Ordinance to Ban Unregulated Deposit Schemes: Bridging the Regulatory Gap

[Anirban Roy Choudhury is a banking and finance lawyer and an LL.M. (Finance) candidate at the Institute for Law and Finance, Goethe University Frankfurt]  

In spite of various legislation, including the Prize Chits and Money Circulation Schemes (Banning) Act, 1978 and the Chit Funds Act, 1982, being in place throughout the last few decades, various entities regularly lured the unwary public with very high returns and tempted them to invest in their Ponzi schemes. The Securities and Exchange Board of India (SEBI) also attempted to tackle the situation by introducing the Securities and Exchange Board of India (Collective Investment Scheme) Regulations, 1999. However, financial scams continued to be reported from various parts of India on a regular basis, of which the Sharda scam originating in West Bengal is a glaring example.

It was clear that most of these Ponzi schemes and financial scams were orchestrated by entities who were completely outside the purview of the regulatory matrix. As a result, the Standing Committee on Finance (2015-16), chaired by Dr. M. Veerappa Moily, in its report dated September 21, 2015, proposed the introduction of a comprehensive regulatory framework for governing all activities involving acceptance of deposits from the public. A high level Inter-Ministerial Group was thereafter mandated to identify the gaps in the existing regulatory framework. The Inter-Ministerial Group, keeping in mind the suggestions of the Standing Committee, proposed the enactment of a comprehensive umbrella legislation aimed at criminalizing any form of promotion, advertisement, solicitation or acceptance of unregulated deposits. In view of the recommendations of the Standing Committee and the proposal of the Inter Ministerial Group, the Government of India promulgated the Banning of Unregulated Deposit Schemes Ordinance, 2019 (the ‘Ordinance’) on February 21, 2019.

Objectives of the Ordinance

The Ordinance is aimed at clearly demarcating deposits into ‘regulated deposit schemes’ and ‘unregulated deposit schemes’ and banning all unregulated deposit schemes. The Ordinance prohibits (i) anyone (being any individual or group of individuals, proprietorship, partnership firm or limited liability partnership, company, association of persons, private or public trust, co-operative society or multi-state co-operative society) from promoting, operating, advertising, soliciting or accepting deposits in connection with any ‘unregulated deposit schemes’, and (ii) fraudulent default in redemption of ‘regulated deposit schemes’ upon maturity.

Pursuant to the Ordinance, regulated deposit schemes include schemes and arrangements stipulated under the first schedule to the Ordinance which are regulated by specified regulatory bodies including, amongst others, SEBI, the Reserve Bank of India, the Insurance Regulatory and Development Authority of India, the National Housing Bank, and the Pension Fund regulatory and Development Authority. Whereas, any scheme or arrangement falling outside the ambit of ‘regulated deposit schemes’ is tantamount to an ‘unregulated deposit scheme’ and are strictly prohibited.

What is a ‘Deposit’ Pursuant to the Ordinance?

There has been much-misinformed outcry that the Ordinance bans all forms of deposits including loans and advance payments. However, that is not true and, although pursuant to the Ordinance deposit includes all monies received by way of an advance or loan or in any other form with a promise to return whether after a fixed tenure or otherwise with or without any interest or profit, it does not include certain types of loans and advance payments.

Section 2(4) of the Ordinance clearly states that, amongst others, (i) loans availed from banks, non-banking financial companies and public financial institutions, (ii) monies availed from foreign banks, foreign governments, multilateral financial institutions, export credit collaborators, etc., (iii) contributions toward partnership capital in partnerships including limited liability partnerships, (iv) loans availed by individuals from relatives or loans availed by partnership firms from relatives of its partners, (v) contributions received by political parties, and (vi) monies (non-refundable) received for the purpose of or in the course of regular business including (a) payments (by way of advance or instalments) received in relation to sale/ hire of any property (movable or immovable) and provision of services, and (b) performance securities deposited for due performance of any contract for supply of goods or provision of services, are outside the purview of the Ordinance and will not be affected by the provisions of the Ordinance. It must, however, be noted that in case of companies receiving any deposits, they will be subject to the definition of ‘deposit’ under section 2(31) of the Companies Act, 2013 read with the provisions of the Companies (Acceptance of Deposits) Rules, 2014 as amended from time to time, and ‘deposits’ as defined under the Ordinance will not be applicable to them.

Central Database and Sharing for Information

The Ordinance proposes to establish a repository for storing all relevant details about deposit takers operating in India. Accordingly, it provides for the setting up of an online database by an authority so designated by the Central Government. All deposit takers are required to report to the said authority such details in such manner as may be prescribed. Any default in complying with the mandatory reporting requirement will call for a fine which may extend up to INR 500,000.

