NBFCs—Formation, Regulation & Remedies

Raghvendra Singh Raghuvanshi * ****

INTRODUCTION

The article endeavor to address the intricacies involved in the business of Non-Banking Financial Companies (hereinafter to be referred as “NBFC”). It shall cover the law governing the NBFCs, with detailed provisions of law and directions issued by different regulators, right from its formation and functions to the regulation of its operation in the market. It shall also deal in detail with the actions available against the NBFCs in noncompliance with the norms prescribed by different regulators and includes judicial approach towards NBFCs with comparison between NBFCs and Foreign Institutional Investors (FII) followed by the conclusion.

WHAT IS NBFC?

NBFCs are those type of companies which are not banking companies but engaged in the business activities related to loan, finance, investment, leasing, hire-purchase and other fund based activities. These companies are required to comply with the provisions of RBI Act and the rules and directions thereof, in addition to the provisions of Companies Act, 1956.

STATUTORY DEFINITION UNDER THE RBI ACT NBFC is defined under sec. 45-I(f)1 as under:

Sec. 45-I(f): ) “non-banking financial company” means

(i) a financial institution which is a company; (ii) a non banking institution which is a company and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner; *

Final Year Student, National Law Institute University, (NLIU) Bhopal. (raghav_nliu@rediffmail.com) 1 Inserted by Reserve Bank of India (Amendment Act), 1997, w.e.f. 9.1.1997.

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(iii) such other non-banking institution or class of such institutions, as the bank may, with the previous approval of the Central Government and by notification in the Official Gazette, specify. The Act defines ‘Financial Institution’ (FI) u/s 45-I(c) as:

“financial institution” means any non-banking institution which carries on as its business or part of its business any of the following activities, namely :

(i) The financing, whether by way of making loans or advances or otherwise, of any activity other than its own; (ii) The acquisition of shares, stock, bonds, debentures or securities issued by a government or local authority or other marketable securities of a like nature; (iii) Letting or delivering of any goods to a hirer under a hire-purchase agreement; (iv) the carrying on of any class of insurance business; (v) Managing, conducting or supervising, as foreman, agent or in any other capacity, of chits or kuries as defined in any law which is for the time being in force in any State, or any business, which is similar thereto; (vi) Collecting, for any purpose or under any scheme or arrangement by whatever name called monies in lump sum or otherwise, by way of subscriptions or by sale of units, or other instruments or in any other manner and awarding prizes or gifts, whether in cash or kind, or disbursing monies in any other way, to persons from whom monies are collected or to any other person, The definition of FI uses the definition of a Non Banking Institution (NBI) and NBI has been defined under the Act as follows:

Sec.45-I(e) : “non-banking institution” means a company, corporation or co-operative society.”

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Under section 45-I(a) of the RBI Act,1934 ‘business of non banking financial institution2‘, is defined in terms of the business of a financial institution and NBFC.

Sec: 45-I(a) : “business of a non-banking financial institution” means carrying on the business of a financial institution referred to in clause (c) and includes business of a non-banking financial company referred to in clause (f).

An analysis of forgoing provisions reveals that except for specifically notified categories, a company that is a FI, or a NBI receiving deposits, alone would qualify as an NBFC. A further reading of the definitions of FI and NBI reveals that for a company to be an NBFC it should either carry on any of the businesses as enumerated in (i) to (vi) of Sec. 45-I(c) or it should otherwise receive public deposits in any manner.

FUNCTIONS OF NBFCS

More specifically, an NBFC is a company registered under the Companies Act, 1956, and obtained a certificate of registration U/s. 45-IA (5) of the Reserve Bank of India Act, 1934 (hereinafter to be referred as “RBI Act”) and is engaged in the business very much similar to banks and also deals in the business of loans and advances, acquisition of shares/stock/bonds/debentures/securities issued by Government or local authority or other securities of like marketable nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, sale/purchase/construction of immovable property. A non-banking institution which is a company and which has its principal business of receiving deposits under any scheme or arrangement or any other manner, or lending in any manner is also a non-banking financial company (Residuary non-banking company).

2 ibid.

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DIFFERENCE BETWEEN NBFC AND BANK

NBFCs are doing functions akin to that of banks, however there are few differences.

NBFC BANK 1. A NBFC cannot accept demand deposits. 1. A bank can accept demand deposits. 2. . It is not a part of the payment and settlement system and as such cannot issue cheques/Demand Drafts to its customers. 2. A bank can issue cheques/ Demand Drafts to its customers. 3. Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation (DICGC) is not available for NBFC depositors. 3. Deposit insurance facility of DICGC is available for Bank’s depositors and their money is pari passu secured.

FORMATION OF NBFC

An NBFC can be either a private limited company or a public limited company. Section 12(1) of the Companies Act, 1956 provides for the mode of forming incorporated company. 3 The persons who intend to incorporate an NBFC are required to fill in the concerned box in the appropriate Form for incorporating their company as an NBFC thereby complying with the other requirements of the Companies Act, 1956 like drafting of Memorandum of Association, Articles of Association etc.

