) or multiples thereof. The issuance must be at a discount to face value with no issuer having such issue underwritten or co-accepted. Optionality clauses, such as put and call options, are not permitted on a CP. The original tenor of a CP must be between seven days to one year.

ii. Companies, including non-banking financial companies and All India Financial Institutions will be eligible to issue CPs, with no minimum net worth requirement. Entities such as co-operative societies / unions, Government entities, trusts, LLPs and other bodies corporate can also issue CPs, provided that they have a presence in India and a minimum net worth of Rs. 100 crores (approx. US$ 15.3 million).

iii. Eligible investors include all residents, non-residents who are permitted to invest in CPs under the exchange control regulations. However, no person is allowed to invest in CPs issued by related parties either in primary or secondary market. Additionally, investment by regulated financial sector entities will be subject to conditions imposed by the concerned regulator.

iv. Issuers, whose total CP issuance during a year is Rs. 1,000 crores (approx. US$ 153 million) or more, should obtain credit rating of a minimum of ‘A3’ from at least two SEBI registered credit rating agencies.

v. No end-use restriction to a CP issuance has been prescribed but it should be disclosed in the offer document at the time of issuance.

vi. The buyback of a CP, in full or in part, must be at the prevailing market rate, which cannot be made before 30 days from the date of the issue.

vii. A CP will be a ‘stand-alone’ product, with banks and financial institutions optionally choosing to provide stand-by assistance / credit, back stop facility, etc. as a means of credit enhancement. Non-banking entities may provide unconditional and irrevocable guarantee for credit enhancement for CP issue provided the offer document for CP properly discloses the net worth of the guarantor company, among other details.

viii. In case of secondary market trading and settlement of CP, all over-the-counter trades in CP will be reported within 15 minutes of the trade to the Financial Market Trade Reporting and Confirmation Platform of Clearcorp Dealing System (India) Ltd.

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Liability of Personal Guarantors of a Corporate Debtor during the Corporate Insolvency Resolution Process

Published In:Inter Alia - Quarterly Edition - October 2017 [ English Chinese japanese ]

State Bank of India (‘SBI’) had sanctioned a loan to Lohia Machines Limited (‘LML’) which was guaranteed by the directors of LML. Upon non repayment, SBI approached the Debt Recovery Tribunal, Allahabad (‘DRT’). However, in parallel, LML also filed an application before the National Company Law Tribunal (‘NCLT’), Allahabad Bench, to initiate a corporate insolvency resolution process (‘CIRP’) in respect of itself. In response to the CIRP being admitted, although the DRT stayed the proceedings against LML, it continued to hear the matter in relation to the enforcement of personal guarantees given by the directors of LML. Aggrieved by DRT, the personal guarantors filed a writ petition before the Allahabad High Court. The Allahabad High Court passed an order[1] dated September 6, 2017, staying the DRT proceedings against the personal guarantors and stated: (i) under Section 60(1) of the Insolvency and Bankruptcy Code, 2016 (‘IBC’), NCLT is the adjudicating authority for resolution of insolvency and liquidation of a corporate person (including a personal guarantor); (ii) when liability is co-extensive and proceedings are still in a fluid stage, two split proceedings cannot go on simultaneously before the DRT and the NCLT for the same cause of action; and (iii) the scope of the CIRP order passed by NCLT imposing a moratorium on all legal proceedings, extends beyond the properties of the corporate debtor and suits/proceedings pertaining to the corporate debtor. Accordingly, the Allahabad High Court stayed the DRT proceedings against the personal guarantors till the finalisation of the CIRP or till approval of the resolution plan by NCLT or passing of an order for liquidation of LML by NCLT, as the case may be.

[1]     Sanjeev Shriya v. State Bank of India, Writ–C Nos. 30285 and 30033 of 2017

 

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Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) (Thirteenth Amendment) Regulations, 2016

Published In:Inter Alia - Quarterly Edition - October 2016 [ English Chinese japanese ]

RBI has, by way of a notification dated September 9, 2016 (‘FEMA 20 Notification’), amended the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (‘FEMA 20 Regulations’), to inter alia: (i) permit 100% foreign direct investment (‘FDI’) under the automatic route in financial services activities regulated by financial sector regulators (as may be notified by the Government of India (‘GoI’)); (ii) remove the restriction for FDI, under the automatic route, in NBFCs engaged in any one of the 18 specified activities; (iii) remove the erstwhile minimum capitalization requirements, however, capitalization norms and other limits prescribed by the relevant financial sector regulator will still apply; and (iv) clarify that in sectors where financial services are not regulated / partially regulated by a financial sector regulator, then 100% FDI is permitted under the Government approval route subject to conditions including minimum capitalization requirements, as may be decided by the Government.

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Corrigendum to Foreign Exchange Management (Deposit) Regulation, 2016

Published In:Inter Alia - Quarterly Edition - October 2016 [ English Chinese japanese ]

RBI has issued a corrigendum dated September 8, 2016 (with effect from April 1, 2016) (‘Corrigendum’) to the Foreign Exchange Management (Deposit) Regulation, 2016 (‘Deposit Regulations’) clarifying that the restriction on ADs from allowing their branches / correspondents outside India to grant loans to or in favour of non–resident depositors or third parties for purposes other than for relending or carrying on agricultural / plantation activities or for investment in real estate business, has now been dispensed with.

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Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016

Published In:Inter Alia - Quarterly Edition - October 2016 [ English Chinese japanese ]

The Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016 (‘ESIRDA Act), which has been enacted by the Parliament and received Presidential assent on August 12, 2016, seeks to amend certain provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI’), the Recovery of Debts due to Banks and Financial Institutions Act, 1993, (‘RDBFI Act’), the Indian Stamp Act, 1899 (‘ISA’), and the Depositories Act, 1996 (‘Depositories Act’). Certain sections of the ESIRDA Act have been notified with effect from September 1, 2016.

i.  Key Amendments to SARFAESI: (a) Debenture trustees registered with SEBI have now been included in the definition of ‘secured creditor’, and can take enforcement action under Section 13 of the SARFAESI, as the remedies under SARFAESI have been extended to apply to listed debt securities. The scope of SARFAESI has been widened to include hire purchase, financial leasing and conditional sale transactions; (b) the process of taking possession over collateral against which a loan has been provided by a secured creditor, with the assistance of the Chief Metropolitan Magistrate or District Magistrate, has been made time-bound, requiring an order to be passed within 30 days from the date of application by the secured creditor; (c) amendments relating to registration of security interest have been introduced, including: (1) a proposal to set up a central database to integrate records of security registered under various registration systems including those made under the Companies Act and the Registration Act, 1908; (2) Central Government may require creditors not qualifying as “secured creditors” under SARFAESI to register the creation, modification and satisfaction of security interest with such central registry; and (3) after registration of security interest with the central registry, the debts due to any secured creditor will have priority over all other debts and all revenues, taxes, cesses and other rates payable to the Central, State or local Governmental authorities.

ii.  Key Amendments to ISA: The ESIRDA Act amends the ISA to exempt stamp duty on instruments of transfer or assignment of rights or interest in financial assets to asset reconstruction companies, where such transfer is for the purpose of asset reconstruction or securitisation. Security receipts issued by such asset reconstruction companies may be subscribed to by non-institutional and other investors of prescribed classes.

iii.  Key Amendments to RDBFI Act: (a) Debenture trustees registered with SEBI can initiate proceedings under the RDBFI Act regarding defaults in listed debt securities; (b) a bank or a financial institution has now been permitted to take proceedings under RDBFI Act before a tribunal in whose jurisdiction where the defaulted account is maintained / located; (c) a defendant, upon service of summons under the RDBFI Act, is restricted from transferring the secured assets or other assets disclosed in the application made by the bank or financial institution without the approval of the tribunal, except in the ordinary course of business; and (d) electronic filing of recovery applications, documents and written statements has been introduced.

iv.  Other Significant Changes: The Depositories Act has been amended to require registration by a depository of any transfer of security in favour of an asset reconstruction company along with or consequent upon transfer or assignment of a financial asset of any bank or financial institution under SARFAESI. Additionally, every depository is also required to register any issue of new shares in favour of any bank or financial institution or asset reconstruction company or any of their assignees, by conversion of part of their debt into shares pursuant to reconstruction of debts of the company agreed between the company and the bank, financial institution or asset reconstruction company.

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Amendment to the Companies (Acceptance of Deposit) Rules, 2014

Published In:Inter Alia - Quarterly Edition - July 2016 [ English Chinese japanese ]

On June 29, 2016, the MCA has notified the Companies (Acceptance of Deposits) Amendment Rules, 2016 (‘Amended Rules’), inter alia, expanding the scope of exemptions available for deposit of monies received by a company from being classified as a ‘deposit’ under the Companies (Acceptance of Deposit) Rules, 2014.

The Amended Rules permit companies to accept or renew deposits from members up to a maximum of 35% of the aggregate of their paid-up share capital, free reserves and securities premium account, as opposed to the earlier limit of 25%. Further, a private company can accept or renew deposits from its members up to 100% of the aggregate of its paid-up share capital, free reserves and securities premium account.

The Amended Rules have included a requirement for every eligible company to obtain a credit rating at least once every year for deposits accepted by it and disclose the deposits received from a director in its financial statements. The Amended Rules will come into force upon publication in the Official Gazette.

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RBI Circular on Investment in Credit Information Companies

Published In:Inter Alia - Quarterly Edition - July 2016 [ English Chinese japanese ]

Pursuant to the circular dated May 19, 2016 issued by RBI, all credit information companies (‘CIC’) have been directed to comply with the following:

i. Investments by any person (whether resident or otherwise), directly or indirectly, in a CIC, must not exceed 10% of the equity capital of the investee company. However, RBI may consider allowing higher FDI limits to entities with an established track record in running a credit information bureau in the following cases:

• up to 49%, if ownership is not well diversified (i.e., one or more shareholders each hold more than 10% of voting rights in the company);

• up to 100%, if ownership is well diversified, or if their ownership is not well diversified, but at least 50% of the directors of the investee CIC are Indian nationals/ NRIs/ persons of Indian origin (out of which at least one third of the directors must be Indian nationals resident in India); and

• The investor company should preferably be listed on a recognised stock exchange.

ii. A foreign institutional investor (‘FII’)/ foreign portfolio investor (‘FPI’) is permitted to invest in a CIC subject to certain prescribed conditions.

If the investor in a CIC is a wholly owned subsidiary (directly or indirectly) of an investment holding company, then the above conditions will be applicable to the operating group company that is engaged in the credit information business and has undertaken to provide technical know-how to the CIC in India.

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Foreign Exchange Management (Deposit) Regulations, 2016

Published In:Inter Alia - Quarterly Edition - July 2016 [ English Chinese japanese ]

RBI has, by way of notification dated April 1, 2016, issued the Foreign Exchange Management (Deposit) Regulations, 2016, which supersede the erstwhile regulations of 2000, with the following key changes:

i. A person resident outside India having a business interest in India is permitted to open a Special Non Resident Rupee Account (‘SNRR Account’) with an AD Bank for bona fide transactions in Rupees subject to certain conditions;

ii. A shipping or airline company incorporated outside India is permitted to hold and maintain a foreign currency account with an AD Bank for meeting expenses in India. However, freight or passage fare collections in India or inward remittances through banking channels from its office outside India are the only permissible credits; and

iii. An AD Bank is permitted to allow unincorporated joint ventures between foreign and Indian entities executing a contract in India, to open and maintain a non-interest bearing foreign currency account and a SNRR Account for the purpose of undertaking transactions in the ordinary course of its business, subject to certain conditions.

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Revision of Sectoral Limits – ARCs

Published In:Inter Alia - Quarterly Edition - July 2016 [ English Chinese japanese ]

DIPP has, by way of Press Note 4 dated May 6, 2016 (‘Press Note 4’), permitted 100% FDI in asset reconstruction companies (‘ARCs’) under the automatic route, from the erstwhile 49%, subject to the following key conditions:

i. Earlier, an ARC sponsor was not allowed to hold more than 50% shareholding, including by way of FDI or by routing it through a FII/ FPI controlled by the same sponsor, in line with the existing restriction under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI’). This restriction is proposed to be done away with by the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Bill, 2016. Therefore, Press Note 4 provides that the investment limit of a sponsor in an ARC’s shareholding will be governed by SARFAESI;

ii. Permissible FII/ FPI investment in each tranche of security receipts has been increased to 100%, as opposed to the earlier 74%, subject to compliance with RBI’s directions; and

iii. Foreign investment in an ARC is now subject to all provisions of SARFAESI (instead of only Section 3(3)(f)).

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RBI Circular on Approval Route Cases for Raising External Commercial Borrowings

Published In:Inter Alia - Quarterly Edition - July 2016 [ English Chinese japanese ]

As a measure to expedite the process for obtaining RBI approval for raising external commercial borrowings (‘ECBs’) through the approval route, RBI has, pursuant to a circular dated June 30, 2016 (‘ECB Circular’), directed that ECBs above certain thresholds (yet to be prescribed) will be required to be placed before an ‘Empowered Committee’ of RBI. RBI will take a final decision on these cases after taking into account the recommendation of the Empowered Committee. Prior to the ECB Circular, all approval route cases were required to be placed before the Empowered Committee for consideration.

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Guidelines for Ownership in Private Sector Banks

Published In:Inter Alia - Quarterly Edition - July 2016 [ English Chinese japanese ]

RBI has, by the master direction dated May 12, 2016 (‘Directions’), issued guidelines regarding ownership and voting rights in private sector banks in India. The Directions prescribe shareholding investment limits in a bank’s paid-up capital by various types of shareholders as follows:

i. Promoters – limits will be as per the prevalent guidelines and in case of existing banks, will be in line with the earlier guidelines issued by RBI, i.e., 15%;

ii. Natural persons and non-financial entities (other than promoters/ promoter group) – limit is 10%;

iii. Financial institutions (which are non-regulated/ non-diversified and non-listed) – limit is 15%; and

iv. Financial institutions (which are regulated, well diversified, and listed entities, supranational institutions or public sector undertaking or government) – limit is 40%.

In certain circumstances, higher stake or strategic investment by promoters or non-promoters through capital infusion by domestic or foreign entities/ institution, may be permitted under circumstances such as relinquishment by existing promoters, rehabilitation or restructuring of weak banks, entrenchment of existing promoters or in the interest of the bank or for consolidation in the banking sector.

Other key principles under the Directions include the following: (a) voting rights will be limited to a ceiling of 15%, regardless of the shareholding limit; (b) any acquisition of shareholding/ voting rights of 5% or more of the paid-up capital or total voting rights of the bank will be subject to prior RBI approval; and (c) no bank in India will acquire an equity stake in another bank, if it results in the investing bank holding 10% or more in the investee bank’s equity capital, other than in case of exceptional circumstances such as restructuring of weak banks or in the interest of consolidation in the banking sector, etc.

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Scheme for Sustainable Structuring of Stressed Assets

Published In:Inter Alia - Quarterly Edition - July 2016 [ English Chinese japanese ]

RBI has, by its circular dated June 13, 2016, introduced a scheme for resolution of large accounts referred to as the ‘Scheme for Sustainable Structuring of Stressed Assets’, which is an optional framework and involves lenders determining the level of sustainable debt for a stressed borrower, and bifurcating the outstanding debt into sustainable debt (being a level of debt whose principal value can be serviced over the same tenor as that of the existing facilities even if future cash flows of the borrower remain at their current level and including new funding required to be sanctioned in the next six months). The remaining debt which will be converted into equity or quasi-equity instruments issued to the lender (subject to the pricing guidelines and other conditions outlined in the circular).

For an account to be eligible to avail of this scheme: (i) the project must have commenced commercial operations; (ii) the aggregate exposure of all institutional lenders (including foreign currency lenders) in the account must be more than Rs 500 crores (approximately US$ 73 million); and (iii) at least 50% of the current funded liabilities of the borrower should constitute ‘sustainable debt’. The resolution plan will be reviewed by an overseeing committee, set up by the Indian Banks Association, in consultation with RBI and comprising eminent experts. Post-resolution, the borrower’s ownership pattern may reflect a change in control of the borrower with either the lenders or a new promoter acquiring a majority stake in the company; or the existing promoters continuing to hold the majority shareholding/ controlling interest in the company, and in either case additional conditions may be imposed by the lenders on the promoters with respect to manner of dilution of shareholding, issuance of guarantee, etc. The resolution plan and control rights are to be structured to ensure that the promoters are not allowed to sell the shares of the borrower without the prior approval of lenders and without sharing the upside, if any, with the lenders towards loss in residual (converted) debt.

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Draft Guidelines for ‘On Tap’ Licensing of Universal Banks in the Private Sector

Published In:Inter Alia - Quarterly Edition - July 2016 [ English Chinese japanese ]

RBI has released draft guidelines for on-tap licensing of universal banks in the private sector (‘Draft Guidelines’) on May 5, 2016 (for comments and suggestions) which will allow applications for bank licenses to be submitted to RBI at any point in time. While the Draft Guidelines follow the earlier 2013 guidelines on bank licensing in many respects, notable changes include: (i) a new category of eligible promoters being resident individuals/ professionals having ten years of experience in banking and finance; (ii) large industrial houses being barred from having a controlling interest in new banks; and (iii) relaxation of the requirement of establishing a bank through a non-operative financial holding company where the applicant is an individual or stand-alone entity not having group entities.

