Tuesday, July 28, 2015

Is the Alternate Listing Platform for Start-Ups Really an Alternative?

[The following guest post is contributed by Geeta Dhania, Partner and Abhyuday Bhotika, Associate at Luthra & Luthra Law Offices. Views are personal.]

For any business to grow it is pertinent that it has access to capital and is able to complete the capital formation cycle. Companies should be able to access the funding they need for their growth and the investors should be able to smoothly exit so that they can reap the benefits of their investment and continue the investment cycle. One of the most popular ways of accessing capital and also providing exit is through an initial public offering (IPO). However, listing conditions and process for the main board of the stock exchanges are sometimes not conducive to start-up companies which do not possess the traditional business set up. Most of these start-up companies operate in unconventional sectors and are typically loss making in the initial years following incorporation. Their business line and the objective for capital raising may not always find favour with the regulator. As a result, many such companies eye the overseas markets which have an appetite for their stock and also relatively relaxed regulations. MakeMyTrip Limited, WNS Holdings Limited, SKIL Ports and Logistics are some of the India-based companies that have listed in the overseas securities market.

The community of these start-up companies is growing and positively impacting the economy. The Securities and Exchange Board of India (SEBI) acknowledged the impact of this growing community (around 3000 Indian start-up companies as it noted) and felt the need to make the existing capital raising avenues amenable for accommodating a large number of start-up companies. Accordingly, SEBI, in its board meeting dated June 23, 2015 (SEBI Board Note) announced an amendment to the existing institutional trading platform (ITP) to simplify and facilitate capital raising by start-ups.

This is not the first attempt by SEBI to provide an alternate listing platform. In 2010, SEBI introduced chapter X-B in the SEBI (Issue of Capital and Disclosure Requirements Regulations, 2009 (ICDR) to provide a dedicated platform for enabling easier access to equity by small and medium enterprises (SMEs). More recently, the ICDR was further amended to introduce chapter X-C for facilitating the issue of capital by small and medium enterprises on ITP of SME exchange without going through an IPO. The drawback with chapter X-C was that while it facilitated listing, it neither enabled public capital raising nor catered to the special needs of the start-ups. SEBI’s Board Note proposes to address this by amending chapter X-C to facilitate capital raising by start-ups. While the proposed amendments are supported by a noble purpose, some of the proposed changes mentioned in the SEBI Board Note do not seem very palatable.

To begin with, SEBI has made it clear that the amended ITP platform is not meant for investment by retail investors. Undeniably, SEBI needs to balance the growth of the securities market and the protection of investors. However, in the regulator’s zeal to “protect” the retail investors, such investors seem to getting edged out of many new products introduced by SEBI in recent past such as real estate investment trusts and infrastructure investment trusts. As a natural corollary, investment platforms available to the retail investors are being truncated. Proscribing investment with a view to protect is no protection indeed. The regulator should therefore find a middle path for permitting retail participation while facilitating listing of the start-ups.

Secondly, while the amendments to the existing ITP platform are being touted as enabling capital raising by start-up companies, the SEBI Board Note mentions that the offer document for such listing would require pre-clearance from SEBI. This seems counterintuitive to the purpose of this platform. The endeavour to simplify the framework of capital raising and yet placing approval barriers is paradoxical. Interestingly, platforms such as qualified institutions placements, institutional placement programs and even the SME platform do not require pre-clearance of the offer document with SEBI.

The new ITP platform is meant to be accessible by only those companies which have substantial investment by qualified institutional buyers (QIBs). Companies that are intensive in their use of technology, intellectual property, data analytics, biotechnology, nanotechnology to provide products, services or business platforms should have at least 25% of the pre-issue capital being held by QIBs and all other companies should have at least 50% of the pre-issue capital being held by QIBs to access the new ITP platform for capital raising. No doubt, QIBs are sophisticated investors and pre-existing QIB investments would lend certain credibility to such companies. However, since the mandatory QIB shareholding levels are pegged rather high, it is sure to leave out many start-up companies from being able to utilize the amended platform. Curiously, apart from the QIB holding in the company, SEBI has not prescribed any other eligibility conditions for these companies and the use of phrase “intensive use of technology, information technology, intellectual property” etc. can be subjective. We do hope that the final prints of the amendment will provide more colour to these terms.