3 Section 12(1): “Any seven or more persons, or where the company to be formed will be a private company, any two or more persons, associated for any lawful purpose may, by subscribing their names to a memorandum of association and otherwise complying with the requirements of this Act in respect of registration, form an incorporated company, with or without limited liability.”

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A. CERTIFICATE OF INCORPORATION FOR PRIVATE LIMITED COMPANY On the satisfaction of the Registrar of Companies (hereinafter to be referred as ‘ROC’) that the requirements specified in sections 33(1) and 33(2), Companies Act, 1956 have been complied with by the company, he shall retain and register the Memorandum of Association (MOA) and Articles of Association (AOA) and other documents. Section 34(1) casts an obligation on the ROC to issue a certificate of Incorporation, normally within 10 days of the receipt of documents.4

B. CERTIFICATE OF COMMENCEMENT OF BUSINESS FOR PUBLIC LIMITED COMPANY

Private limited company and companies not having share capital may commence its business activities from the date of its incorporation. Public limited companies having share capital are required to obtain, in addition to the certificate of incorporation of public limited company, a separate certificate of commencement of business according to Section 149(2A) of the Companies Act, 1956.

C. CERTIFICATE OF REGISTRATION OF NBFC FROM RBI A company incorporated as an NBFC under the Companies Act, 1956 is mandatorily required to be registered with RBI under section 45-IA of the RBI Act to commence or carry on any business of non-banking financial institution as defined in clause (a) of Section 45 I of the RBI Act.

Section 45-IA, RBI Act reads as:

“Notwithstanding anything contained in this Chapter or in any other law for the time being in force, no non-banking financial company shall commence or carry on the business of a non-banking financial institution without

(a) obtaining a certificate of registration issued under this Chapter 4 Section 34(1): “On the registration of the memorandum of a company, the Registrar shall certify under his hand that the company is incorporated and, in the case of a limited company that the company is limited.”

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(2) Every non-banking financial company shall make an application for registration to the bank in such form as the bank may specify” D. NET OWNED FUND REQUIREMENTS FOR NBFC A company incorporated under the Companies Act, 1956 and desirous of commencing business of Non-Banking Financial Institution as defined under Section 45 I(a) of the RBI Act, 1934 should have a minimum net owned fund of Rs 25 lakh (raised to Rs 200 lakh)5 under Section 45-IA (b), RBI Act, 1934.

What is Net Owned Fund (NOF)?

Explanation to Section 45-IA(7), RBI Act defines NOF as: NOF = Paid up equity capital + Free Reserves Minus (-)

1. [Accumulated balance of loss + deferred revenue expenditure + other intangible assets 2. INVESTMENT in its subsidiaries + companies in the same group + all other NBFCs 3. BOOK value of debentures, bonds, outstanding loans and advances made to its subsidiaries and companies in the same group to the extent such book value exceeds 10% of the aggregate paid up capital and free reserves]. WHO ARE THE REGULATORS?

OBJECTIVE OF RBI IN REGULATORY FRAMEWORK OF NBFC’S

RBI is entrusted with the responsibility of regulating and supervising NBFCs by virtue of powers vested in Chapter IIIB and by sections 45J, 45K and 45 MA of the RBI Act. The regulatory and supervisory objective is to;

5 RBI notification No. DNBS 132/CGM (VSNM)-99 dated 20-04-1999 issued by Department of Non Banking Supervision, RBI (w.e.f April 21, 1999).

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• Ensure healthy growth of financial companies; • Ensure that these companies function as a part of the financial system within the policy framework, in such a manner that their existence and functioning do not lead to systematic aberration; and that • The quality of surveillance and supervision exercised by the Bank over the NBFCs is sustained by keeping pace with developments that take place in this sector of the financial system. A. RESERVE BANK OF INDIA—RELEVANT PROVISIONS The activities of the NBFCs accepting deposits from public are regulated by the provisions chapter IIIB of the RBI Act, 1934. It was generally felt that these provisions were neither adequate to regulate the business activities of these companies nor did they provide adequate protection to the depositors. Therefore, the RBI Act, 1934 was amended as Reserve Bank of India (Amendment) Act, 1997.6 The changes made, in main, relates to as follows:

1. Compulsory registration of NBFCs with RBI with minimum net owned funds (Section 45IA) 2. Maintenance of liquid assets (Section 45IB) 3. Creation of reserve funds and transfer of certain percentage of profits every year to the fund (Section 45IC) 4. Empowering RBI to issue directions (Section 45JA) 5. Issue of directions by RBI to NBFCs and the auditors relating to annual accounts, disclosure of liabilities or any other matter and to order special audit (Section 45MA) 6. Prohibit acceptance of deposits by NBFCs and alienation of assets (Section 45MB) 7. RBI is empowered to file a petition for winding up of an NBFC (Section 45MC) 8. Power to conduct inspection (Section 45N) 9. Power of RBI to impose fine (Section 58G) 6 W.e.f. 09/01/1997

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10. Nomination facility for deposits held by the NBFCs has been introduced on the lines of bank deposits under section 45ZA of Banking Regulation Act, 1943. The primary purpose of this provision is to regulate the acceptance of public deposits by NBFCs of all categories, with a view to safeguard the interest of the depositors. (Section 45QB). A.1 NON-BANKING FINANCIAL COMPANIES ACCEPTANCE OF PUBLIC DEPOSITS (RESERVE BANK) DIRECTIONS, 19987

In the above-said RBI directions, certain restrictions have been put on acceptance of public deposits by the NBFCs.

