Legal and Regulatory Updates: January 2022

1. RBI releases new factoring regulations, 2022

The Reserve Bank of India (“RBI”) by the powers conferred on it under the Factoring Regulations Act, 2011 (“Act”) has issued two regulations on 14th January 2022 namely ‘Registration of Factors (Reserve Bank) Regulations, 2022’ (“Registration Regulations”) and ‘Registration of Assignment of Receivables (Reserve Bank) Regulations, 2022’ (“Assignment Regulations”) and in line with the recent amendment in the Act by Government of India. Under the provisions of the Regulations mentioned above, all existing non-deposit taking NBFC-Investment and Credit Companies (NBFC-ICCs) with asset size of INR 1,000 crore & above will be permitted to undertake factoring business subject to satisfaction of certain conditions.

Applicability: Both the regulations shall come into effect immediately, i.e., from 14th January 2022.

Salient features of Registration Regulations: As suggested by their name, the Registration Regulations essentially lay down regulations dealing with registration of factors.

Prerequisites: The Registration Regulations provide that factoring services can be carried out by either an NBFC-Factor or an NBFC-Investment and Credit Company (NBFC-ICC) after having obtained the certificate of registration (“CoR”) from RBI. Prerequisites for making an application to RBI for a CoR for each of the eligible classes are herein below:

1. Prerequisites for NBFC-Factor-:
  1. NBFC-Factor should ensure that its financial assets in the factoring business constitute at least 50% (fifty per cent) of its total assets and its income derived from factoring business is not less than fifty per cent of its gross income;
  2. It should obtain the CoR from RBI.
2. Prerequisites for NBFC-ICC-
  1. It does not hold or accept public deposits;
  2. It should have total assets of at least INR 1000 (one thousand) crore as per the last audited balance sheet;
  3. It should have net owned fund of at least INR 5 (five) crore;
  4. It must be regularly compliant with applicable regulations.

The Registration Regulations further provide that every company seeking a CoR must have a minimum Net Owned Fund (NOF) of ₹5 crore, or as specified by the RBI from time to time.

Any existing NBFC-ICC, which does not satisfy the conditions prescribed in regulation 5(2), but intends to undertake factoring business, shall approach RBI for conversion from NBFC-ICC to NBFC-Factor. Such NBFC-ICCs shall comply with Regulation 4 of the Registration Regulations.
Application for such conversion shall be submitted with all supporting documents meant for new registration as NBFC-Factor, together with surrender of original CoR issued by the RBI to the NBFC-ICC.
Exemptions under section 5 of the Act, with respect to banks, and body corporates established under an Act of Parliament or State Legislature, or a Government Company, continue to be in operation.
NBFC-Factor or eligible NBFC-ICC which has been granted CoR by RBI under these regulations, shall commence factoring business within 6 (six) months from the date of grant of CoR.

Analysis:

The new set of registration conditions have led to the identification two broad classes of registration – an ‘Inclusive Registration’ and an ‘Exclusive Registration’.
It is understood from the Regulations that where an NBFC-ICC acts as a factor, it retains its registration required for its principal business, say, lending and investment, granted by the RBI – the CoR for carrying out factoring services is simply an additional registration that the NBFC-ICC obtains – hence, inclusive in nature.
On the other hand, a registration specifically as an NBFC-Factor implies that factoring is the principal business of such an entity – hence, such a registration is exclusive in nature, implying that the factoring is the exclusive business of such an entity.

Salient features of Assignment Regulations:

The Assignment Regulations contains the norms and the manner of filing of transactions with the Central Registry by a Trade Receivable Discounting System (“TReDS”) on behalf of Factors. As per norms, TReDS on behalf of the factor shall file within 10 days from the date of such assignment or satisfaction with Central Registry (“CERSAI”) the particulars of assignment or satisfaction in prescribed forms. If the particulars as required is not filed within the prescribed time, CERSAI allows an additional time not exceeding ten days, upon payment of the fee as prescribed by GoI in Registration of Assignment of Receivables Rules, 2012 (“Assignment Rules”).

Further, every Form for registration of any transaction relating to assignment of receivables or satisfaction of receivables on realisation shall be accompanied by the fee, as prescribed in the Assignment Rules.