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RBI notifies the Cross Border Merger Regulations

Published In:Inter Alia - Quarterly Edition - March 2018 [ English Chinese japanese ]

The Reserve Bank of India (‘RBI’) has notified the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (‘Cross Border Merger Regulations’), by way of a notification dated March 20, 2018. Some of the key provisions of the Cross Border Merger Regulations are set out below:

i.  Inbound Mergers: In case of an inbound merger (i.e. a cross border merger wherein an Indian company is the resultant company), the resultant Indian company may issue shares to persons resident outside India, subject to compliance with the requirements prescribed by the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (‘FEMA 2017’). Further, if (a) the foreign company in an inbound merger is a joint venture (‘JV’) or wholly owned subsidiary (‘WOS’) of the Indian company; or (b) the inbound merger of a JV or WOS results in the acquisition of a step down subsidiary, then compliance with the provisions of the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 (‘ODI Regulations’) is required. Some of the key provisions governing inbound mergers are set out below –

•   Acquisition/transfer of assets and liabilities by the resultant Indian Company: If the resultant Indian company acquires any asset or comes to hold any liability outside of India as a result of the inbound merger, which acquisition is not permitted under FEMA, then the resultant Indian company would be required to sell such asset / security or extinguish such liability from the sale proceeds of the overseas assets, within two years of the merger scheme being sanctioned by the National Company Law Tribunal (‘NCLT’).

•   Offices of the foreign transferor company: The overseas office(s) of the foreign transferor company would be deemed to be the offshore branches/office outside India of the resultant Indian company, which will be required to undertake the activities of a branch/office as permitted under the Foreign Exchange Management (Foreign Currency Account by a person resident in India) Regulations, 2015.

•   Borrowings and guarantees of the foreign transferor company: Any borrowings raised or guarantees issued by the foreign transferor company, which come to be held by the resultant Indian company, will have a period of two years to become compliant with the applicable foreign exchange regulations governing external commercial borrowings, borrowing or lending in Rupees or guarantees. No remittance for paying such liability can be made by the resultant Indian company within the two years of the merger scheme being sanctioned by the NCLT. In such cases, end use restrictions will not apply.

With respect to an inbound merger, if the resultant Indian company intends to continue operations outside India post completion of such cross-border merger, then such resultant Indian company will be required to maintain a presence outside India, through an offshore branch or a subsidiary in the manner permitted under foreign exchange regulations.

ii.  Outbound Mergers: In case of an outbound merger (i.e. a cross border merger wherein a foreign company is the resultant company), a person resident in India may hold or acquire securities of the resultant foreign company, in accordance with the provisions of ODI Regulations (including the fair market value of such foreign securities being within the limits prescribed under the Liberalized Remittance Scheme, where the resident Indian is an individual). Some of the key provisions governing outbound mergers are set out below:

•   Offices of the Indian transferor company: Indian offices of the Indian transferor company will be deemed to be branch offices of the resultant foreign company. Transactions can be undertaken out of such Indian branch offices in accordance with the Foreign Exchange Management (Establishment in India of a branch office or a liaison office or a project office or any other place of business) Regulations, 2016.

•   Borrowings and guarantees of the Indian transferor company: The guarantees or outstanding borrowings of the Indian company which become the liabilities of the resultant foreign company are required to be paid as per the scheme sanctioned by the NCLT. However, the resultant foreign company will not be permitted to acquire any liability payable towards an Indian lender in Rupees which is not in conformity with the provisions of the Foreign Exchange Management Act, 1999 (‘FEMA’).

•   Acquisition/transfer of assets by the resultant foreign Company: If the resultant foreign company acquires any asset or security which it is not otherwise permitted to hold under FEMA, it will be required to sell such asset or security within two years of the merger scheme being sanctioned by the NCLT, and the proceeds of such divestment are required to be repatriated outside India immediately through normal banking channels. However, repayment of Indian liabilities from the proceeds of the sale of such assets or securities within such two year period is permitted.

•   Valuation: In accordance with Rule 25A of the Companies (Compromises, Arrangement and Amalgamations) Rules, 2016, valuation for an outbound merger has to be conducted by a valuer who is a member of a recognized professional body in the jurisdiction of the transferee company in accordance with internationally accepted principles on accounting and valuation.

With respect to an outbound merger, if the resultant offshore company intends to continue operations in India post completion of such cross-border merger, then such resultant offshore company will be required to maintain a presence outside India through a subsidiary in the manner permitted under foreign exchange regulations.

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Amendments to FEMA 2017

Published In:Inter Alia - Quarterly Edition - March 2018 [ English Chinese japanese ]

The RBI has, by its notification dated March 26, 2018 introduced the following amendments to the sector specific policy for foreign investment, under FEMA 2017:

i. Foreign investment in investing companies: (a) Foreign investments in investing companies not registered as non-banking financial companies (‘NBFCs’) with the RBI and in core investment companies, both engaged in the activity of investing in the capital of other Indian entities, will require prior Government approval; and (b) foreign investment in investing companies registered as NBFCs with the RBI, will not require any prior approval and will be permissible under 100% automatic route.

ii. Single brand product retail trading: In case of entities undertaking single brand retail trading of products having ‘state-of-art’ and ‘cutting-edge’ technology and where local sourcing is not possible, a committee under the chairmanship of the Secretary, DIPP, with representatives from Niti Aayog, concerned Administrative Ministry and independent technical expert(s) on the subject will examine the claim on the issue of the products being in the nature of ‘state-of-art’ and ‘cutting-edge’ technology, and give recommendations for such relaxation.

iii. Issuance of capital instruments to persons resident outside India: No prior Government approval will now be required for issuance of capital instruments to persons resident outside India against: (a) import of capital goods / machinery / equipment (excluding second hand machinery); or (b) pre-operative / pre-incorporation expenses, unless the Indian investee company is engaged in a sector under the Government route.

As set out in our January 2018 edition of the Inter Alia, the Union Cabinet had approved certain amendments to the foreign direct investment regime in India on January 10, 2018, which have now been incorporated in FEMA 2017.

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Easing of access norms for investments by Foreign Portfolio Investors

Published In:Inter Alia - Quarterly Edition - March 2018 [ English Chinese japanese ]

SEBI has, by way of circulars dated February 15, 2018 and March 13, 2018 (collectively, the ‘FPI Circulars’), revised the regulatory framework governing foreign portfolio investors (‘FPIs’) under the SEBI (Foreign Portfolio Investors) Regulations, 2014 (‘FPI Regulations’) to ease the access norms for investments by FPIs. Some of the key changes that have come into force are set out below:

i. The current requirement of prior SEBI approval for a change in local custodian/ designated depository participant (‘DDP’) has been replaced with the requirement of obtaining a no-objection certificate from the earlier DDP, followed by a post-facto intimation to SEBI.

ii. The regime has been liberalized concerning FPIs having ‘Multiple Investment Managers’ structure and the same permanent account number, with respect to ‘Free of Cost’ transfer of assets. Approval of SEBI is now not required and DPPs are now entitled to process such requests.

iii. In case of addition of a new share class, where a common portfolio of Indian securities is maintained across all classes of shares/fund/sub-fund and broad based criteria are fulfilled at a portfolio level after adding a new share class, prior approval of the DDP is no longer required.

iv. Private banks and merchant banks are now permitted to undertake investments on behalf of their respective investors, provided that the investment banker/merchant banker submits a prescribed declaration.

v. SEBI also clarified that appropriately regulated Category II FPIs viz. asset management companies, investment managers/ advisers, Portfolio managers, Broker-dealer and Swap-dealer etc. are permitted to invest their proprietary funds.

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SEBI informal guidance in the matter of UBS AG

Published In:Inter Alia - Quarterly Edition - March 2018 [ English Chinese japanese ]

UBS AG is a Category II registered FPI and is not a promoter of any listed entity. Regulation 32(2)(d) of the FPI Regulations requires the depository participant engaged by an FPI to ensure that equity shares held by the FPI are free from encumbrances and to obtain a declaration from the FPI to this effect. UBS AG, under the SEBI (Informal Guidance) Scheme, 2003, sought certain clarifications from SEBI:

i. whether the term ‘encumbrance’ would include non – disposal undertakings in relation to the FPIs who are investors in the capacity of acquirer and not promoter.[1]; and

ii. whether the FPIs are restricted from executing non disposal undertaking with third parties by providing limited undertaking to the depository participant.

SEBI, by way of clarification dated March 14, 2018, was of the view that the term ‘encumbrance’ would include non – disposal undertakings and accordingly, FPIs would not be permitted to execute the non – disposal undertakings.

[1]     It is pertinent to note that the term ‘encumbrance’ is not defined under the FPI Regulations. However the term includes pledges, liens, non disposal undertakings and other transactions in terms of SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011.

 

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RBI Circular on Revised Framework for Resolution of Stressed Assets

Published In:Inter Alia - Quarterly Edition - March 2018 [ English Chinese japanese ]

RBI, by its circular dated February 12, 2018 on ‘Resolution of Stressed Assets – Revised Framework’ (‘Revised Framework’), has discontinued all existing RBI schemes on the resolution of stressed assets including the Corporate Debt Restructuring Scheme, Strategic Debt Restructuring Scheme, Scheme for Sustainable Structuring of Stressed Assets and the Framework for Revitalising Distressed Assets (collectively, ‘Extant Stressed Asset Schemes’) as well as the Joint Lenders’ Forum (‘JLF’) as an institutional mechanism for resolution of stressed accounts. The Revised Framework accounts for the changes brought about by the Insolvency and Bankruptcy Code, 2016 (‘IBC’) and creates a streamlined framework for the resolution of non-performing assets (‘NPAs’) and other stressed assets. Some of the salient features are set out below:

i. The Revised Framework applies to all accounts, excluding accounts where any of the Extant Stressed Asset Schemes have been implemented [except where the aggregate exposure of lenders is at least Rs. 20 billion (approx. US$ 300 million)]. It currently does not cover NBFCs, Asset Reconstruction Companies or Regional Rural Banks – applicability is limited to Scheduled Commercial Banks and All-India Financial Institutions (such as Exim Bank, National Bank for Agriculture and Rural Development, National Housing Bank and Small Industries Development Bank of India).

ii. All lenders are required to prepare board approved policies for resolution of stressed assets (‘Resolution Plan’) and take steps to resolve accounts immediately upon default. Each lender is required to document a Resolution Plan, even if there is no change in the terms between the Resolution Plans prepared by different lenders.

iii. A Resolution Plan is ‘implemented’ if the borrower is no longer in default with any of the lenders. However, if the Resolution Plan involves ‘restructuring’, then implementation requires certain additional steps.

iv. For accounts where the aggregate exposure of lenders, on or after March 1, 2018, is at least Rs. 20 billion (approx. US$ 300 million) (‘Large Accounts’), a Resolution Plan is required to be ‘implemented’ within 180 days from the date of first default, failing which the lenders are required to file a corporate insolvency application under the IBC before the NCLT within 15 days from the expiry of the above timeline.

v. If the Resolution Plan for a Large Account involves restructuring / change in ownership, lenders are mandated to file a corporate insolvency application under the IBC before the NCLT if such Large Account goes into default before the completion of the ‘Specified Period’, which is the later of: (a) one year from the first payment of principal / interest (whichever is later) of the credit facility with the longest period of moratorium under the terms of the Resolution Plan; or (b) repayment of at least 20% of the outstanding debt. Notwithstanding the above, lenders can file an application under IBC any time, even without attempting a Resolution Plan.

vi. The Revised Framework further prescribes requirements for independent credit evaluation of accounts by the Lenders and imposes stricter reporting norms.

vii. Upon a change of ownership of the borrower, the restructured account would be upgraded to ‘standard’, upon satisfaction of certain conditions.

viii. The Revised Framework further states that the RBI would take ‘stringent supervisory / enforcement actions as deemed appropriate’ including monetary penalties and increased provisioning requirements, in the event of (a) actions by lenders with an intent to evergreen stressed accounts / conceal the actual status of accounts; or (b) failure on part of the lenders to meet the prescribed timelines.

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Ombudsman Scheme for Non-Banking Financial Companies, 2018

Published In:Inter Alia - Quarterly Edition - March 2018 [ English Chinese japanese ]

RBI, by its notification dated February 23, 2018, notified the Ombudsman Scheme for NBFCs, 2018 (‘Ombudsman Scheme’) to regulate the credit system of the country and to provide for a system of ombudsman for redressal of complaints against deficiency in services concerning deposits, loans and advances and other specified matters.

NBFCs registered with the RBI under Section 45-IA of the RBI Act, 1934 which (i) are authorised to accept deposits; or (ii) have customer interface, with assets size of Rs. 1 billion (approx. US$ 15 million) or above, as on the date of the audited balance sheet of the previous financial year, or of any such asset size as the RBI may prescribe, should comply with the Ombudsman Scheme, whereas, NBFC–infrastructure finance company, core investment company, infrastructure debt fund–NBFC and an NBFC under liquidation, are excluded from the ambit of the Ombudsman Scheme.

The Ombudsman Scheme came into force on February 23, 2018 and is being introduced at the four metro centers viz. Chennai, Kolkata, Mumbai and New Delhi.

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Changes to Framework for Masala Bonds

Published In:Inter Alia - Quarterly Edition - July 2017 [ English Chinese japanese ]

The RBI, by way of Circular No. 47 dated June 7, 2017, has reviewed the existing framework in relation to the issuance of rupee denominated bonds overseas (‘Masala Bonds’) in order to harmonize the various elements of the ECB framework and revised the framework. The circular provides as follows:

(i) Proposal for issuance of Masala Bonds will be examined by the Foreign Exchange Department; (ii) The minimum original maturity period for Masala Bonds up to USD 50 million (equivalent in INR per financial year) is 3 years and for Masala Bonds above USD 50 million is 5 years. Previously, such bonds were subject to a minimum maturity of 3 years; (iii) The all-in-cost ceiling for Masala Bonds will be 300 basis points over the prevailing yield of the Government of India securities of corresponding maturity. Previously, the all-in-cost ceiling was to be commensurate with the prevailing market conditions; and (iv) Investors in Masala Bonds should not be related parties (within the meaning given in Ind-AS 24).

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Disclosure Requirements for Issuance and Listing of Green Debt Securities

Published In:Inter Alia - Quarterly Edition - July 2017 [ English Chinese japanese ]

The Securities and Exchange Board of India (‘SEBI’) has, by way of circular dated May 30, 2017, set out certain requirements to be considered, along with the requirements set out in the SEBI (Issue and Listing of Debt Securities) Regulations, 2008, for the issuance of and disclosures pertaining to ‘Green Debt Securities’.

A debt security will be considered as a ‘Green Debt Security’, if the funds raised through its issuance are to be utilized for the following project(s)/ asset(s): (a) renewable and sustainable energy; (b) clean transportation; (c) sustainable water management; (d) climate change adaptation; (e) energy efficiency; (f) sustainable waste management; (g) sustainable land use; and (h) biodiversity conservation.

The issuer of green debt securities is required to make certain disclosures in its offer / disclosure documents including inter alia: (a) a statement on the environmental objectives of the issuance; (b) details of the system / procedures to be employed for tracking the deployment of proceeds of the issue; and (c) details of the project and/or assets where the issuer proposes to utilize the proceeds of the green debt securities.

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Clarifications on Framework for Revitalizing Distressed Assets

Published In:Inter Alia - Quarterly Edition - July 2017 [ English Chinese japanese ]

The RBI has, by a notification dated May 5, 2017, issued clarifications on the Framework for Revitalizing Distressed Assets in the Economy – Guidelines on Joint Lenders’ Forum (‘JLF’) and Corrective Action Plan (‘CAP’) after observing delays in finalizing and implementation of the CAP, leading to delays in resolution of stressed assets in the banking system. These clarifications include:

i. CAP can also include resolution by following the process stipulated under the ‘Flexible Structuring of Project Loans’ (‘5-25 Scheme’) – the change of ownership under the ‘Strategic Debt Restructuring Scheme’ (‘SDR Scheme’) and the ‘Scheme for Sustainable Structuring of Stressed Assets’, (‘S4A Scheme’), etc.

ii. Lenders must adhere to the prescribed timelines for finalizing and implementing the CAP decisions and decisions agreed upon by a minimum of 60% of creditors by value and 50% of creditors by number in the JLF would be considered binding on all lenders.

iii. RBI has additionally noted that the stand of the participating banks while voting on the final proposal before the JLF shall be unambiguous and unconditional. Any bank which does not support the majority decision on the CAP may exit subject to substitution within the stipulated timelines, failing which it shall abide the decision of the JLF (as decided above) and that the bank shall implement the JLF decision without any additional conditions. Non-adherence to the instructions and frameworks under the timeline may attract monetary penalties.

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IBC Update: Shareholders’ Resolution not required for a resolution plan.

Published In:Inter alia- IBC Client Update- October 2017- 3 [ English ]

The Ministry of Corporate Affairs (‘MCA’) released a circular last evening, clarifying a significant issue under the Insolvency and Bankruptcy Code, 2016 (‘IBC’).

