Wednesday, May 4, 2016

Second Leg of SARFAESI: All Transactions to be Registered with CERSAI

[The following guest post is contributed by Niddhi Parmar of Vinod Kothari & Company. The author can be contacted at parmar@vinodkothari.com]

Introduction

The Central Government introduced the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Central Registry) Amendment Rules, 2016 (hereinafter referred as ‘Amendment Rules, 2016’) on January 22, 2016 (being the date of publication in the Official Gazette) requiring the particulars of transactions to be registered with Central Registry of Securitisation Asset Reconstruction and Security Interest of India (‘CERSAI’) by banks and financial institutions as the Central Government may notify. The term “financial institutions” has been defined under section 2(m) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act, 2002 (SARFAESI Act) to mean –

“XX

(iv)    any other institution or non-banking financial company as defined in clause (f) of section 45-I of the Reserve Bank of India Act, 1934 (2 of 1934), which the Central Government may, by notification, specify as financial institution for the purposes of this Act.”

Section 45NC of the Reserve Bank of India Act, 1934 grants power to the Reserve Bank of India (RBI) to exempt non-banking institutions from the applicability of the provisions of the RBI Act. Housing Finance Companies (HFCs), being, financial institutions are exempted from complying with the provisions of the RBI Act. However, they are regulated by the National Housing Bank. The Central Government has notified 19 HFCs as on July 25, 2014 to make use of the SARFAESI Act. Subsequently, 41 more HFCs were notified on December 18, 2015.

Non-Banking Financial Companies (‘NBFCs’) irrespective of class or asset size were advised to file and register the records of all equitable mortgages created in their favour on or after March 31, 2011 with the CERSAI as and when equitable mortgages are created in their favour vide its circular no. RBI/2013-14/369 DNBS.(PD).CC.No.360 /03.10.001/2013-14 dated November 12, 2013. Subsequently, NBFCs were advised to register all types of mortgages with CERSAI.

Prior to the Amendment Rules, 2016

Banks and financial institutions were required to register equitable mortgages with CERSAI pursuant to section 23, 24 and 25 of the SARFAESI Act read with rule 4(2) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Central Registry) Rules, 2011 (hereinafter referred to as ‘Rules, 2011’).

Why only equitable mortgages?

Rule 4(2) of the Rules, 2011 required as follows:

“Particulars of every transaction of securitisation and reconstruction of financial assets and creation, modification or satisfaction of security interest by way of mortgage by deposit of title deeds shall be filed in Form I, Form II, Form III or Form IV, as the case may be, and shall be authenticated by a person specified in the Form for such purpose by use of a valid digital signature.”

The most common form of mortgage is mortgage by deposit of title deeds wherein the debtor simply delivers the title deeds to the creditor or its agent. Section 58(f) of the Transfer of Property Act, 1882 defines the term “mortgage by deposit of title-deeds” as follows –

“Where a person in any of the following towns, namely, the towns of Calcutta, Madras, and Bombay, and in any other town which the State Government concerned may, by notification in the Official Gazette, specify in this behalf, delivers to a creditor or his agent documents of title to immovable property, with intent to create a security thereon, the transaction is called a mortgage by deposit of title-deeds.”

There exist three important elements for mortgage by deposit of title deeds: debt owed by the mortgagor, deposit of title deeds, and the intent to create security. In India, the expressions “mortgage by deposit of title deeds” and “equitable mortgage” are used interchangeably.

Post Amendment Rules, 2016

Post Amendment Rules, 2016, the institutions are not only required to register the equitable mortgages with CERSAI but also need to register the following:[1]

“2(A). Particulars of creation, modification or satisfaction of security interest in immovable property by mortgage other than mortgage by deposit of title deeds shall be filed in Form I or Form II, as the case may be, and shall be authenticated by a person specified in the Form for such purpose by use of a valid digital signature.

(2B). Particulars of creation, modification or satisfaction of security interest in hypothecation of plant and machinery, stocks, debt including book debt or receivables, whether existing or future shall be filed in Form I or Form II, as the case may be, and shall be authenticated by a person specified in the Form for such purpose by use of a valid digital signature.

(2C). Particulars of creation, modification or satisfaction of security interest in intangible assets, being knowhow, patent, copyright, trade mark, licence, franchise or any other business or commercial right of similar nature, shall be filed in Form I or Form II, as the case may be, and shall be authenticated by a person specified in the Form for such purpose by use of a valid digital signature.

(2D). Particulars of creation, modification or satisfaction of security interest in any under construction residential or commercial building or a part thereof by an agreement or instrument other than by mortgage, shall be filed in Form I or Form II, as the case may be, and shall be authenticated by a person specified in the Form for such purpose by use of a valid digital signature.”

