VHVK Law Bulletin December
December 2017
Volume I Issue 3
VHVK Law Bulletin
In this third issue of VHVK Law Bulletin, we bring you topical developments in business law and regulation. The subjects covered in the current issue include finance law (acceptance of fixed deposits by companies from shareholders and Peer-to-Peer (P2P) lending), company law (use of subsidiaries), corporate governance, insolvency and bankruptcy, and the current proposal for regulation of medical services in Karnataka.
Fixed deposits rules relaxed for private companies
Government of India introduced new rules in June 2015 to enable private companies to accept fixed deposits from shareholders. 1 Under the new rules, no quantitative limits apply on the amount of deposits qualifying private companies and start-up companies (defined as under 5 years of age since incorporation) can raise from their shareholders.
The rules governing acceptance of fixed deposits by companies seek to balance protection of depositors’ interests and enabling companies to use deposits as a source of business capital. In this effort, the Companies (Acceptance of Deposits) Rules, 2014 prefer “light-touch” regulation when it is shareholders making deposits in private companies. In general, shareholders in private companies have ongoing relationship with the companies and quite often, they directly manage the companies. These considerations underpin the “light-touch” of regulation in dealing with shareholders’ deposits in private companies.
Recent amendments permit qualifying private companies and start-ups to accept fixed deposits without any monetary limits from their shareholders. To be eligible, a private company’s total borrowings must be less than twice its paid-up capital or ₹ 50 crores, whichever is less, and the company must not be in any default with respect to its borrowings. Apparently, companies fulfilling these criteria are considered financially sound and there is no cap on the amount they can raise from shareholders through fixed deposits. The position is even better for start-ups. They can also raise any amount from their shareholders as deposits, but are not subject to any qualification conditions, unlike older private companies.
The fixed deposit mechanism can be valuable for companies in managing their capital structure, in particular borrowings, if they have well-resourced shareholders. Significantly, the rules do not link the amount of deposit shareholders can have with a company to the extent or level of their shareholding and this can offer an opportunity for private companies and start-ups to develop suitable capital structures with a combination of shares and deposits. They can use the flexibility in deposits to both expand their shareholder base and raise capital on advantageous terms, through a combination of debt and equity.
Peer-to-Peer (P2P) lending – coming of age?
Online platforms that provide alternative loan funding are a new feature in the Indian finance landscape. Some examples of Peer-to-Peer (P2P) lending platforms are www.faircent.com and www.lendbox.in. These platforms match persons willing to lend with others wanting to borrow and facilitate direct, or Peer-to-Peer, lending. Some of the available platforms offer both business and personal loans, while some only offer personal loans. P2P lending platforms, in general, stress that they can service clients who are unable to borrow from traditional channels – mainly, banks. P2P lending has emerged as an alternative source of finance, particularly for borrowers that are unable to procure loans from banks and other conventional channels such as finance companies.
With the rise of P2P lending, the Reserve Bank of India (RBI) as India’s principal financial regulator has stepped in and introduced a set of norms to govern the sector. RBI’s foray began with a Consultation Paper published in April 2016. Recently by a notification issued in August 2017,2 RBI designated the P2P platforms as Non-Banking Financial Companies (NBFCs), which are regulated under the Reserve Bank of India Act, 1934.
The norms RBI has set for P2P platforms are mainly the following.
- Registration with RBI: To do business, P2P platforms must be registered with RBI. The registration process is designed to ensure that applicants possess necessary financial, technological, and human resources for the business.
- Intermediaries only: The rules restrict P2P platforms to the intermediary activity of matching lenders and borrowers. The platforms cannot directly engage in financing activities.
- Prudential norms: P2P lending platforms must have a minimum of net worth of ₹ 2 crores and their leverage ratio is capped at 2.
- Lending norms: Loan transactions on P2P platforms are subject to the following limits:
- Maximum loan from a lender to a borrower, ₹ 50,000
- Maximum exposure to one borrower by all lenders, ₹ 10,00,000
- Maximum exposure by one lender to all borrowers, ₹ 10,00,000
- Operations policy: P2P lending platforms must have an operations policy approved by their boards of directors and explaining matters such as eligibility criteria for lenders/ borrowers, pricing of services, and methods used for matching lenders and borrowers. Cash transactions are prohibited as are “strong-arm” methods for recovery of money from borrowers.