Finally, the decision of a company to list its securities is influenced by many factors and the cost and process of listing is an important one. SEBI has rationalized disclosures required in the offer documents of these start-ups. It has done away with the limit on the amount that can be raised for general corporate purposes. This is a welcome change since the funding requirements of most of these new age companies may not involve creating any tangible asset but activities like brand building or buying software. However, while the disclosures on the group companies, litigations and creditors can be based on a materiality threshold, the SEBI Board Note suggests that full disclosures need to be made on the website of the issuer which defeats the very purpose of materiality threshold. Thus, barring the removal of cap on general corporate purposes, SEBI does not seem to have taken any substantial steps to reduce the disclosure/compliance costs of smaller companies accessing the capital markets. The SEBI Board Note indicates that lock-in for pre-issue capital shall be for a period of six months from the date of allotment uniformly for all categories of shareholders, this implies that shares allotted under employee stock option plans would also be subject to lock-in, which is however currently exempted under the extant framework for main board listing.

Providing an alternative platform to list is not a new concept in the international securities market. United States (US), United Kingdom (UK), Hong Kong, Japan, Singapore and China, have all provided an alternative platform for smaller companies to list. Most of the international regulators who have provided an alternate listing platform have conferred significant disclosure/process relaxations to enable smooth listing. The Jumpstart Our Business Start-ups Act, 2012 (JOBS Act) in the US was enacted to allow emerging companies to list on the stock market without complying with detailed regulation and contains amendments of various securities regulations, which are intended to help emerging growth companies by reducing the cost of going public. To accomplish this goal, the JOBS Act makes certain disclosure required during IPO process voluntary of emerging growth companies and phases in certain ongoing regulatory requirement following the completion of the IPO. Besides providing emerging growth companies with a set of more relaxed disclosure requirements during and subsequent to an IPO, the JOBS Act eases regulatory regime by providing for provisions as to “testing the waters” which permits an emerging growth company to market the securities and gauge investor’s interest before filing of initial registration statement and without having to worry about the potential liability that may result from an improper offer. The Shenzhen Stock Exchange opened the ChiNext, a platform for high-growth, high-tech start-ups in 2009 with listing standards less stringent than those of the main and SME boards of the Shenzhen Stock Exchange. As on July 15, 2015, 484 companies were listed on ChiNext and since the introduction of JOBS Act, of the approximately 660 companies that went public in United States, over 500 completed IPO’s under the JOBS Act. In comparison on the even date, only 38 companies are listed on the ITP platforms of BSE SME and NSE Emerge. The minuscule number of companies listed on the ITP platform is an indication that something is amiss.

Most of the regulators in the international jurisdictions have gone through many rounds of trial and error to find the right combination that works for the start-up companies in their jurisdiction. The JOBS Act by curtailing the quantum of disclosures and enabling easier access to capital markets seems to be of next generation compared to the SEBI Board Note. While SEBI has been working to provide a viable alternative listing platform, the effectiveness of the amended ITP platform is yet to be tested.

- Geeta Dhania & Abhyuday Bhotika

Saturday, July 25, 2015

Revitalising Distressed Assets Through the Joint Lenders Forum

[The following post is contributed by Dhanush. M, a 4th year studnent at the Jindal Global law School]

The rapid growth of non-performing assets (NPAs), especially with regard to public sector banks (PSBs) is a major hurdle to the sustenance of the banking system. This prompted the Reserve Bank of India (RBI) to issue a paper in early 2014 titled “Framework ForRevitalising Distressed Assets and Their Restructuring” for early detection, rectification and restructuring of stressed accounts under Special Mention Account (SMA) category.[1]

The categorisation of the SMA account was as follows: (i) “SMA-0”, where principal or interest payment has not been overdue for more than 30 days but the account has been showing incipient stress; (ii) “SMA-1” where principal or interest payment from an account is overdue between 31-60 days; and (iii) “SMA-2” where principal or interest payment is overdue between 61-90 days.

RBI has set up the Central Repository of Information on Large Credits (CRILC) to collect, store and disseminate data on all borrowers' credit exposures including SMAs having aggregate fund and non-fund based exposure of Rs. 50 million or more. RBI has advised the banks that if an account is reported by any of the lenders to CRILC as SMA-2, they should mandatorily form a committee to be called Joint Lenders’ Forum (JLF) if the aggregate exposure (AE) (fund based and non-fund based taken together) of lenders in that account is Rs 1000 million and above.