If a corporate action is contemplated in a resolution plan approved by the National Law Company Tribunal (‘NCLT’)stakeholders have queried whether the existing shareholders need to approve such corporate action (where required under the Companies Act, 2013 (‘CA 2013’) or any other law). Such corporate actions could include issuance of further shares, a merger/demerger or a slump sale.

Industry participants and stakeholders have considered this issue critical because a resolution plan approved by the committee of creditors and the NCLT could fail to obtain shareholders’ approval. Such failure would raise difficult legal questions. This includes whether the relevant resolution plan can be implemented thereafter, whether the relevant company may fall into liquidation, and what consequences may ensue for the shareholders themselves for failure to approve a plan which is supposed to be binding on them. These unanswered questions caused significant unease for potential investors (who feared that a seemingly completed acquisition may unravel) and the committee of creditors (who feared that a seemingly completed restructuring may fall into liquidation), amongst other stakeholders.

Two provisions of the IBC seemed to be inconsistent and left room for divergent interpretation. Section 31(1) of the IBC provides that once the resolution plan is approved by the NCLT it shall be binding on the company and its shareholders, amongst others. However, Section 30(2)(e) of the IBC states that the resolution plan must not contravene any provisions of law for the time being in force. So does the approved resolution plan bind shareholders and therefore remove the need for their separate consent in a general meeting, or should the resolution plan contemplate the need for a shareholders’ approval to ensure compliance with the CA 2013 and then proceed to obtain it post approval by the NCLT?

The MCA has now clarified that approval of shareholders of the company for any corporate action in the resolution plan (otherwise required under the CA 2013 or any other law) is deemed to have been given on its approval by the NCLT. As such, at no stage (whether before approval by the NCLT or indeed after), is shareholders’ approval required for the implementation of an approved resolution plan.

The circular offers significant clarity to market participants and confirms a decisive shift in decision making power away from the shareholders in favour of the committee of creditors. However, this is a clarification and has been offered by way of a circular issued by the MCA and is not a legislative amendment.

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RBI sends 25% of India’s non-performing loans to the Insolvency and Bankruptcy Code, 2016

Published In:IBC Update - June 14, 2017 [ English ]

The Reserve Bank of India (‘RBI’) issued a press release on June 13, 2017 announcing that its Internal Advisory Committee (‘IAC’) has identified 12 Indian companies which qualify for immediate reference under the Insolvency and Bankruptcy Code, 2016 (‘IBC’). These 12 accounts constitute about 25% of the current non-performing loans (‘NPLs’) in India.

The RBI had last month constituted an IAC for the purpose of identifying NPLs that would be recommended for the corporate insolvency resolution process under the IBC.

The IAC had its first meeting on Monday, June 12, 2017 and agreed to focus on large stressed accounts. The IAC reviewed and considered the largest 500 NPLs. In identifying the 12 largest accounts, the IAC recommended that all accounts with outstandings greater than INR 50 billion (approximately USD 800 million) of which 60% or more are classified as non-performing as of March 31, 2016, qualify for reference to the IBC.

Crucially, the IAC also recommended that for NPLs, where the above criteria do not apply, a viable resolution plan must be finalised by banks within six months, failing which banks may be required to push these companied into the corporate insolvency resolution process under the IBC. More details on these other NPLs are expected in the coming days.

The RBI also confirmed that it will be publishing revised provisioning norms for cases admitted under the IBC. This was something which the banking industry had been keenly waiting for and will be relieved to hear is in the pipelines.

On May 4, 2017, an ordinance amended the Banking Regulation Act, 1949 empowering the RBI to direct banks to lead certain NPLs into the IBC process. On May 5, 2017 the Ministry of Finance empowered the RBI to do so. Also on May 5, 2017, the RBI revised and clarified important aspects of its restructuring circular. On May 22, 2017, the RBI announced that that it will form a committee to recommend cases for the IBC process (which is now called the IAC). This committee was formed and had its first meeting within three weeks of that announcement (June 12, 2017). And a day after its first meeting, the above announcement was made. The sense of purpose and impatience in the fight against NPLs is palpable and unprecedented. The next six to nine months are going to be very interesting to watch for stakeholders in the finance, restructuring and M&A space.

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IBC Amendment: Legislating for Moral Hazard with a Broad Brush – Take 2

Published In:IBC Update - January 2, 2018 [ English ]

The President of India promulgated an ordinance on November 23, 2017 amending the Insolvency and Bankruptcy Code, 2016 (‘IBC’) (‘Ordinance’). Please refer to our previous edition of Inter Alia update attached herewith (readers may benefit from a second read of our previous edition before considering this update). A key change brought in by the Ordinance was the introduction of eligibility criteria for resolution applicants with an express prohibition on certain persons from submitting a resolution plan for a corporate debtor in a corporate insolvency resolution process (‘CIRP’) and also preventing such persons from purchasing the corporate debtor’s assets in liquidation.

Some market participants argued that these new eligibility criteria were too restrictive and may disqualify applicants whose participation in the IBC resolution process could be economically and strategically important for all stakeholders.

In this backdrop, a Bill was introduced in the Parliament (“Bill”) on December 29, 2017 by Mr. Arun Jaitley, the Finance Minister, to replace the Ordinance. The Bill has now been passed by the Lok Sabha and the Rajya Sabha (Lower and Upper House of the Parliament respectively). When the Bill is approved and signed by the President of India and then notified, it will amend some of the provisions of the IBC recently introduced by the Ordinance. The key changes proposed are set out below:

1. Who must be eligible?

The eligibility criteria for submitting a resolution plan under the Ordinance applied to the applicant or any person acting jointly with such person. The Bill requires that any person acting in concert with the applicant must also meet the eligibility criteria.

While ‘acting jointly’ may have been interpreted to be restricted to a joint applicant or equivalent, ‘persons acting in concert’ will be interpreted to have a wider import. The interpretation of this phrase as used in other Indian laws will be referred to. Resolution applicants, insolvency professionals and members of committees of creditors will carefully consider this much expanded scope and eagerly await jurisprudence to clarify the reach of this term.

2. Some disqualifications now time bound

The Bill clarifies that ineligibility on account of: (a) being a willful defaulter, (b) being disqualified to act as a director, and (c) prohibition by the Securities and Exchange Board of India from trading in securities or accessing the securities market, will only subsist as long as the person suffers from such ‘deficiency’ and not thereafter.

3. Disqualification for being classified as a non-performing asset (‘NPA’)

The Bill clarifies that in order to ascertain if one year has elapsed from classification of an account as an NPA (resulting in disqualification), the relevant look-back period will be from the date of the commencement of the CIRP of the corporate debtor. The interpretation of the language of the Ordinance was that the look-back period started from the date of submission of a resolution plan. This may help would-be-applicants that are involved with companies that have only recently become stressed.

The Bill clarifies that this ‘disqualification’ also applies to the promoter of the corporate debtor (whose account is so classified) and to anyone in management or control of the corporate debtor. Many stakeholders were already interpreting the language in the Ordinance to mean this. The clarification is, nonetheless, helpful.

The Ordinance indicated that any person affected by such ‘NPA disqualification’ may cure such ineligibility by making payments of all overdue amounts with interest thereon. The Bill clarifies this. There has been some suggestion in the Parliamentary debate on the Bill and speeches of Government officials that payment of overdue interest may be enough to avail of this cure. However, the text of the Bill which refers to “overdue amounts with interest” suggests otherwise and this now remains a matter left for interpretation by the relevant lenders.

The Bill also permits a resolution applicant who is otherwise ineligible due to this disqualification to remain an eligible resolution applicant if such person makes payment of the overdue amounts with interest within 30 days (or such shorter period permitted by the committee of creditors).

4. Preferential, undervalued or fraudulent transactions; and now extortionate credit transactions

The Bill clarifies that this ‘disqualification’ also applies to the promoter of the corporate debtor (in which such transactions took place) and to anyone who has been in management or control of such corporate debtor. Some stakeholders were already interpreting the language in the Ordinance to mean this. The clarification is, nonetheless, helpful. The Bill also adds extortionate credit transactions to the list of disqualifications.

5. Connected persons – now a global check with some exceptions

The Ordinance listed a number of disabilities in the context of Indian law. The Ordinance also listed any ‘corresponding disabilities’ under any foreign law as a relevant disability. This ‘foreign disability’ test did not seem to apply to connected persons under the Ordinance. The Bill will extend this ‘foreign disability’ test to connected persons also.

Under the Ordinance, connected persons included the holding company, subsidiary company, associate company or a related party of the relevant person. As all connected persons also need to pass the eligibility test, this became a challenge for some ‘bona fide’ applicants. The Bill provides that the extension of connected persons to include holding companies, subsidiary companies, associate companies or related parties will not apply to a scheduled bank, a registered asset reconstruction company or a registered alternate investment fund.

6. Disqualifications in respect of Guarantors

The Ordinance disqualified any person who had executed an enforceable guarantee in favour of a creditor in respect of a corporate debtor under CIRP. This provision was recently interpreted by a Court to refer to guarantees which had been invoked but remained unpaid. The Bill seems to narrow the scope of this disqualification – which may assist persons involved with corporate debtors that have become stressed more recently.

To conclude, the Bill seeks to reduce some of the rigour of the disqualifications contained in the Ordinance while raising the bar and widening the impact in other respects. The eligibility criteria remain restrictive and may end up disqualifying some key players.

Separately, on December 31, 2017 the Insolvency and Bankruptcy Board of India amended the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 and the Insolvency and Bankruptcy Board of India (Fast Track Insolvency Resolution Process for Corporate Persons) Regulations, 2017 (“Amendments”). The Amendments clarify that the term “dissenting financial creditor” will also include financial creditors who abstained from voting for the resolution plan approved by the CoC. Many stakeholders were already interpreting the language in the IBC and the regulations to mean this (including in relation to payment of liquidation value to such creditors). The clarification is, nonetheless, helpful. Additionally, the Amendments (i) omit the requirement to state the liquidation value of the corporate debtor in the information memorandum; (ii) mandates all stakeholders to keep the liquidation value of the corporate debtor confidential; and (iii) provides for submission of resolution plan within the time given in the invitation for the resolution plans. Many members of the CoC were concerned that general publication of liquidation value could depress bids. This amendment attempts to alleviate this concern.

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IBBI- Press Release- India wins the GRR Award for the Most Improved Jurisdiction

Insolvency and Bankruptcy Board of India Press Release No. IBBI/PR/2018/20

India won the prestigious GRR Award for the Most Improved Jurisdiction in a glittering ceremony held in Banking Hall, London on 26th June, 2018. This award recognises the jurisdiction which improved its restructuring and insolvency regime the most over the last year. Other jurisdictions shortlisted for this award included the European Union and Switzerland.

The award is given by the Global Restructuring Review (GRR), an online daily news service and magazine on cross-border restructuring and insolvency law. The GRR introduced global awards in nine categories in 2017. One of the nine award categories is the Most Improved Jurisdiction. The winner is selected basis a rigorous global nomination process. Singapore won the award in Most Improved Jurisdiction category in 2017.

Ms. Kyriaki Karadelis, Editor, GRR observed on the occasion, “The award for “most improved jurisdiction” is extremely well-deserved. As you know, India narrowly missed out on the title to Singapore last year, but as the Insolvency and Bankruptcy Law of 2016 has begun to be tested in the new network of National Company Law Tribunals resulting in several key, precedent-setting judgements, we felt it was the right time to celebrate India’s progress in this sector.”

While shortlisting India for this award in 2018, the GRR observed: “It has been all change in India since it enacted its first ever Insolvency and Bankruptcy Code in 2016, bringing in greater empowerment for creditors, registered insolvency professionals and a whole new network of National Company Law Tribunals (NCLTs).

An almost constant stream of improvements and updates has followed in response to feedback and practical experience: for example, in early 2018, new regulator the Insolvency and Bankruptcy Board of India (IBBI) introduced additional rules defining how to calculate the fair value of debtors’ assets requiring registered valuers to do the maths. Case law is now beginning to build up on the interpretation of the new rules too. …..”.

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IBC Update: Approval of Resolution Plans under the IBC

Published In:Inter alia- IBC Client Update- November 2017- 2 [ English ]

Three resolution plans have recently been approved by different benches of the National Company Law Tribunal (‘NCLT’) under the provisions of the Insolvency and Bankruptcy Code, 2016. These three cases are briefly discussed below:

Sree Metaliks Limited

The NCLT, Kolkata Bench on November 7, 2017, approved the resolution plan proposed by the promoters and approved by the Committee of Creditors (‘CoC’) by a 78.5% majority. The plan inter alia provides for:

1.division of financial creditors (‘FC’) into two buckets (Class A and Class B) based on the different levels of charge created by the company;

2. haircut of 25% for Class A FCs and 50% for Class B FCs;

3. and capital infusion by a strategic investor.

Prowess International Private Limited

An operational creditor (‘OC’) had initiated the corporate insolvency resolution process (‘CIRP’) at the NCLT, Kolkata Bench, against a company which was solvent and financially sound. During the CIRP, two OCs which had a major claim against the company settled their dues by way of a compromise. The resolution plan, approved by the NCLT on October 17, 2017, provided for:

1.payment to the sole FC without any haircut; and

2. payment to OCs (other than the two whose claims were settled) without any haircut during normal course of business.

Chhaparia Industries Private Limited

The NCLT, Mumbai Bench on September 29, 2017 approved the resolution plan proposed by the promoters. The order passed by the NCLT does not discuss the commercials in depth. However, the plan provides for reinstatement of the suspended board of directors;

1. Payment of liquidation value to OCs (of which part payment had already been made and the remainder was to be paid within 30 days); and

2. Payment to the sole FC, Asset Care and Reconstruction Enterprises Limited within 25 months from the date of the order. It is not clear if the FC suffered a haircut, if any.

The common theme amongst all of the above cases has been that the plan proposed by the erstwhile promoters has been approved by the CoC and NCLT.

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IBC Update: Shareholders’ approval not required for Resolution Plan

Published In:Inter alia- IBC Client Update- October 2017 [ English ]

The Ministry of Corporate Affairs (‘MCA’) released a circular last evening, clarifying a significant issue under the Insolvency and Bankruptcy Code, 2016 (‘IBC’).

If a corporate action is contemplated in a resolution plan approved by the National Law Company Tribunal (‘NCLT’)stakeholders have queried whether the existing shareholders need to approve such corporate action (where required under the Companies Act, 2013 (‘CA 2013’) or any other law). Such corporate actions could include issuance of further shares, a merger/demerger or a slump sale.

Industry participants and stakeholders have considered this issue critical because a resolution plan approved by the committee of creditors and the NCLT could fail to obtain shareholders’ approval. Such failure would raise difficult legal questions. This includes whether the relevant resolution plan can be implemented thereafter, whether the relevant company may fall into liquidation, and what consequences may ensue for the shareholders themselves for failure to approve a plan which is supposed to be binding on them. These unanswered questions caused significant unease for potential investors (who feared that a seemingly completed acquisition may unravel) and the committee of creditors (who feared that a seemingly completed restructuring may fall into liquidation), amongst other stakeholders.

Two provisions of the IBC seemed to be inconsistent and left room for divergent interpretation. Section 31(1) of the IBC provides that once the resolution plan is approved by the NCLT it shall be binding on the company and its shareholders, amongst others. However, Section 30(2)(e) of the IBC states that the resolution plan must not contravene any provisions of law for the time being in force. So does the approved resolution plan bind shareholders and therefore remove the need for their separate consent in a general meeting, or should the resolution plan contemplate the need for a shareholders’ approval to ensure compliance with the CA 2013 and then proceed to obtain it post approval by the NCLT?

The MCA has now clarified that approval of shareholders of the company for any corporate action in the resolution plan (otherwise required under the CA 2013 or any other law) is deemed to have been given on its approval by the NCLT. As such, at no stage (whether before approval by the NCLT or indeed after), is shareholders’ approval required for the implementation of an approved resolution plan.

The circular offers significant clarity to market participants and confirms a decisive shift in decision making power away from the shareholders in favour of the committee of creditors. However, this is a clarification and has been offered by way of a circular issued by the MCA and is not a legislative amendment.

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IBC Update: India’s First Interim Finance

Published In:Inter alia- IBC Client Update- October 2017- 2 [ English ]

AZB & Partners represented Edelweiss in the country’s first significant interim finance under the Insolvency and Bankruptcy Code, 2016 (‘IBC’). The interim finance was raised by the resolution professional of Alok Industries Limited, Mr. Ajay Joshi (assisted by Grant Thornton).

Alok Industries Limited is one of the 12 accounts where the Reserve Bank of India directed banks to initiate insolvency proceedings under the IBC. The National Company Law Tribunal initiated a corporate insolvency resolution process against Alok Industries Limited on July 18, 2017.

The IBC provides specific provisions for raising interim finance by the resolution professional for the purposes of protecting and preserving the value of the property of the company and managing its operations as a going concern – and consequently achieve a viable resolution plan for the company.
The IBC classifies all interim finance raised as ‘insolvency resolution process costs’ (‘IRPC’). Payment of IRPC gets highest priority in a resolution plan or in liquidation.

