Author name: CBCL

Doha Bank v. Anish Nanavathy: Hurdle for third-party creditors?

Insolvency Law /

[By Dhruv Kohli] The author is a student of Gujarat National Law University.   Introduction In its judgment dated 9th September, 2022, the principal bench of NCLAT has held that a “Deed of Hypothecation” executed in favour of a third-party creditor is not to be construed as a “financial debt” under the IBC. As a corollary, the bench noted that such a third-party secured creditor shall not be eligible to file its claims as a “financial creditor” and hence neither file an application to initiate CIRP nor be a part of the Committee of Creditors. Interestingly, the bench came to this conclusion on the basis that the deed did not carry an explicit clause to the effect that it is a “guarantee” and hence cannot be construed as a “financial debt”. The author in this article makes an attempt to argue that the judgement of NCLAT is flawed and suffers from non-application of mind. Facts The Appellant (Doha Bank) in the present case had extended a loan facility to Reliance Infratel (Corporate Debtor/CD). The CD along with Reliance Communications Infrastructure (RCIL), Reliance Communications (RCom) and Reliance Telecom (RTL) (collectively who were referred to as “RCom entities”) had further availed loan facilities from various other lenders (referred to as the “indirect lenders”). As a part of the latter facility, all the RCom entities had pooled in all of their assets and created a first pari passu charge over them. In order to create the same, RCom entities had executed a “Deed of Hypothecation (DOH)”. Upon initiation of CIRP against the CD in 2017, the indirect lenders had filed their claim with the RP who accepted their claims and the same were categorized as “financial creditors”. However, this categorization was objected by the Appellant on the ground that the indirect lenders had not extended any “direct loan” to the CD and that DOH was extended only as a part of normal contractual practice and the same cannot be construed as a deed of guarantee. The RP rejected the contention of the appellant, holding that upon a combined reading of the entire DOH, it emerges that there is a covenant to pay upon occurrence of any shortfall or deficiency and the same is to be construed as a contract of guarantee. In appeal, the NCLT too rejected the appellant’s contention by upholding the argument as given by the RP. NCLAT’s Judgment In appeal, the principal bench came to the conclusion that the DOH that has been executed by the CD in favour of the indirect lenders while it does create a security interest, the same cannot be construed as a financial debt under IBC. While coming to this decision, the NCLAT held that section 5(8) of the IBC provides for an “exhaustive list” of what can be construed as “financial debt” and that the DOH does not fall within this ambit. Secondly, the NCLAT also held that to construe an instrument as a contract of guarantee, is to be specifically specified in the initial part or object of the agreement or preamble and not somewhere some wordings are mentioned in the agreement. The bench observed that a clause within the agreement stating that the deficiency will be recouped, cannot be the basis to claim that there exists a contract of guarantee. By upholding this, the NCLAT reversed the judgment of NCLT. Analysis A guarantee as defined under the Indian Contract Act means “a contract to perform the promise, or discharge the liability, of a third person in case of his default”. Therefore, the essential element herein is that there ought to be an obligation to fulfil the obligations of a third party. In the present case, the NCLAT erred in holding that the DOH is not a guarantee under Indian Contract Act. Clause 2 of the DOH specifically provided that each of the chargor(s) had covenanted to pay all the amount that is repayable under the loan facilities. Further clause 5(iii) of the DOH provided that in case there is any shortfall or deficiency even after the sale of the hypothecated assets, all of the chargor(s) specifically agreed to provide for amount to cover this deficiency. What appears from these two clauses is that the CD had not merely created a charge on its assets; instead it had specifically undertaken to pay the amount taken under the facility as well as any shortfall/deficiency that arises. As a general rule, the liability of the surety is co- extensive with that of the principal debtor unless otherwise provided by the contract. Clause 2 and 5(iii) of the DOH prima facie imposed an obligation upon the CD to pay even on behalf of other RCom entities. This transforms the DOH from a mere security interest into a contract of guarantee. In Intesa Sanpaola v. Videocon Industries, the Bombay HC had opined that an undertaking to pay is a guarantee. Further, in the case of IL&FS Infrastructure Debt Fund v. Mcleod Russel India, the NCLT categorically came to the conclusion that a ‘shortfall undertaking’ executed by the parent company of the CD can be construed as a guarantee and the same can be further construed as a financial debt under IBC. Interestingly, the NCLT in Mcleod Russel rejected the argument that since the instrument did not carry the term ‘guarantee’ the same cannot be construed as one. Deriving from the same, in the present case the CD had undertaken to pay under the facility. Even if the facility was not directly taken by the CD, its undertaking to pay under the DOH transformed the document directly into a guarantee. The NCLAT also failed to take into consideration the observation as made by the Insolvency Law Committee report of 2020, wherein, it was categorically mentioned that “by creating a security interest in favour of the creditor, the security provider undertakes to repay the debt owed to the creditor to the extent of the security interest, in the event that the borrower fails to do so. Therefore, just

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Debt Debacle Diplomacy: India’s G20 Stance and Tackling Holdouts in Sri Lanka