1. Minimum Credit Rating requirements On and from January 31, 1998,

• No non-banking financial company having Net Owned Fund (hereinafter referred to as ‘NOF’) of twenty five lacs of rupees and above shall accept public deposit unless it has obtained minimum investment grade or other specified credit rating for fixed deposits from any one of the approved credit rating agencies at least once a year Provided that this clause shall not apply to an Equipment Leasing or Hire Purchase Finance Company.

• In the event of upgrading or downgrading of credit rating of any non-banking financial company to any level from the level previously held by the non-banking financial company, it shall within fifteen working days of its being so rated inform, in writing, of such upgrading/downgrading to the Reserve Bank of India. 7 Also Including relevant amended directions inserted in NBFC (APD) Directions, 1998, as Amended by a RBI Amendment Notification w.e.f. March 4, 2003.

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2. Prohibition from accepting demand deposit: On and from January 31, 1998, no NBFC shall accept or renew any public deposit whether accepted before or after January 31, 1998, which is repayable on demand.

3. Period of Public Deposit On and from January 31, 1998, no NBFC shall accept or renew any public deposit whether accepted before or after January 31, 1998 unless such deposit is repayable after a period of twelve months but not later than sixty months from the date of acceptance or renewal thereof.

4. Ceiling On Quantum Of Deposits No equipment leasing company or hire purchase finance company or Loan Company or Investment Company shall, accept or renew public deposit except as provided hereunder: Equipment Leasing Company (EL) or Hire Purchase Finance Company (HPFC) An ELC/HPFC having:

• NOF of twenty five lacs of rupees or more; • Minimum investment grade credit rating; • May accept or renew public deposit, not exceeding four times of its NOF or public deposit up to ten crore of rupees, whichever is lower. Loan Company (LC) or An Investment Company (IC)

An LC/IC having:

• NOF of twenty five lacs of rupees or more; • Minimum investment grade credit rating; and • May accept or renew public deposit not exceeding one and one half times of its NOF Page 9 of 9

5. Ceiling on the rate of interest • On and from March 4, 2003, no NBFC shall invite or accept or renew public deposit at a rate of interest exceeding 11% per annum. • On and from September 18, 2003, no NBFC shall invite or accept or renew repatriable deposits from Non-Resident Indians under Non-Resident (External) Account Scheme at a rate exceeding the rate specified by the Reserve Bank of India for such deposits with scheduled commercial 8

banks.

6. Payment of brokerage On and from January 31, 1998 no NBFC shall pay to any broker on public deposit collected by or through him brokerage, commission, incentive or any other benefit by whatever name called, in excess of 2% of the deposit so collected.

7. Branches and appointment of agents to collect deposits On and from January 13, 2000, no NBFC shall open its branch or appoint agents to collect deposits except as provided hereunder:

An NBFC having the certificate of registration issued by RBI U/s. 45IA, RBI Act, may open its branch or appoint agents if its:

• NOF is up to Rs. 50 crore within the State where its registered office is situated; and • NOF is more than Rs. 50 crore and anywhere in India its credit rating is AA or above • For the purpose of opening a branch, an NBFC shall notify to the RBI of its intention to open the proposed branch; 8 In terms of Notification No.FEMA.5/2000-RB dated May 03, 2000.

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8. Employees Security Deposit An NBFC receiving any amount in the ordinary course of its business as security deposit from any of its employees for due performance of his duties shall keep such amount in an account with a scheduled commercial bank or in a post office in the joint names of the employee and the company on the conditions that

• It shall not withdraw the amount without the consent in writing of the employee; and • The amount shall be repayable to the employee along with interest payable on such deposit account unless such amount or any part thereof is liable to be appropriated by the company for the failure on the part of the employee for due performance of his duties. 9. Safe custody of approved securities Every non-banking financial company shall open a Constituent’s Subsidiary General Ledger (CSGL) account with a scheduled commercial bank, or the Stock Holding Corporation of India Ltd. (SHCIL) or a dematerialized account with a depository through a depository participant registered with the SEBI and keep the unencumbered approved securities required to be maintained by it in such CSGL account or dematerialised

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account.