The IBC requires that, in a resolution plan, IRPC must be paid out prior to any recoveries being made by any creditor. Such payment includes interim finance (interest and principal) which also gets this priority. Similarly, in liquidation also, the distribution waterfall set out in the IBC provides for highest priority to IRPC (which must be paid out of the liquidation estate).

Interim finance is an important ingredient to resolve and restructure a stressed and potentially insolvent company and in some cases can be critical for the company’s business operations to survive during the corporate insolvency resolution process. A number of companies undergoing the IBC process have sought to raise formal interim finance. There has also been sufficient interest in this space from various financial institutions. We expect that with this first deal underway, many others will be encouraged to follow suit.

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IBC Update: First Information Utility

Published In:Inter alia- IBC Client Update- October 2017- 1 [ English ]

National e-Governance Services Limited (‘NeSL’), a Union Government company that received an in-principle approval for establishing an information utility (‘IU’) in June, 2017, has now received the final approval to become India’s first IU with the initial registration valid till September 24, 2022. Indira Gandhi Institute of Development Research has been appointed as the knowledge partner of NeSL, and Mr. S Ramann has been appointed as the Managing Director and Chief Executive Officer. The framework of NeSL is governed by the Insolvency and Bankruptcy Board of India (Information Utilities) Regulations, 2017.

Under the Insolvency and Bankruptcy Code, 2016 (‘IBC’), IUs are envisaged as record keeping entities which assist in providing accurate, secure and the most up-to-date financial information relating to companies which will assist creditors and other stakeholders in the context of insolvency proceedings.

IUs are designed to provide services such as accepting, authenticating and providing access to financial information. Under the IBC, the information stored with an IU can be relied upon by the National Company Law Tribunal (‘NCLT’) at the time of admission of an insolvency application. Such information will assist in determining whether a payment default has occurred or if there is a pre-existing dispute in relation to an IBC application filed by an operational creditor. In addition, IUs are also envisaged to function as a public record of security interests created by companies in favour of creditors and such record can be relied upon by creditors to establish perfection of security in a liquidation scenario.

Persons permitted to access information stored with an IU include the debtor, the subject creditor, the insolvency professional, the NCLT, the Insolvency and Bankruptcy Board of India and other persons who are permitted to access such information by the debtor or the creditor, as the case may be (subject to payment of prescribed fees).

This is an important and much awaited development in the restructuring and banking space, and we are hopeful that the many expected benefits of an IU for various stakeholders will emerge soon.

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Essar vs. RBI: Start to finish in 10 working days!

Published In:Inter alia- IBC Client Update- July 2017 [ English ]

On June 13, 2017, the Reserve Bank of India (‘RBI’) issued a press release stating that the Internal Advisory Committee (‘IAC’) had identified 12 accounts that would qualify for immediate reference under the Insolvency and Bankruptcy Code, 2016 (‘IBC’) and thereafter, the RBI issued directions to the relevant lead banks directing them to commence IBC proceedings against these 12 companies.

The State Bank of India (‘SBI’) commenced IBC proceedings against Essar Steel India Limited (‘Essar Steel’) on June 22, 2017 (shortly before this Standard Chartered Bank (‘SCB’) had also commenced IBC proceedings against Essar Steel).

Essar Steel challenged both SBI’s and SCB’s IBC proceedings in the Gujarat High Court on July 4, 2017 and RBI’s identification of Essar Steel as one of the 12 companies directed for immediate IBC proceedings. AZB & Partners was instructed to represent the RBI.

After fully hearing all parties (Essar Steel, RBI, SBI, SCB and the National Company Law Tribunal (‘NCLT’)), on July 17, 2017 the Gujarat High Court dismissed Essar Steel’s petition and declined to grant any of the reliefs requested by Essar Steel. The Gujarat High Court moved in an efficient and speedy fashion and the order was passed within 10 working days of commencement of proceedings by Essar Steel.

This decision is crucial as it will ensure Essar Steel and the other identified debt-laden companies will be referred to the NCLT without further delays. As of this morning, Essar Steel has not filed an appeal against the decision of the Gujarat High Court.

NCLT Ahmedabad has ordered that the Essar Steel IBC proceedings be heard on July 24, 2017 and has given time to Essar Steel to file its reply until July 22, 2017.

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Bankruptcy code on its way

Published In:Inter alia- IBC Client Alert- December 2016 [ ]

Ever since the Insolvency and Bankruptcy Code, 2016 (“IBC”) was passed by Parliament, the Ministry of Corporate Affairs (“MCA”) has been notifying portions of the IBC selectively as and when supporting infrastructure was created.

Set out below are some of the major provisions of the IBC, the related Central Government Rules and the Insolvency and Bankruptcy Board of India (“IBBI”) Regulations, which have been notified.

A. Insolvency Professionals and Insolvency Professional Agencies

The IBBI notified three regulations this month:

(1) IBBI (Insolvency Professionals) Regulations, 2016 (“IP Regulations”), which took effect on November 29, 2016.

The IP Regulations set out the categories of persons who are eligible to become insolvency professionals (“IPs”):

(a) Advocates, chartered accountants, company secretaries and cost accountants (“Regulated Professionals”) who have been in practice for more than 15 years will be automatically grandfathered to qualify as IPs on registering with an Insolvency Professional Agency (“IPA”). However, their registration will be provisional and valid for only six months, after which they will have to clear the ‘Limited Insolvency Exam’ to be held by the IBBI.

(b) Regulated Professionals with 10 years of experience in practice must first clear the Limited Insolvency Exam.

(c) Graduates other than Regulated Professionals with more than 15 years of experience in management must first clear the Limited Insolvency Exam.

(d) Any person who is an Indian resident and is ‘fit and proper’ must first clear the ‘National Insolvency Exam’, which is intended to be more rigorous than the Limited Insolvency Exam.

(2) IBBI (Insolvency Professional Agencies) Regulations, 2016 (“IPA Regulations”), which took effect on November 21, 2016.

IPAs operate as self-regulatory organisations whose objective is the enrollment of IPs, regulation of IPs and the enforcement of a code of conduct for their member IPs. The IPA Regulations provide that:

(a) Only companies registered under Section 8 of the Companies Act, 2013 may be registered as IPAs;

(b) IPAs must have a minimum net worth of INR 100,000,000 (approximately USD 1,500,000) and a paid-up share capital of INR 50,000,000 (approximately USD 700,000);

(c) At least 51% of the share capital of the IPA must be held by persons resident in India.

The Institute of Chartered Accountants of India and Institute of Company Secretaries of India have obtained registration from the IBBI to function as IPAs.

(3) IBBI (Model Bye-Laws and Governing Board of Insolvency Professional Agencies) Regulations, 2016 (“Model Bye-Law Regulations”), which took effect on November 21, 2016.

These regulations mandate that the bye-laws of IPAs must be in conformity with the Model Bye-Law Regulations. These regulations provide for the internal governance of the IPA; registration of member IPs; instituting a disciplinary procedure; and grievance redressal mechanism in respect of member IPs.

B. Corporate Insolvency Resolution Process (“CIRP”) (Chapter II, Part II of IBC) most likely to be notified on December 1, 2016

Sections 6 to 32 of the IBC deal with the operation of the CIRP. These sections entitle foreign and domestic creditors (both financial and operational) as well as corporate debtors to initiate a CIRP on the occurrence of a payment default of more than INR 100,000 (approximately USD 1,500).

Notably, this part deals with the triggering of CIRP, taking over of the management by the IP, creation of the committee of creditors and the submission and consideration of resolution plans for revival of the corporate debtor as a going concern. The IBBI is also notifying IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“CIRP Regulations”), most likely with effect from December 1, 2016. The CIRP Regulations elaborate in greater detail how an IP is appointed and how the CIRP process is conducted.

C. Notable parts that have not been notified

(1) Liquidation Process (Chapter III, Part II of IBC): This part deals with the provisions relating to the conduct of liquidation proceedings in respect of the corporate debtor. We understand the MCA intends to notify these parts within the next two to three weeks. The IBBI is in the process of finalizing the IBBI (Liquidation of Insolvent Corporate Persons) Regulations, 2016, which will contain the specific details of how liquidators will be appointed, their duties and remuneration.

(2) Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms (Part III of IBC): This part deals with the provisions relating to the conduct of the bankruptcy process for individuals and partnership firms.

Voluntary Liquidation of Corporate Persons (Chapter V, Part II of IBC): This part deals with provisions relating to voluntary liquidation of corporate persons i.e. instances where the corporate debtor intends to initiate a liquidation proceeding without the occurrence of a payment default.

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A Guaranteed Mess?

Published In:IBC Update - January 31, 2018 [ ]

Recent news reports indicate that State Bank of India, India’s largest corporate lender has decided to invoke all outstanding personal and corporate guarantees in relation to companies undergoing Corporate Insolvency Resolution Process (‘CIRP’) under the Insolvency and Bankruptcy Code 2016 (‘IBC’).

The treatment of guarantees issued by and in favour of companies undergoing CIRP should be relatively straightforward under the IBC. But jurisprudence over the last few months in this context has introduced complexity. This note briefly sets out the key themes that have evolved so far.

Invocation of Guarantee issued by a corporate debtor after Insolvency Commencement Date (‘ICD’)
.

Courts (in the Edu Smart case and MBL case)[i] have held that invoking a guarantee issued by a corporate debtor after its ICD is analogous to foreclosing, recovering or enforcing any security interest in respect of the property of the corporate debtor, which is prohibited on account of the moratorium imposed under Section 14 of the IBC.

Submission of proof of claim for guarantees yet to be invoked

Courts (in the Edu Smart case and the Binani case)[ii] have held that a proof of claim can only be submitted for claims that have crystallized “i.e.,” are due and payable by the corporate debtor on the ICD. A guarantee claim will be considered due and payable only after due invocation under the terms of the contract. So effectively, if a guarantee issued by a corporate debtor has not been invoked before ICD, no proof of claim can be filed. As a result, the rights of such beneficiary post-resolution plan remains uncertain (for the beneficiary and the resolution applicant).

Guarantee issued by a third party (“e.g.,” promoter or group company of the corporate debtor) not undergoing CIRP not hit by moratorium

Some judgements (the Alpha & Omega case and the Schweitzer case)[iii] have indicated that enforcement of any security interest granted by a third party for the debts of the corporate debtor is not prohibited by the moratorium under Section 14 of the IBC, since the moratorium only applies to the security created in respect of the assets of the corporate debtor appearing on its balance sheet. Though these cases don’t explicitly deal with third party guarantees, the principal enunciated could easily be extended to guarantees as well inferring that invoking a third party guarantee after ICD would not be prohibited.

On second thoughts, (invoked) guarantee issued by a third party (“e.g.,” promoter or group company of the corporate debtor) not undergoing CIRP hit by moratorium

Somewhat contrary to the above, the Allahabad High Court (in the Sanjeev Shriya case)[iv] held that in an ongoing CIRP, the obligations of the corporate debtor are in a fluid state and have not been conclusively determined; and that therefore, till such time as the CIRP continues any guarantee given by the promoters of the corporate debtor cannot be enforced since the guarantor’s obligations cannot be established while the company’s obligations are in flux. For the record, the guarantee was invoked before ICD of the corporate debtor.

On further reflection, (invoked) guarantee issued by a third party (“e.g.,” promoter or group company of the corporate debtor) not undergoing CIRP hit by moratorium and cannot be used to start IBC proceedings against the issuer

In the recent Vista Steel case[v], a group company of a borrower had provided a guarantee to a financial creditor. This financial creditor also benefited from security provided by the borrower. There was an ongoing CIRP against the borrower/principal debtor. The financial creditor of the principal debtor (in CIRP) invoked the guarantee granted by the group company before the ICD of the principal debtor. The guarantor did not make payment under the invoked guarantee and so the creditor sought to invoke IBC proceedings against the guarantor (for crystallised debt). The court held that doing so would cause the guarantor to be subrogated to the rights of the secured financial creditor causing creation of a security interest over the assets of the borrower/principal debtor, violating the moratorium under Section 14 of the IBC. On this basis, the court denied the financial creditor from proceeding with the IBC application against the guarantor.

Where do we stand?

The principle set out by the Alpha & Omega case and the Schweitzer case was, in our view, the right way to approach the matter. Subsequent decisions have made it difficult for lenders to proceed simultaneously against guarantors and borrowers. This dilutes the usefulness of a guarantee for a lender and currently provides one of the few silver linings for promoters whose companies are in CIRP/IBC.

 

[i] Axis Bank Limited v. Edu Smart Services Private Limited NCLT, New Delhi October 27, 2017 and RBL Bank Limited v. MBL Infrastructures, NCLT Kolkata, December 18, 2017.
[ii] Axis Bank Limited v. Edu Smart Services Private Limited NCLT, New Delhi October 27, 2017 and Bank of Baroda v. Binani Cements Ltd., NCLT Kolkata, November 17, 2017.
[iii] Alpha & Omega Diagnostics (India) Ltd. v. Asset Reconstruction Company of India Ltd & Ors, NCLAT, New Delhi July 31, 2017 and Shweitzer Systemtek India Pvt. Ltd. v. Phoenix ARC Pvt. Ltd. & Ors, NCLAT, New Delhi, August 9, 2017.
[iv] Sanjeev Shriya v. State Bank of India, Allahabad High Court, September 6, 2017.
[v] ICICI Bank Limited v. Vista Steel Private Limited, NCLT Kolkata Bench, December 15, 2017

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Amendments to the ECB Policy

Published In:Inter Alia - Quarterly Edition - June 2018 [ English Chinese japanese ]

On April 27, 2018, the RBI has issued the External Commercial Borrowings (‘ECB’) Policy – Rationalisation and Liberalisation (‘ECB Policy’), which provides for the following key relaxations in the existing ECB framework:

i. A uniform all-in-cost ceiling of 450 basis points over the benchmark rate has been stipulated. The benchmark rate will be 6 month USD LIBOR (or applicable benchmark for respective currency) for Track I and Track II, while it will be the prevailing yield of the Government of India securities of corresponding maturity for Track III (Rupee ECBs) and rupee denominated bonds.

ii. The liability to equity ratio for ECBs raised from direct foreign equity holder under the automatic route has been increased to 7:1. This ratio will not be applicable if the aggregate amount of ECBs raised by an entity do not exceed USD 5 million.

iii. The RBI has permitted housing finance companies, regulated by the National Housing Bank, and port trusts, constituted under the Major Port Trusts Act, 1908, to avail ECBs under all tracks; provided such entities maintain a Board approved risk management policy and keep the ECB exposure hedged 100% for ECBs raised under Track I. Companies engaged in the business of maintenance, repair and overhaul and freight forwarding have been permitted to raise ECBs denominated in INR only.

iv. The RBI has stipulated a negative list for end use for all tracks which includes investment in real estate or purchase of land except when used for affordable housing, investment in capital market and equity investment. Additionally, for tracks I and III, except when raised ECB has been raised from direct and indirect equity holders or from a group company and provided the loan is for a minimum average maturity of five years, the following negative end uses will also apply: (i) working capital purposes, (ii) general corporate purposes, and (iii) repayment of Rupee loans. Additionally, on-lending to entities for the aforementioned activities would not be permitted.

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Prohibition on dealing in Virtual Currencies

Published In:Inter Alia - Quarterly Edition - June 2018 [ English Chinese japanese ]

On April 6, 2018, the RBI issued a circular prohibiting entities regulated by the RBI from dealing in virtual currencies or providing services (including maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer / receipt of money in accounts relating to purchase / sale of virtual currencies) for facilitating any person or entity in dealing with or settling virtual currencies. Prohibited entities already providing these services as on the date of the circular, have been directed to exit such relationship by July 6, 2018.

This RBI circular was challenged in the Supreme Court, which has not granted a stay on the circular.

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Blockchain & Cryptocurrency Regulation – 2019 | India

Published In:Blockchain & Cryptocurrency Regulation – 2019, 1st Edition [ ]

Introduction

In India, cryptocurrencies started gaining popularity since around 2013, when small scale businesses began accepting bitcoin as a form of payment. Since then, cryptocurrencies have grown into a means of investment evidenced by the emergence of cryptocurrency exchanges in India.
The first regulatory response in the context of cryptocurrencies was when the Reserve Bank of India (“RBI”) issued a press release – on December 24, 2013 (“Press Note 1”). The RBI (which is in charge of monetary policy, regulation of financial markets and exchange control related issues) was careful in terms of neither sanctioning, nor prohibiting, cryptocurrencies; rather, all that Press Note 1 constituted was a caution to users, holders and traders of ‘virtual currency’, of potential risks associated with cryptocurrencies.

Almost immediately after the issuance of Press Note 1, several bitcoin exchanges such as ‘Buysellbitco.in’ and ‘INRBTC’ temporarily shut operations. The Enforcement Directorate (“ED”, which enforces exchange control regulations) undertook raids on the proprietor of ‘Buysellbitco.in’ to examine if transactions being carried out on its platform violated foreign exchange control regulations.

