[The following post is contributed by Nidhi Ladha and Vinita Nair of Vinod Kothari & Co. They can be contacted at firstname.lastname@example.org and email@example.com respectively.
This is a continuation of a previous post accessible here]
The present Guidelines
From June 27, 2013 onwards, any issue of debentures- whether convertible or non convertible, by NBFCs – whether public or private, listed or unlisted, on preferential basis or on privately placed basis, shall be governed by the Guidelines and provisions of the Guidelines shall have an overriding effect on provisions of other laws, if found contradictory with each other.
Issuance of Non-Convertible Debentures (Reserve Bank) Directions, 2010
These Directions will be applicable to Non-Convertible Debenture (NCD) issued by a corporate (including NBFCs) with original or initial maturity up to one year and issued by way of private placement.
Compliance needed under the Guidelines:
1) Offer Document:
a. Should be issued within maximum period of 6 months from the date of the Board Resolution authorizing the issue.
b. Should include the names and designations of the authorized officials and must contain information on purpose for which resources are being raised.
c. "For Private Circulation Only" should be printed or typed on the same.
d. General information with respect to the issue should be clearly mentioned.
2) Debentures shall be issued by NBFCs only for deployment of funds on its own balance sheet and not to facilitate resource requests of group entities/ parent company / associates.
3) Private placement shall be done only to 49 investors identified upfront by NBFCs.
4) Minimum subscription amount for a single investor shall be Rs. 25 lakh and in multiples of Rs.10 lakh thereafter.
5) Minimum time gap of at least six months between two private placements was envisaged by the Guidelines. However, the Clarification has made this clear that this condition is to be complied with as and when so notified by the RBI.
6) Issue of Secured Debentures: NBFCs to issue only fully secured debentures. If, at the stage of issue, in case of insufficient security cover, the same needs to be created within one month from the date of issue and till then the issue proceeds shall be placed under escrow.
Clarification issued by RBI to curb the damaging effect of the Guidelines:
The Guidelines seems to have startled the NBFCs. This is evident from the quantum of queries and clarifications raised by the industry resulting in issue of the Clarifications by RBI within 5 days of issue of Guidelines.
1. Definition of “Preferential Allotment or Private Placement”
1.1 Position subsequent to issue of Guidelines - Guidelines encompassed an issue of capital by an NBFC pursuant to Section 81 (1A) of the Companies Act, 1956
1.2 Position subsequent to issue of Clarifications - The Clarification suitably restricted the meaning of private placement to non-public offering of NCDs by NBFCs made to such number of select subscribers and such subscription amounts as may be specified by the RBI from time to time
2. Minimum time gap between two successive issuances:
2.1 Position subsequent to issue of Guidelines - Atleast 6 months between two private placements.
2.2 Position subsequent to issue of Clarifications - The instruction need not be operationalized immediately. RBI would decide upon the minimum time gap in due course.
3. Applicability of the Guidelines:
3.1 Position subsequent to issue of Guidelines - All NBFCs (including Primary Dealers).
3.2 Position subsequent to issue of Clarifications - All NBFCs (excluding Primary Dealers)
4. Permissible Purpose of Issue of Debentures by NBFCs:
4.1 Position subsequent to issue of Guidelines - For deployment of funds on its own balance sheet and not to facilitate resource requests of group entities/ parent company / associates.
4.2 Position subsequent to issue of Clarifications - The restriction is not applicable to Core Investment Companies. (CICs)
5. Applicability of Security Cover requirement:
5.1 Position subsequent to issue of Guidelines - To all debentures issued, including Short Term NCDs.
5.2 Position subsequent to issue of Clarifications - The condition shall not apply to subordinated debt, as pursuant to definition subordinated debt is an unsecured instrument.
The Guidelines were initially applicable to private placement defined as an issue of capital made by an NBFC in pursuance of a resolution passed under sub-section (1A) of section 81 of the Companies Act, 1956. Now, only convertible debentures issued by an NBFC will be requiring approval under Section 81(1A) and definitely not NCDs. So the Guidelines were originally not applicable to NCDs at all. However, in the Clarification, RBI simply amended the definition to now include non-public offering of NCDs by NBFCs to such number of select subscribers and such subscription amounts, as may be specified by the Reserve Bank from time to time. The excluded instrument of the Guideline became the main crux of the Clarification. Further, The requirement of maintenance of security cover at all points of time was initially applicable to all debentures issued, including short term NCDs. However, realizing that subordinated debt are primarily unsecured instrument, later excluded the same in the Clarifications. NBFCs intending to issue unsecured instrument will now begin exploiting this instrument, as subordinated debt are excluded from the definition of Public Deposits.