Strucutre of a JLF

The formation of a JLF will be mandatory in accounts having AE of Rs.1000 million and above; in other cases also the lenders will have to monitor the asset quality closely and take corrective action for effective resolution as deemed appropriate.[2] The lender with the highest AE will convene the JLF at the earliest and facilitate exchange of credit information on the account. In case there are multiple consortium of lenders for a borrower (e.g. separate consortium for working capital and term loans), the lender with the highest AE will convene the JLF.

It is mandated that all the lenders should formulate and sign an Agreement incorporating the broad rules for the functioning of the JLF. The Indian Banks’ Association (IBA) has prepared a Master JLF agreement and operational guidelines for JLF which can be adopted by all lenders.

The JLF may explore various options through the Corrective Action Alan (CAP) to resolve the stress in the accounts. The first option may involve rectification, by obtaining a specific commitment from the borrower to regularise the account so that the account comes out of SMA status or does not slip into the NPA category.

The second option may involve the possibility of restructuring the account if it is prima facie viable and the borrower is not a wilful defaulter. Restructuring an account would involve a commitment from promoters for extending their personal guarantees along with their net worth statement supported by copies of legal titles to assets may be obtained along with a declaration that they would not undertake any transaction that would alienate assets without the permission of the JLF.[3]

To effectuate restructuring, the lenders in the JLF may sign an Inter Creditor Agreement (ICA) and also require the borrower to sign the Debtor Creditor Agreement (DCA) which would provide the legal basis for any restructuring process. A “stand-still” clause popularly referred to as a “moratorium” could be stipulated in the DCA to enable a smooth process of restructuring.

The “stand-still” clause does not mean that the borrower is precluded from making payments to the lenders, but prohibits the parties from taking recourse to any other legal action during the “stand-still” period. This would be necessary to undertake the necessary debt restructuring exercise without any outside intervention, judicial or otherwise. The ICA may also stipulate that both secured and unsecured creditors need to agree to the final resolution.

The third option could involve the JLF deciding the most preferred recovery process to be followed, among the various legal and other recovery options available, with a view to optimising the efforts and results.

The decisions agreed upon by a minimum of 75% of creditors by value and 60% of creditors by number in the JLF would be considered as the basis for proceeding with the restructuring of the account, which will be binding on all lenders under the terms of the ICA. However, if the JLF decides to proceed with recovery, the minimum criteria for binding decision, if any, under any relevant laws/Acts would be applicable.

The JLF would consider the possibility of transferring equity of the company held by promoters to the lenders to compensate for their sacrifices, promoters infusing more equity into their companies, or transfer of the promoters’ holdings to a security trustee or an escrow arrangement until turnaround of company. This will enable a change in management control, should lenders favour it, where the loan of the distressed company is being restructured.

In case a borrower has undertaken diversification or expansion of the activities which has resulted in the stress on the core-business of the group, a clause for sale of non-core assets or other assets may be stipulated as a condition for restructuring the account, if under the Techno Economic Viability (TEV) study, which provides appraisal of technological parameters of a project and its impact on the financial viability of project,  the account is likely to become viable on hiving-off of non-core activities and other assets.


The abovementioned method of “out-of-court” debt restructuring popularly referred to as the “London approach” is beneficial to the extent that it is able to save  transaction costs, particularly litigation costs involved in a case of restructuring by the court. However, there is a possibility of coordination problems between various lenders owing to their differing interests, which may delay the formation of a CAP at the earliest as in the instance ofdebt-laden Bhushan Steel, which had outstanding loans amounting to 40,000 crore, where there were several reports in the media as to the reluctance of certain private lenders in taking part in the revival plan.

Also, when dealing with the JLF, the bank can act in manner that caters to its short-term interests, as the JLF is required to arrive at an agreement on the option to be adopted for CAP within 30 days from the date of an account being reported as SMA-2 by one or more lenders.

The JLF should sign off the detailed final CAP within the next 30 days from the date of arriving at such an agreement. Therefore, it is recommended that the time period for the CAP be increased from 30 days as banks have to be very cautious when they are take an incremental exposure to stressed companies.