While Press Note 1 and the ED’s actions caused a setback in the popularity of cryptocurrency transactions. This was only temporary; ultimately, cryptocurrencies weren’t banned or prohibited, and India witnessed a steady rise in transactions in cryptocurrency, tracking the global increase in similar activities.

The RBI released warnings similar in scope to Press Note 1 on February 01, 2017 (“Press Note 2”) and December 5, 2017 (“Press Note 3”) reiterating its caution, and went one step further to clarify that it (i.e. the RBI) has not provided any entity any license or sanction to transact with cryptocurrency.

It should be noted that the government does distinguish between bitcoin and its underlying technology, i.e., block chain. Despite the issuance of the press notes cited above, the RBI has issued a White Paper on ‘Applications of Block Chain Technology to the Banking and Financial Sector in India’ in January 2017, which views the application of block chain technology by banks favorably. The RBI has also indicated that it may create a domestic ledger platform involving National Payment Corporation of India similar to existing platforms (such as RTGS, NEFT and IMPS). Towards this end in particular, the RBI, in September 2017, announced that it has taken steps to create such a platform, and also filed three patent applications in this regard.

Along similar lines, the Indian Finance Minister, in his Budget Speech on February 1, 2018 stated that although the Indian government does not recognize bitcoin as legal tender, it does encourage the use of block chain technology in payment systems.

The Budget Speech is often cited as the precursor to the regulation on cryptocurrency in India, although it is certainly not the sole reflection of the Indian government’s attitude to cryptocurrency. Since RBI’s press releases, the government has constituted an inter-disciplinary committee (which includes representatives from the RBI) to examine (i) the present status of cryptocurrency in India and globally; (ii) the existing global regulatory and legal structures governing cryptocurrency; (iii) measures to address issues relating to consumer protection and money laundering.

These developments initially suggested a positive approach towards the regulation of cryptocurrency, in that it was expected, by some quarters at least, that the RBI and the government would officially permit the use of cryptocurrencies.

All that changed with RBI’s circular dated April 6, 2018 (“Circular”), as a result of which the dealing of cryptocurrency in India today has been substantially impeded. Through the Circular, the RBI banned all entitles regulated by it (i.e., banks, financing institutions, non banking financing institutions, payment system providers and the like) from dealing in, or facilitating any dealings in, cryptocurrencies. These entities were provided a three month period within which all accounts dealing with cryptocurrency would have to be shut down.

As a consequence, while the government has not per se banned cryptocurrency in India, it has certainly made it quite difficult for participants to conduct transactions by using traditional banking channels.

No other regulator in India has issued any directions concerning cryptocurrencies.

Press releases as recent as July, 2018, indicate that the government will clarify its stand on cryptocurrency and is working with various industry participants to issue detailed guidelines, although timing in this regard remains uncertain.

Indian Supreme Court on Cryptocurrency

Along with the executive contemplating regulation of cryptocurrency, several stakeholders have also approached the judiciary by filing petitions before the Indian Supreme Court (“SC”) in order to compel the government to provide clarity.

The two primary petitions seeking to address the legality of cryptocurrency were filed by (i) Vijay Pal Dalmia and Siddharth Dalmia through civil writ petition 1071 of 2017 on June 2, 2017 (“Dalmia Petition”), and (ii) Dwaipayan Bhowmick through civil writ petition 1076 of 2017 on November 03, 2017 (“Bhowmick Petition”).

The Dalmia Petition was filed against the Union of India (through the cabinet secretary), Ministry of Home Affairs, Ministry of Finance and the RBI (“Respondents 1”), seeking an order to direct Respondents 1 to “restrain/ ban the sale/ purchase of or investment in, illegal cryptocurrencies and initiate investigation and prosecution against all parties which indulged in the sale/ purchase of cryptocurrency.”

The grounds for the stated petition, as available on public sources, was based on (i) the anonymous nature of cryptocurrency transactions which makes it well-suited for funding terrorism, corruption, money laundering, tax evasion, etc.; (ii) production and introduction of new cryptocurrency being generated by private parties, without the intervention of the government, and hence violating the Constitution; (iii) use of cryptocurrency being in contravention of several laws such as FEMA and Prevention of Money Laundering Act, 2002; (iv) ransomware attacks having occurred through the use of bitcoin; (v) illegal cryptocurrency providing an outlet for personal wealth that is beyond restriction and confiscation; (vi) cryptocurrency exchanges encouraging undeclared and anonymous transactions making it difficult for government authorities to identify such transactions; and (vii) the fact that trading of cryptocurrencies permits players to bypass prescribed KYC norms.

The Bhowmick Petition was filed against the Union of India, Ministry of Finance, Ministry of Law and Justice, Ministry of Electronic and Information Technology, SEBI, RBI, Income Tax Dept. (through its secretary) and Enforcement Directorate (through its joint director) seeking an “issuance of direction to regulate the flow of bitcoins as well as requiring the constitution of a committee of experts to consider prohibition/regulation of bitcoins and other cryptocurrencies.”

The grounds for the petition, as reflected in public sources, inter alia include (i) bitcoin trading/ transactions, being unregulated, lack accountability; (ii) investigators can only track bitcoin holders who convert their bitcoin to regular currency; (iii) counterfeiting of cryptocurrency is not an issue so long as the miners keep the block chain secure; (iv) bitcoins may be used for trade and other financial activities without accountability, having an affect on the market value of other commodities; (v) conversion of bitcoin into foreign exchange does not fall under the purview of the RBI, making such transactions highly unsafe and vulnerable to cyber attacks; (vi) presently, no regulator has the power to track, monitor and regulate cryptocurrency transfers; (vii) cryptocurrency has the potential to support criminal, anti-social activities, like money laundering, terrorist funding and tax evasion; and (viii) use of cryptocurrency could result in widespread adverse financial implications if left unchecked.

Subsequent to the aforementioned petitions, certain industry participants have filed writ petitions challenging the constitutionality of the RBI’s Circular and reiterated the need for clarity on regulation. Other stakeholders, such as the Internet and Mobile Association of India have filed intervention applications in the Bhowmick Petition in order to draw attention to the impact that any restrictive regulation on cryptocurrencies may have to their businesses.

Till date, while the Supreme Court has admitted these petitions, the matters remain sub judice offering limited insight on the judiciary’s stance. Nevertheless, the arguments made (as publicy reported) indicate that there is a degree of acknowledgment that various risks are presented by the continuing lack of regulation around cryptocurrencies.

Is cryptocurrency valid currency in India?

The Indian Parliament has enacted (i) Reserve Bank of India, 1934 (“RBI Act”) regulating inter alia bank notes; and (ii) Coinage Act, 2011 (“Coinage Act”) regulating coins, and these remain the only statutes that define and recognize legal tender.

Per section 26 of the RBI Act, ‘every bank note shall be legal tender at any place in India for payment, or on account for the amount expressed therein, and shall be guaranteed by the Central Government.” The central government specifies and approves the denomination value, form and material of such bank notes and the RBI has the sole right to issue bank notes in the country. Similarly, section 6 (1) of the Coinage Act provides legal sanction to coins that are made of any metal or other material as approved by the Central Government. Bank notes and coins therefore encompass the entire universe of physical legal tender available in India.

Under the existing framework therefore, there is no sanction for cryptocurrencies as legal tender.

Is cryptocurrency a valid payment system in India?

In India, prepaid instruments and payment systems are regulated by the Payments and Settlement Act, 2007 (“PSSA”). Prior to the enactment of PSSA, a working group on electronic money set up by the RBI, issued a report in July 11, 2002 (“Report”), which defined electronic money as ‘an electronic store of monetary value on a technical device used for making payments to undertakings other than the issuer without necessarily involving bank accounts in the transaction, but acting as a prepaid bearer instrument.’

These products could be classified into two broad categories that is, (a) pre-paid stored value card (sometimes called “electronic purse” or “e-wallet”) and (b) pre-paid software based product that uses computer networks (sometimes referred to as “digital cash” or “network money”). It was highlighted that the stored value card scheme typically uses a microprocessor chip embedded in a physical device (such as a plastic card) while software based scheme typically uses specialized software installed in a personal computer.

The aforementioned definition may seem wide enough to include cryptocurrency in its scope. However, this must be read in conjunction with the PSSA which does not explicitly define electronic money, but regulates payment systems that affect electronic fund transfer. These payment systems include ‘systems that enable payment between a payer and beneficiary, involving clearing, payment or settlement service or all of them, but does not include a stock exchange’. Such systems include credit cards, debit cards, smart cards, and money transfer operations.
In addition to the PSSA, the RBI has also issued the ‘Master Direction on Issuance and Operation of Prepaid Payment Instruments’ dated October 11, 2017 (“PPI Regulations’) that regulate prepaid wallets. Prepaid wallets may be issued by bank or non-bank entities to facilitate the purchase of goods and services, including financial services, remittance facilities, etc., against the value stored on such instruments.

In order to fall under the purview of the above, the instrument in question must store some monetary value. Cryptocurrencies may not have any value stored on them and their value (if any) is contingent on market speculation. Consequently, their issuance are not likely to be construed as regulated electronic money, or a valid payment system, as is currently understood by Indian regulation. Consequently, associated compliance requirements such as obtaining RBI registration, the requirement to establish an entity incorporated in India, the requirement to comply with AML regulations etc. are not applicable.

Are cryptocurrency cross border trades, valid?

Cryptocurrencies are easily capable of being traded on a cross-border basis, and are generaqlly speaking exchangeable into fiat currency. Under the RBI Master Directions – Liberalized Remittance Scheme dated January 1, 2016, an Indian resident individual may remit up to USD 250,000 per year towards a permissible current or capital account transaction or both.

A permissible current account transaction includes inter alia remittance towards (i) private visits, business travel, or remittance by tour operators; (ii) fee for participation in global conferences and specialized training; (iii) remittance for participation in international events / competitions (towards training, sponsorship and prize money); (iv) film shooting; (v) medical treatment abroad; (vi) disbursement of crew wages, overseas education, remittance under educational tie up arrangements with universities abroad; (vii) remittance towards fees for examinations held in India and abroad and additional score sheets for GRE, TOEFL, etc; (viii) employment and processing, assessment fees for overseas job applications; (ix) emigration and emigration consultancy fees; (x) skills / credential assessment fees for intending migrants; (xi) visa fees, or processing fees required for registration of documents with other governments; (xii) registration / subscription / membership fees to international organizations.

A permissible capital account transaction includes inter alia remittance towards (i) investment in foreign securities; (ii) foreign currency loans; (iii) transfer of immovable property; (iv) guarantees; (v) export, import or holding of currency notes; (vi) loans and overdrafts; (vii) maintenance of foreign currency accounts overseas; (viii) insurance policies; (ix) capital assets; (x) sale and purchase of foreign exchange derivatives.

As is evident from the above, payments for cryptocurrency is not per se listed as a permitted activity. Nevertheless, it may have been possible for an individual to broadly declare the remittance of funds towards investments, without specifying that the intent was to invest in cryptocurrency. At present, given the financial blockage imposed by RBI’s Circular, if a banking institution were to examine the purpose of the remittance further or trace such remittance to its ultimate use, the individual may be held liable for violating foreign exchange regulations (at the very least, the banking institution in question would be unable to facilitate the transaction).

Closely associated with cross border transactions are anti-money laundering regimes that require periodic reporting and declarations being made prior to undertaking the transaction. While Indian money laundering regulations only apply to specific regulated entities such as banks, financial institutions, securities market intermediaries, etc., as a means to address concerns relating to money laundering, several cryptocurrency participants, such as cryptocurrency exchanges have imposed self regulatory measures such as complying with standard ‘know your customer’ obligations.

Conclusion

Regulatory uncertainty doesn’t seem to have hindered industry participants from applying creative alternatives to capitalize on the Indian cryptocurrency market. For instance, cryptocurrency exchanges are exploring the option of setting up a ‘peer to peer’ platform to act as an intermediary between entities trading in cryptocurrency. As a proof of concept, it can be argued that businesses in India are keen to adopt block chain and cryptocurrency, evidenced by various banks exploring the use of block-chain to facilitate cross border payments and large business houses contemplating issuing their own cryptocurrency.
Given the burgeoning market and technological potential, the Indian government is likely to seek to strike a balance in its approach. It will be interesting to witness whether the government recognizes the need of such technology by provisioning for regulation similar to the United States or Singapore governments that have imposed their taxation regime on cryptocurrency or, in the alternative, choose to nip this disruptive technology in the bud, like China, which has banned cryptocurrency.

Authors

1. Ashwin Ramanathan, Partner
2. Anu Tiwari, Partner
3. Rachana Rautray, Associate

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How the 2008 financial crisis changed banking

Published In:livemint [ ]

It all happened this week, 10 years ago. A lot has changed in the decade since the collapse of the storied Wall Street bank, Lehman Brothers. The past 10 years have changed everything: The nature of recessions, received economic wisdom, acceptable cultural markers, moderate politics of centre-left or centre-right. But how has banking, the core business responsible for the collapse, changed? Mint invited four professionals—Zia Mody, senior partner of law firm AZB & Partners; S.S. Mundra, former deputy governor of the Reserve Bank of India; Arijit Basu, managing director of State Bank of India; and Sanjay Nayar, India CEO of private equity firm KKR—to discuss how banking and financial services has changed over the past decade. Mint’s Rajrishi Singhal moderated the discussion.
Welcome to this roundtable. Why don’t we talk about what happened in the past 10 years. What are the lessons learnt? And, what does it tell us about the future? What does each of you think how the financial sector has changed in the past 10 years and, if possible, what are the regulatory structures that have accompanied these changes?

Nayar: A combination of things led to the financial crisis, but the biggest reason was huge over-leverage.
And, when there was an unwinding of risk, there was massive capitulation because of the huge leverage. Second, there were certain idiosyncrasies in regulation that were arbitraged. The fact is that two people were valuing risk in a different way: One part of the firm was putting on risk and the other part was shedding risk. Thirdly, banking system had a prima-donna culture.
What’s broadly changed in the past 10 years is technology playing a huge role, regulations have been tightened big-time, there has been a lot of separation of businesses that have conflict of interest; regulators and governments have seen what damage it can do and are therefore hugely hawkish. And I think we’re pretty balanced where we are.

Mundra: Firstly, the events 10 years ago have clearly established that self-regulation is a myth. Secondly, it clearly emerges that whenever the financial sector outpaces the real sector, such problems recur. As long as the financial sector is serving the real sector for real economic activities, things remain in control.
The day it becomes self-propelling, all kinds of problems start. The events a decade ago were a culmination of something that was already brewing. It will be wrong to believe that those events (Lehman Brothers collapse) were because of what happened three months ago or even six months before that.
US financial history shows that the Glass-Steagall Act was put in place under similar circumstances; and then when it was withdrawn in 1999, that was the beginning. Then gradually one thing led to another and it was famously mentioned in Fault Lines (by Raghuram Rajan) that at some point the political angle came in and then they said if you can’t provide employment, let them eat credit. Global regulation had a four-point agenda after the crisis: financial institutions should be made more resilient, too-big-to-fail should be done away with, make derivatives markets safer and the so-called shadow-banking should be converted into more market-based finance.
A lot of work is done, but a lot is still work-in-progress. Even for the international market, it is a mixed outcome. But for emerging markets, including India, these reforms had many unintended consequences: The banking sector has become very regulated, even perhaps over-regulated, whereas the same hasn’t happened to other sectors.

Mody: For me the journey, rather than the anniversary of the Lehman crisis, has been contradictory. Post Lehman, of course, regulators clamped down.
Today, as an intermediary, you proceed assuming that the regulator is not going to take your word at face value. You need to back it up with credible data.
In terms of over-leverage, 10 years later, are we less leveraged? The over-burdening of debt by businesses, maybe because of some slight euphoria after Lehman subsided and the recovery started, remains one of the biggest problems we face today. I also think, in some sense, we haven’t really moved. Crony capitalism is now termed as stigmatized capitalism; and how are we going to deal with that? The contradiction for me is that the system, from a deal-flow or an investment point of view, is on quite a bull run.
There is excitement, euphoria. The contradiction is: Do we have an economy as vibrant as we would like it to be? And do we really see a vibrant private sector putting money into the ground? How are these two going to converge? And if the financial sector doesn’t keep up with the real sector, we’re going to have the same problems again. This contradiction is a worry.
Do we have a bull run? If so, how do we sustain it? It is a global economy, where a lot is interconnected—you’ve got Trump, our elections. So, interesting times.

Basu: Lehman is just a date. If we step back a little, the subprime crisis was there in the US from 2006. But the impact has been tremendous across the globe.
Unemployment had started hurting; 20-25% unemployment in Europe and other parts is still par for the course.
Inequality has widened, which is why you see far-right and far-left everywhere. Because of the low interest rates, which came in due to quantitative easing, the mark-to-market pressure on pension funds has put their viability in question.
Insurance companies are reworking their models, which is not the case in India because we are still in the growth phase. In India, a lot of ground has been covered. Trade and protectionism has multiplied, which is worrying.
USA was one clear leader in 2008, which brought the world together; but now it seems to say I don’t need to be the leader any longer and I will do what is best for my country. And even if you look at debt, it was 110% of the total GDP then, it is at 170% today. In total terms, I believe it has increased by $70 trillion to $237 trillion.
The balance sheets of the central banks of developed countries have taken on $15 trillion. If something new were to happen today, the easing which was possible in 2008 would not be possible.
But then we have covered a lot of important ground. Liquidity is an important consideration for all banks; banks globally have become more universal. And emerging economies such as India and China are growing.
Crisis can again happen at any time, but I don’t think it will happen in the same manner or for the reasons that was behind the crisis in 2008.
From where do you see the next crisis emerging? What are the pressure points? Can our huge consumer lending be one?