It must be noted that only deposit takers engaged in accepting ‘deposits’ as defined under section 2(4) of the Ordinance are required to comply with the said reporting requirements. Therefore, deposits, loans and advances exempted under the said section 2(4) are not required to be reported. However, companies accepting deposits under chapter V (Acceptance of Deposits by Companies) of the Companies Act, 2013 are required to comply with the said reporting requirements. Further, every State Government is required to appoint a competent authority in terms of section 7(1) of the Ordinance (the ‘Competent Authority’), who shall have the same powers as vested in a civil court under the Code of Civil Procedure, 1908. The Competent Authority can, if it is of the opinion that any entity is soliciting or accepting deposits pursuant to any unregulated deposit schemes, seek such further information from such entities as it may consider necessary.

The Ordinance also provides for sharing of information and mandates the Competent Authority to share all information received from the police in connection with any unregulated deposit scheme with the Central Bureau of Investigation (‘CBI’). The Ordinance also requires the government, regulators, the income tax department and other investigation agencies, in case it has any information or document pertaining to any offence under the Ordinance being investigated by the police or the CBI, to share such information or document with the police or CBI, as the case may be.

Restitution Mechanism, Offences and Penalties

The Ponzi schemes in the past managed to swindle monies collected by them and it has been extremely difficult for authorities to recover such monies from the defaulters. In order to overcome this challenge, the Ordinance provides for a restitution mechanism and proposes to attach properties of the defaulting deposit takers and repay the depositors from its proceeds.

It is also relevant to note that the Ordinance, subject to the provisions of the SARFEASI Act, 2002 and the Insolvency and Bankruptcy Code, 2016, places claims of depositors in priority before all other outstanding debts and tax liabilities. Further, a provisional attachment order passed by the Competent Authority pursuant to the Ordinance will, to the extent of the claims of depositors, have priority over attachment order(s) passed by any other authority.

The Ordinance also requires State Governments, in consultation with the Chief Justice of the concerned High Court, to appoint one or more courts presided by a judge not below the rank of a district and sessions judge or additional district and sessions judge to be the designated court (‘Designated Court’). The Designated Court(s) shall have the exclusive jurisdiction to adjudicate matters in connection with the provisions of the Ordinance.

The Ordinance has paved the way for stringent penalties, including imprisonment, for anyone involved in soliciting or accepting deposits pursuant to any unregulated deposit scheme, both of which are cognizable and non-bailable offences. According to section 21 of the Ordinance, anyone who solicit deposits pursuant to any unregulated deposit scheme will be liable for imprisonment for a minimum term of one year (and maximum, five years) together with a fine of minimum INR 200,000 (and maximum, INR 1 million). Moreover, if they accept from anyone such deposits, they will be liable for imprisonment for a minimum term of two years (and maximum, seven years) together with a fine of minimum INR 300,000. Further, in case such deposit taker defaults in repayment of the deposits, they will be liable for imprisonment for a minimum term of three year (and maximum, ten years) together with a fine of minimum INR 500,000 (and maximum, twice the aggregate amount of deposits collected).

The Ordinance also criminalises any default in redemption of regulated deposit schemes. Pursuant to section 22, in case of any such default, the deposit taker will be liable for imprisonment for a term of up to seven years and/or fine of minimum INR 500,000 which may extend up to INR 250 million or three times the amounts of profits generated from such default, whichever is higher.

For repeat offenders, the penalties are even more stringent and includes imprisonment for a minimum term of five years and fine of INR 1 million which may extend up to INR 500 million. Further, in case where the deposit takers are not individuals, all persons who at the time were in charge of its affairs will be deemed guilty of the offences.

Way Forward

Two issues that have been especially harrowing since the time the idea of the central legislation was floated are the treatment of (i) loans received from relatives and (ii) advance payments received by real estate companies. Section 2(4) of the Ordinance makes it abundantly clear that such loans and advance payments are not ‘unregulated deposit schemes’ and therefore will not be affected by the provisions of the Ordinance. However, it must be noted that while all form of loans from relatives (‘relatives’ having the same meaning as ascribed under the Companies Act, 2013) are outside the purview of the Ordinance, only advance payments received by a real estate company towards an actual sale of an immovable property is outside the purview of the Ordinance. Therefore, only amounts received for a designated transaction is allowed and such amount can only be adjusted against the future sale consideration. In case the amounts received by such real estate companies are proposed to be returned to the depositor with or without any form of interest, after a fixed tenure or otherwise, such amounts received will tantamount to be ‘unregulated deposits’ and will be barred by the provisions of the Ordinance.

The Ordinance is issued in public interest and its key objective is to prevent unscrupulous persons from luring the unwary and gullible public to invest in their Ponzi schemes. It should not create any roadblock for legitimate business transactions as enough carve-outs have been made in the Ordinance to that effect.

However, while the Ordinance is a step in the right direction and attempts to bridge the regulatory gap and put in place a comprehensive law for tackling unregulated deposit schemes, its success will largely depend on each state government and its agencies who are ultimately responsible for implementing most of the provisions of the Ordinance.

Anirban Roy Choudhury

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