All subsisting transactions under sub-rules (2A) to (2D) need to be registered with CERSAI by the secured creditor on or before such date as may be specified by the Central Government wherein no fee shall be payable on such filing. However, in case of failure to register within the prescribed time limit, the same shall be subject to applicable fees specified in table below.

The term subsisting transaction has been defined under the explanation to proviso to mean those transactions which existed before the Amendment Rules, 2016 coming into force.

Fees for creation and modification of security interest:

Particulars
Form No.
Amount of fee payable (in Rs.)
Post Amendment Rules, 2016[2]
Prior to the Amendment Rules, 2016
Creation or modification of security interest by way of mortgage by deposit of title deeds:

1.      For a loan upto Rs.5 lakh
2.      For a loan above Rs. 5 lakh

Form I




50
100




250
500
Creation or modification of security interest by way of mortgage of immovable property other than by deposit of title deeds

Form I
NIL
NA
Creation or modification of security interest in hypothecation of plant and machinery, stocks, debt including book debt or receivables, whether existing or future:

1.      For a loan upto Rs.5 lakh
2.      For a loan above Rs. 5 lakh

Form I






50
100
NA
Creation or modification of security interest in intangible assets, being know- how, patent, copyright, trade mark, licence, franchise or any other business or commercial right of similar nature:

1.      For a loan upto Rs.5 lakh
2.      For a loan above Rs. 5 lakh

Form I






50
100
NA
Creation or modification of security interest in any under construction residential or commercial building or a part thereof by an agreement or instrument other than by mortgage:

1.      For a loan upto Rs.5 lakh
2.      For a loan above Rs. 5 lakh

Form I






50
100
NA
Satisfaction of charge for security interest filed under subrule (2) and (2A) to (2D) of rule 4

Form II
NIL
250
(only for subrule 2)
Securitisation or reconstruction of financial assets

Form III
500
1000
satisfaction of securitisation or reconstruction transactions

Form IV
50
50
Any application for information recorded/ maintained in the Register by any person

-
10
-
Any application for condonation of delay upto 30 days
-
Not exceeding 10 times of the basic fee , as applicable
Not exceeding 2500 in case of creation of security interest for loan upto 5 lakh and not exceeding 5000 in all other cases


An additional fee[3] is payable on delay in filing the records from January 22, 2016 as below:

- From 31 days to 40 days – twice the amount of applicable fees;

- From 41 days to 50 days – five times the amount of applicable fees;

- From 51 days to 60 days – ten times the amount of applicable fees.

Conclusion

Post Amendment Rules, 2016, the banks and financial institutions are required to register all transactions referred in rule 4(2) to (2D) with CERSAI within a period of 30 days from the date of such transactions. Further, the gazetted copy of the Amendment Rules, 2016 states that the fees payable in case of security interest being created under sub-rule (2A) of rule 4 shall be NIL. However, a notification issued by CERSAI dated February 1, 2016[4] states that no fees shall be payable in case of security interest being created under sub-rule (2A) of rule 4 to sub-rule (2D) of rule 4.

- Niddhi Parmar



[1] Sub-rules have been inserted in rule 4 of the Rules, 2011.
[2] As per the Gazetted Amendment Rules, 2016.
[3] CERSAI Notification No. CERSAI/CMD/2016-1232 dated March 4, 2016 - site last visited on April 30, 2016.
[4] CERSAI Notification No. CERSAI/IT/1178/2016 – site last visited on April 30, 2016.

Sunday, May 1, 2016

Messer Holdings: Supreme Court Refuses to Decide on the Enforceability of Share Transfer Restrictions

As we have previously discussed on several occasions (here and here), the question of enforceability of share transfer restrictions in Indian companies has been a vexed one. Although the Bombay High Court has sought to bring about some resolution of the issues in its leading judgments of Messer Holdings v. Shyam Madanmohan Ruia and Bajaj Auto Ltd. v. Western Maharashtra Development Corporation Ltd., and Parliament has sought to clarify the position in the proviso to section 58(2) of the Companies Act, 2013, several ambiguities continue.

In this background, it was reasonable for one to anticipate clarity from the Supreme Court in the appeal that was preferred from the Messer Holdings judgment of the Bombay High Court. A couple of weeks ago, the Supreme Court delivered its judgment in Messer Holdings Ltd. v. Shyam Madanmohan Ruia. However, not only did it refuse to answer the questions of law posed before it, but it also criticized the parties for unreasonably taking up valuable time of the court. Hence, no further guidance has come forth from the Supreme Court on the question of the validity and enforceability of share transfer restrictions in Indian companies.

In this case, the Supreme Court considered different appeals from four separate suits preferred by the parties, all relating to a series of transactions involving restrictions on transfer of shares. The detailed facts of the case are not entirely relevant for the discussion in the present post. One suit stood withdrawn. Certain others were affected by a settlement agreement subsequently entered into between the relevant parties. The Supreme Court found that no dispute survives on the transfer restrictions in view of the settlement agreement between the parties, and hence the suits are to be dismissed without any cause of action. Consequently, all interim orders passed by various courts in earlier proceedings also lapse.