A.2 PUBLIC DEPOSITS BY PRIVATE LIMITED NBFCs The provisions of section 3(1) of the Companies Act, 1956 have been amended in terms of which the definition of ‘private company’ has been modified. The additional requirement imposed by the amendment for a private limited company is that any invitation or acceptance of deposits from persons other than its members (shareholders), directors or their relatives is prohibited.10

It is advised that the NBFCs, which were hitherto private limited companies and were intending to take or holding public deposits are now public deposit companies under the

9 In pursuance of Section 45-IB of the RBI Act, 1934 and the Notification No. DFC.121/ ED(G)-98, dated January 31, 1998. 10 Inserted by Companies (Amendment) Act, 2000 (w.e.f. 13/12/2000)

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companies Act, 1956. It is presumed that they have done the needful as required of them under the companies Act. They may approach RBI for change in the certificate of registration to reflect the new name as a public limited company.11

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A.3 GUIDELINES FOR ENTRY INTO INSURANCE SECTOR 1. Any NBFC registered with RBI having net owned fund of Rs. 2 crore would be permitted to undertake insurance business as agent of insurance companies on fee basis, without any risk participation. 2. All NBFCs registered with RBI, which satisfy the eligibility criteria given below, will be permitted to set up a Joint Venture (JV) company for undertaking insurance business with risk participation, subject to safeguards. The maximum equity contribution such an NBFC can hold in the JV company will normally be 50% of the paid up capital of the insurance companion a selective basis, RBI may permit a higher equity contribution by a promoter NBFC initially. The eligibility criteria for JV participant will be as under: • The owned fund of the NBFC should not be less than Rs. 500 crore, • The CRAR of the NBFC engaged in loan and investment activities holding public deposits should not be less than 15% and for other NBFCs at 12%, irrespective of their holding public deposits or not, • The NBFC should have net profit for the last three continuous years, • The track record of the performance of the subsidiaries, if any, of the concerned NBFC should be satisfactory. 3. No NBFCs would be allowed to conduct such business departmentally. 4. All NBFCs registered with RBI entering into insurance business on risk participation basis will be required to obtain prior approval of the RBI. 11 RBI Clarification Circular No. DNBS(PD). CC. No. 18/02.01/2001-02, Dated 01-01-2002. 12 Vide Circular DNBS (PD)CC No.13/02.01/99-2000 dated June 30, 2000.

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5. It has now been decided that NBFCs registered with Reserve Bank of India may take up insurance agency business on fee basis and without risk participation, without the approval of Reserve Bank of India13 subject to the following conditions: • The NBFCs should obtain requisite permission from IRDA and comply with the IRDA regulations for acting as `composite corporate agent’ with insurance companies. • The NBFCs should not adopt any restrictive practice of forcing its customers to go in only for a particular insurance company in respect of assets financed by the NBFC. The customers should be allowed to exercise their own choice. • The premium should be paid by the insured directly to the insurance company without routing through the NBFC. • The risks, if any, involved in insurance agency should not get transferred to the business of the NBFC. A.4 MONTHLY RETURN FILING GUIDELINES FOR NBFCS The NBFCs accepting/holding public deposits of Rs.50 crore and above shall be required to file monthly returns to RBI.

NBFCs not accepting/holding public deposits and having assets size of Rs. 100 crore and above will be required to submit monthly returns. The return shall be submitted within seven days of the month following the month to which it pertains. The return certified by statutory auditors may, however, be submitted within seven days of finalisation of final

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accounts.

13 Vide RBI Circular No. DNBS (PD) C.C. No. 35 / 10.24 / 2003-04, dated February 10, 2004. 14 RBI/2005-06/157/ DNBS (RID) C.C. No. 57/02.05.15/2005-06, dated September 6, 2005.

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A.5 BANK FINANCE TO NBFCs The RBI guidelines to provide finance to the NBFCs15 are as under:

• Bank credit to Loan And Investment Companies should not exceed twice the NOF of such companies. • Bank credit to Equipment Leasing And Hire Purchase Companies will continue at the present level of four times the NOF of such companies, provided the company is predominantly engaged in equipment leasing/hire purchase business i.e. at least75% of the companies assets are in the Equipment leasing/hire purchase and 75%of its gross income is derived from these two types of activities as per the last audited balance sheet of the company. • The banks should undertake an immediate review of the credit limits sanctioned to all NBFCs and reassess the limits to ensure that they are within the ceiling limits now prescribed. In cases, where the outstanding are in excess of the reassessed limits so arrived at, the excess borrowings should be reduced within a period not exceeding 30 days form the date of this circular. A.5.1 NO BRIDGE LOANS OR INTERIM FINANCE BE GRANTED TO NBFCs The RBI has issued guidelines16 stating that banks should not grant bridge loans or interim finance against capital/debenture issues and/or in the form of loans of a bridging nature pending raising of long term funds from the market by way of capital, deposits etc. to all categories of NBFCs.

Any such loan or interim finance already granted and outstanding in the books of the banks should be recalled within a period of days, if the agreement entered into by the banks with their borrowers provides for exercising such a right to recall. In case the agreement does not provide for an early recall of such bridge loan/interim finance, banks should ensure that the bridge loan/interim finance stand repaid on the due date.