Bottomline:

The Registration Regulations has effectively widened up the space for doing factoring business in India as more and more NBFCs can now participate in the factoring business compared to earlier situation where only certain NBFCs only could operate as factors.

As on January 2022, there are three entities which are operating the TReDS platform in India (namely – RXIL, M1xchange and Invoicemart) and have since collectively discounted invoices worth INR 15,000 (fifteen thousand) crores drawn by 25,000 (twenty five thousand) MSMEs. While the TReDS platforms over the last 3 (three) years has shown potential to provide affordable receivables financing to MSMEs across the country, the MSMEs still face challenges in accessing formal financing channels. The Regulation is a step towards providing (i) operational efficiency for exchange of information, and (ii) timebound reporting of such transactions.

For detailed reading on the Registration Regulations, please click here and for Assignment Regulations, click here on the link.

2. SEBI introduces to Special Situation Funds (SSFs) as a sub-category under Category I AIFs

On December 28, 2021, the Securities and Exchange Board of India (SEBI) had decided to introduce the ‘Special Situation Funds’ (SSFs), as a sub-category of Category I – Alternative Investment Funds (AIFs), by making suitable amendments to the SEBI (Alternative Investment Funds) Regulations 2012 (AIF Regulations). SSFs are conceptualised as funds which would invest only in ‘stressed assets’, as permitted under the AIF Regulations. In furtherance to this, on January 24, 2022, SEBI has notified amendments to the AIF Regulations to include SSFs as a sub-category of Category – I AIFs (as further supplemented by circular dated January 27, 2022 (circular)). The amendments are primarily included as a new Chapter (i.e. Chapter III-B) within the AIF Regulations and define SSFs as Category – I AIFs that invest in ‘special situation assets’, in accordance with its investment objectives and may act as a ‘resolution applicant’ under the Insolvency and Bankruptcy Code, 2016 (IBC).

Applicability: AIF Regulations, was notified on January 24, 2022, and the circular came into force with immediate effect i.e. January 27, 2022.

Salient features of special situation assets:

The ‘special situation assets’ in which SSFs are permitted to invest are:

stressed loans available for acquisition in terms of Clause 58 of Master Direction – Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 (“RBI Master Directions”), or as a part of a resolution plan approved under the IBC or in terms of any other policy of RBI or the Government of India issued in this regard from time to time (hereinafter, the “Eligible Stressed Loans”);
security receipts issued by an Asset Reconstruction Company registered with the Reserve Bank of India;
securities of investee companies:
1. whose stressed loans are available for acquisition in terms of Clause 58 of the Master Direction as amended from time to time or as part of a resolution plan approved under the IBC or in terms of any other policy of RBI or Government of India issued in this regard from time to time;
2. against whose borrowings, security receipts have been issued by an Asset Reconstruction Company registered with RBI;
3. whose borrowings are subject to corporate insolvency resolution process under Chapter II of the IBC;
4. who have disclosed all the defaults relating to the payment of interest/ repayment of principal amount on loans from banks / financial institutions/ Systemically Important Non-Deposit taking Non-Banking Financial Companies/ Deposit taking Non-Banking Financial Companies and /or listed or unlisted debt securities in terms of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 and such payment default is continuing for a period of at least 90 calendar days after the occurrence of such default; Provided that in case of sub-clauses (c) and (d), the credit rating of the financial instruments or credit instruments or borrowings of the company has been downgraded to “D” or equivalent;
Any other asset as may be specified by the Board from time to time.

Other key features of SSFs are as follows:

Investment in SSFs:

The SSFs shall not accept investments from any other Alternative Investment Fund other than a special situation fund.
SSFs are require to have a minimum corpus of INR 100 crore, and that SSFs would have to raise a minimum commitment of INR 10 crore from each investor. This limit is lower for Accredited Investors at INR 5 crore per investor.