Amendment to the NBFC Public Deposit Directions:
Prior to the amendment, in terms of Para 2(xii)(f) of the Directions, any amount raised by the issue of bonds or debentures secured by the mortgage of any immovable property of the company; or by any other asset or with an option to convert them into shares in the company were excluded from the definition of public deposits provided that the amount of such bonds or debentures did not exceed the market value of security. Further, para 2(xii)(i) of the Directions excludes any amount received as hybrid debt or subordinated debt with minimum maturity period of sixty months.
RBI by this Notification has suitably amended the Directions thereby clarifying that only Debentures that are compulsorily convertible into equity or fully secured would be exempted from the definition of public deposits. Further, it has been clarified that hybrid debt or subordinated debt would be excluded if such instruments have been issued with no recall option within the tenure of the instrument.
For ease of reference, below we reproduce the changes notified by the RBI in the definition of ‘Public Deposit’:
1. Availability of Exemption to Debentures:
1.1 Position prior to amendment - Exemption was to debentures issued with an option to convert them into shares of the company.
1.2 Position post amendment - Debentures compulsorily convertible into equity are excluded
2. Availability of Exemption to hybrid debt or subordinated debt:
2.1 Position prior to amendment - Exemption was available to hybrid debt or subordinated debt with minimum maturity period of sixty months.
2.2 Position post amendment - Hybrid debt or subordinated debt with minimum maturity period of sixty months will be excluded provided no recall option
Taking away the exemption earlier available to Optionally Convertible Debentures (OCDs) , is a very serious amendment. NBFCs-ND will now require to mandatorily issue Compulsorily Convertible Debentures (CCDs), as issuance of OCDs will qualify as Public Deposits.
Effect on existing issues of debentures of NBFCs:
The Guidelines were applicable to Private Placement by NBFCs by any issue of shares and/or debentures, as the Guidelines defined the term ‘private placement’ as issue of capital under section 81(1)(A) of the Companies Act, having an overriding effect on provisions of other laws, if found contradictory with each other. However, pursuant to the Clarification, the Guidelines will apply only to non-public offering of Non Convertible Debentures (NCDs) by NBFCs (excluding Primary Dealers). Further, there being no clarity on applicability of Guidelines on the existing issues of debentures, the author’s view is that all NCDs issued after the date of notification will necessarily have to comply with the Guidelines. Therefore, there is no need to create security over existing unsecured debentures in terms of the Guidelines issued by the NBFCs so far. The Guidelines have come into effect with effect from the notification date i.e. from June 27, 2013.
Applicability of Guidelines to NBFC-CIC:
Core Investment Companies (CICs) are the class of NBFCs which does not require registration with RBI if they fulfill the prescribed conditions. Such companies are NBFCs but not registered. Applicability of the Guidelines to such Companies is not clear in the notification issued by RBI. However, the Guidelines have defined ‘NBFC’ as an NBFC defined in the RBI Act. It is pertinent to note that the Guidelines do not use the phrases ‘registered as NBFC with the RBI’. Therefore, in author’s view, debentures issued by CICs shall also be governed by the Guidelines. However, in view of the Clarification, the restriction pertaining to issue of debentures for deployment of funds on its own balance sheet shall not apply to CICs.
Status of Housing Finance Companies (“HFCs”):
The Guidelines are applicable to NBFCs as defined in Section 45 I (f) read with Section 45 I (c) of the RBI Act, 1934. Therefore, the Guidelines will not be applicable to the HFCs which are registered with NHB.
The Guidelines have been issued by RBI with an intent to curb the practice of NBFCs of raising resources from the retail public on a large scale, through private placement, especially by issue of debentures and to ensure proper resource planning to be undertaken by NBFCs. Despite being excluded from the limit of 49 investors under the Companies Act, NBFCs will not be able to privately place their NCDs with more than 49 investors as per the Guidelines. The stringent condition requiring sufficient security cover even for privately placed debentures, including NCDs, will surely affect the NBFCs who primarily raise money by issue of debentures. However, RBI seems determined to correct the faulty resource planning of NBFCs and may come up with a circular specifying the minimum time gap between two private placements too in near future.