Private placement of NCDs for HFCs and the new Companies Act

Will the NHB's directions on private placement of NCDs by HFCs be effective with the near enforcement of Companies Act, 2013?

In what seems to be a clear after thought, Housing finance industry regulator, National Housing Bank (NHB) on 19 March 2014 came up with directions for the issue of non-convertible debentures (NCDs) by housing finance companies (HFCs). With the directions
of Reserve Bank of India (RBI) on issue of NCDs by private placement by non-banking finance companies (NBFCs) issued on 27 June 2013 () (June 2013 Directions) leaving a clear gap, this was an expected move by the NHB.  In this write up we intend to bring out the highlights of the stated directions and also to analyze the impact that the Companies Act, 2013 will create on the effectiveness of these directions.

Why the need for separate guidelines?

The RBI’s guidelines are applicable to NBFCs as defined in Section 45 I (f) read with Section 45 I (c) of the RBI Act, 1934. Therefore, the guidelines are applicable only to the NBFCs registered with the RBI and not to HFCs, though being NBFCs they have to be registered with NHB. Hence, there was a need to come up with specific set of directions for issue of NCDs by HFCs. The gap, earlier created, has now been bridged by NHB through the directions issued on March 19 2014 (“March, 2014 Directions”).

Highlights of March 2014 Directions:

The highlights of the stated directions are:

1. Eligibility Criteria – Only HFCs having net owned funds of Rs10 crore as per the last audited balance sheet are allowed to issue NCDs on private placement.

2. Rating requirement – The NCDs needs to be rated from any of the following credit rating agencies – the Credit Rating Information Services of India Ltd (CRISIL) or the Investment Information and Credit Rating Agency of India Ltd (ICRA) or the Credit Analysis and Research Ltd (CARE), or the FITCH Ratings India Pvt Ltd or Brickwork Ratings India Pvt Ltd or such other agencies registered with Securities and Exchange Board of India (SEBI) or such other credit rating agencies as may be specified by the National Housing Bank.

3. Maturity of the security – The maturity period of the NCDs shall not be less than 12 months, but it should not exceed the validity period of the credit rating, if any. In case of put/call option, the exercise date shall not be within 1 year from the date of issuance.

The NCDs having tenure of less than 1 year are anyways covered by the Non-Convertible Debentures (Reserve Bank) Directions, 2010 , which regulates the issuance of NCDs having maturity of less than 1 year but more than 90 days. Those directions are applicable to all the participants of capital market; hence the HFCs coming out with private placement of NCDs of maturity of less than 1 (one) year are also covered by these directions.

4. Subscription criteria – The maximum number of investors to whom the NCDs can be issued has been restricted to 49, with the minimum subscription being Rs25 lakh for a single investor and in multiples of Rs5 lakh thereafter.

5. Quantum of issuance by the HFC – The maximum amount of NCDs that a HFC can issue is the lower of the following –
   1. Amount as decided by the Board of Directors; or
   2. Amount prescribed by the Credit Rating Agencies, if any.

6. Security – The NCDs will have to be secured at all points of time. If at the time of the issuance, the security cover is insufficient/ not created, the issue proceeds shall be placed under escrow until creation of security, however such security creation shall be completed within 1 month from the date of issue. This direction is not applicable in case the HFC is issuing sub-ordinate debt instruments or hybrid debt instruments. However, the directions are silent with respect to the type of security to be created.

7. Other highlights –

1. A debenture trustee has to be appointed for the issuance of NCDs through private placement.
2. Lending against own debentures has been barred for the HFCs.
3. While issuing other provisions laid down by SEBI (Issue and Listing of Debt Securities) Regulations, 2008, Companies Act, 1956 or any other law that may be applicable.

Impact of the Companies Act, 2013 on the effectiveness of these directions:

The March, 2014 Directions state that HFCs are to comply with all other applicable laws at the time of issuance, so if any HFC issuing NCDs after the Act, 2013 gets enforced, will have to also comply with the provisions of the stated act as well. We detail below the effect that the provisions of Act, 2013 can have on such issuances.

Applicability of Draft Deposit Rules to HFCs

Peculiarly, where the extant Public Deposit Rules, 1975 are not applicable to HFCs, the draft Public Deposit Rules, 2013 seems to have been so ambitiously drafted that it has altogether not considered HFCs at all. To put it simply, the draft Public Deposit Rules, 2013 are applicable to HFCs also.

As per rule number 2 (ix) of the draft Public Deposit Rules, 2013, any amount accepted by the company by way of issuing bonds and debentures without adequate security covered by first charge or charge ranking pari passu to the first charge on any assets which are mentioned in the Schedule III of the Act, 2013, shall be treated as deposits. However, the rules also specify that the debentures which are compulsorily convertible in to equity shall not be treated as deposits in the hands of the issuer.  Thus, issue of NCDs by private placement may be classified as a deposit unless they are adequately secured.

Creation of charge on the issue of NCDs

Though the directions remain silent with respect to the nature of charge to be created by HFCs to back the debentures, but the applicability of the Act, 2013 brings in various complexities. After going through Section 71 of the Act, 2013 and the draft rules, dealing with debentures, what we understand is that NCDs cannot be issued unless it is secured by charge created on specific movable or immovable properties. Mostly, NBFCs issue NCDs secured by receivables and for obvious reasons. We typically cannot expect NBFCs to own a tangible asset. Now since the draft rules under Act, 2013 require charge to be on specific movable and immovable property, HFCs may have to create charge only on any movable or immovable property. This particular provision, which is still in the draft stage, if gets enforced then will impact harshly not only the HFCs but also the entire non-banking financial sector as a whole.

Private Placement of NCDs under Act, 2013

The draft rules of the Companies Act, 2013 with respect to the private placement of securities provides exemption to the NBFCs registered with the RBI from the provisions of Section 42 of the Act, 2013, which deals with the private placement of securities. Though the HFCs are NBFCs, but they are registered with NHB, thus they fall within the purview of Section 42.  The section lays elaborate provisions; some of them have been discussed below:

• • Maximum number of allottees is 50.
   
• • A company cannot come up with a fresh private placement unless allotment with respect to earlier offer or invitations has been made.
   
• • The companies are to allot the securities within 60 days from the date of receipt of application money.
   
• • The companies will not be able to make any advertisements in public that the company is coming out with private placement of securities.
   

If the company accepts any money in contravention of this section then the company, its directors and the promoters shall be liable with a penalty of Rs2 crore or the amount involved in the offer or invitation, whichever is higher. The company will also have to refund the money so collected within a period of 30 days of the order imposing the penalty.

As per the draft rules, the company will also require a special resolution for making an offer or inviting people for issuing securities through private placement. It also states the requirement of an offer document. The Directions, 2014 also talks about the offer document and specifically states that the same should contain the following - address of the Registered Office of the HFC, date of opening/ closing of the issue, maturity period, rate of interest and others. It also states that one single offer document will be valid for a period of not more than 6 months. The rules of the Act, 2013 are of course still in the draft stage and the actual text of finalised rules remains to be seen which is again round the corner.

Given the little room provided by the Act, 2013 to raise funds through NCDs, March 2014 Directions will hardly create any impact on the HFCs’ fund raising through NCDs, both privately and publicly. Instead of concentrating on these directions, they should be more concerned with the bigger problem that they are likely to face in terms of fund raising once the Act, 2013 gets enforced. Needless to say this is a beacon for innovative instruments.

(Abhirup Ghosh is research analyst at Vinod Kothari & Company)