The Court came down heavily on the parties as follows:

40. We make it clear that we are not deciding by this order, the existence or otherwise of any right or its enforceability in the … shares of [the company] …. It is open to them to establish their right in [the suit]. The defendants in the [suit] are at liberty to raise every defence available in law and fact to them.

41. A great deal of effort was made both by [the parties] to convince the court that in view of the protracted litigation between the parties this court should examine all the questions of rights, title and interest in these shares between the various parties as if this were the court of first instance trying these various suits.

43. The net effect of all the litigation is this. For the last 18 years, the litigation is going on. Considerable judicial time of this country is spent on this litigation. The conduct of none of the parties to this litigation is wholesome. The instant [special leave petitions] arise out of various interlocutory proceedings. … We believe that it is only the parties who are to be blamed for the state of affairs. This case, in our view, is a classic example of the abuse of the judicial process by unscrupulous litigants with money power, all in the name of legal rights by resorting to halftruths, misleading representations and suppression of facts. Each and every party is guilty of one or the other of the above-mentioned misconducts. It can be demonstrated (by a more elaborate explanation but we believe the facts narrated so far would be sufficient to indicate) but we do not wish to waste any more time in these matters.

44. This case should also serve as proof of the abuse of the discretionary Jurisdiction of this Court under Article 136 by the rich and powerful in the name of a ‘fight for justice’ at each and every interlocutory step of a suit. Enormous amount of judicial time of this Court and two High Courts was spent on this litigation. Most of it is avoidable and could have been well spent on more deserving cases. …

45. We therefore, deem it appropriate to impose exemplary costs quantified at Rs.25,00,000.00 (Rupees Twenty Five Lakhs only) to be paid by each of the three parties ... The said amount is to be paid to National Legal Services Authority as compensation for the loss of judicial time of this country and the same may be utilized by the National Legal Services Authority to fund poor litigants to pursue their claims before this Court in deserving cases.

In the light of these observations, it is not clear as to what effect this would have on the judgment of the Bombay High Court in the Messer Holdings case in so far as its holdings on the position of law on share transfer restrictions are concerned. But, since the Bombay High Court adopted a similar approach in the Western Maharashtra Development Corporation case, the law as set forth in that case will in any event hold good, at least as of now.


Some Ambiguities in the Rules on Downstream Investments

[The following guest post is contributed by Ajay G. Prasad, who is a Senior Associate with Kochhar & Co, Bangalore. Views expressed in this post are personal and do not reflect the views of the firm.]

Exchange control rules on downstream investment form an important aspect to consider in M&A transactions. As per the foreign direct investment policy (“FDI Policy”) of the Department of Industrial Policy & Promotion (the “DIPP”), the expression “downstream investment” means indirect foreign investment by one Indian company into another Indian company (either by way of purchase of shares or by way of fresh allotment of shares).

Until Press notes 2, 3 and 4 were issued by the DIPP in 2009, there was considerable ambiguity surrounding the treatment of such indirect foreign investment. Although the issuance of these press notes sought to clear the ambiguity, the DIPP unwittingly gave room for further uncertainty by creating new classes of companies called “operating companies”, “investment companies” and so on. As a result, stakeholders were required to apply the downstream rules contained in these press notes after determining which category a given company fell. This was a difficult exercise to undertake.

Fortunately, the DIPP did away with most of these differentiations through the FDI policy released in April 2011. Ever since, the downstream investment rules are being continuously pruned. Press note 12 of 2015 read with the amendments to the FEMA (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (the “2016 FEMA Amendment”) dated 15 February 2016 has further liberalized these rules. But despite numerous attempts of the Government and the Reserve Bank of India (RBI) to fine tune these rules, I submit that some issues and ambiguities persist. I provide a few illustrations below.

Ambiguity in the expression “foreign investment” as appearing in paragraph 3.10.3.1 of the FDI Policy

Chapter 3.10 of the FDI Policy specifies that (for the purpose of that chapter) the expression “foreign investment” would have the same meaning as in Paragraph 4.1. Paragraph 4.1 does not contain a specific definition of foreign investment. It however specifies that foreign investment into an Indian company comprises both direct foreign investment (i.e. a non resident entity directly investing in an Indian entity) and indirect foreign investment (i.e. one Indian company /LLP with foreign investment investing in another Indian company/LLP). It goes on to state that for the purpose of counting foreign investment in an Indian company/entity, all of the direct foreign investment by a non-resident would be counted towards foreign investment. As far as counting indirect foreign investment goes, the same would be counted towards calculating foreign investment if the investing Indian company/entity is either owned or controlled (or both) by non-residents.