Nayar: I don’t think we’re going to have a crisis because we do one thing right. We have a big fiscal deficit, but we borrow locally, in rupees, so it crowds all of us out. We are not a disaster waiting to happen, because we don’t borrow in dollars, which is what happened in Argentina, Brazil, Mexico and other markets. Our crisis must be redefined: Getting stuck in this band of 6-7% growth. That’s our crisis. We won’t grow at a higher rate unless there are some serious reforms. And let’s focus on only one reform—banking reforms. We have talked about it for so long, there have been so many committees, it’s time to implement the ideas. We should be regrouping the public sector banks. This can be done. Given that we have large fiscal deficit, bond markets are not going to boom overnight, and insurance companies will not start capital lending overnight. So even if the animal spirits come back, where is the money going to come from? India has a real capital issue, which is when you borrow using foreign capital. Between private equity and venture capital, 90% is foreign capital. And then you have FII (foreign institutional investor) money coming in. A small tweak from Sebi generates so much noise today, which tells you how dependent we have become on foreign savings. The more you bring in imported savings—either debt or equity—then the fact that we didn’t borrow for fiscal deficit in dollars, gets nullified. Ultimately that money has to go back.

Mundra: There is another proposal in global regulations—that risk weight should also be assigned to sovereign borrowing. This is because many EU countries have borrowed in dollars and have defaulted. But if you apply the same principle, banks’ entire SLR (statutory liquidity ratio) portfolio, which is currently carrying a nil rate, will have to carry some weight—even if it is 1-2%, it will stress the already stressed capital condition and affect the banks’ ability. External linkages will always be a potential problem that may arise. Within the banking system, while retail looks like a new mantra for everyone and panacea for all ills, what is slightly worrying is whether people doing the underwriting have the right capabilities. Banks need capabilities on three sides: Identification of borrower, processing of loan application and collecting ability. Another very important point is that retail has become the game of selling at the point of origin. There are nimble and younger players who can go to the point of origin and cater to customers. There is another segment that is equally enamoured with retail, but does it from the comforts of its cabin. There is a possibility that they are getting the leftovers or the rejected, and that can create a problem.

Mody: I don’t think we will have a large Lehman type crisis, but I think the crisis is—India growing at 6-7%. We don’t need to do anything for it to grow at that rate, it’s just India will keep growing at that rate. How do you really enhance that? How do you create responsible capitalism, responsible banking? I go back to the question of the ecosystem that has to be created. You need to energize bankers so that they can accept the proper risk. But it seems, every banker is concerned about how this is happening on my watch, and why should I take any blame. If you look at the situation commercial banks are in, they are forced to become development banks. You didn’t give them 20-30-year money, but forced them to lend development funding on a short-term basis. I think the crisis is for everybody, and everyone should share the blame and go back to the real economy.

Basu: All calculations say that we should multiply five times by 2028, we should have a $5-7 trillion economy and I don’t see why it can’t happen with a one-billion-plus population. But we are facing structural issues, which need to be addressed. While we are not staring at a crisis (because the potential which is inherent in the economy is so vast), we cannot say that global issues like trade don’t affect us. The banking sector is also impacted globally, but not to a large extent. The regulator needs to find the right balance. To be fair, the regulator appears to be more conservative than in the past, and that is because the economy is in a situation that it has never confronted before. We cannot blindly borrow norms from the West. On the other hand, the capital ratios have traditionally been higher than what it was overseas. Our credit-deposit ratio has been much lower at 70-75%, whereas other economies of our size have 110-125% ratio. And this makes India much safer. Even the kind of risks that regulators have to address in India are different. Some of it might be more intense than other countries, some of it can be much more relaxed. Financial institutions will remain, As will the public sector, given the state of the country and the inequalities. But this digital thing will be a major differentiator. In terms of risk mitigation, there are endless possibilities that are available. When CIBIL makes a presentation to us, the kind of data they have and which can be used to mitigate corporate risk, is huge. But banks will have to find a balance—it cannot all be retail lending.

Mundra: But that brings a larger risk issue, which is an entirely different debate—the way roles are now commingling. Insurers are lending, asset managers are lending, banks are doing distribution. The question that should be debated now is: Should regulations be entity-based or activity-based?
Former RBI governor Raghuram Rajan said that one of the outcomes of the global quantitative easing was a surge of liquidity in the system, which led to misallocation of capital, mis-pricing of assets and distorted investment decisions. Do you see distorted investments?

Nayar: In India, I don’t think so. Of course, the markets are a little overvalued, and somebody might say undervalued, but I don’t think there is any distorted lending happening. There isn’t that much of capital around. The US has real capital and real deals.

Basu: If you want to do project finance in India, there are certain structural issues, which lead to problems. So, one has to be selective. In roads, the centre has come up with new models, but even in these we see weaknesses, such as the hybrid annuity model. We need employment, which can only come from SMEs. We do whatever government-directed lending we are mandated to do. But there are companies which are not mandated to do so. These are between ₹10-100 crore entities and employ 50-100 people. Here, banks are not taking the kind of risk they should be taking, perhaps because of the systemic problems. The ecosystem has to improve. The banks have to look at risk a lot closer than what they did five years ago.

Mundra: One thing is clear: A few things coincided. Fiscal stimulus at the time, introduction of public-private partnership model, infra becoming a new sector, all these things conspired to happen at the same time. Bankers have learnt a strong lesson. Lending on faith, belief and assumption has always been a part of banking. But they have realized today you can’t do any lending based on any of these. And then, it is important to bring in the policy environment, because it is not only careless bankers or rogue borrowers, but a larger play which has brought us to this situation. With the bankruptcy code, the borrowing community is far more disciplined and the banking industry is more informed. If all get their act together, it will be good for the economy. Globally, the so-called shadow banking and derivative markets are very different; asset managers can leverage, use derivatives. There are many problems in that segment and regulations are yet to reach them like they have for banks. In India, this segment is not facing the problem; they are strictly regulated. In India, what is worrying are the strong interlinkages between banks, asset management companies and finance firms. What concerns me more are global banking regulations designed for international banks with cross-border operations. Each country is at a different stage of political and economic progress and applying the same law to everyone is not an ideal solution. It could even be counterproductive for an emerging market like India. There is room within global regulations to apply national discretion and seek long time periods for implementing a new regulation. Take capital, for example. The kind of risk weight you give to different assets, or the kind of treatment you give to collaterals, differ from one country to another. If you normalize every-thing, it is quite possible that you may find Indian banks quite overcapitalized compared to its counterparts. There is a need to have a relook at international regulatory norms.
Disruptions seem to be the new normal. After 2008, we had the taper tantrum, Silent Spring, Grexit, Brexit, the Portugal, Italy, Greece, Spain (PIGS ) crisis, the Chinese devaluation, and then Kim Jong Un. Every time there’s a bit of a kerfuffle the markets tank, and the ripple effects spread far and wide. What kind of regulatory structures will help stabilize something like this?

Basu: A lot of regulations have come in, both globally and in India. There are two broad aspects. If you want financial institutions to be resilient, you need both capital resilience and liquidity. So, liquidity coverage ratios, BIS guidelines and Basel-III guidelines have kicked in across the globe and they are valid for us. India, in any case, was a little more prudent than other countries. Even globally, we will not see a liquidity problem, if some crisis emerges today. Capital ratios are 3-7 times the leverage that’s being taken. But just a warning: In the 1929 crisis, the capital ratios were fairly good and it did not help. So, by itself, capital and liquidity will not help. But in the Indian context, right after the crisis, we managed it well. From 2007-10 we did not see Indian banks face any issue. But there are many peculiarities in the Indian economy and its banking system. For example, because of the absence of term lending institutions in the system, commercial banks had to take up the slack. Thereafter, because of how the economy has played out since then, a lot of it has turned sour. Not just banks, but the economy has also been affected. The regulator has taken steps to ensure that stress is revealed. We are at the end of the cycle, where, whether banks want it or not, the stress is out. How it will play out from now, will depend on banks’ financing, and how the economy grows. But the impact is different in every country. Argentina is in a huge crisis again, today, even though everybody thought they were past it after their 1999 crisis. Turkey was supposed to be in a growth phase, but see where it is today. In spite of all the regulations, you can have surprises anywhere in the world, and we need to guard against that.

Mody: Given what has been said about banks having the necessary ratios, etc., we see very little lending on the ground. Put that down to fear factor, paralysis factor, risk factor. And this has adversely affected the SMEs, who are in a sense the engine of the economy. You could have reasonably healthy balance sheets after the clean-up is done, but I am not sure that lending will continue. While we claim the macros will look good, there are so many external issues that affect us—our balance of payments, the oil prices, the sliding rupee. I’m not sure prudent regulation is always a good thing. How is it dripping down into letting the economy kick-start? I see very little enthusiasm in banking.

Mundra: The most prominent risk in the global economy over the past few years is event risk, not market risk or credit risk or operational risk. I don’t think there is any mechanism, which can insulate nations from event risks. My suspicion is they will keep happening with regular frequency. And, as past governors have famously mentioned, it is impossible to control a crisis. What is important is when the bubble bursts, how fast do you clean up. Let’s first understand what’s going on at the global level. Post crisis, global trade has grown at 2%, whereas world GDP has grown at 3%. It means trade finance growth is lagging behind GDP, which never happened earlier. It has always outpaced GDP growth. We have gone back to basics, regional protectionism is already happening. Hence, investment activity at the firm-level has dampened. More interestingly, if you look at total international capital flows, there is no reduction in FDI at the global level; it has slightly increased. Also, there is no reduction in investment in the stock and bond markets. Only thing that has reduced is the international flow of bank capital and bank lending. So, only banks have been strictly regulated, while other sectors remain as they were. Since banks are no more in their business, these events will happen, we cannot wish them away. Compared to 2013, we are better prepared now, our forex reserves are much higher. But you can’t remain insulated from global developments, nor can you prevent them. You have to prepare to deal with them as they happen.

Nayar: Banks overseas are very well governed and restructured, the real economies have picked up in the West. One risk developing is that in the search for higher yields, a lot of alternative lenders and high-yield funds have given very cheap and high-risk credit for acquisitions. That is one bubble. However, the Western economies have many checks and balances and the market is a true corrector. Closer home, we don’t need more regulations. Today, banks under prompt corrective action (PCA) are unable to give ₹5 crore more to a well-meaning company, growing at 10-15% organically. They don’t even give you a no-objection certificate for a pari passu charge to a non-PCA bank, or a functioning NBFC that can give extra credit. We escaped the 2008 crisis with a massive consumption stimulus. We all know what happened after that. We built overcapacity and over-leverage, and unwinding is happening. We really need to capitalize on the next 3-4 years, but for three decades we haven’t done any real economic reform. I think IBC is perhaps the most significant one. Real economic reforms are those which will de-bottleneck India’s supply side. When demand picks up, inflation picks up, rates go up. We need the private sector to come back with a fairly high degree of confidence, and banks and capital markets to play their role. Though we’ve been saying capital markets are robust, we’re not actually creating new assets. We’re just refinancing. Real asset creation has got to be the main agenda. Then we are the least vulnerable because we’ve got a massive domestic economy and, thanks to our regulators, we do nothing in an extreme way. So, although we are less vulnerable, we’ll become vulnerable if we depend on every marginal dollar to support our stock market or rupee. We should use our local savings pool, go into long duration, and real assets.

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Banking regulation in India: overview

Published In:Practical Law [ ]

Legislation and regulatory authorities

Legislation

1.      What is the legal framework for banking regulation?

Banking business and related financial services are governed primarily by the Banking Regulation Act, 1949 (“Banking Regulation Act”).

The Reserve Bank of India Act, 1934 (“RBI Act”) empowers the Reserve Bank of India (RBI) to issue rules, regulations, directions and guidelines on a wide range of issues relating to banking and the financial sector. The RBI is the central bank of India, and the primary regulatory authority for banking.

Cross-border transactions and related activities are governed by the Foreign Exchange Management Act, 1999. This provides for, among other things, certain banking and other institutions to be licensed as authorized dealers in foreign exchange.

Regulatory authorities

2.      What are the regulatory authorities for banking regulation in your jurisdiction? What is the role of the central bank in banking regulation?

Lead bank regulators

The primary banking regulator in India is the Reserve Bank of India (RBI). The RBI has wide-ranging powers to regulate the financial sector. These include prescribing norms for setting up and licensing banks (including branches of foreign banks in India), corporate governance, prudential norms and conditions for structuring products and services.

Its other functions include, among other things:

·         Setting monetary policy.

·         Regulation of money, foreign exchange, government securities markets and financial derivatives.

·         Debt and cash management for the government.

·         Oversight of payment and settlement systems.

·         Currency management.

Other authorities

India has several other financial sector regulators, including the:

·         Securities Exchange Board of India (“SEBI”), which is the regulatory authority for the securities market in India.

·         Insurance Regulatory and Development Authority of India (“IRDAI”), which regulates the insurance sector.

·         Insolvency and Bankruptcy Board of India (“IBBI”), which regulates the process relating to conducting insolvency proceedings under the Insolvency and Bankruptcy Code (“IBC”).

The RBI often liaises closely with the SEBI, IRDAI and, where required, other financial sector regulators, to regulate banking activities which interact with other financial activities.

Central bank

See above, Lead bank regulators.

Others

The central government, in particular the Ministry of Finance, also supervises and legislates on the functioning of banks and financial institutions. Acting through its Department of Financial Services, it:

·         Monitors banking operations.

·         Prescribes norms for the operation and functioning of public sector banks.

·         Examines legislative measures for recovery of bank debts, and establishes judicial mechanisms for this purpose.

Bank licences

3.      What licence(s) are required to conduct banking services and what activities do they cover?

An entity intending to carry out banking business in India must obtain a license from the RBI.

A licensed banking company can also conduct certain ancillary business such as borrowing and lending, trade finance, guarantee and indemnity business, financial leasing and hire purchase and securitization.

An entity proposing to deal in foreign exchange is also required to obtain a separate license as an authorized dealer from the RBI. This license is issued under the Foreign Exchange Management Act. Authorised dealers are granted wide-ranging powers to monitor and facilitate foreign exchange and cross-border transactions. All remittances of foreign currency from or into India are routed through such authorized dealers.

4.      What is the application process for bank licences?

Application

An application for a bank licence must be made to the RBI. The RBI on August 1, 2016, introduced Guidelines for “on-tap” Licensing of Universal Banks in the Private Sector (“On-Tap Guidelines”). This replaces the previous approach which involved a ‘Stop and Go’ licensing policy by providing a window for applicants to approach the RBI for a licence.

The application is usually prepared by the company seeking to obtain the licence.  The On-Tap Guidelines prescribe requirements such as ‘fit and proper’ criteria for the promoters of the applicants, eligibility conditions such as the bank being controlled by residents and shareholding requirements including minimum capitalisation requirements etc. For Indian incorporated entities seeking a bank licence, the initial minimum paid-up voting equity capital must be at least INR 5 billion. Thereafter, the bank must have a minimum net worth of INR 5 billion at all times.

The form of application is set out in the Banking Regulation (Companies) Rules, 1949. This prescribes different forms, depending on the nature of the applicant and whether it is a domestic or foreign company.

The application must be submitted with:

·         A copy of the company’s constitutional documents.

·         Copies of a prospectus (for a new company) and the balance sheet and profit and loss account statements for the previous 5 years (for an existing company).

The application must also include information as below in relation to the promoters or the promoter group:

·         Information on the ultimate individual promoters, including:

  •            a self-declaration by the individual promoters in a prescribed form; and
  •           detailed profiles on their individual background and experience, expertise, and business track record.

·         Information on entities in the promoter group, including:

  •               names and details of the promoter group entities;
  •             shareholding structure of the entities;
  •            a pictorial diagram indicating the corporate structure of the entities  and the shareholdings and total assets; and
  •             annual reports of the past 5 years of all the group entities.

·         Information on the promoting/converting entity, including:

  •            a declaration by the promoting/converting entity in a prescribed form;
  •          its shareholding pattern;
  •         constitutional documents and financial statements for the previous 5 years (including important financial indicators);
  •          board composition and representation of the directors over a period of 10 years;
  •            income tax returns for last 3 years; and
  •          Chartered accountant’s certificate indicating the source of funds for the promoting/converting entity.

·         Information about the persons/entities who will subscribe to 5% or more of the paid-up equity capital of the proposed bank, including foreign equity participation and the sources of capital of the proposed investors.

·         The proposed promoter shareholding, and plan for dilution of the shareholding.

·         Proposed management of the bank.

In addition, the applicant must provide a project report covering:

·         Business potential and viability of the proposed bank.

·         Any other financial services proposed to be offered.