- Grievance redressal: P2P platforms must have in place mechanisms for dealing with customers’ grievances and they must also publicize that if a problem is not resolved within 30 days, parties can appeal to the Customer Education and Protection Department of RBI.
In sum, the regulatory measures while encouraging the new channel of alternative lending also seek to promote orderly development and assure a level of integrity in the sector.
Corporate structure – limiting layers of subsidiaries
Apparently in keeping with the Government of India’s recent drive to check dormant or shell companies, the government recently introduced the Companies (Restrictions on Number of Layers) Rules, 2017. These rules attempt to simplify corporate business structures by restricting the layers or generations of subsidiaries a company can have. Subject to limited exceptions, companies can only have two layers of subsidiaries. This new measure can also be viewed as an effort to promote healthy use of the corporate form for legitimate business purposes.
Companies Act, 2013 recognizes two types of activities by companies – namely, business operations and investing in other ventures. As for the investing activity, the Companies Act directly restricts the layer of subsidiaries to two (section 186). This has been in effect since 2014. The only exceptions recognized are for overseas subsidiaries permitted in the host jurisdiction and domestic subsidiaries formed to comply with requirements under any law. The limit on layers of subsidiaries for investment/lending activities is in keeping with the longstanding cautious approach in dealing with companies engaging in these activities and attendant risks, such as diversion of funds and tax evasion.
The new Layering Rules extend the limit on subsidiaries to business operations also. With this, the government has clarified its intention to keep corporate business structures relatively simple and transparent. The effort to check the layers of subsidiaries can also reduce government’s compliance monitoring work, which was a major issue in the recent drive against so-called shell companies that did no substantive business and were also in default with their compliance requirements under company law. As mentioned, the rules permit limited exceptions to the limit on layers of subsidiaries. Wholly-owned subsidiaries are excluded. The limit does not also apply to banks, systemically important non-banking finance companies, insurance companies and government companies.
Corporate governance trends – Kotak Committee report
The SEBI Committee on Corporate Governance, chaired by Uday Kotak, submitted its report in October this year, just four months after it was setup in June 2017. The lengthy report (104 pages plus annexures, totaling 176 pages) makes a number of recommendations.3 The proposals range from board composition and board committees to related party transactions and accounting/ audit issues. Many are inspired by norms in mature overseas jurisdictions, such as UK, Germany, and the Netherlands.
Some of the major recommendations made by the Kotak Committee on Corporate Governance are summarized below.
- Equal representation for independent directors: At least fifty percent of the boards of listed companies must be independent directors. The timeline for achieving the target percentage is April 2019 for the 500 largest listed companies and April 2020 for other companies. The proposal expands the current requirement that at least fifty percent of board members must be independent only in companies where the chair is an executive, or full-time, director.
- Eligibility for independent directors: Related to the above, the eligibility norms for independent directors are proposed to be strengthened. The effort is to distance this class of directors from the promoter/controlling shareholder groups in companies and check interlocked directorships where candidates sit as independent directors on the boards of one another’s companies.
- Directors’ skills: Disclosure is recommended both on the skill sets needed for a company’s business (technical, financial, administrative, etc.) and the skills actually possessed by board members. This can facilitate the detection of any skills deficit in a company’s board, and hopefully, initiating corrective action.
- Board committees – mandatory and optional: With regard to committees of boards, the recommendations made in the Kotak Committee report (such as increasing the ratio of independent directors in Nomination and Remuneration committee) seek, essentially, to strengthen the committees and improve their efficacy.
- Related party transactions: With shareholder-controlled companies, which are common in India, related party transactions are a concern of corporate governance. These transactions, usually designed to benefit the group in control, are already subject to regulation. Related party transactions require shareholder vote, excluding the interested group. The Kotak Committee does not propose any major alterations to the current regime.
The Kotak Committee report will require action from SEBI for implementation. Considering it is less than two months since the publication of the report, future directions are awaited on this front. A significant feature in the Kotak Committee report is its reference to the “custodian model” of corporate governance based on “Gandhian principles.” In this model, “promoters, boards and management wear the hat of “trustees” and act in the interest of all stakeholders – shareholders, investors, employees, customers, et al, keeping stakeholder interests before self-interest. Corporate India needs to move in this direction” (Kotak Committee Report, Preface).
