India Inc. Hit By New Deposit Rules!
The Government of India has recently notified Companies Act, 2013 (“CA 2013”), which shall replace the erstwhile Companies Act, 1956 (“CA 1956”). To help understand the changes introduced under the CA 2013, we are undertaking a series of updates on the CA 2013 (“NDA CA 2013 Series”) analyzing the key changes and their implications for all stakeholders by setting out the practical aspects of some of the important changes introduced by CA 2013.
For a quick look at our analyses so far on the changes brought forth by the CA 2013, please refer to our first and second hotlines in this series through this link.
In this third hotline, we analyze sections 73 to 76 under Chapter V of CA 2013, along with the Companies (Acceptance of Deposits) Rules, 2014 (“Deposit Rules”), which lay down the provisions regarding the acceptance of deposits by companies.
Companies aim to secure finance by different cost-effective methods to suit their financial requirements. However, apart from the cost of raising capital often there are other considerations in choosing a particular method of financing over other. Raising money from venture capital, private equity firms or by way of loans from financial institutions is a common practice. However, this form of financing often curtails the freedom of the promoter / company as they have to provide some management or control of the company to the financers. To avoid the loss of management or control, companies preferred to raise money from the public by way of invitation of deposits, although the amounts to be raised through deposits is limited to 25% of the aggregate of the paid-up capital and free reserves. Investing into fixed deposits of companies is a relatively attractive option for public or members of the company as it gives them an opportunity to earn at least 2 – 5% more than fixed deposits with banks. Like CA 1956, CA 2013 also provides the framework under which a company may accept deposits. In this hotline, we aim to briefly discuss the frame work of accepting deposits under CA 2013, the key changes brought about by CA 2013 in comparison to the regime under CA 1956 and the consequential changes.
Framework of accepting deposits
The basic framework for accepting deposits under CA 2013 is largely same except for certain additions provided for enhancing investor protection. CA 2013, like CA 1956, also provides that a public company can accept deposits from its members and other persons, while private companies can accept deposits only from its members (it should be noted that CA 1956 permitted a private company to accept deposits from members, directors or their relatives also).
Further, any company accepting deposits must fulfill certain criteria such as having a minimum networth or a turnover. The criteria under CA 1956 and CA 2013 are briefly discussed in point 3 below.
The definition of the term ‘Deposit’ is different under CA 1956 and CA 2013, however, in principle the meaning is same except the fact that definition under CA 2013 is clearer as the definition includes any receipt of money by a company by way of deposits or loans or in any other form, subject to certain exceptions. We have further discussed the exceptions in point 1 below.
Key Changes under CA 2013
1. Exceptions to the definition of ‘Deposit’
Under the Deposit Rules, large number of exceptions have been retained from the Companies (Acceptance of Deposits) Rules, 1975, for example the exception for an amount received by a company from another company, amount received from foreign investors subject to the provisions of the Foreign Exchange Management Act, 1999 ("FEMA") etc. still continue. However, some additional exceptions are provided under the Deposit Rules, few of them are discussed as follows:
(i) It is provided that the securities application money received by a company shall not be considered as a deposit, only if the securities are allotted within 60 (sixty) days of receipt of such amount or if the amount is refunded within the period of 15 (fifteen) days after the completion of this 60 (sixty) day period. Here it is pertinent to note that while FEMA provided a time limit of 180 days for allotment of securities to foreign investors, CA 1956 did not provide for any such time period.
(ii) Under CA 1956, the amount raised by bonds or debentures was not considered as ‘deposits’ if such bonds or debentures were secured by the mortgage of any immoveable property of the company, wherein the value of the bonds or debentures so issued shall not be more than the market value of such immoveable property, or if such bonds or debentures had an option to convert them into shares of the company. However, with CA 2013, an onerous requirement is provided wherein the bonds or debentures issued by a company should be secured by a first charge or a charge ranking pari passu with the first charge on the assets of the company (excluding the intangible assets) or such bonds or debentures should be compulsorily convertible into shares of the company within 5 (five) years for availing the exemption from the definition of deposits.
(iii) Any advance amount received by a company for its business purposes is deemed to be deposits on the expiry of the 15 (fifteen) days from the date they become due for refund. Also, it is provided that an amount received by the company for supply of goods or provisions of services is required to be appropriated against supply of good or provision of services for within a period of 365 days, failing which it should be refunded within 15 (fifteen) days otherwise the advance amount will be treated as a deposit for the company. The ambiguity arises with the usage of the term ‘appropriate’, as it is not clear if the company is deemed to be compliant with this requirement merely by appropriating the money for procuring raw material etc for the supply of goods or provision of services within 365 days, or is it that the company is required to actually supply the goods or provide these services within 365 days.