15 RBI Circular IECD NO. 14/08.12.01/94-95 dated 28-09-1994. 16 ibid.

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A.6 AMALGAMATION/MERGER OF NBFCs WITH BANKS With regard to amalgamation/merger of a NBFC with a bank, it has been decided that in order to ensure that the post-merger bank continues to be in compliance with the legal provisions contained in the Banking Regulation Act, 1949 and other relevant statutes and also the regulatory prescriptions of RBI, banks should obtain prior approval of Reserve Bank of India before initiating steps for amalgamation/merger of a NBFC with the bank.17

A.7 PARTIAL EXEMPTION FROM RBI ACT TO CERTAIN KINDS OF NBFCS A.7.1 Vide the RBI Notification,18 the provisions of section 45IA, 45IC, 45MB and 45MC of RBI Act and provisions of Non Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) directions, 1998,19 the Non Banking Financial Companies Prudential Norms (Reserve Bank) Directions, 199820 shall not apply to any NBFC: 1. Not holding/accepting public deposits 2. Doing the business of insurance, holding a valid certificate of registration issued under Section 3 of The Insurance Act, 1938; 3. Being a stock exchange, recognized under Section 4 of the Securities Contracts (Regulation) Act, 1956; 4. Doing the business of a stock broker or sub-broker holding a valid certificate of registration obtained under Section 12 of the Securities And Exchange Board Of India Act, 1992. A.7.2 The provisions of Sections 45IA, 45IB and 45IC of the RBI Act shall not apply to any NBFC: 1. Notified under section 620A of the companies Act, 1956 known as Nidhi Companies; and 2. Doing the business of chits, as defined in section 2(b) of the Chit Funds Act, 1982. 17 Vide RBI Circular No. DBOD.BP.BC. 89/21.02.043/2003-04, dated 09/06/2004. 18 No. 164/CGM (CSM)-2003, dated 08/01/2003. 19 As contained in Notification No. DFC. 118/DG (SPT)-98. 20 As contained in Notification No. DFC. 119/DG (SPT)-98.

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A.7.3. Government companies falling in the category of NBFCs have also been partially exempted from the applicability of the provisions of RBI Act relating to maintenance of liquid assets and creation of Reserve Fund u/s. 45-IC and the direction relating to acceptance of public deposits (APD Directions of 1998). The registration requirements of these companies will, however, continue to exist. B. FOREIGN EXCHANGE MANAGEMENT ACT (FEMA) FEM (Deposits) Regulations, 2000 framed under Foreign Exchange Management Act, 1999 (FEMA) relate to deposits between a person resident in India and a person resident outside India. It says that a company incorporated in India including an NBFC registered with RBI has been granted general permission to accept deposits from NRIs on repatriation basis.

C. PREVENTION OF MONEY LAUNDERING ACT, 2002 Section 12(1) of the Prevention of Money Laundering Act, 2002 (hereinafter to be referred as ‘PMLA’) lays down following obligations on banking companies, financial institutions and intermediaries. Section 12(1): Every banking company, financial institution and intermediary shall – (a) Maintain a record of all transactions, the nature and value of which may be prescribed, whether such transactions comprise of a single transaction or a series of transactions integrally connected to each other, and where such series of transactions take place within a month; (b) Furnish information of transactions referred to in clause (a) to the Director21 within such time as may be prescribed; (c) Verify and maintain the records of the identity of all its clients, in such a manner as may be prescribed. 21 Director of Financial Intelligence Unit – India.

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Section 12(2): The records referred to in sub-section (1) shall be maintained for a period of ten years from the date of cessation of the transactions between the clients and the banking company or financial institution or intermediary, as the case may be."

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C.1 OBLIGATIONS OF NBFCS UNDER PMLA, 2002—RBI DIRECTIONS Maintenance Of Records Of Transactions NBFCs should introduce a system of maintaining proper record of transactions prescribed under Rule 323, as mentioned below:

1. All cash transactions of the value of more than Rs.10 lacs or its equivalent in foreign currency; 2. All series of cash transactions integrally connected to each other which have been valued below Rs.10 lacs or its equivalent in foreign currency where such series of transactions have taken place within a month and the aggregate value of such transactions exceeds Rs.10 lacs; 3. All cash transactions where forged or counterfeit currency notes or bank notes have been used as genuine and where any forgery of a valuable security has taken place; 4. All suspicious transactions whether or not made in cash and in manner as mentioned in the Rules framed by Government of India under the PMLA, 2002. Information To Be Preserved

NBFCs are required to maintain the following information in respect of transactions referred to in Rule 3:

1. The nature of the transactions; 2. The amount of the transaction and the currency in which it was denominated; 3. The date on which the transaction was conducted; and 4. The parties to the transaction. 22 DNBS (PD). CC 68 /03.10.042/2005-06, dated April 5, 2006. 23 Government of India, Ministry of Finance, Department of Revenue, issued a notification dated July 1, 2005 in the Gazette of India, notifying the Rules.

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D. COMPANIES ACT, 1956 D.1 INTIMATION OF DEFAULT IN REPAYMENT OF DEPOSITS AND INTERESTS TO CLB Section 58-AA (1 & 2) of the Companies Act, 1956 says that-Every company (including an NBFC24) shall intimate to the regional bench of the CLB25 within 60 days from the first day of default in repayment of deposits and interest due thereon. The intimation shall also contain the particulars of the names and address of all small depositors, deposit amount in each case, reasons for non-payment or late payment and shall send Annual Reports and cash flow etc.26 This intimation is to be given on monthly basis.27 It may be noted that a default is deemed to be made in case deposit/interest is not paid even to a single small depositor on the date of maturity.

