The unprecedented and unanticipated business disruption that Covid-19 has brought has sharpened the focus on the importance of conservation and optimum utilisation of cash by various companies. In this context, the requirement for a company to maintain 15% of the value of all non-convertible debentures maturing in a year (“NCD Deposit requirement”) by April 30th of that year in fixed deposits with scheduled commercial banks or other specified investments[1] is likely to be a cause of concern. This is especially true when one considers the negative carry on such funds in a falling interest rate regime as well as the opportunity cost of being able to utilise such available cash for the company’s operations at a time when cashflows of most companies have been drastically impacted.

In a welcome move, the MCA has on June 5, 2020 through issuance of the Companies (Share Capital and Debentures) Amendment Rules, 2020 (“2020 Amendment Rules”)[2] done away with the NCD Deposit requirement for all listed companies (including NBFCs and HFCs) in the context of their issuance of privately placed debentures. This is in addition to the temporary breather which was previously provided by MCA through extension of the timeline for complying with the NCD Deposit requirement, from April 30, 2020 to June 30, 2020.

We examine below: the genesis of the NCD Deposit requirement, the issues which had arisen by virtue of the 2019 amendments, the remedial action taken through issuance of the 2020 Amendments Rules and whether there is a case for further relaxations.

Genesis of the NCD Deposit requirement

While the requirement for companies to create a debenture redemption reserve (“DRR”) through appropriation from the profits of the company is relatively older, the NCD Deposit requirement was first introduced by the MCA in 2013[3] for all companies who were required to maintain DRR. Therefore, by virtue of the NCD Deposit requirement being tagged on to the DRR requirement all cases where companies were exempt from the requirement of DRR were also automatically exempt from the NCD Deposit requirement. The same position was also carried into the rules framed under the Companies Act, 2013 and continued until the introduction of the Companies (Share Capital and Debenture) Amendment Rules, 2019, dated August 16, 2019 (“2019 Amendment Rules”).

2019 Amendment Rules – when cross referencing caused chaos

As noted in the MCA Press Release accompanying the 2019 Amendment Rules, the 2019 Amendment Rules were notified with the objective of providing greater ‘Ease of Doing Business’ for companies in India, reducing the cost of capital raised through debentures and with the expectation that the amendments would significantly deepen the bond market. The 2019 Amendment Rules did provide welcome relief to listed companies by doing away with the DRR requirement in certain cases. However, due to what appears to be an inadvertent cross-referencing error, the 2019 Amendment Rules imposed the NCD Deposit requirement on listed NBFCs and HFCs in respect of privately placed debentures issued by them, which were formerly exempted from this requirement. This was at complete odds with the intent for the 2019 Amendment Rules as expressed in the MCA Press Release as well as the 2019-2020 budget announcements pursuant to which the amendments were made. It was also widely felt that the objective for issuance of the 2019 Amendment Rules would be better achieved if all listed companies which had been exempted from the DRR Requirement were also exempted from the NCD Deposit Requirement.

2020 Amendment Rules – A timely intervention

The 2020 Amendment Rules, by exempting listed NBFCs and HFCs as well as other listed companies from the NCD Deposit Requirement, in relation to privately placed NCDs, have, in addition to restoring the status quo for listed NBFCs and HFCs, gone a step further by exempting even other classes of listed companies from the purview of the NCD Deposit Requirement. MCA’s move also comes in the nick of time as June 30, 2020 was the deadline for these companies to have complied with the NCD Deposit Requirement. The amendment is significant and will assist in freeing up vital cash resources of listed companies which would have otherwise been kept idle and blocked for compliance with the NCD Deposit Requirement.

Case for further relaxations

Even after the 2020 Amendment Rules, unlisted companies (other than NBFCs and HFCs) will still be required to continue to comply with the NCD Deposit Requirement for privately placed NCDs issued by them. It may be worthwhile to consider whether this can also be done away with. While the suggestion of doing away with the NCD Deposit requirement may, at first blush, appear controversial, it may not be as outlandish as it sounds especially in the context of privately placed debentures which are usually subscribed to by institutional players as opposed to retail investors. This is more so when one considers the efficacy or lack thereof of the requirement in its present form. Presently, the NCD Deposit requirement functions more as a compliance requirement rather than something which offers any genuine protection to NCD holders. This is evident from the following:

(i) The NCD Deposit requirement does not envisage the creation of any charge on the investments/deposits made and/or other ring-fencing mechanism which can provide the holders of NCDs any degree of control or ability to appropriate the amounts so deposited;

(ii) As there is no operational control, there is nothing which could practically stop an issuer company who is likely to default, to liquidate and transfer funds out of such investments/deposits;

This seeming irrelevance of the NCD Deposit requirement is also buttressed by the fact that typically the NCD Deposit requirement is not commercially or otherwise construed as a security and is usually not given any weightage whether by rating agencies or investors when assessing a particular NCD transaction.

In conclusion, considering the crippling effect on liquidity that the Covid-19 pandemic has brought, it may also be worth re-examining the utility of the NCD Deposit requirement and consider doing away with it; either altogether or alteast in the context of all private placements irrespective of the nature of the issuer company.

We do hope the above is helpful. Please do not hesitate to reach out to the authors, Gautam Ganjawala (gautam.ganjawala@azbpartners.com) and Karthik Mudaliar (karthik.mudaliar@azbpartners.com) for any clarifications.

Authors:
Gautam Ganjawala, Partner
Karthik Mudaliar, Senior Associate

Footnotes:

[1] In terms of Rule 18(7)(vi) of the Companies (Share Capital and Debentures) Rules, 2014, the NCD Deposit may be maintained in the following investments:
(a) in deposits with any scheduled bank, free;
(b) in unencumbered securities of the Central Government or any State Government;
(c) in unencumbered securities mentioned in sub-clause (a) to (d) and (ee) of section 20 of the Indian Trusts Act, 1882;
(d) in unencumbered bonds issued by any other company which is notified under sub-clause (f) of section 20 of the Indian Trusts Act, 1882.
[2] While the 2020 Amendment Rules are dated June 5, 2020, they will come into operation from the date of publication thereof in the Official Gazette.
[3] General Circular, dated February 11, 2013, bearing reference number no. 11/02/2012- CL-V (A) issued by the Ministry of Corporate Affairs, Government of India.