The financial year 2013-14 has witnessed a significant number (by value and volume) of non-convertible debenture (NCD) issuances. There are many factors which could account for this, including lagging equity markets in the first quarter of the year, regulatory clarifications in the previous year from both the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) permitting Foreign Institutional Investor (FII)/Qualified Foreign Investor (QFI) investment in primary issuances of NCDs, permitting the use of corporate debt as collateral in futures and options, and permitting/regulating the use of shelf-disclosure documents to reduce the “time-to-market” for NCD issuances. As tacit recognition of the impact of NCDs on corporate India, the RBI increased the limit for foreign investors in corporate debt by $1.5 billion to $52.5 billion. In this backdrop came the new Companies Act, 2013 and its rules (New Act).
The New Act contains some key provisions which impact the NCD market. A significant number of provisions of the New Act have been notified into law with effect from 1 April 2014. Some of the provisions under the New Act which impact the NCD market are discussed here.
Becoming a listed company: The New Act treats, as a “listed company”, a company which has issued and listed NCDs on a recognized stock exchange. Some of the implications of this are that:
- every public company with listed NCDs is required to have 1/3rd of its board as independent regardless of the value of the paid-up share capital or borrowings of that public company; and
- every listed company (including a private company with listed NCDs) (a) is required to appoint one woman director within one year of commencement of Section 149 of the New Act and (b) may be required to appoint one small shareholder director.
These provisions of the New Act may dampen the market for listed NCDs which are privately placed with FIIs/QFIs by private companies and small public companies. Under Indian law, FIIs/QFIs are only permitted to invest in NCDs if they are listed or committed to be listed within 15 days. Private companies and small public companies looking to privately place NCDs with FIIs/QFIs are evaluating the obligations placed on a “listed company” under the New Act.
100% security cover: The New Act provides that no company can issue secured NCDs unless they are secured by the creation of a charge on the assets of the issuer “having value "sufficient for the due repayment of the principal amount and interest on the NCDs”. Unless clarified this appears to be a 100% security cover requirement. Presently, the 100% security cover requirement does not apply in all cases or to all issuers, for e.g. the RBI requires that any NBFC issuing NCDs is required to ensure 100% security cover. Corporate India would prefer for this requirement to not apply to private placements allowing the market to approve of the security being offered. Given that this requirement is enshrined in the rules, it would be easier to amend and not require approval from Parliament.
Share pledges not recognised as security: The rules under the New Act for issuance of “secured debentures” do not recognise debentures secured by way of share pledges as “secured debentures”. In devising a security package for NCDs, investors need to be mindful of using share pledge security and the impact, if any, that these rules have on the enforceability of such share pledges.
Restricted use of securities premium account: Under the Companies Act 1956, issuers often used their securities premium account to provide for the redemption premium on NCDs. The New Act prohibits such use for a class of issuers which is yet to be prescribed by the Government. Since the class of issuers to which this provision applies has not yet been prescribed and since there is no grandfathering of this provision, it is unlikely to distort the market for NCDs significantly prior to Government notification on which class of issuers this restriction relates to. However, issuers who seek to reduce their coupon burden by loading the redemption premium on NCDs should keep an eye on this provision.
Compliance with private placement norms: The New Act has introduced a specific provision on “private placements” which also applies to private placement of NCDs. The key requirements of a private placement are:
- the issuer is required to prepare an offer letter;
- the issuer is required to procure the prior approval of its shareholders by way of a special resolution (in the case of NCDs one special resolution in a year suffices);
- the offer for private placement cannot be made to more than 200 persons in the aggregate in a financial year;
- a return specifying, inter alia, the name of NCD holders, is required to be filed with the RoC within thirty days of allotment; and
- the issuer is not permitted to publicise or market the offering to the public at large.
If the provisions of a private placement are not complied with, the offer is deemed to be a public offer and the provisions of applicable SEBI regulations are required to be complied with, which, as we know, are onerous in nature.
Private debt (as opposed to private equity) investment: Private equity (PE) players have increasingly used NCDs as their investment route. The terms and conditions of the NCDs can provide equity-like affirmative right protection to protect the value of the investment (i.e. the NCDs). In addition, return on NCDs may be linked to performance of underlying equity securities by the issuance of market-linked NCDs, which are regulated by SEBI. Also, the treatment of compulsorily convertible preference shares (CCPS), the other preferred choice for PE investment, under the New Act and its rules, may distort the market into preferring NCDs instead. These rules require that where CCPS are preferentially allotted by an unlisted company, the price of the resultant shares into which the CCPS are convertible, needs to be fixed up front on the basis of the valuation report of a registered valuer. In most cases it is difficult, and indeed self-defeating, to have this price fixed up-front. NCDs, like CCPS, mitigate the insolvency risk, and can provide some of the benefits of an equity investment.
The deepening of the corporate debt market in India is a much overdue phenomenon and has resulted in more funding avenues for corporate India and investors alike. The effort of the Government to reboot Indian corporate law needs to be lauded. I am sure that the new Government will, with the same vigour, address some of the unintended consequences that have crept into the New Act and its impact on NCDs.