Investment by SSFs:

SSFs shall invest only in special situation assets and may act as a resolution applicant under the IBC. SSF intending to act as a resolution applicant shall ensure compliance with the eligibility requirement provided under the IBC. Provided that SSFs can invest in units of other SSFs, but not in associates or SSFs managed or sponsored by the same manager/ sponsor or associates or its manager/ sponsor units of non-SSF AIFs and also not in units of any non-SSF AIFs.
Further, in respect of SSF acquiring stressed loan in terms of Clause 58 of the Master Direction, the following is specified:
1. SSF may acquire stressed loan in terms of clause 58 of RBI Master Direction upon inclusion of SSF in the respective Annex of the RBI Master Direction.
2. Stressed loan acquired by SSF in terms of clause 58 of the RBI Master Direction shall be subject to a minimum lock-in period of six (6) months. The lock in period shall not be applicable in case of recovery of the stressed loan from the borrower.
3. SSF acquiring stressed loans in terms of the RBI Master Direction shall comply with the same initial and continuous due diligence requirements for its investors, as those mandated by Reserve Bank of India for investors in Asset Reconstruction Companies.

Analysis:

SSFs would have the ability to invest in both securities and eligible stressed loans of stressed companies and also subscribe to SRs issued by ARCs. SSFs are also permitted to act as a ‘resolution applicant’ under the IBC through which the SSF can acquire the debt as well as securities, including shares of stressed companies undergoing a corporate insolvency resolution process under the IBC. Therefore, SSFs can be used to provide a complete exit to the lenders and control the revival of the stressed company, without any restriction on investment concentration.

Bottomline:

With SSFs having been introduced as a vehicle in the stressed asset space they are likely to become a suitable funds for foreign investors to acquire both loans and other securities of stressed companies, including in IBC situations.

For a detailed reading on the Circulars, please click here.

3. SEBI notifies Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) (Amendment) Regulations, 2022

On January 14, 2022, SEBI notified The Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) (Amendment) Regulations, 2022 (“2022 SEBI ICDR Amendment Regulations”). It amends certain specific regulations of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018, as amended (“SEBI ICDR Regulations”) based on past learnings of the SEBI. These amendments are aimed at, inter alia, protection of public investors, exits by investors by way of IPOs, etc.

Applicability: 2022 SEBI ICDR Amendment Regulations, was notified on January 14, 2022. Hence applicable to all DRHPs which are proposed to be filed from the date of notification.

Salient features of 2022 SEBI ICDR Amendment Regulations:

Restrictions on IPOs filed under (Regulation 6(2) of the SEBI ICDR Regulations-

SEBI now looks to be seeking to impose certain additional restrictions on non-profitable issuers accessing public funds, with the purported intention of protecting public investors, and hence has introduced the following changes in relation to offer for sale (“OFS”) by shareholders in a public issue by way of the SEBI ICDR Amendment Regulations, 2022:

shares offered for sale to the public by shareholders holding, individually or with persons acting in concert, more than 20% of pre-IPO shareholding of the issuer on a fully diluted basis, shall not exceed more than 50% of their pre-IPO shareholding on a fully diluted basis. Thus, such shareholder is restricted from fully selling its shares in an IPO or even undertaking a secondary sale, in excess of the aforementioned limits, of equity shares not forming part of the IPO;
shares offered for sale to the public by shareholder(s) holding, individually or with persons acting in concert, less than 20% of pre-IPO shareholding of the issuer based on a fully diluted basis, shall not exceed more than 10% of the pre-IPO shareholding of the issuer on a fully diluted basis; and
if the shareholder(s) mentioned in (a) above are alternative investment funds (category I or II) (“AIF”), foreign venture capital investors (“FVCI”) or venture capital funds (“VCF”), such shareholders shall continue to be subject to a 6 month lock in, post the IPO, for the remainder of the equity shares held by them.

It is pertinent to note that the restriction mentioned in (a) above, is capped to 50% of the pre-IPO shareholding of the selling shareholder in the issuer whereas the restriction in (b) is capped to 10% of the pre-IPO share capital of the issuer. Hence, a shareholder in the category falling under (b) can, depending on its shareholding, sell a greater proportion of shares than a shareholder falling under (a). The restrictions place clear restrictions on existing shareholders from exiting completely during/ via an IPO.