Contemporary Issues /

[By Divya Upadhyay] The author is a student of National University of Advanced Legal Studies, Kochi.   Introduction In the wake of the upcoming 18th G20 Summit being hosted by India, debt relief is one of the most significant changes posed to be brought in through India’s presidency for the 2022 – 23 tenure. Prime Minister Narendra Modi has recently highlighted India’s commitment to address matters of sovereign debt restructuring while at the same time decrying the advantage of debt crisis taken by “certain forces” – implying Chinese involvement through its massive lending programme under the Belt and Road Initiative to developing and emerging economies. In the South Asian region, particularly hit has been the Sri Lankan Economy with its external debt posed to reach a record high of  58.5 billion USD in 2023. There is substantial discourse surrounding China’s dual role as the single largest creditor to Sri Lanka and its non – involvement in the multilateral debt resolution process, which has led to a significant lack of transparency. However, there has been relatively little discussion about the ancillary consequences stemming from this situation. China’s avoidance to cut down on Sri Lanka’s debt through writing off, disrupts the larger multilateral process initiated by the International Monetary Fund and Paris Club – an informal group of official creditors, seeking to find sustainable solutions for the debtor nations. The Paris Club operates based on the principle of “comparability of treatment”. This means that a debtor country should not accept less favourable terms from non-Paris Club creditors, such as China, than those negotiated with the Paris Club. In essence, this principle aims to ensure that all creditors are treated equally and that no single creditor, like China in this case, receives preferential treatment. However, China’s unwillingness to participate in debt relief efforts can create a situation where private sector creditors are encouraged to demand more favourable terms from debtor nations. When China does not write off or reduce the debt, it sets a precedent where other creditors, especially private sector ones, may hold out for better repayment terms, further complicating the debt resolution process. Holdout creditors often reject the haircuts (or discounts) taken up by other creditors and insist on the full repayment of their debt. This reduces the debt relief received by the indebted country as well as increases the costs through disruptive individual litigation. Sri Lankan Single Series CAC Problem Thus far, the main policy response to solve this type of creditor coordination problem has been the introduction of Collective Action Clauses (CACs) in sovereign bond contracts. CACs are majority restructuring clauses, that alleviate the creditor coordination challenge by specifying threshold requirements for creditor approval and establishing a voting mechanism, often requiring a majority or supermajority vote. Once the threshold is met, the restructuring plan becomes binding on all creditors, preventing holdouts from obstructing the process. However, restructuring expert, Lee Buchheit has noted that a CAC on some of Sri Lanka’s older dollar bonds gives creditors a potential opening to hold the sovereign nation hostage and stall restructuring negotiations. This is a “single series” CAC, which allows a minority of bondholders to veto or demand terms in the negotiations. Single series CACs typically require a 66 ⅔% or 75% majority in “each individual series” irrespective of the aggregate acceptance rate. In Greece in 2012, in particular, more than half of the foreign-law bonds that had this type of bond-by-bond clauses did not reach the necessary voting threshold, resulting in large-scale holdouts despite CACs. As opposed to this, “enhanced” CACs in Argentina, Ecuador and Ukraine reduced the average duration of a sovereign debt restructuring from 3.5 years to 1.2 years. These enhanced CACs bind all creditors to any deal agreed to by a supermajority of creditors, making it easier to get to a deal, and removing the power of holdouts. Indian Intervention to Avert Hold Out The difficulty in Sri Lanka’s case is that while a majority of its private creditors hail from Western developed economies, the pivotal bilateral creditors originate from Asia. Middle-income countries such as China and India, alongside high-income Japan, wield notable significance. Effective collaboration between official creditors notably China and the Paris Club of Creditors, thus becomes paramount. To avoid a repeat of earlier debt crises and “a lost decade”, restructuring efforts should prioritize write-downs rather than emphasizing maturity extensions and interest rate reductions. The IMF relies on the Debt Sustainability Assessment as its primary tool to evaluate debt sustainability risks. If this assessment indicates the necessity of write-downs to restore sustainability, they should take precedence over other measures like extending maturities and reducing interest rates, a practice observed in China. Past major debt crises in the 1980s and 1990s were only resolved when the focus finally shifted to debt relief through write-downs, first with the Brady Plan and later the Heavily Indebted Poor Country Initiative. However, both these measures primarily accommodated low-income countries. While India through its G20 presidency has expanded the focus to even middle-income countries such as Sri Lanka, it can further establish a local South Asian threshold through its domestic framework. India could take from the three New York proposed legislations, which seek to address some of the challenges that sovereigns face when seeking to restructure their debt. This would address the efforts of some holdout creditors to frustrate or circumvent the consensual resolution of a sovereign debt crisis. The proposed legislations would apply a CAC-style collective voting process to a wide range of New York law-governed debt claims. Assembly Bill A2102A will retrospectively change debt contracts by introducing the statutory collective voting mechanism under a new Article 7 to the New York State Banking Law. This would override any existing CACs to make the mechanism binding. A second bill, A2970 aims to extend “burden-sharing standards” to include private creditors. Under these standards, private creditors would be required to absorb the same level of losses or haircuts, as the U.S. government, acting as a sovereign creditor, when a financially distressed low-income country

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Position of Revival of Company Petition under the Insolvency Bankruptcy Code