·         Plan for compliance with prudential norms.

·         How the bank proposes to achieve financial inclusion.

·         In the case of a non-banking financial company as the applicant, how the existing lending business will fold into the bank or be disposed of.

The RBI can call for other additional information, if required.

Requirements

The RBI’s decision to grant a licence is based on several factors, including whether:

·         The company is or will be able to pay its present or future depositors in full as their claims accrue.

·         The promoters / promoter groups are ‘`fit and proper’ in order to be eligible to promote banks.

·         The company complies with the conditions specified in the On-Tap Guidelines.

·         The company’s affairs are not being, or are not likely to be, conducted in a manner detrimental to the interests of its present or future depositors.

·         The general character of the proposed management will not be prejudicial to the public interest or its depositors.

·         The company has adequate capital structure and earning prospects.

·         The public interest will be served by granting the licence.

·         In relation to banking facilities in the company’s proposed main area of operations, the potential expansion of banks already in the area and other relevant factors, granting the licence is not prejudicial to the operation and consolidation of the banking system, and is consistent with monetary stability and economic growth.

The RBI can also consider any other condition which, in the RBI’s opinion, is necessary to ensure that the company carrying on banking business will not prejudice the public interest or the interests of the depositors.  The RBI’s decision to grant a licence is discretionary and based on its assessment of the above conditions.

At the first stage, the applications are screened by the RBI to assess the eligibility of the applicants vis-à-vis the criteria laid down in the On-Tap Guidelines. RBI may apply additional criteria to determine the suitability of applications and thereafter, the applications will be referred to a Standing External Advisory Committee (SEAC) to be set up by RBI.

The SEAC will meet periodically, as and when required. SEAC has the right to call for more information as well as to have discussions with any applicant/s and seek clarification on any issue as may be required by it and subsequently, submit its recommendations to RBI for consideration.

The Internal Screening Committee (ISC), consisting of the Governor and the Deputy Governors of RBI examine all the applications. The ISC also deliberates on the rationale of the recommendations made by SEAC and then submits its recommendations to the Committee of the Central Board (CCB) of RBI for the final decision to issue in-principle approval.

Foreign applicants

In addition to the general conditions, in case of foreign entities the RBI must be satisfied that both:

·         The government or law of the country in which the foreign bank is incorporated does not discriminate against banking companies registered in India.

·         The banking company complies with the provisions of the Banking Regulation Act that apply to banking companies incorporated outside India.

Timing and basis of decision

While there is no specific time-line prescribed for the RBI to issue a decision, typically the process can take about 18 months or longer. This also depends on discussions with the RBI, clarifications and information sought by the RBI, and how quickly these issues are resolved.

The validity of the in-principle approval issued by RBI will be 18 months from the date of granting in-principle approval and would thereafter lapse automatically. Therefore, the applicant bank will have to obtain the banking licence within a period of 18 months of granting of the in-principle approval.

An applicant who has not been found suitable for issue of licence will be advised of RBI’s decision. Such applicants will not be eligible to make an application for a banking licence for a period of 3 years from the date of that decision

Cost and duration

Apart from the prudential norms of maintaining capital and liquidity reserves there are no specific ongoing costs associated with a bank licence. In the authors’ experience, bank licences issued by the RBI are not usually subject to an expiry date. There is no licence fee while submitting the form to apply for a banking licence.

5.      Can banks headquartered in other jurisdictions operate in your jurisdiction on the basis of their home state banking licence?

Foreign banks must obtain a banking licence in India before carrying on banking business in India, regardless of whether they are licensed to carry on such activities in their home state.

Forms of banks

6.      What forms of bank operate in your jurisdiction, and how are they generally regulated? Does the regulatory regime distinguish between different forms of banks?

State-owned banks

The largest state-owned bank in India is the State Bank of India (SBI), which is established under and governed by a special statute, the State Bank of India Act, 1955. Over the years, SBI has acquired several other state owned banks, which are governed by the State Bank of India (Subsidiary Banks) Act, 1959. Additionally, between 1969 and 1980, the government nationalised several banks by legislative mandate.

Universal banks, commercial and retail banks

Universal banks are full service banks offering a wide range of financial products. These can be categorised into domestic private sector banks (not state-owned), public sector banks (state-owned) and foreign banks. The licensing and operation of these banks is governed by the Banking Regulation Act and the guidelines issued under it.

Investment banks

Investment advisory services and related services are governed by the Securities Exchange Board of India (SEBI). Such activities are undertaken by entities which are licensed by and registered with the SEBI. The licensing and regulatory regime for such entities depends largely on the activities they undertake.

Private banks

Private banks can be domestic entities or foreign banks operating through a branch in India. The licensing and operation of these banks is governed by the Banking Regulation Act and the guidelines issued under it.

Other banks

The Indian banking sector has introduced certain special types of banks to support banking activities in underdeveloped and non-urban sectors. For instance, co-operative banks cater for the rural sector and small borrowers. They are organised on a co-operative basis, and governed by co-operative laws introduced by the state governments of India and the central banking laws. Similarly, regional rural banks are incorporated under the Regional Rural Banks Act, 1976 to develop the rural economy.

The RBI has also introduced the following categories of banks to promote financial inclusion and support small businesses, the unorganised sector, low income households, farmers and migrant workers:

·         Payment banks vide the issue of guidelines for licensing of payment banks in 2014. Payments banks are governed by the Banking Regulation Act, Payments and Settlement Systems Act, 2007 and other applicable laws. Payment banks offer basic banking services such as accepting demand deposits, issuing payment instruments other than credit cards, payment and remittance services, and distribution of financial products.

·         Small finance banks offer limited services such as savings vehicles and credit.  They are subject to special operational guidelines and licensing conditions prescribed by the RBI.

Regulation of systemically important financial institutions (SIFIs)

The RBI Act also recognises non-banking financial companies (NBFCs), which are registered with the RBI. NBFCs are companies undertaking financial activities but not regulated as banks. NBFCs undertake a range of activities such as investment, hire-purchase, leasing, factoring and lending, subject to the RBI Act and RBI regulations specifically for NBFCs. Under the powers provided under the RBI Act, RBI also issues directions, guidelines, and circulars in relation to activities, operations, prudential norms and other related aspects of NBFC operations.

Organisation of banks

Legal entities

7.      What legal entities can operate as banks? What legal forms are generally used to operate as banks?

Under the Banking Regulation Act, banking business must be conducted by a company.

Corporate governance

8.      What are the legislative and non-legislative corporate governance rules for banks?

Corporate Governance for Banks

Corporate governance rules for banks in India are governed by the Companies Act 2013. If a banking company is listed, the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 also apply.

The Companies Act does not differentiate between financial and non-financial companies. SEBI Guidelines are generally from the perspective of investor protection, with an emphasis on disclosure and transparency. The RBI, as the prudential regulator of non-banking financial companies, additionally emphasises risk management and business practices, and its framework is mainly from the angle of depositor and customer protection.

Various guidelines have been issued to strengthen corporate governance, for instance relating to the fit and proper criteria for the directors of banks, separation of the post of chairman and managing director, and remuneration.

To ensure that ownership and control of banks are well diversified, guidelines on ownership and governance in private sector banks were issued by RBI in February 2005.

The importance of diversified ownership is also underlined in recent guidelines on new bank licences. These stipulate that non-operative financial holding companies (NOFHC) which set up new banks should, after an initial lock in period of 5 years, reduce their equity capital in the bank from the minimum requirement of 40% down to 15% within 12 years.

To ensure the fit and proper status of groups that set up new banks, entities/groups must have a past record of sound credentials and integrity, and be financially sound with a successful track record of 10 years.

The RBI has also issued minimum guidelines in relation to a bank’s compliance function. A bank must comply with:

·         Various statutes such as the Banking Regulation Act, RBI Act, Foreign Exchange Management Act and Prevention of Money Laundering Act.

·         Regulatory guidelines issued from time to time.

·         Standards and codes prescribed by bodies such as the Basel Committee and the Indian Banks Association.

·         Its internal policies and fair practices code.

Compliance laws, rules and standards generally cover matters such as observing proper standards of market conduct, managing conflicts of interest, treating customers fairly, and ensuring the suitability of customer advice.  Each bank must formulate a list of compliance functions. The bank’s compliance officer must assist the senior management in managing compliance risks.

Corporate Governance for NBFC(s)

Due to the significance of NBFCs in the financial system, the regulatory framework on corporate governance for NBFCs was revamped in 2014 and strengthened in terms of capital adequacy and exposure norms. In 2015, the RBI issued revised guidelines/directions on corporate governance for NBFCs with a certain deposit base or asset size. Listed NBFCs must also comply with the Listing Agreement of the Securities and Exchange Board of India (SEBI). Other NBFCs are governed by the Companies Act, 1956.

Certain NBFCs with having assets of at least INR 5 billion have been notified by the Ministry of Finance as a ‘financial institution’ under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (SARFAESI). Such NBFCs have been granted enforcement powers under the provisions of the SARFAESI, which include rights to enforce security interests outside of  court process.

9.      What are the organisational requirements for banks?

Under the Banking Regulation Act, banking business can only be conducted by a company. State-owned banks are typically incorporated under specific statutes. Private Banks are incorporated as companies and governed by the Companies Act. Their constitutional documents include the following:

·         Memorandum of association.

·         Articles of association.

·         Certificate of incorporation.

·         Certificate of commencement of business.

Foreign banks are not required to incorporate a separate company in India and can operate through a branch in India. In certain cases, RBI can require the foreign entity to set up its banking presence in India through a wholly owned subsidiary. This is usually due to the RBI’s assessment of the laws of the applicant’s home country, and a general preference for systemically important banks to have a wholly-owned-subsidiary in India and not a branch. Foreign banks will be permitted to either have branches or subsidiaries but not both. A foreign bank may operate in India through only 1 of the 3 channels viz., (i) branches (ii) a wholly-owned subsidiary (iii) a subsidiary with aggregate foreign investment up to a maximum of 74 % in a private bank.

10.  What are the rules concerning appointment of auditors and other experts?

The Banking Regulation Act requires all banks to have their balance sheet and profit and loss statements audited. The appointment/re-appointment and removal of auditors is permissible only with prior approval of RBI. Persons qualified to be auditors by law are also eligible to audit banks. Along with compliance with the Companies Act, auditors must provide additional information. For banks incorporated in India, auditors must provide the following information:

·         Whether information supplied to the auditor was satisfactory.

·         Whether transactions noticed by the auditor were within the powers of the bank.

·         Whether returns from branches were adequate for the purposes of the audit.

·         Whether the profit and loss account shows a true account of the status of the bank.

·         Any other matter the auditor considers necessary to bring to the notice of the shareholders.

Case law suggests that the auditor will be liable if, after signing the auditors’ report for an apparently sound balance sheet, it is found that the banking company is insolvent.

The RBI can, under the Banking Regulation Act, order a special audit of a banking company, if it believes that the audit is necessary in the interests of the public, the depositors, or the banking company. A special audit can relate to any class of transactions or period as specified by the RBI. The RBI can appoint an auditor, or require the bank’s auditor to produce the special audit report.

Further, as per a recent notification of the RBI an audit firm, after completing its 4 year tenure as the auditor in a particular private/ foreign bank, will not be eligible for appointment as the auditor of the same bank for a period of 6 years.

11.  What is the supervisory regime for management of banks?

In accordance with the provisions of the Banking Regulation Act, the appointment, re-appointment or termination or remuneration of a chairman, a managing or whole-time director, manager or chief executive officer and any amendment thereto requires prior approval of the RBI. Further, various guidelines have been issued on the role of the board of directors of banks and the fit and proper criteria for appointing directors of banks. Some key requirements regarding bank boards under the Banking Regulation Act are set out below:

·         Directors must have professional or other experience, and at least 51% of the board must have special knowledge or practical experience in any of the following fields: accountancy, agriculture and rural economy, banking, co-operation, economics, finance, law, small-scale industry, or any other matter which in the RBI’s opinion would be useful to the bank. Of these directors, at least 2 must have special knowledge in agriculture and rural economy, co-operation or small-scale industry.

·         A bank director must not have a substantial interest in, or be connected with (as an employee, manager or managing agent) any company or firm carrying on trade, commerce or industry which is not a small-scale industrial concern.

·         Directors of banks are not allowed to own a trading, commercial or industrial concern.

·         A director cannot hold office continuously for a period exceeding 8 years, except for the chairman or a full-time director.

·         A bank cannot have a director that is a director of another bank, unless the director is appointed by the RBI. A bank cannot have more than 3 directors who are directors of companies which are together entitled to exercise voting rights exceeding 20% of the total voting rights of the bank’s shareholders.

·         Each bank must appoint 1 director as chairman of the board. A full-time chairman is manages the bank’s affairs, subject to the superintendence, control and direction of the board.

Under the Banking Regulation Act, the RBI can remove from office any chairman, director, chief executive officer or other officer or employee of a bank, on the following grounds:

·         Public interest.

·         To prevent the bank’s affairs being conducted in a manner detrimental to the interests of the depositors.

·         To ensure proper management of the bank.

In all instances, the individual must be provided a reasonable opportunity to be heard.

If the delay caused in removing any chairman, director, chief executive officer or other officer or employee of a bank is detrimental to the bank or its depositors, the RBI can immediately remove an individual from office and provide an opportunity to make a representation. Such an order can be appealed to the central government and its decision is final. An individual removed from office cannot be involved in the affairs of another bank for a period of 5 years. The RBI also has power to appoint another individual to replace a removed individual who will hold office at the pleasure of the RBI for a period not exceeding 3 years or such further periods not exceeding 3 years as may be prescribed by RBI.

12.  Do any remuneration policies apply?

The Banking Regulation Act states that no banking company shall employ or continue the employment of any person whose remuneration or part of whose remuneration takes the form of commission or of a share in the profits of the company, or whose remuneration is, in the opinion of the RBI, excessive. Under the Banking Regulation Act, the remuneration of a chairman, a managing or whole-time director, manager or chief executive officer and any amendment thereto requires prior approval of the RBI

The RBI also published the Guidelines on Compensation of Whole Time Directors/Chief Executive Officers/Risk takers and Control function staff (Guidelines) on January 13, 2012. These apply to private and foreign banks. Compensation packages in state-owned banks are determined by the central government.

The Guidelines have adopted the Financial Stability Board Principles for Sound Compensation. These intend to reduce incentives for excessive risk taking that may arise from compensation schemes. The principles call for effective governance of compensation, alignment of compensation with prudent risk taking, effective supervisory oversight and stakeholder engagement. They have been endorsed by the G-20 countries and the Basel Committee on Banking Supervision.

The Guidelines provide that banks should formulate and adopt a comprehensive compensation policy covering all their employees. This policy must cover aspects such as fixed pay, benefits, bonuses, guaranteed pay, severance packages, stocks, pension plans and gratuities. The Guidelines call for the board to set up a remuneration committee, to oversee the framing, review and implementation of the bank’s compensation policy.

The Guidelines also provide that the board of directors of banks should constitute a ‘Remuneration Committee’ of the board of directors to oversee the framing, review and implementation of compensation policy of the bank on behalf of the board.

For full time directors and chief executive officers (CEO), the Guidelines state that banks should ensure compensation is adjusted for all types of risk. The Guidelines set out the compensation structure for full time directors/CEOs with the following components:

·         Fixed pay: reasonable fixed pay, based on factors such as industry practice.

·         Variable pay: proper balance of variable and fixed pay. Variable pay should not exceed 70% of the fixed pay in a year. Variable pay can be in cash, stock linked instruments, or both.

·         Clawback: in the event of negative contributions of the bank and/or a relevant business line in any year, deferred compensation should be subject to malus/clawback arrangements.

·         Guaranteed bonus: these are not consistent with sound risk management or pay-for-performance principles, and should not be part of a compensation plan.

The Guidelines also provide that members of staff engaged in financial and risk control should be compensated independently of the business areas they oversee, and in proportion to their key role in the bank. Additionally, the Guidelines provide that foreign banks operating in India must submit a declaration to RBI annually from their head office that their compensation structure in India complies with Financial Stability Board principles and standards.

To ensure regulatory and supervisory oversight, banks’ compensation policies are subject to review. Deficiencies in the policy have the effect of increasing the risk profile of banks, including requiring additional capital if they are very significant.

Further, the RBI also released ‘Guidelines on Compensation of Non-executive Directors of Private Sector Banks’ to address the need to bring professionalism to the boards of banks. As per the said guidelines, the board of directors of a bank, in consultation with the Remuneration Committee, are required to formulate and adopt a comprehensive compensation policy for the non-executive directors (other than part-time non-executive chairman), in accordance with the provisions of Companies Act, 2013. The board may, at its discretion, provide for payment of compensation in the form of profit related commission to the non-executive directors, subject to the bank making profits and such compensation not exceeding INR 1 million per annum for each director. In addition to the compensation, the non-executive directors will also be entitled to sitting fees and reimbursement of expenses. The banks are required to obtain approval of the RBI for remuneration of part-time non-executive chairman.