When funding is infused in a restructuring proposal and accorded priority status over other creditors, there is a strong possibility of legal complications arising when the original creditors have stipulated negative pledges as per the terms of the original loan agreement. The law in regard to negative pledge is that any later perfecting secured party would accordingly be subordinate to the negative pledgee, just as a later perfected secured party is subordinate to a prior one.

With regard to unsecured creditors like bondholders, restructuring by the JLF would adversely affect their interests as there is a risk that secured creditors would infuse more capital in distressed unviable firms, as secured creditors would stand to gain a from seeing a firm continuing as a “going concern” relative to the liquidation proceedings.

Also, in a scenario where a firm has defaulted on its bonds and its accounts are stressed but the JLF infuses more capital, then such actions would be considered invalid in law as the Bombay High in the case of  M/s. Asian Power Controls Ltd. V/s. Mrs. Bubbles Goyal categorically stated that the only right an unsecured creditor has is seeking the winding up of the company and the law itself clearly says that merely because all the assets of the company are secured in favour of secured creditors, it is no ground to refuse winding up.

Due to the abovementioned reasons, there is a strong possibility that the JLF method of restructuring distressed assets may end up being very litigious.


To ensure that the lenders committee reaches early consensus, the JLF decision threshold should be revised to 60% in terms of value and 51% in terms of number as against the Framework’s 75% by value and 60% by number. To deal with any bondholder holdouts for restructuring of a company, the RBI may consider the possibility of inserting `Collective Action Clauses` which enables qualified majority of consent to bind other bondholders legally.

Further, if any lender does not participate in the meetings, the said lender should not be considered in the consensus estimation, and should attract a negative supervisory view. This would reduce the problem of banks “holding out” and speed up the process.

Also, tax breaks, in the form of exemptions from capital gains tax on hiving off non-core assets should be provided to promoters that initiate rectification under the SMA classification, as defined by the RBI, at the first signs of incipient stress. To resolve the legal complications associated with negative pledges when new funding is infused in a restructuring proposal, it is recommended that the JLF use arrangements such as transferring assets into new special-purpose vehicle companies or by the creditors “acquiring” assets either in the traditional sense or through repurchase structures.

Indian companies structure their investments through several related parties and subsidiaries. Therefore, the JLF needs to effectively scrutinize huge investments are undertaken in step down subsidiaries and related parties by a multi-tier structure. It is recommended that where investments in associates and subsidiaries are more than 25% of the net worth, while appraising the term loan / working capital requirements of the parent company, the detailed analysis of financials of associates and subsidiaries must be undertaken.

Effective restructuring of a distressed enterprise hinges greatly on the commitment of the board of directors to turnaround an enterprise. It is recommended that promoters and directors should not be permitted to float new ventures or take directorship in other companies. This must be a condition under debtor creditor agreement.

With regard to a “change in management” by the JLF, it would extremely difficult to implement management change, where promoters have controlled the management for a significant period of time. It is recommended that the JLF should consider taking assistance of specialised management agencies that can take over the companies that have productive assets and keep the assets in running condition.

I conclude by stating that early recognition of distressed assets would go a long way in solving the chronic problem of NPAs, but it is important to do so in a manner where the views of the relevant stakeholders are considered in a democratic fashion.

- Dhanush. M

[1] The concept of SMA category serves as a medium for early detection of stress in an account unlike the Non-Performing asset (NPA) model of monitoring stress, wherein banks only question the stress in an account where interest on a loan and/ or instalment of principal remained overdue for a period of more than 90 days in respect of a term loan.
[2] Master Circular - Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances (Available at (https://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=9009#CT94)
[3] Master Circular, as above.

Monday, July 20, 2015

Call for Papers: Journal on Corporate Law & Governance

[The following announcement is posted on behalf of The Centre for Corporate Governance at National Law University, Jodhpur]

The Centre for Corporate Governance at National Law University, Jodhpur is proud to announce the launch of Volume II Issue 1 of its Journal on Corporate Law & Governance, 2015-16.

This issue is focused on recent legislative changes in the corporate sector, which have led to the creation of a favorable business environment in India. Various policies launched by the government, easing of stringent norms, and important amendments to key corporate legislation have collectively led to a boost in investments and a pro-business climate in the country. The broad theme for Volume II Issue 1 of the Journal is “The Ease of Doing Business: A New Era of Corporate Law in India”.
More information regarding the journal is available here and details regarding the Call for Papers & Submission Guidelines are available here.