Insolvency Law /

[By Akshita Grover] The author is a student of Jindal Global Law School.   INTRODUCTION The Insolvency Bankruptcy Code 2016 was essentially a product of India’s efforts about building a competitive stance in the Ease of Doing Business Index of the World Bank Group. The Code consolidates several pieces of insolvency procedures from different legislations to uniformalise the process of Corporate Insolvency Resolution Processes (CIRP). This process is initiated by a Corporate Creditor via Company Petitions under the Code to ensure the revival of the Corporate Debtor. But sometimes this process is halted when the Creditor & the Debtor sign Consent Terms, wherein the Debtor promises to pay the Creditor and the Creditor thus takes down the process of CIRP by withdrawing the Company Petition. But what if after this legally valid agreement, the Debtor defaults on making the payment? Can this Company Petition then be revived by the Creditor as a recourse, especially because the Code is silent on this mechanism.  Thus, the paper attempts to provide an answer to the legal jigsaw at hand. CAUSE OF ACTION REMAINS POST THE EXECUTION OF THE COMPANY PETITION The Gujarat HC in the case of Gujarat State Financial Services vs Amar Polyester Ltd held that the cause of action in the CP does not survive when Consent Terms by the debtor and creditor are voluntarily signed. The court reasoned that Insolvency Proceedings are initiated in the public interest and not to protect the selective interests of any single creditor. While deliberating on this judgement delivered by the Gujrat HC, the Bombay HC in the case of M/S Corporate Couriers Ltd. vs M/S. Wall Street Finance Ltd felt otherwise and dismissed the applicability of this judgement by holding that the cause of action remains the same and holding that “both parties are aware that the proceedings are not closed and that the company petition would revive in the event there is a default in terms of the consent terms. In our opinion, the company cannot take advantage of its own wrong, more so as in this case where the creditor went out of its way even to reduce its claim….. in such a case, there is no change of cause of action. The cause of action is the cause based upon which the Company Petition was filed, and the company petition admitted. Only further proceedings were not taken in view of the consent terms.”   The Court in this case linked the cause of action to the company petition and not the insolvency proceedings. Thus when the company petition signed voluntarily has not been obeyed by the debtor, then the creditor still has the opportunity of knocking the doors of the court/tribunal to ensure the revival of the petition, giving the cause of action is still surviving. Hence, the point of law taken by Bombay HC is that upon admission of the CP and upon the filing of the consent terms, any failure to comply with the consent terms will revoke the revival of the CP. CONSENT TERMS ONCE LAID BEFORE THE COURT BECOME ENFORCEABLE There are a string of judicial authorities that hold that the laying down of Consent Terms granting liberty to the Tribunal to revive the CP is an essential element strengthening the case for the Creditor to revive the Petition. These authorities strengthen the case of the creditor in ensuring that once the Debtor confirms to pay back, then there is no backing out especially when the judicial authorities are recording this confirmation in their court orders. The NCLAT in the case of Krishna Garg & Anr v. Pioneer Fabricators Pvt Ltd explained the importance of filing the settlement terms before the Tribunal and bringing them on record to ensure that the agreement between the parties is an essential part of the order so that in case of a breach of the terms of the agreement, the Tribunal has the liberty to exercise its liberty. The case of SRLK Enterprises LLP v. Jalan Tran solutions India Ltd. provides more clarity on this proposition by giving the following reasoning that, there is a difference between cases where CIRP proceedings are withdrawn without much reference and acknowledgement of the Settlement Terms, versus cases where CIRP proceedings are withdrawn on the basis of the Corporate Debtor agreeing to the Settlement Agreement; wherein the later gives an explicit liberty to the adjudicating authority and thus necessitates revival. In the case of IDBI Trausteeship Services Limited v. Nirmal Lifestyle Limited, the NCLAT held that the settlement between the parties was well within the Order of court and thus the Consent Terms will be a part of the Court Order and enforceable.  In the case of Pooja Finlease v. Auto Needs (India) Pvt. Ltd. the company petition was withdrawn based on consent terms signed between the corporate debtor and the creditor, post which a default in payment was committed, and an application requesting for revival of the company petition was rejected. The Court again held that because this was not a case where “neither settlement terms were filed nor the same were brought on the record ” rather a case where “Consent Terms were filed and also were taken on record by the Adjudicating Authority” the appeal could be allowed revival of the Company Law petition.   NCLAT in Himadri Foods Ltd vs Credit Suisse Funds Ag held that “It appears that the Terms of Settlement providing a repayment schedule was incorporated in the order thereby making it an order or decree of the Court, and once this was the position, giving liberty to the Financial Creditor to come back can be interpreted on no hypothesis other than that the revival of CIRP would be sought for non-compliance with the Terms of Settlement”. Therefore, once the consent terms are executed in the company petition, which is admitted by the NCLT, they become a part of the court order making it necessary for the parties to comply accordingly. REVIVAL CLAUSES IN CONSENT TERMS MANDATE

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The Analysis of Contradiction Between Penal Charges and Penal Interest with Respect to Borrowers