D.2 CONSEQUENCES OF DEFAULT IN PAYMENT OF DEPOSITS/INTERSTS The following consequences follow in case of default by the company/NBFC in repayment of deposits and interest thereon on due date of maturity:

• The company/NBFC shall not accept or invite fresh deposits or renew existing deposits [Section 58-A(2)(c) and 58-AA(4), Companies Act] • A director of a public company, which has failed to repay its deposits or interests on due date and such default persists for a period of 1 year, shall not be eligible to be appointed as a director of the company and any other public company for a period of 5 years form the date of default. [Section 274(1)(g), Companies Act] • The company/NBFC shall not make any inter-corporate loan or investment or give guarantee or provide security [Section 372A(4), Companies Act] • The company/NBFC shall not, directly or indirectly, purchase its own shares or other securities. [Section 77B(1)(c), Companies Act] 24 Section 58-AA also applies to NBFCs vide a RBI Circular NO. DNBSC (PD) CC No. 18/02.01/2001

2002, dated 1-1-2002. 25 Having jurisdiction over the registered office of the company. 26 However, it is open to the company to submit a scheme for repayment of deposits to small depositors

with full justification and projected cash flow statement for consideration of CLB. 27 Under Section 58-AA (1 & 2) of the Companies Act, 1956.

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NBFCs AND FOREIGN INSTITUTIONAL INVESTORS (FII)—COMPARISON

NBFC FII An NBFC is a company incorporated in A FII may be a company, trust, Asset the Companies Act, 1956 and registered as Management Companies, Pension Funds, a private or public company in India. Mutual Funds, Investment Trusts as Nominee Companies, Incorporated/Institutional Portfolio Managers or their Power of Attorney holders, University Funds, Endowment Foundations, Charitable Trusts and Charitable Societies. FII is always an entity registered outside India. An NBFC is required to obtain a FIIs are required to apply to SEBI in a certificate of registration from the RBI common application form in duplicate. A under Section 45-IA, RBI Act, 1934 to copy of the application form is sent by commence its business as an NBFC. SEBI to RBI along with their ‘No Objection’ so as to enable RBI to grant necessary permission under FEMA. RBI approval under FEMA enables an FII to buy/sell securities on Stock Exchanges and open foreign currency and Indian Rupee accounts with a designated bank branch. No permission from RBI is needed so long as the FIIs purchase and sell on recognized stock exchange. All non-stock exchange sales/purchases require RBI permission.

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An NBFC, inter alia, proposes to lend money/accept deposits from the public and also finance the equipments. FIIs cannot accept deposits from public neither can it commence business like an NBFC by financing the equipments. FII proposes to make investment in India by purchasing/selling the securities of Indian companies. Thus indirectly it lends money to the Indian companies and not the public. Parameters for Registration 1. An NBFC is required to have at least Rs. 200 lacs as minimum Net Owned Fund (NOF) as required by Section 45-IA (b), RBI Act. Parameters for Registration 1. Applicant’s track record, professional competence, financial soundness, experience, general reputation of fairness and integrity. 2. The applicant should have been in existence for at least one year, 3. Whether the applicant is registered with and regulated by an appropriate Foreign Regulatory Authority in the same capacity in which the application is filed with SEBI. There is no fee to be paid by an NBFC to The fee payable for getting a FII registered get the certificate of registration from RBI. with SEBI is US $ 5000. But for getting it registered as a company, the fees payable depends upon the authorized capital of the company at the time of its registration.

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FIIs REGULATION AND MONITORING BY RBI

The Foreign Institutional Investors (hereinafter to be referred to as “FIIs”) are allowed to invest in the securities trade in primary and secondary markets. The FIIs, Non-Residents Indians (NRIs) and Overseas Corporate Bodies (OCBs) may invest in portfolio investments in any of the listed companies (including any listed NBFC) of Indian Stock Exchanges subject to the condition that the aggregate holding of shares/convertible debentures of these institutions put together does not exceed 24% of the issued paid up capital of the company. The ceiling of 24 per cent for FII investment can be raised up to sectoral cap/statutory ceiling, subject to the approval of the board and the general body of the company passing a special resolution to that effect.28

The Reserve Bank of India monitors the ceilings on FII investments in Indian companies on a daily basis. For effective monitoring of foreign investment ceiling limits, the Reserve Bank has fixed cut-off points that are two percentage points lower than the actual ceilings. For instance, the cut-off limit for companies with 24 per cent ceiling is 22 per cent and for companies with 30 per cent ceiling, is 28 per cent and so on.

Once the aggregate net purchases of equity shares of the company by FIIs reach the cutoff point, which is 2% below the overall limit, the Reserve Bank cautions all designated bank branches so as not to purchase any more equity shares of the respective company on behalf of FIIs without prior approval of the Reserve Bank. The link offices are then required to intimate the Reserve Bank about the total number and value of equity shares/convertible debentures of the company they propose to buy on behalf of FIIs. On receipt of such proposals, the Reserve Bank gives clearances on a first-come-first served basis till such investments in companies reach the sectoral caps/statutory ceilings as applicable. On reaching the aggregate ceiling limit, the Reserve Bank advises all designated bank branches to stop purchases on behalf of their FIIs clients. The Reserve Bank also informs the general public about the ‘caution’ and the ‘stop purchase’ in these companies through a press release.

