SEBI’s Proposal on “Wilful Defaulters”

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).
Comments
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.

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.

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