Banking Law /

[By Yuvraj Sharma & Jatin Patil] The authors are students of School of Law, Narsee Monjee Institute of Management & Studies, Hyderabad.   Introduction On August 18, 2023, the Reserve Bank of India (“RBI”) has recently released fresh directives regarding the imposition of Penal interest rates on loan accounts. These guidelines will affect from January 1, 2024. According to these new guidelines, any penalties incurred by borrowers due to Not adhering to loan terms will be classified as “penal charges” rather than “penal interest”, added to the existing interest rate on the loans. These guidelines, titled “Fair Lending Practice- Penal Charges in Loan Accounts”, also emphasise that penal charges should not be subjected to interest accumulation, effectively preventing additional interest from being calculated on these charges. This blog analyses critically evaluates the benefit and drawbacks of these guidelines and proposed potentials for enhancements for their effectiveness. Background The Reserve Bank of India has issued guidelines to regulated entities to ensure transparency and fairness in disclosing penal interest. The current regulations provide lending institution with the authority to formulate board approved policies governing the application of Penal Interest rates. However, The RBI has observed that a significant number of Real Estate (“RE”) firms levy penal interest rates alongside the regular interest rate for instances of default or non-compliance with credit terms. The purpose of penal interest Is to promote credit discipline among borrowers and ensure equitable compensation for lenders. Not to serve as a revenue enhancement mechanism beyond the contracted interest rate. The Supervisory assessment conducted by the RBI have unveiled a wide range of practices within the real estate sector concerning the imposition of penal charges or interest. This disparity in approaches has given rise to customer grievances and dispute, highlighting the need for standardization and better regulatory oversight. Presently, these rates and charges vary across banks and other lenders. They are applied in scenarios like missed or delayed EMI repayment, check bounces, repayment of loans. The Term “Penal Charges” and “Penal Interest” ‘Penal charges’ represent extra fees imposed by lenders upon borrowers. These charges become applicable when a borrower experience delays in repaying a loan or the equated monthly installment linked to a loan or other financial instruments. These specific of penal charges for payment defaults differ across banks and non-banking financial companies letting standardized guidelines. These charges are usually stipulated in the agreement terms for payment default. Nevertheless, instances have arisen where lenders attempted to impose higher charges than outlined in the agreement as reported by borrowers. ‘Penal Interest’, In the event that the borrower does not receive the installments in accordance with the specified repayment terms by the end of the month, they will incur an additional charge known as Penal Interest on the delayed installments. This practice is designed to ensure timely to ensure repayment and discourage delays in meeting financial obligations. Triggered Reason for RBI Guidelines The Central Bank has issues new regulations due to the discovery that numerous lending institutions it regulates were imposing extra penal interest rates on borrowers who defaulted or failed to comply with the terms of their credit agreements. These regulations state that penal charges should not be compounded, meaning no additional interest should be calculated based on these charges. However, the standard interest compounding procedure for the loan account remains unaffected. The guidelines set by the regulatory authority RBI concerning penal charges for non-compliance with non-contract terms. These guidelines, effective from January 1, 2024, apply to various financial entities under RBI regulation, including commercial banks, cooperative banks and NBFC’s, housing financial companies and board. The guidelines prohibited imposing penal interest as an additional interest rate on top of the loans rate and institute maintained reasonable “penal charges” for breach of loan terms. These charges must be non-discriminatory and proportional to the severity of non-compliance. The instruction requires entities to disclose the nature and amount of penal charges in loan agreements, important terms and their websites. Furthermore, communication of applicable charges and reason is mandatory when notifying borrowers about non-compliance. Existing loans will transition to the new regime. Their next review or renewal date or within six months of the circular effective date. Notably, these rules exclude credit card, external commercial borrowings, trade units and structure obligations which are covered by civil specific product directions. In essence, the RBI mandates that financial entities regulated by it implement guidelines to ensure fair and transparent penal Charges for Loan Non-Compliance while providing clear disclosure to borrowers. The new rules are applicable to various financial institutions under the RBI jurisdiction except for specific financial product outlines in the text. Fostering Equitable Borrowing Practice: Promoting Uniformity and Fairness through new lending guidelines The new guidelines have been introduced with the intention of covering divergent practice among lending institutions and ensuring that borrowers are not burdened with excessive charges for defaults or non-compliance. This progressive step aims to establish uniformity in the penalties being charged, thus preventing the abuse of process. While instances of process abuse have been noted in the past, these guidelines seek to comprehensively address the issue. As stated, the RBI intention in implementing these guidelines is not to employ them as a tool for revenue enhancement beyond the contracted interest rate. The primary objective of achieving uniformity is a crucial step, although it is important to note that these guidelines do not extend to areas such as credit cards external, commercial borrowings, trade credit, etc. This approach is distinctly centered around individual borrowers aiming to safeguard their interest. These guidelines also mandate that both the rational and the quantum of charges must be transparently disclosed to the borrower within the loan agreement. This major ensures the overall well-being of the borrower and is warmly welcomed. Moreover, these guidelines are the purpose of installing senses of credit discipline among borrowers, emphasizing fairness and the paramount factor, these guidelines have been introduced to uphold the principle of fairness Conclusion In conclusion, The Reserve Bank of India has introduced vital guidelines with the

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Navigating the Efficacy of Post-Crisis Legal Reforms of The IL&FC Crises In India