Be that as it may, paragraph 3.10.3.1 of the FDI Policy specifies that foreign investment into an Indian company engaged only in the activity of investing in the capital of other Indian companies will require prior Government / Foreign Investment Promotion Board approval, regardless of the amount or extent of foreign investment (emphasis supplied). The ambiguity arises when one compares the aforesaid language to the language and intent of paragraph 4.1 (which clearly mentions that indirect foreign investment by Indian companies owned and controlled by resident Indian citizens would not be counted towards foreign investment). What then is the intent of using the expression “regardless of the amount or extent of foreign investment”? Does it mean that only for the purpose of paragraph 3.10.3.1 even indirect foreign investment by companies which are owned and controlled by Indian companies and / or Indian citizens would be counted towards foreign investment? That should clearly not be the case (and presumably, the intent).

Therefore, a couple of possible solutions could be to either amend the definition of the expression “foreign investment” or delete the language  “regardless of the amount or extent of foreign investment” (which was emphasized above).

No guidance around the meaning of the expression, “domestic market”

The downstream investment rules of the FDI Policy specify that: (i) an Indian company undertaking downstream investment would have to bring in requisite funds from abroad and not leverage funds from the domestic market (emphasis supplied); (ii) this would however not preclude downstream companies with operations from raising debt in the domestic market; and (iii) downstream investment through internal accruals are permitted. The 2016 FEMA Amendment defined the expression “internal accruals” for the very first time in the context of these rules to mean profits transferred to the reserve account after payment of taxes.

The expression “domestic market” used in the rules has created some uncertainty as there is no regulatory guidance as to what is the meaning of the same. This is particularly so in transactions which involve one Indian company (say “X”, owned and controlled by non-residents or owned or controlled by non-residents) lending to an Indian subsidiary company (say “Y”) for the purpose of Y making investment in another unrelated Indian company (say “Z”).

In this context, I have come across several stakeholders who tend to concentrate only on the word “domestic” to the exclusion of “market” and argue that investment by Y into Z is not permitted under the automatic route (i.e. without Government / FIPB approval). Typically, they interpret “domestic market” to mean “domestic source”. However, in my view the intent of the policy is not to prohibit such downstream transactions; or make them subject to the approval route. The intent is to regulate transactions where Y, instead of obtaining a loan from its holding company X, raises funds from a bank or a financial institution or a non-banking financial company to fund the acquisition. As per Black’s Law Dictionary, “market” means: (i) place of commercial activity in which goods, commodities, securities, service, etc. are bought and sold; (ii) a public time and appointed place of buying and selling; also purchase and sale. The rules also use the expression “raise debt”. Typically, the word “raise” means raising a loan in the debt market or through a bank or financial institution.

Based on the above, I submit that from an exchange control law perspective, the intent is not to prohibit lending by a holding company to a subsidiary company for making investments. The reason X is lending to Y is on account of the relationship that they share. Hence, it should be covered under the automatic route. In this connection, one needs to also examine the legality of these transactions from an Indian Companies Act, 2013 perspective. That is a different topic and not part of the scope of this post.

Confusion around using the escrow mechanism

Exchange control laws permit parties to an FDI transaction to set up an escrow account with an authorized dealer bank wherein consideration payable on account of transactions may be deposited in the escrow account for a period of six months. This is allowed under the automatic route (i.e. without taking special RBI permission). In case the parties intend that escrow to be operational beyond six months, they need to obtain special RBI permission. Recently, some relaxations have been made available in this respect. Where parties to a transaction so agree, an escrow account, wherein not more than twenty five percent of the total consideration is deposited, can be operational for a period up to eighteen months without taking special RBI permission.

While the above rules seem clear enough, when it comes to their application in a downstream investment scenario, things get slightly muddied. The relevant language in the downstream investment section of the FEMA Regulations specifies five [(a) to (e)] conditions, none relating to opening an escrow account to undertake downstream investments. Therefore, when it comes to opening an escrow account for downstream investment, one would assume that parties are not required to comply with the rules relating to escrow (even the recently released FEMA Deposit Regulations seems to suggest the same).

However, some stakeholders (including a few authorized dealer banks) have taken a view that since downstream investment is indirect foreign investment, an escrow account for the purpose of facilitating downstream transactions should also be subject to the same rules. As there is no express regulatory guidance on this, most transactions are structured after taking the inputs of the authorized dealer banks (who in turn would have obtained some sort of comfort from the RBI after presenting all the facts to the RBI, mostly on a no-names basis). In the absence of clear regulatory guidance, the RBI’s approach may have been based on transaction-specific facts (and slightly ad-hoc). In my view, having clarity on this issue would go a long way in avoiding this case to case approach currently being adopted.

It is hoped that the new FDI policy (scheduled to be released soon by the DIPP as per past precedents) would address some of these issues.


- Ajay G. Prasad