2. Increased investor protection
Unlike CA 1956, the CA 2013 now provides the following safeguards to protect the interest of the depositors like the obligation of the company to provide, inter alia, the following additional information in the circular to the members for acceptance of deposits:
Also, CA 2013 provides that the company should (i) maintain a deposit insurance equal to the principal amount of deposits and the interest due thereon, however, the company is required to obtain an insurance for payment of interest upto INR 20,000 only in case of any default in repayment of principal amount and interest thereon, (ii) for secured deposits, create charge on the assets of the company, as a security for the deposits, wherein the total value of security by deposit insurance or by way of charge or by both shall not be less than the aggregate of the deposits accepted and the interest payable (Note: creation of charge may not be mandatory provided the security by deposit insurance is equivalent to the aggregate of the deposits accepted and the interest due thereon. However, this position is not free from ambiguity because of the language under sub clause (d) and (f) of section 73 (2) of CA 2013), (iii) appoint a trustee for depositors, for creating security for their secured deposits in favor of the trustee, and (iv) obtain credit rating of the company at the time of invitation of deposits from the public and shall have an obligation to continuously obtain such ratings every year during the tenure of deposits.
3. Preconditions for accepting deposits by public companies
CA 1956 required that the company should have a net owned fund of more than INR 10 million for accepting public deposits,2 however, CA 2013 provides that a public company should have a net worth of not less than INR 1 billion or a turnover of not less than INR 5 billion. In addition, the public company should have (i) obtained prior consent by way of special resolution for accepting deposits and (ii) filed such resolution with the RoC. However, if the aggregate of the amount of deposits, as proposed to be accepted and existing deposits of the company do not exceed the aggregate of the paid-up share capital and free reserves (excluding temporary loans obtained in the ordinary course of business), the prior consent by way of an ordinary resolution is also sufficient for accepting public deposits.
4. Deposits accepted prior to CA 2013
Section 74 of CA 2013 provides, that with respect to the ‘deposits’ of a company accepted prior to CA 2013, the company should file a statement with the RoC, to mention the details about all the deposits and the interest due thereon. Also, the company is required to repay such deposits and the interest due, within (i) one year from commencement of CA 2013, or (ii) one year from the date when the payments are due, whichever is earlier.3 However, this obligation to repay is not applicable if the company complies with the requirements under CA 2013 and the Deposit Rules, and makes the pending payments when due. However, it remains ambiguous if the term ‘deposit’ under section 74 is meant to derive its meaning from CA 1956 or from CA 2013, the Deposit Rules. The ambiguity arises because explanation to rule 19 of the Deposit Rules specifically refers to CA 1956 also while referring to the term ‘public deposits’ thereby clarifying that the meaning of the term ‘public deposits’ has to be derived from within the ambit of CA 1956 and the rules therein. However, there is no such reference of CA 1956 under Section 74 of CA 2013 when the term ‘deposit’ is used. If it is the intention that the term ‘deposit’ is to be interpreted as per the provisions of CA 2013 and the Deposit Rules, it may have a huge implication under the existing investment agreements where the companies had raised monies by issuance of optionally convertible debentures or if the company has a pending allotment of securities for the securities application money.
Analysis and Conclusion
CA 2013 along with the Deposit Rules call for some significant changes to the investment structures used by the private equity and venture capital firms due to restrictions regarding the securities application money and the optionally convertible debentures. The capital raising may be affected by deposit rules as a deposit, now means, receipt of money by a company and therefore should an acceptance of capital be tantamount to an acceptance of a deposit, the rules relating to acceptance will have to be complied with. The additional compliance requirements will make it difficult for the companies to raise money in a cost effective manner. However, on the contrary the added requirements introduced by the Deposit Rules like the obligation to maintain deposit insurance will be helpful in securing the monies invested by the depositors. Other than that, like most of the new legislations in India, the provision regarding acceptance of deposits bring few ambiguities, some of which are discussed above. India Inc. will have to grapple with these ambiguities till the time necessary clarifications are provided.
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1 Rule 2 (ix) of the Deposit Rules
2 Rule 3(1)(e) of the Companies (Acceptance of Deposits) Rules, 1975
3 Section 74(1) was notified on March 26, 2014 and is effective from April 1, 2014. Hence, it may be assumed that the term ‘commencement of this Act’ under section 74(1) should be considered to be the date of April 1, 2014 only.