Insolvency Law /

[By Shraddha Tiwari & Tejaswini Kaushal] The authors are students of School of Law Christ University, Bangalore and Dr. Ram Manohar Lohiya National Law University, Lucknow.   Introduction Infrastructure Leasing & Financial Services Limited (“IL&FS”), a distinguished stalwart in infrastructure financing, boasted a legacy spanning over three decades. Functioning as a shadow bank, this non-banking financial company (“NBFC”) emulated the services provided by conventional commercial banks. With its ownership lying substantially in the hands of esteemed state-backed entities and prominent international organizations and boasting an intricate network of subsidiaries coupled with connections with banks, mutual funds, and infrastructure players, it was recognized as a ‘systemically important’ enterprise. It was, somewhat ironically, classified as “too big to fail.” In 2018, the shadow bank faced a liquidity crisis and payment defaults due to a risky combination of short-term debt and imbalances in long-term assets. Compounded by delayed bond issuance, disputes over government payments, and investigations by the Serious Fraud Investigation Office (“SFIO”)and the Enforcement Directorate (“ED”)for procedural lapses and money laundering, the IL&FS crisis sent shockwaves across the stock market. The company’s market reputation suffered, leading to a downgrade in its debt rating, causing concerns among investors such as banks, insurance companies, and mutual funds about its financial stability and potential ripple effects. As the company experienced delays and defaults on its debt obligations and inter-corporate deposits, it ultimately collapsed, worsening existing issues arising from mismanagement in the banking sector and regulatory shortcomings. Evidently, insolvency was IL&FS’s only chance to limit further economic damage. IL&FS, an NBFC established under the Companies Act (“CA”) 2013, faces challenges in efficient insolvency proceedings due to delays and concerns in implementing the recommended ‘Financial Data and Management Centre’ to monitor systemic risk. The proposed Resolution Corporation, meant for crisis resolution, also encountered opposition, leading to the withdrawal of the Financial Resolution and Deposit Insurance Bill 2017 (“Bill 2017”). These issues hinder the smooth functioning of insolvency proceedings for NBFCs. Under the Insolvency and Bankruptcy Code (“IBC”) 2016, IL&FS wasn’t subjected to the insolvency process despite the Central Government’s authority to invoke its Section 2 to refer financial service providers for resolution since NBFCs themselves cannot resort to the IBC owing to their status as financial service providers. However, IL&FS’s non-financial subsidiary entities, such as power and infrastructure projects, could use the IBC individually. However, the complicated connections between group companies and the uncertainty surrounding group bankruptcies were obstacles for a conglomerate like IL&FS in choosing the IBC route. The inability to bring the ultimate holding company, IL&FS, under the purview of the IBC posed a significant obstacle to the resolution process, and the creditor-driven nature of the IBC did not align with the desires of IL&FS’s promoters to retain control and management. Additionally, prior scholarship suggested that IL&FS primarily faces a temporary liquidity issue rather than insolvency, further dampening the desirability of the IBC as a resolution option. The Alternate Route taken by IL&FS The alternate route that IL&FS undertook was of Sections 230, 231 and 232, CA 2013, which offer provisions for schemes of arrangements and compromises, although infrequently utilized in India for debt restructuring purposes. Unlike the UK and Singapore, the schemes of arrangements mechanism have faced limited adoption in India due to cumbersome procedural requirements, lengthy delays, and creditor resistance. However, for IL&FS, this route presented certain advantages over the IBC, given its broader scope and flexibility to tailor the revival plan to the company’s specific needs, encompassing corporate and credit restructuring. Moreover, promoters can retain control throughout the scheme’s implementation, and unlike the IBC, a particular default is not a prerequisite under Section 230 of the CA 2013. This potentially allowed IL&FS to include financially sound entities within the scheme as necessary. Though the best suited for IL&FS, this crisis underscored that the CA 2013 only offered a potential but imperfect solution through a scheme of compromise or arrangement between a company and its creditors or shareholders to reorganize its financial structure. The CA 2013 route entails securing approval from at least 75 percent of secured creditors or shareholders and the National Company Law Tribunal. While it preserves equity rights and provides flexibility for crafting comprehensive solutions, its drawbacks include the absence of explicit provisions for a moratorium or fixed timelines, and the lack of overriding effect over other laws like the Income Tax Act, 1961 unlike resolutions approved under the IBC. Challenges arise from the absence of a comprehensive framework encompassing all classes of creditors and the untested nature of anonymity of schemes in group insolvency scenarios. Additionally, the CA 2013, lacking a moratorium provision like Section 14 of the IBC, does not offer a time-bound resolution, which it reserves solely for specific creditors, and leaves uncertainty regarding the impact of IBC proceedings initiated during the scheme’s NCLT approval. Effect of the Crisis The IL&FS crisis exposed weaknesses in India’s financial regulatory framework, emphasizing the urgent need for comprehensive reforms to manage risks effectively. The default sent shockwaves, impacting NBFCs significantly as they are primary borrowers from banks. Credit rating downgrades affected even stable NBFCs, eroding credit profiles and damaging the overall economy. Investors lost confidence and withdrew investments, leading to a liquidity crunch. The absence of a specific bankruptcy law for financial service providers made the resolution and liquidation processes cumbersome and costly under the CA 2013. This highlighted the critical necessity of implementing a tailored bankruptcy law for such entities. Post-Crisis Legal Reforms The Central Government, by §227 of the IBC 2016, came up with the Bill 2017, but it was withdrawn due to various loopholes. Against the backdrop of the IL&FC crisis, it formulated the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019, for NBFCs. These rules incline more towards the ‘regulator-driven approach’ than the traditional ‘creditor-driven approach’ followed by the IBC. These rules include housing finance companies with asset size of Rs. 500 core or more as per the previously audited balance sheet. The insolvency process

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Inverse ETFs Revisited: A Case for Regulatory Reassessment by SEBI

