RBI Guidelines on Private Placement of Debentures by NBFCs – Part 2

[The following post is contributed by
Nidhi Ladha and Vinita Nair of Vinod Kothari & Co. They can be contacted at
[email protected] and [email protected] respectively.
This
is a continuation of a previous post accessible here]

RBI Directions

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[1]
subordinated debt is an unsecured instrument.

Our
Analysis:

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

Our
Analysis:

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.

 

Conclusion

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.
(concluded)

– Nidhi Ladha & Vinita Nair



[1]
Provided in paragraph 2(1)(xvii) of the Non-Banking Financial (Non-Deposit
Accepting or Holding Companies Prudential Norms (Reserve Bank) Directions, 2007

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

3 comments

  • I would beg to differ on the fact that the June 27th RBI circular, ("Circular"), (read with the July 2nd clarification) does not apply to a Housing finance company registered with the NHB. Housing finance companies, stock-broking companies, insurance companies or other companies which are “financial institutions” would all be viewed a “non-banking financial company” as defined in the Circular, irrespective of whether such companies are exempted from registering with the RBI as an NBFC. The Circular refers to Section 45 I (f) read with Section 45 I (c) of the RBI Act, 1934 for the definition of a “Non-Banking Financial Company”. Section 45 I (f) of the RBI Act, 1934 inter-alia defines a “non banking financial company” as a financial institution which is a company. The Master Circular on Exemptions from the Provisions of RBI Act, 1934 dated July 2, 2013 only provides clarity that companies which are financial institutions and are regulated by regulators other than RBI need not register with RBI as NBFCs and need not comply with certain provisions of the RBI Act, 1934, and other specified directions circulars and notifications issued by RBI. The aforesaid Master Circular however does not anywhere state that such entities will not be considered as “non banking financial companies” as defined in Section 45I (f) of the RBI Act. Accordingly, housing finance companies, stock-broking companies, insurance companies or other companies which are “financial institutions” as defined in the RBI Act, would fall within the purview of the definition of “non banking financial companies” under the RBI Act, 1934 and consequently the Circular would apply to such companies.

  • Whether restriction of 49 subscribers and Rs. 25 lac will apply in case of issue of subordinated debt issued in the nature of debentures. Whether Gap of 6 months will also apply to such issues. Since the definition of private placement means issue of NCD. please comment.

  • Whether Subordinated debt issued by NBFC is treated as a debenture within the meaning of Section 2(12) of the Companies Act, 1956. And whether the NBFCs can issue Subordinated Debt to more than 49 subscribers with less than Rs. 25 lacs. Please comment.

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