28 In terms of RBI Press Release dated Sept.20, 2001 and FEMA Notification No.45 dated Sept. 20, 2001.

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REMEDIES ENFORCEABLE AGAINST THE NBFCS

A. ACTIONS AVAILABLE AGAINST A DEFAULTING NBFC Very frequently there is news of a scam committed by some financial company. There are cases where the finance company has stopped paying interest and maturity amount to its depositors. The helpless investors, with their dreams shattered, run from pillar to post in search of recourse against these finance companies. Nothing happens, either because the investor cannot afford a lawyer to fight a court case or he is ignorant of the laws. Here I wish to mention certain ways to tackle such a problem and how one can lodge a complaint against the defaulting NBFC.

Firstly, try to collect as many investors as possible for a united action. To collect more people, give your advertisement free of cost in the help line column of various newspapers asking the investors of the defaulting company to telephone you. When you have collected many investors, hold a meeting and collect individual applications from each investor to make a joint complaint.

1. What you have to do is jointly approach the defaulting company with a written application asking for refund of your interest amount and the maturity amount. If you all are not satisfied with the reply of the owner of the defaulting company, then jointly lodge a complaint against the defaulting company with the local Police Department.29 2. Another recourse is that you file a complaint with the appropriate Consumer Forum depending upon the amount involved. 3. One can also file a complaint against the defaulting company with the Reserve Bank of India. 4. Where an NBFC fails to repay any deposit, the Company Law Board (CLB), either on its own or on being approached by a depositor/depositors, may direct the NBFC to repay the deposit forthwith, or within such time and subject to such 29 One can lodge an FIR U/s. 154, Cr.P.C. against the concerned NBFC for cheating, criminal breach of trust, misappropriation of funds etc. These acts are punishable under the Indian Penal Code, 1860.

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conditions as may be specified.30 The aggrieved depositor has to make his application to the concerned CLB Bench, in the prescribed Form No. 4 appended to the Regulation 37 of the Company Law Board Regulations, 1991 u/s. 58A(9) of the Companies Act, 1956. The application is required to be accompanied by a fee of Rs. 50.31

5. In case of non-compliance with the orders of the CLB, the RBI has been authorized to take penal action against the NBFC under Section 58E of the RBI Act, 1934. Non-compliance of order passed is also punishable u/s. 58A(10) of the Companies Act with imprisonment up to 3 years and fine not less than Rs. 500 per day for each day of default. 6. Investors’ complaints relating to NBFCs (Listed) are also dealt with by the Securities and Exchange Board Of India (SEBI). 7. Public Interest Litigation (PIL) can also be filed in a High Court under its writ jurisdiction. B. PENALTY FOR NOT COMPLYING WITH RBI ACT The RBI has been empowered to impose penalty on NBFCs for violation of the provisions of the RBI Act. RBI Act provides that carrying on business without a certificate of registration is an offence punishable with imprisonment of not less than one year, which may extend to five years and with a fine not less than Rs.1 lac, which may extend up to the extent of Rs. 5 lacs.32 For any other contravention, a fine not exceeding Rs. 5000 can be imposed by the Reserve Bank.

Section 58B (4AAA), RBI Act provides that any non-compliance with the order of the CLB is punishable with imprisonment up to three years and a fine of not less than Rs. 50 everyday during which such non-compliance continues.

30 Company Law Board (CLB) is now also vested with additional powers to take action against the defaulting NBFC and to order repayment of deposit. u/s. 45QA of RBI Act, 1934.

31 31

In Edpuganti Bapanaiah v. Nagarjuna Finance Ltd., it was held that the orders of CLB directing repayment of deposits and also for recovering deposits of the company with other companies are enforceable u/s. 634A, Companies Act, 1956. The CLB can fall back on the assistance of the courts of competent jurisdiction for execution of its orders.

32 Section 58B (4A), RBI Act.

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JUDICIAL APPROACH vis-à-vis NBFCs

The ROC has been held to be competent to file a complaint even in the matter of NBFCs. The case before the Madras High Court was that of Vishwapriya Financial Services and Securities Ltd. v. ROC.33 In this case an NBFC issued an advertisement for public deposits. There was a failure to furnish to the Registrar the requisite statement with details. The court said that the question whether the company was exempt from the requirement or whether the statement had to be filed only with the RBI could be gone into at the trial. The court also ruled out the contention that the wording of the advertisement did not amount to an invitation. The ROC was competent to file the complaint.

In Re Hindustan Financial Management34An NBFC was lagging behind in repayments. The suo motu power of the CLB u/s. 45QA of the RBI Act could be exercised in the public and depositors’ interest. The delay in repayments was unavoidable because of very poor inflow of cash. The scheme which was proposed by the company was modified and approved and the company directed to carry out repayments accordingly. Another case in which this power was exercised by the CLB in similar circumstances is Members Of The Public Holding Deposits in Kothari Oriented Finance Ltd. v. Kothari Orient Finance

Ltd.35

In In Re Allianz Capital & Management Services Ltd.36 Using the powers under Section 45QA of the RBI Act, a defaulting NBFC was directed to repay the deposits having regard to the cash flow projection. Certain guidelines were also provided to the company for keeping in mind in implementing the scheme of repayment In Pinna NR v. Commissioner of Police,37 the RBI issued directions to the state government for follow up action against a defaulting NBFC for protecting the interests of depositors.