Friday, July 17, 2015

Composite Caps for Foreign Investment

Although liberalized over time, caps on foreign investments in select sectors have been a hallmark of India’s foreign investment policy. Added to this is the prescription of “sub-limits” for specific types of foreign investment such as foreign portfolio investment (FPI) and foreign direct investment (FDI). Currently, in several sectors there are different caps for FPI and FDI. For example, in the banking sector, while there is an overall foreign investment cap of 74%, FPI is capped at 49%. The rest of the foreign investment must necessarily come in through FDI. This has resulted in a complex regulatory regime that curbs the required flow of foreign investment. In order to address concerns, in his Budget Speech in February 2015 the Finance Minister proposed the abolition of sub-limits (or caps) on different categories of investment and the creation of an overall caps for foreign investment. Going by the banking example, therefore, once introduced the total investment through either the FPI or FDI routes (or both collectively) could be 74%.

The Union Cabinet yesterday approved the change as proposed in the Budget, and made available further details regarding the manner in which the composite caps will function. The press release setting out the changes to the Consolidated FDI Policy Circular of 2015 is available here.

The main function of this change is to lump all types of foreign investment into one single category and to obliterate any distinctions for the purpose of computing the sectoral caps. The different categories included are:

- foreign direct investment (FDI);

- foreign institutional investment (FII);

- foreign portfolio investment (FPI);

- non-resident Indian investment (NRI);

- foreign venture capital investment (FVCI);

- qualified foreign institutional investment (QFI);

- limited liability partnership investments (LLPs); and

- depository receipts (DRs).

The outcome of this change is that while certain categories of investors, primarily portfolio investors, were subject to sub-limits, now they can invest up to the maximum permissible composite cap in the relevant sector. This will therefore create additional headroom for foreign investors, which the Government expects will result in further inflow of investments into India. Although the Government’s press release makes these changes uniformly applicable to all sectors, some media reports (here and here) indicate that the banking and defences sectors are excluded from this new dispensation. The Government needs to clarify this position.

The Cabinet decision consistent with various efforts by the Government to ease the doing of business and also to boost manufacturing within the country through its “Make in India” campaign. The background to the press release sets out in great detail the intention of the Government increasing investment flows into India, and seeks to demonstrate the efforts it has already taken in the last year or so in liberalizing the foreign investment policies by using some comparable data from the previous period.

At the same time, foreign investment would be required to comply with various conditions prescribed in specific sectors, and also with other laws and regulations as may be applicable. Moreover, foreign investment in sectors that are under the Government approval route will require such approval to be obtained if a transactions results in a transfer of ownership and/or control of Indian entities from resident Indian citizens to non-resident entities.

One change that could potentially have significant implications is that “portfolio investment, upto aggregate foreign investment level of 49%, will not be subject to either government approval or compliance of sectoral conditions, as the case may be” so long as ownership and/or control is not transferred to non-resident entities. This would have an impact on sectors that are currently eligible for foreign investment of less than 49%, that too under the Government route. Examples of this include terrestrial broadcasting (FM radio), news and current affairs TV channels and print media (news and current affairs) where foreign investment is permitted up to 26% under the Government route. The implications of the present change on these sectors are unclear. One interpretation (more aggressive) would be that portfolio investment is now available up to 49% under the automatic route, which effectively means that the new composite cap overrides the erstwhile lower foreign investment limit. The other interpretation (more conservative) would mean that the new regime applies only to scenarios where foreign investment is otherwise allowed up to 49% or more, but that now it is permitted under the automatic route rather than the Government route for portfolio investment up to 49%. More clarity is awaited.

The press release further clarifies that:

(i)        the composite sectoral cap will consider both direct and indirect foreign investment;

(ii)       sectors which are already under 100% automatic route without conditionalities would be unaffected by the changes; and

(iii)      foreign investments already made under the existing policy to date would be unaffected, and will not require any changes to be made.

While the Cabinet decision eases and streamlines the foreign investment policy, some grey areas arise as a result as discussed above. Given that the decision is to be implemented through a Press Note to be issued by the Department of Industrial Policy and Promotion (DIPP) that effectively amends the Consolidated Foreign Investment Policy, including the sub-limits set out in various sectors indicated in Chapter 6 thereof, a more definitive picture is likely to emerge once that step is accomplished.