Insolvency & Bankruptcy Act proceedings – a twist to withdrawal upon settlement
A risk in initiating insolvency proceedings against corporate debtors, under the Insolvency & Bankruptcy Code, 2016 (I&B Code), has become apparent with the outcome in Nisus Investment Managers LLP v Lokhandwala Kataria Construction Pvt Ltd.4 To enforce the guarantee obligations of Lokhandwala, the petitioner Nisus initiated corporate insolvency proceedings under the I&B Code. Corporate insolvency proceedings under the I&B Code lack the flexibility to accommodate individual settlements. This created problems for the parties who arrived at a negotiated settlement and wanted to terminate the insolvency proceedings. The National Company Law Tribunal did not permit the withdrawal of the creditor’s petition, because of the limitation in Rule 8 of the I&B (Application to Adjudicating Authority) Rules, 2016. Under this rule, withdrawal is permitted only until the stage of admission of the petition.
The restriction in Rule 8 reflects the focus of the I&B Code – to facilitate debt restructuring and revival of business for indebted enterprises. With this goal, the I&B Code enables debt restructuring plans for companies and is less concerned with individual creditors and their issues. With this philosophy, Rule 8 permits a petitioning creditor to withdraw the petition only until the stage of admission. Once a petition is admitted, the debt restructuring process is set in motion and the interests of all creditors are involved. As such, Rule 8 blocks withdrawal of proceedings by the petitioning creditor once an admission order is made.
In Nisus v Lokhandwala, the petitioning creditor that successfully negotiated a settlement had problems in terminating the proceeding. Finally, the Supreme Court of India did terminated the insolvency resolution proceedings in exercise of its lawmaking powers under Article 142 of the Constitution of India.5 With this constitutional tool, the Supreme Court overcame the restriction in the Application to Adjudicating Authority Rules.
In the present scheme of rules under the I&B Code, only the Supreme Court can terminate insolvency resolution proceedings upon parties’ application once a petition has been admitted by the National Company Law Tribunal. It is a moot point whether the Supreme Court’s ruling in Nisus can be a precedent for the National Company Law Tribunal if similar situations arise in the future.
Given the experience, creditors who are optimistic of a settlement from their corporate debtors can instead consider initiating the more traditional winding up proceeding under the Companies Act, 2013 (section 271(1)). With this alternative, there would be no technical difficulties in putting an end to legal proceedings at the National Company Law Tribunal itself, if the parties are able to resolve the issue and do not wish to continue with litigation.
Karnataka regulation of healthcare sector
The Government of Karnataka recently took a far-reaching step with its effort to actively regulate the healthcare sector, including limits on price for services.6 The proposed measures include providing emergency/life-saving treatments without advance payment, regulation of charges for different procedures, compulsory patients’ charters spelling out rights and duties, and strengthening oversight of healthcare services. Predictably, there has been strong criticism from the medical sector that opposes enhanced government intervention, particularly in fixing rates for treatment and procedures.
The new measures proposed are, apparently, a response to the trend of rise in medical costs over the last several years and reflect some issues that have been the target of public criticism. As mentioned, the planned regulation is far-reaching. It includes a grievance redressal agency at the district level. Important elements of the proposed regime are summarized below.
- The existing system of registration of private medical establishments continues, but with the validity period for registration reduced from five to three years. This means more frequent government inspection and approval of medical facilities.
- Medical establishments must provide emergency/life-saving treatment to patients without insisting on advance payment.
- In the event of death, again, medical establishments must release the body of the deceased patient without insisting on advance payment.
- Expert committees would recommend the ceiling on cost for different health services and medical establishments would be bound by these limits in charging patients. This is, perhaps, the most controversial of the proposed rules. Price regulation would be comprehensive and extend to a range of healthcare services – namely, “investigation, bed charges, operation theatre procedure, intensive care, ventilation, implants, consultation and similar tests and procedures”7
- Medical establishments would be bound by the patients’ charter, model provided in the legislation. The charter seeks to promote equitable treatment of patients and one of the significant features is doctors’ duty to also provide generic options for prescribed medicines. This reflects the higher cost of branded drugs and informing patients about cheaper alternatives.
- Grievance redressal committees established by the government have the authority to act on complaints and direct medical establishments to take corrective action.
The proposed rules, according to Karnataka Health Minister K.R. Ramesh Kumar, also reflect the fact that the government makes large payments to private hospitals for treating patients and the complaints received from health insurers.
VHVK Law Bulletin is issued for information purposes only and does not constitute legal advice. For more information on any of the material covered here and/or their implications for your situation, please obtain competent legal advice.