IndiaCorpLaw

SEBI’s Regime on Wilful Defaulters

Earlier this year, the Securities and Exchange Board of India
(SEBI) had issued a discussion paper that proposed tight curbs against wilful
defaulters from accessing the capital markets. We had commented on the
discussion paper in previous posts (here
and here).
Pursuant to the consultation process, SEBI last week issued amendments to
various regulations in order to operationalize such curbs. Under the new
regime, wilful defaulters who are declared as such through the process
stipulated by the Reserve Bank of India (RBI) would not be in a position to
access the capital markets or otherwise act as market intermediaries. This
establishes a connection between the banking system and the capital markets. In
other words, any person who is a wilful defaulter under the banking system
would effectively be kept out of the capital markets through mechanisms akin to
a cross-default.

A person is categorized as a wilful defaulter by a bank or
financial institution or consortium in accordance with the relevant guidelines
issued by the RBI for the purpose. It also includes a company whose promoter or
director is recognized as a wilful defaulter.

SEBI has implemented the new regime by amending various
regulations as follows:

1.         Primary
Markets
: A company is prevented from issuing equity shares to the
public if it or any of its promoters or directors is a wilful defaulter. A
company is prevented from issuing convertible securities to the public if it is
in default of payment of interest or principal for a period of more than six months
in respect of debt instruments it has issued to the public.

            A company that falls within the category of wilful
defaulter may, however, proceed with a rights issue so long as appropriate
disclosures are made regarding the circumstances in which it has been declared
a wilful defaulter. Moreover, the promoters cannot renounce their rights in
favour of outsiders. Similarly, a preferential allotment of securities is
permissible if it is accompanied with appropriate disclosures.

2.         Market
for Corporate Control
: Wilful defaulters are prevented from taking control
of a company. Hence, they can neither make a takeover offer nor can they
acquire such number of shares that would trigger a mandatory offer requirement.
By way of exception, a wilful defaulter can make a competing offer, presumably
a method that enables such a person to defend its position in a company that is
the subject matter of a takeover offer for acquisition of control.

3.         Debt
Securities
and Preference
Shares
: Wilful defaulters are prohibited from making a public issue of
debt securities or of non-convertible redeemable preference shares if they are
restrained, prohibited or debarred by SEBI from accessing the capital markets,
or if they are a wilful defaulter in respect of the relevant securities for a
period of more than six months.

4.         Intermediaries:
Persons who are categorized as wilful defaulters would be disqualified from
acting as intermediaries in the capital markets, and they would not be granted
registration by SEBI.

As discussed in the previous posts (linked above), this move
would have a deterrent effect on borrowers who borrow monies from banks and
financial institutions. On the other hand, it may also be considered an
overkill because by default the new regime disentitles wilful defaulters from
accessing the capital markets even though that may be necessary for a
restructuring or revival of the business. In that sense, SEBI has adopted a
uniform approach by banning all entities as opposed to permitting some on a
case-by-case basis. This may have the effect of adversely affecting
shareholders or lenders of a wilful defaulter who may not be able to improve
their position in the company by accessing the capital markets. In its zeal to
target the promoter or directors who are labeled wilful defaulters, this
development may result in adverse consequences on other stakeholders who may be
innocent.