33 (2002) 108 Comp Cases 160 (Mad). 34 (1999) 1 Comp LJ 344 (CLB-NB). 35 (1999) 1 Comp LJ 149 (CLB-SB). 36 (2000) CLC 592 (CLB-NB). 37 (2000) 3 SCL 340 (AP).

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The Calcutta High Court in its decision in state of State of W.B. v. Union of India38 allowed the Writ Petition filed in the interest of depositors by way of Public Interest Litigation (PIL) and observed that a PIL filed by the State against NBFCs alleging that they were diverting the money of small depositors to subsidiary companies and were unable to return their deposits, the petition cannot be dismissed on the ground of alternative remedy under the companies Act. The provisions of the companies Act can hardly be said to be efficacious remedies for helpless small depositors belonging to the weaker section of the society to get their money with the interest on the basis of which it can be said that such remedies are alternative remedies. In Nagarjuna Finance Ltd., Re,39 an NBFC was given up financing and became an industrial company. The industrial company was not entitled to hold as much deposit as it was holding in its capacity as NBFC. On its application to the CLB, the company was permitted to retain excess deposits and repay them on maturity.

In Dy. Chief Officer, Department of Non-Banking Companies, RBI v. Arihant Finance and Chit Fund P. Ltd.,40 The managing director was held liable to be convicted whebn there was enough proof of the fact that he was running the business of the company in violation of the RBI Guidelines.

In Reserve Bank of India v. D.K. Kapur,41 it was again the case of an NBFC, which failed in repayment of deposits, which was also in contravention of RBI directions. The person sought to be prosecuted was described in the complaint as Executive Director (Finance). The report attached to the complaint stated that he signed salary cheques and was also a signatory of various bank accounts. He also signed agreements on behalf of the company. The court held that the complaint was not to be quashed and maintained the conviction.

38 AIR 1996 Cal 181. 39 (1999) 97 Comp Cases 171. 40 (1991) 2 Comp LJ 128 (Bom). 41 (2001) 105 Com Cases 639 (Delhi).

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In Bari Daob Bank Ltd. v. Union of India,42 Delhi High Court ruled that without obtaining a certificate of registration, An NBFC cannot carry or commence the business of NBFI. it is not permitted to the petitioner bank to convert itself into a NBFC.

In RBI v. Kuber Mutual Benefits Ltd.,43 the Allahabad High Court A company is not entitled to carry on business of non banking financial activity unless it has a certificate of registration issued by RBI.

In Peerless General Finance and Investment Co. Ltd. v. RBI44, the Supreme Court ruled that:

1. RBI can issue directions to NBFCs in respect of matters connected receipts of deposits including rates of interest payable on such deposits. Such power is available to the RBI from Section 45-K(3), RBI Act. Any matter and any field is open for RBI under this Section on which RBI can issue the directions. 2. If RBI issue directions, which provides the procedure for investing deposits received by NBFCs and also provides the way it is to be disclosed in account books, the said directions are covered under Section 45-K(3), RBI Act and are reasonable and are not invalid. In Peerless General Finance and Investment Co. Ltd. v. RBI,45 the Supreme court again ruled that powers of RBI are intra vires in following terms:

1. RBI is competent under Section 45-K(3) to deal with or take appropriate action, as it may deem fit and proper in public interest with regard to deposit or receipt relating to deposits if it so desires. 2. Under the above-mentioned Section, the RBI must be satisfied that it is necessary to issue directions to regulate the credit system of the country to its advantage. 42 AIR 1998 Del 95. 43 (2002) 3 CLC 1105 (All). 44 AIR 1992 SC 1033 45 (1996) 85 Comp Cas 808.

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CONCLUSION AFTER A DEEP RESEARCH RELATING TO MANY ASPECTS OF NBFCS I CAN NOW CONCLUDE THAT the existing governance system with laws and updated guidelines/directions issued

by Reserve Bank of India is doing justice to many viz. The Economy Of The Nation, as the guidelines currently existing have pace with the dynamic commercial economy and the RBI comes up with updated and amended guidelines as and when it is required; The Public, as the RBI guidelines and the different laws governing NBFCs have been vested with many powers and procedures so as to enable the depositors of these NBFCs to enforce their rights; the NBFCs, as the RBI guidelines and the laws governing have generally given bright prospects to the NBFCs. RBI, thus, can be said to be a cautious and active watchman of the financial market, who keeps a vigil on the market and ensures a positive growth of the nation. Emergence of NBFCs in the Indian market has also created alternative of savings to the people but it has always to be borne in mind while investing in the NBFCs that they cannot be compared at all with the Banks and today also Banks are the safest place to deposit/invest money into.

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