Capital Markets and Securities Law /

[By Hemant Tewari & Apoorva Singh Rathaur] The authors are students of Dharmashastra National Law University, Jabalpur.   Introduction Exchange Traded Funds (ETFs) stand as mutual fund instruments affording access to an index or a collection of securities, trading on exchanges akin to individual stocks. Investors can seamlessly trade ETF units at prevailing market prices, enjoying exposure to distinct sectors, styles, asset categories, industries, or nations. ETFs offer cost efficiency surpassing conventional open-end funds, coupled with trading flexibility, diversification, and heightened transparency. The buy-and-forget strategy is often forced down retail investors’ throats with all finfluencers standing mighty behind it. As a retail investor, one can buy instruments like mutual funds and ETFs and only hope helplessly that their value increases. But retail investors are left without options when they would want to hedge their portfolios or short-sell securities. Derivatives like futures, options, and short-selling are risky and expensive ways of facilitating your bearish ambitions. On such occasions, Inverse ETFs become the harbinger of financial justice. The goal of inverse exchange-traded funds is to produce returns that are the opposite of those of an underlying index or benchmark. Inverse ETFs use financial derivatives like futures contracts to achieve their inverse performance. They are cheaper as compared to traditional shorting of stocks and using derivatives, with no need of maintaining a margin account or pay a stock loan fee. Daily churning is the norm with inverse ETFs and they are recommended for investors with a short-term view of the index. Currently, Inverse ETFs are not allowed in India and are regulated by SEBI. Introducing inverse ETFs would provide a wider range of financial products to retail investors and can facilitate the development of the market. It would also improve the ease of doing business without compromising the basic tenets of investor protection and risk mitigation in the market ecosystem. Present Standings In India, the first ETF, called Nifty BeEs, was launched in 2002 by Benchmark MF. The ETF industry has matured since then, the number of passive mutual fund schemes in March 2023 was 349, up from 229 in June 2022, representing a 52% increase with a net Asset under management(AUM) upwards of 5 lakh crores. It represents the growing trend of passive investors and the strength of the ETF market. Benchmark MF had submitted a document proposing setting up India’s first Inverse ETF in 2004 but later withdrew the document after it was acquired by Reliance from Goldman Sachs. No such attempts have been made by any AMC since and Inverse ETFs were unable to garner any support from SEBI or any AMC. The Indian Regulator does not allow Inverse ETFs in India. However, the National Stock Exchange(NSE) has two Inverse indices that the AMCs or retail investors can track- NIFTY50 PR 1x Inverse Index NIFTY50 TR 1x Inverse Index Inverse ETFs that track these Indian indices do exist. They are however listed in foreign jurisdictions and not in India. Fubon Asset Management, located in Taiwan, launched the Nifty50 PR 1X Inverse ETF in October 2014. Similarly, in 2016, Hong Kong-based CSOP Asset Management created the CSOP Nifty 50 Daily (-1x) Inverse ETF. Inverse ETFs have grown in developed markets with the introduction of leveraged inverse ETFs wherein a move in any direction in the index is inversely mirrored by 200% i.e. if the leverage is 2x. Recently, Horizons ETF became the first fund to release the Bitcoin inverse ETF called the BetaPro Inverse Bitcoin ETF (“BITI”) on the Toronto stock exchange. The Indian markets also welcomed for the first time, debt ETFs in the markets. Internationally, there are Inverse ETFs for almost all the major global markets e.g. Europe (ProShares UltraShort FTSE Europe), China (Direxion Daily CSI 300 China A Share Bear 1X Shares), Japan (UltraShort MSCI Japan ProShares), Brazil (ProShares UltraShort MSCI Brazil), Emerging Markets (UltraShort MSCI Emerging Markets). There are Inverse ETFs for currencies as well like e.g. ProShares Short Euro (EUFX); which seeks to deliver minus 1x return of EUR over USD. Such developments in developed and emerging markets signify a strong demand for Inverse tracking products and subsequently indicate the robustness of Inverse ETFs. Benefits Inverse index ETFs offer several compelling advantages: Limited Risk: When investing in inverse index ETFs, the maximum potential loss is confined to the unit price of the ETF, similar to purchasing regular stocks. This is a significant improvement over alternative bearish strategies like shorting stocks or utilizing option strategies, both of which can lead to potentially unlimited losses. In this sense, using inverse index ETFs provides a more controlled risk environment. Daily Profit Potential: Investors leveraging inverse index ETFs have the unique opportunity to profit from declining stock prices on a daily basis. This ability to benefit from short-term market movements provides a dynamic approach for capitalizing on bearish trends. Cost-Effective Approach: Inverse index ETFs serve as a cost-effective means to express a bearish stance. Comparable to other exchange-traded funds, they typically maintain low expense ratios. This cost efficiency is particularly valuable for investors seeking to implement tactical strategies without incurring substantial fees. For domestic investors, options for bearish strategies are limited. Shorting stock or index futures is risky. Buying index or stock put options can be easier, but timing the market is challenging due to time value. Additionally, less-traded options and the volatile volatility index are risky alternatives, especially during turbulent times. Foreign Jurisdictions A direct comparison with developed markets might not be the best comparative strategy but comparing Indian markets to such jurisdictions where the markets are somewhat similar in size and socio-political context might help. For example, in Asia, countries like Japan, South Korea, Taiwan, and Hong Kong, have Inverse ETF products where total assets in such instruments at the end of 2022 amounted to about $20bn. The first Inverse ETF in Asia was launched by Deutsche Bank on the Singapore stock exchange tracking the S&P500 index. Outside Asia, New Zealand, and France have allowed Inverse ETFs. Maybank Asset Management is preparing to introduce Malaysia’s inaugural mutual

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India’s Differential Voting Right Structure- A Futile Attempt to Change Corporate Framework?