Interestingly, the definition of “persons acting in concert” has been linked to the meaning ascribed to such term in accordance with the provisions of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, as amended. Hence, investors in any company going public should be mindful of voting arrangements with other shareholders as the voting rights held by the investor could have an impact on them being categorised as a ‘person acting in concert’ for the purposes of SEBI ICDR Regulations as well and consequently on the quantum of equity shares that may be offered for sale in the IPO. Existing arrangements may need to be revisited before the draft is filed with the SEBI.

Minimum holding period of 6 months of securities held by AIFs, FVCIs and VCFs if applied to bonus issues –

Pursuant to the 2022 SEBI ICDR Amendment Regulations, SEBI has clarified that if bonus equity shares are issued to AIFs, FVCIs and VCFs prior to the filing of the DRHP, then the holding period of the bonus equity shares as well as the underlying equity shares together, must be 6 months for such equity shares to be exempt from the lock-in.

Monitoring of Issue Proceeds-

SEBI has strengthened the post IPO monitoring mechanism of the funds raised under the primary market of the IPO by way of the following measures:

only credit rating agencies registered with SEBI have been allowed to act as monitoring agencies instead of scheduled commercial banks and public financial institutions;
the entire proceeds under the primary component of the IPO is to be monitored instead of 95% of the issue proceeds (as previously required). Proceeds earmarked towards general corporate purposes shall also come under the ambit of the monitoring agency; and
revision in the format of the report to be issued by the monitoring agency to ensure the following below:
verification of sub-heads under each object by the monitoring agency;
verification of documentary evidence by the monitoring agency against each object (including sub-heads); and
inclusion of “general corporate purpose” as a separate heading in the report.

This amendment will provide flexibility to issuers to approach CAs to audit and sign restated financial statements, certify proforma financial statements and issue certificates in case of nonmaterial acquisitions or divestments.

Bottomline:

The 2022 SEBI ICDR Amendment Regulations are primarily a reaction to some of the IPOs of 2021. While some amendments maybe considered a welcome step in the market regulator’s endeavours to ensure growth and development of the Indian securities market, restrictions on secondary components for non-profitable issuers seem to disregard the principle of determination of the fate of an IPO by market forces. Further, the amendments may render an exit option by way of a public issuance less attractive to investors.

The effectiveness of the amendments and the impact of these amendments to listing in India will need to be analysed on their implementation.

For a detailed reading on the Circulars, please click here.

4. Initiation of CIRP is not a pre-requisite to initiate IRP against the personal guarantor

National Company Law Appellate Tribunal (NCLAT) in State Bank of India v. Mahendra Kumar Jajodia held that initiation of Corporate Insolvency Resolution Process (CIRP) is not a pre-requisite to initiate Insolvency Resolution Process (IRP) against the Personal Guarantor of the Corporate Debtor. The Appellant, State Bank of India, who is the financial creditor of the corporate debtor filed an appeal against the order of the adjudicating authority, National Company Law Tribunal (NCLT) Kolkata Bench, which refused to entertain an application under Section 95(1) of the Insolvency and Bankruptcy Code, 2016 (Code) for initiation of IRP against the Respondent/Personal Guarantor, on the ground that the same is pre-mature as CIRP against the corporate debtor had not yet been initiated.

NCLAT observed that, sub-section 2 of Section 60 requires that where a CIRP or liquidation process of the corporate debtor is pending before ‘a’ National Company Law Tribunal the application relating to CIRP of the corporate guarantor or personal guarantor as the case may be of such corporate debtor shall be filed before ‘such’ National Company Law Tribunal. The purpose and object of the sub-section 2 of Section 60 of the Code is that when proceedings are pending in a specific National Company Law Tribunal, any proceeding against corporate guarantor should also be filed before the same National Company Law Tribunal. The idea is that both proceedings be entertained by one and the same NCLT. The sub-section 2 of Section 60 does not in any way prohibit filing of proceedings under Section 95 of the Code even if no proceeding are pending before NCLT.

Bottomline:

The judgement will prove immensely beneficial to lenders in light of the fact that contractually, a creditor has the right to proceed independently against a personal guarantor without first having proceeded against the borrower and a personal guarantor is intended to have the same obligations as a primary debtor. The judgement will further the benefit so available to the creditor.

For detailed reading of the judgement, please click here.