Over the years, the Reserve Bank of India (RBI) has significantly tightened the regime relating to “wilful defaulters” who are declared as such through a process stipulated by the RBI. Upon such a declaration, the regulatory regime of the RBI effectively stifles the ability of a wilful defaulter from raising further bank financing.
However, realisation seems to have dawned more lately on the fact that there is some incongruity between the RBI’s prescription on wilful defaulters and the ability of such defaulters to raise financing from the equity capital markets through norms prescribed by the Securities and Exchange Board of India (SEBI). Under the current SEBI regulations, wilful defaulters are only prohibited from raising finances through the issue of convertible securities, and nothing prevents them from accessing the capital markets through the issue of equity shares or non-convertible debt securities. This effectively undermines the RBI’s restrictions because the inability of a wilful defaulter from raising bank financing can be remedied by obtaining financing from the capital markets.
SEBI Discussion Paper
It is to plug the aforesaid incongruity that SEBI has issued a discussion paper for public consultation (with comments due by January 23, 2015). SEBI’s recommendation is to prohibit issuers that have been categorised as wilful defaulters from issuing any kind of securities, whether equity, convertibles, or debt securities. In the case of convertibles and debt securities, the prohibition will apply whenever there is a default in payment of interest or repayment of principal in respect of such securities. However, issuers who are treated as wilful defaulters will be able to make a rights issue or a private placement to qualified institutional buyers (QIBs) so long as to the offer document contains appropriate disclosures. This is perhaps an indication of the fact that QIBs are better placed to absorb the risk as they have the requisite sophistication, unlike retain investors who need greater regulatory protection.
Wilful defaulters also face prohibitions in the takeover markets, whereby they are prevented from acquiring control over other listed companies. An exception has been made, however, whereby a wilful defaulter may make a counter offer in case of a hostile bid (thereby effectively providing it with the ability to defend itself).
The primary purpose of SEBI’s proposed amendments is to bridge the gap between its regime and that of the RBI so that there can be no circumvention of the effect of declaration as a wilful defaulter. These amendments also do not turn off the tap completely for issuer companies as issue of securities to QIBs is permitted, and so is defending against a hostile takeover. To that extent, this regulatory prescription seems to be carefully balanced taking into account the interests of the wilful defaulters and its financiers.
Any prescription is likely to be tricky and needs to take into account the strains between different interest groups. Over-broad measures against wilful defaulters would protect the lenders as well as prospective investors, but would adversely affect the interests of the current shareholders (particularly in the case of listed companies) as the inability of the company to raise further finances would guarantee its downfall. Hence, some measures to keep the company afloat must be permitted. The wilful defaulter tag on companies (as opposed to wrongdoers such as promoters or officers) may have the effect of unwittingly affecting the interests of external stakeholders such as public shareholders, employees and customers.
Finally, a lot depends on the robustness of declaring companies as wilful defaulters. Given the extensive ramifications such a categorisation may have on companies and their stakeholders, such a process must be beyond doubt and challenge.