Company Law /

[By Shyam Gandhi] The author is a student of National Law University, Jodhpur.   INTRODUCTION The introduction of Differential voting rights (DVR) shares was initially facilitated by the Companies (Amendment) Act of 2000. In 2008, Tata Motors became the first business to issue DVR shares. Subsequently, in 2009, the Securities and Exchange Board of India (SEBI) implemented a prohibition on the issuance of ‘Superior Voting Right’ shares due to concerns of potential financial misappropriation by shareholders holding shares with differential voting rights (DVRs). The decision was motivated by the aim of safeguarding minority shareholders from potential tyranny and preventing the consolidation of managerial control within family-owned enterprises. In the year 2019, the Securities and Exchange Board of India (SEBI) implemented a policy reversal by disallowing the issuing of shares with inferior voting rights while simultaneously allowing listed businesses to issue shares with Superior Voting Rights (SVR). Section 43(a)(ii) of the Companies Act permits companies to issue equity shares with differential rights in terms of dividend, voting, or other aspects. These shares are commonly referred to as DVR shares. DVR shares can be categorized into two types: ‘Superior Voting Right’ shares, which grant voting rights beyond the conventional ‘one share, one vote’ principle, and ‘Inferior/Fractional Voting Right’ shares. REINTRODUCTION OF DVR MECHANISM SEBI, the Securities and Exchange Board of India, published a consultation paper on March 20, 2019, on the issuing of DVR shares. The purpose of this document is to address the growing discussion surrounding the necessity of allowing the issuance and listing of shares with DVRs in India. The study underscored the advantages and necessity of DVRs in the context of India’s period of rapid economic expansion, which necessitates firms to secure funds in order to maintain this growth. Moreover, it is worth noting that certain companies that adopt asset light business models may exhibit a preference for equity capital as opposed to debt capital. In order to raise equity capital, these companies may consider the issuance of shares with superior voting rights (SRs) to founders as well as shares with lower or fractional voting rights (FRs) to private or public investors. This approach can be viewed as a feasible alternative for such companies. SEBI approved a framework for the issuance of DVRs, on 27th June 2019. ADOPTING A FLEXIBLE APPROACH On September 28, 2021, SEBI proposed the relaxation of restrictions pertaining to differential voting rights (DVRs) for company founders. This recommendation is intended to enhance the prospects of technology startups, wherein founders often possess minimal ownership stakes in later stages but wield disproportionate control over operational matters. During the meeting, SEBI made the decision to raise the minimum net worth requirement for entrepreneurs and their companies from Rs 500 crore to Rs 1,000 crore. This adjustment aims to grant these entrepreneurs enhanced voting rights within their own companies. Moreover, prior to the present time, corporations were required to observe a waiting period of six months before issuing these shares and submitting their documents for the purpose of being listed on the stock market. Based on the recorded minutes of the meeting, the duration has been reduced to a period of three months. The strategy is based on the model observed at prominent companies in Silicon Valley, such as Facebook and Alphabet’s Google. In this model, investors possess larger ownership stakes than the founders, yet the founders maintain control through the allocation of greater voting rights. Typically, this entails granting the founders 10-20 votes per share, while investors are granted one vote per share. EXISTING CHALLENGES REGARDING CURRENT FRAMEWORK Currently, DVRs mechanism faces several challenges. Firstly, there is a lack of awareness and knowledge regarding the DVR. One of the primary factors contributing to the low level of knowledge about DVR shares is the minimal marketing and educational initiatives that have been made. It is possible that many people who are interested in investing do not have a complete understanding of what DVR shares are and how they operate. People are less inclined to make financial commitments to something they do not fully comprehend if there are not sufficient marketing and education efforts. Secondly, those who are in possession of shares that have superior voting rights may, in some situations and under certain conditions, exploit their influence for the purpose of seeking personal gain or moving themselves closer to their own goals. It is possible that, as a result of this, decisions will be taken that are not in the best interest of the company or the individuals who have a stake in it. Third, companies that are organised in a DVR fashion could run into a number of obstacles when they are attempting to raise capital. If a company does not grant equal voting rights to all of its shareholders, there is a risk that some investors may be hesitant to join that company. Thus, as a consequence of this fact, the business can have a more challenging time generating capital. Lastly, there is an unequal distribution of voting power, which prompts people to worry about the propriety of corporate governance. Shareholders who have greater voting rights than other shareholders may be more likely to make decisions that prioritise their own personal interests above the long-term prosperity of the company as a whole or the interests of other shareholders. This has the potential to result in conflicts of interest as well as assessments that are not in line with the development of long-term value. FAILURE OF DIFFERENTIAL VOTING RIGHTS MECHANISM Even after more than 23 years of operation in India, only a handful of listed businesses have issued DVR shares, despite the fact that DVR Shares were originally established there in 2000. Tata Motors, was the first to opt for the DVR Shares, but recently Tata Motors announced that it will convert the DVR Shares into ordinary shares. The aforementioned action is being undertaken with the intention of streamlining its capital structure. As per the company’s statement, the proprietors of ‘A’ shares, who currently receive superior dividends compared to

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Exploring the Sony-Zee Merger: A Comprehensive Analysis