The RBI has further specified that for the purposes of the Banking Regulation Act, the following loans/advances granted to the chief executive officer / whole time directors will not be considered as ‘loans and advances’:

·         Loan for purchasing of car

·         Loan for purchasing of personal computer

·         Loan for purchasing of furniture

·         Loan for constructing/acquiring a house for personal use

·         Festival advance

·         Credit limit under credit card facility

The RBI has in relation to the above categories of loan, permitted commercial banks to grant loans and advances to the chief executive officer/ whole time directors as part of the compensation and remuneration policy of the bank, without seeking prior approval of RBI, subject to certain conditions. The guidelines on base rate will not be applicable on the interest charged on such loans. However, the interest rate charged on such loans cannot be lower than the rate charged on loans to the bank’s own employees.

13.  What are the risk management rules for banks?

The RBI has issued various guidelines on risk management policies to be adopted by banks. Risk management should include:

·         The organisational structure of the bank.

·         A comprehensive risk measurement approach.

·         Risk management policies approved by the board, consistent with broader business strategies, capital strength, management expertise and overall willingness to assume risk.

·         Guidelines and other parameters used to govern risk taking, including detailed structure of prudential limits.

·         A strong management information system for reporting, monitoring and controlling risks.

·         Well laid out procedures, effective control and a comprehensive risk reporting framework.

·         A separate risk management framework independent of operational departments, with clear delineation of responsibility for risk management.

·         Periodical review and evaluation of the risk management function.

The primary responsibility of understanding risks and ensuring that risks are appropriately managed is vested with the board. The board should set risk limits by assessing the risk-bearing capacity of the bank. At an organisational level, overall risk management should be assigned to an independent risk management committee or executive committee of senior executives reporting directly to the board.

The functions of the risk management committee are to identify, monitor and measure the risk profile of the bank. The committee should also:

·         Develop policies and procedures.

·         Verify the models used for pricing complex products.

·         Review the risk models as development takes place in the markets.

·         Identify new risks.

The RBI has also issued guidance notes on the management of credit risk and market risk. As part of effective risk management, banks are required, inter-alia, to have a system of separation of credit risk management function from the credit sanction process. As a step to bring uniformity in risk management across banks, the RBI has in 2017, advised banks to appoint a chief risk officer (CRO) and has prescribed certain  role and responsibilities of such CRO, such as:

·         Banks should have a board approved policy clearly defining the role and responsibilities of the CRO.

·         The CRO shall be a senior official in the banks’ hierarchy and shall have the necessary and adequate professional qualification/experience in the areas of risk management.

·         The CRO shall have direct reporting lines to the MD & CEO / Risk Management Committee of the Board.

·         The CRO shall not have any reporting relationship with the business verticals of the bank and shall not be given any business targets.

·         In case the CRO is associated with the credit sanction process, it shall be clearly enunciated whether the CRO’s role would be that of an adviser or a decision maker. The policy shall include the necessary safeguards to ensure the independence of the CRO.

·         There shall not be any ‘dual hatting’ i.e. the CRO shall not be given the responsibility of chief executive officer, chief operating officer, chief financial officer, chief of the internal audit function or any other function.

Liquidity and capital adequacy

Role of international standards

14.  What international standards apply? How have they been incorporated into domestic law/regulation?

The Basel III capital regulations are being implemented in India with effect from 1 April 2013. Banks must comply with the regulatory limits and minima prescribed under Basel III capital regulations.

To ensure a smooth transition to Basel III, appropriate transitional arrangements have been provided for meeting the minimum Basel III capital ratios and adjustments to the capital components. Basel III capital regulations will be fully implemented by 31 March 2019. The phasing out of non-Basel III compliant regulatory capital instruments began from 1 January 2013.

The RBI also continues to monitor and review the Indian framework of Basel III capital regulations and releases periodical circulars/notifications aligning the Indian framework with Basel committee rules and reports wherever there are discrepancies. As an example, the RBI has issued notifications modifying the treatment of certain balance sheet items under the Indian regulations on Basel III to align the same with what has been prescribed by the Basel Committee on Banking Supervision.

Further, while the RBI has previously released guidelines on maintenance and computation of liquidity ratio, the RBI has recently issued guidelines on Net Stable Funding Ratio (NSFR) which are based on final rules on NSFR published by the Basel Committee. The NSFR should be equal to at least 100% on an ongoing basis. However, the NSFR would be supplemented by supervisory assessment of the stable funding and liquidity risk profile of a bank. On the basis of such assessment, RBI may require an individual bank to adopt more stringent standards. The requirement to maintain 100% NSFR would be binding on banks with effect from a date which will be communicated by the RBI in due course.

Main liquidity/capital adequacy requirements

15.  What liquidity requirements apply?

The cash reserve ratio (CRR) is the average daily balance that a bank must maintain with RBI, as a share of its net demand and time liabilities deposits (NDTL). The RBI has issued guidelines to determine the calculation of NDTL. Currently, banks must maintain a CRR of 4%.

The statutory liquidity ratio (SLR) is the share of NDTL that banks must maintain in safe and liquid assets, such as unencumbered government securities, cash and gold. Currently, banks must maintain an SLR of 19.5%. As mentioned in the response to Question 15, from a date to be notified by the RBI, the banks must maintain NSFR (i.e. ratio of available stable funding to required stable funding) of 100%.

16.  Is a leverage ratio applicable?

Yes. Currently, the Indian banking system is operating at a leverage ratio of more than 4.5%. However, under the Basel III framework, the minimum leverage ratio is 3% and will be set in line with the final rules prescribed by the Basel Committee. The Basel committee intends to migrate to a pillar 1 (minimum capital requirements) approach in 2018. In the meantime, the RBI will monitor individual banks against an indicative leverage ratio of more than 4.5%.

Banks in India have been required to disclose the leverage ratio and its components from 1 April 2015 on a quarterly basis, according to prescribed disclosure templates, along with detailed calculations of capital and exposure measures.

As the leverage ratio is an important supplementary measure to the risk-based capital requirements, the same disclosure requirement also applies to the leverage ratio. Therefore banks, at minimum, must disclose Tier 1 capital, exposure measure and leverage ratio on a quarterly basis, irrespective of whether their financial statements are audited.

17.  What is the capital adequacy framework that applies for banks?

The capital adequacy ratio is the ratio of capital funds (including tier I capital and tier II capital) to risk weighted assets.

The RBI prescribes the:

·         Risk weights for balance sheet assets, non-funded items and other off-balance sheet exposures.

·         Minimum capital funds to be maintained as a ratio to total risk weighted assets and other exposures.

·         Capital requirements in the trading book.

Banks must maintain a minimum capital adequacy ratio of 9%. Wholly owned subsidiaries of foreign banks must maintain a minimum capital adequacy ratio of 10%, continuously for an initial period of 3 years from the start of its operations (that is, 1% higher than that required under the phased implementation of Basel III).

Consolidated supervision

Role and requirements

18.  What is the role of consolidated supervision of a bank in your jurisdiction and what are the requirements?

Role

Consolidated supervision consists of an overall evaluation of the strength of a group with a large bank. The objective is to assess the potential impact of other group companies on the bank. All risks run by the banking group are taken into account, independent of where they are booked.

A major element is financial statements prepared on a consolidated basis, combining the assets and liabilities and off-balance sheet items of banks and their related entities, as if they were a single entity. Supervisors can then measure the financial risks faced by bank groups and apply supervisory standards on a group basis, such as large exposure and connected exposure limits and minimum capital adequacy ratios.

Requirements

The RBI has issued guidelines for consolidated supervision. The supervisory framework consists of:

·         Consolidated financial statements.

·         Consolidated prudential returns.

·         Consolidated supervision by application of prudential regulations like capital adequacy, large exposures and liquidity gaps on a group basis.

Consolidated financial statements are public documents prepared and published annually, in addition to solo annual reports of financial institutions and their subsidiaries, and submitted to RBI.

The objective of a consolidated prudential return is to collect consolidated prudential information at group level. It aims to capture data, in the prescribed format, mainly on the:

·         Consolidated balance sheet.

·         Consolidated profit and loss account.

·         Financial/risk profile of the group.

·         Operations of subsidiaries and related entities.

The RBI has prescribed group prudential norms for capital adequacy and large exposures for financial institutions, taking into account the assets and liabilities of their subsidiaries and associates, in addition to prudential norms that may apply on a solo basis. For group prudential norms, a group is defined as a group of entities (which can include a bank) engaged in financial activities, with a financial institution as the parent. Areas have been prescribed for compliance on a group basis for capital adequacy, large exposures and liquidity mismatches.

International co-ordination and co-operation

19.  To what extent is there co-operation with other jurisdictions?

The RBI regularly enters into memoranda of understanding and agreements for co-operation with the central banks of other jurisdictions. For instance, the RBI has entered into a memorandum of understanding:

·         On Supervisory Cooperation and Exchange of Supervisory Information with the Bank of Israel.

·         With the European Central Bank for co-operation in the area of central banking.

·         On co-operation on currency swap agreements with the Central Bank of the United Arab Emirates (UAE).

·         With Bangladesh Bank for exchange of supervisory information.

·         On Supervisory Cooperation and Exchange of Supervisory Information with the National Bank of Cambodia Bank of Guyana, Bank of Thailand, the Royal Monetary Authority of Bhutan, Central Bank of Nigeria, Bank of Zambia, Nepal Rastra Bank etc.

Shareholdings/acquisition of control

Shareholdings

20.  What reporting requirements apply to the acquisition of shareholdings in banks?

The requirements on shareholdings and change of control in banks in India depend on the nature of the entity.

In a private Indian bank, the Banking Regulation Act and RBI impose shareholding limits on certain types of shareholders as follows (not applicable to urban co-operative banks, foreign banks and banks established under specific statutes).

Further, a bank cannot acquire equity shares in another bank if the acquisition leads to the acquiring bank holding 10% or more in the other bank’s equity capital. The RBI can in certain circumstances allow an entity to acquire shares in a domestic private bank in excess of the above limits. In some cases, such as new banks set up under a holding company, promoters have been provided a time limit in which they must dilute or divest their shareholding to meet the above limits.

Despite the shareholding limits, voting rights are limited to the ceiling notified by RBI under the Banking Regulation Act, which is currently 10%.

Further, an acquisition of shareholding voting rights of 5% or more of the paid-up capital of a bank or total voting rights of a bank is subject to prior approval from the RBI.

For a foreign banking company operating through a branch in India, there are no specific regulations on a change in its shareholding or acquisition, but this may be subject to a condition in its banking licence. In addition it is advisable to notify the RBI of the acquisition, particularly if it results in a change in control of the entity (when issuing the licence to the foreign entity, the RBI would have considered its promoters and major shareholders).

21.  What approval requirements apply to the acquisition of shareholdings and of control of banks?

See Question 20.

Foreign investment

22.  Are there specific restrictions on foreign shareholdings in banks?

Acquisition of shareholdings by foreign entities in an Indian bank is subject to the limits and conditions in the Foreign Direct Investment (FDI) policy issued by the government, and to any specific requirements in the relevant bank’s licence.

Under the latest FDI Policy (August 2017):

(i) foreign investment in domestic private banks from all sources is permitted up to 49% without approval, and up to 74% with government approval. At all times, at least 26% of the paid-up capital must be held by residents, except in case of a wholly owned subsidiary of a foreign bank. In case of Non-Resident Indians (NRIs), individual holdings is restricted to 5% of the total paid up capital both on repatriation and non-repatriation basis and aggregate limit cannot exceed 10% of the total paid up capital both on repatriation and non-repatriation basis. However, NRI holdings can be allowed up to 24% of the total paid up capital both on repatriation and non-repatriation basis subject to a special resolution to this effect passed by the banking company’s general body.

(ii) foreign investment in public sector banks, including the State Bank of India (subject to Banking Companies (Acquisition & Transfer of Undertakings) Acts, 1970/ 80) is 20% with government approval.

100% foreign investment is also permitted in NBFC’s under the automatic route.

Resolution

23.  What is the legal framework for liquidation of banks?

The High Court has authority to order the winding up or liquidation of a bank. Its jurisdiction is based on where the registered office of the bank is located (for a bank incorporated in India) and where the principal place of business is located (for a bank incorporated outside India).

Under the Banking Regulation Act, the following can apply to wind up a banking company:

·         The central government can direct the RBI to inspect or report on a bank. After examining the report and giving the bank an opportunity to respond, if the central government believes that the bank’s affairs are detrimental to the interests of its depositors, it will direct the RBI to apply to wind up the bank.

·         The RBI can initiate the winding up of a bank if the:

  •              bank fails to comply with its minimum capital and reserve requirements or other provisions of the Banking Regulation Act;
  •             banks’ licence is cancelled;
  •            bank is prohibited from accepting fresh deposits, under certain provisions of the Banking Regulation Act or RBI Act; or
  •             RBI believes that the bank is unable to pay its debts, or is continuing to the detriment of its depositors; or
  •               In the opinion of RBI, a compromise or arrangement sanctioned by a Court in respect of the banking company cannot be worked satisfactorily with or without modifications; or
  •            The bank itself can apply for voluntary winding up (solvent) if the RBI certifies that it is able to pay its debts in full.

Under the Banking Regulation Act, once an order for winding up a bank is passed by the High Court, a liquidator attached to the High Court is appointed to conduct the liquidation. The RBI can also apply to the High Court to be appointed as the liquidator.

The Insolvency and Bankruptcy Code (‘IBC’) was passed by the Indian parliament in 2016 to deal with cases of corporate entities (other than financial service providers). The government is in the process of drafting and introducing a separate bankruptcy law to deal with insolvency in financial sector companies which includes banks and NBFCs.

24.  What is the resolution regime for banks?

Currently there are no statutory provisions for bank resolution. However under the Banking Regulation Act, a bank that is unable to temporarily pay its debts can apply to the High Court for a moratorium to stay continuance or commencement of proceedings against it. The High Court can grant this moratorium for up to 6 months.

The application must be supported by a report from the RBI indicating that if the moratorium is granted, the bank will be able to pay its debts. The High Court can grant such relief even without a report from the RBI, but the report will be called for and the order for relief may be modified.  The High Court can also appoint a special officer to take control of the bank’s assets and books in the interest of its depositors. If the RBI applies to the High Court to wind up the bank, the High Court will not extend the moratorium period.

The Financial Resolution and Deposit Insurance Bill, 2017 has been introduced in the Lok Sabha and provides for the resolution of financial firms, including banks. It proposes to, among others:

·         Provide speedy and efficient resolution of financial firms in distress.

·         Establish a resolution corporation.

·         Provide deposit insurance for consumers of certain categories of financial services.

·         Provide for the liquidation and winding up of financial firms as per the provisions of the IBC.

Regulatory developments and recent trends

25.  What are the regulatory developments and recent trends in bank regulation?

As mentioned in our response to Question 23, the IBC was notified in 2016, replacing the entire gamut of corporate insolvency laws in India by introducing a single comprehensive law that empowers all creditors (whether secured, unsecured, domestic, international, financial or operational) to trigger resolution processes. The IBC distinguishes between two main categories of creditors; financial creditors and operational creditors. A financial creditor is a person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred. An operational creditor is any person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.

Prior to the introduction of IBC, RBI had issued various instructions/ schemes (such as Framework for Revitalizing Distressed Assets, Corporate Debt Restructuring Scheme, Strategic Debt Restructuring Scheme, Formation of Joint Lenders Forum and Scheme for Sustainable Structuring of Stressed Assets (S4A)) aimed at resolution of stressed assets in the Indian economy. However, in view of the enactment of IBC, RBI has withdrawn the said schemes and substituted the existing guidelines with a harmonized and simplified framework for resolution of stressed assets. Key features of the said framework are as set out below:

·         Early identification and reporting of stress: Lenders are required to identify incipient stress in loan accounts, immediately on default, by classifying stressed assets as ‘special mention accounts’ in the categories specified by RBI.

·         Implementation of Resolution Plan: All lenders are required to have board approved policies for resolution of stressed assets including the timelines for resolution and upon default in the borrower entity’s account with any lender all lenders should initiate steps to cure the default. The resolution plan (RP) may involve actions including sale of the exposures to other entities, change in ownership, or restructuring.

·         ‘Large Accounts’ under IBC: For accounts with aggregate exposure of lenders at INR 20 billion and above, on or after March 1, 2018, the RP shall be implemented in accordance with the timelines specified by RBI and if a RP in respect of large accounts is not implemented as per such timelines, lenders are required to initiate insolvency under IBC.

Separately, recently, the Union Cabinet has approved the proposal for establishment of National Financial Reporting Authority (NFRA), which is an independent regulator for the auditors (aimed to be established under the Companies Act, 2013). This will help strengthen the auditing process of banks and financial institutions as well.

Recently, the Union Cabinet has also approved the proposal of the Ministry of Finance to introduce the Fugitive Economic Offenders Bill, 2018 in Parliament. The said bill lays down measures to deter economic offenders from evading the process of Indian law by remaining outside the jurisdiction of Indian courts. The bill deals with cases where the total value involved in such offences is INR 1 billon or more and is aimed at curbing the instances of economic offenders fleeing the jurisdiction of Indian courts, anticipating the commencement, or during the pendency of proceedings.

 

Authors

1. Bahram N Vakil, Partner
2. Suharsh Sinha, Partner

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