Mergers & Acquisitions /

[By Jose S Jose] The author is a student of The National University of Advanced Legal Studies (NUALS), Kochi.   INTRODUCTION In a significant stride within the entertainment industry, NCLT (National Company Law Tribunal) Mumbai recently granted approval for the merger of Zee Entertainment Enterprises and Culver Max Entertainment, previously known as Sony Pictures Networks India. This transformative green light not only ushers in the possibility of a formidable entertainment giant commanding about 26% of India’s entertainment market but also beckons the amalgamation of rich content portfolios and industry expertise. However, beneath this promising surface, a series of legal challenges have cast shadows over the merger’s realization, resulting in protracted delays. In this comprehensive analysis, we’ll first explore the intricacies of the Corporate Insolvency Resolution Process (CIRP) proceedings against Zee by NCLT Delhi and the subsequent SEBI (Securities and Exchange Board of India) ban on Punit Goenka, Managing Director of Zee, which have collectively contributed to this prolonged period of uncertainty. Beyond legal matters, we’ll discuss the background of the merger, the strategic agreement between Sony and Zee, and the potential benefits for shareholders and consumers. We’ll also navigate the legal hurdles and strategic intricacies of the Sony-Zee Entertainment merger, ultimately shedding light on the promising future it holds for India’s entertainment landscape. BACKGROUND While industry analysts speculate that the merger could potentially materialize within the next 2 to 3 months, the  timeline remains subject to various factors, introducing an element of uncertainty. In the dynamic landscape of mergers and acquisitions, anticipation is met with caution. The seeds of this partnership were sown back in 2021 when both entertainment juggernauts, Sony and Zee, forged an agreement to pool their expertise, digital assets, and extensive networks. With this ambitious alignment, a new chapter in the entertainment industry seems inevitable. Under the terms of this strategic agreement, the Sony group stands poised to claim a controlling stake of approximately 51% in the nascent entity. Meanwhile, the founders of Zee are set to retain a notable 4% share. The remaining equity will be thoughtfully allocated among the existing shareholders of Zee, allowing for a diversified ownership structure reflective of the company’s roots. This merger is a juncture of strategic relevance, offering manifold advantages for the new conglomerate. By synergizing their strengths, these companies aim to fortify their competitive edge in the market. Beyond boardrooms, shareholders too are poised to reap the rewards, as the merger is anticipated to translate into an augmented value of shares. At the same time, consumers are expected to be the ultimate beneficiaries, as the amalgamation promises an enhanced content palette, catering to an ever-evolving appetite for diverse entertainment experiences. This significant milestone is currently hindered by the legal obstacles that have raised significant concerns. LEGAL IMPEDIMENTS: CORPORATE INSOLVENCY RESOLUTION PROCESS (CIRP) A significant turning point emerged when IndusInd Bank set in motion the process for Corporate Insolvency Resolution Proceedings (CIRP) against Zee Entertainment. The initial salvo was fired with an application filed at the NCLT Mumbai, invoking Section 7 of the Insolvency and Bankruptcy Code (IBC), complemented by Rule 4 of the Insolvency & Bankruptcy (Application to Adjudication Authority) Rules, 2016. Section 7 of the IBC confers the authority upon financial creditors to initiate the corporate insolvency resolution process against a corporate debtor before the NCLT. Meanwhile, Rule 4 of the Application to Adjudication Authority Rules outlines the procedural compass for filing such an application. In this legal overture, IndusInd Bank set its sights on resolving a financial debt that scaled beyond 90 crores—a threshold that bore implications for both Zee Entertainment and the proposed merger. The filing of this application injected a notable pause into the rhythm of the merger’s progression, casting a shadow of uncertainty over its timeline. The unfolding narrative took a series of twists as the legal pendulum swung back and forth. The order initiating the insolvency process issued by the NCLT Mumbai, which carried the resonance of a significant pronouncement, encountered an intermission when it was effectively stayed by an order from the NCLAT Delhi. However, the tide shifted once more as the same judicial forum, the NCLAT Delhi, ultimately terminated the CIRP order. The restoration of movement was prompted by a pivotal development—namely, the emergence of a settlement between the two principal entities involved: Zee Entertainment and IndusInd Bank. Remarkably, the settlement between the two has streamlined the process of merger. DISQUALIFICATION OF DIRECTOR BY SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI) Empowered by the SEBI Act of 1992, the Securities and Exchange Board of India (SEBI) stands as a consequential statutory body entrusted with safeguarding investor interests and fostering the growth of India’s securities market. In a sweeping move, SEBI wielded its regulatory authority to impose bans on two significant figures within the Essel Group—the Chairman, Subhash Chandra, and Zee’s CEO, Punit Goenka. This decisive action was catalyzed by compelling evidence that illuminated a troubling pattern: both individuals had allegedly misappropriated funds through a misuse of their directorial positions. The reverberations of SEBI’s stance echoed beyond its initial pronouncement. This interim ban, effectuated with resolute intent, was upheld by the Securities Appellate Tribunal (SAT). This affirmation cemented the gravity of the allegations and the necessity of the actions undertaken. The consequences rippled across the corporate landscape, throwing into question the identity of the future director of the envisaged merged entity—a role previously slated for Zee’s incumbent CEO, Punit Goenka. This unforeseen hurdle cast a shadow over the merger’s strategic blueprint, inducing fluctuations in market sentiment. The tangible ramifications extended to Zee’s stock price, experiencing a noteworthy reduction. Mandated by SEBI, a probe has been set in motion with the express aim of unravelling the intricate threads that have woven this complex narrative. The investigation’s scope, ambitiously encompassing an 8-month timeline, serves as a testament to the gravity of the situation and the meticulous inquiry required. NCLT APPROVAL OF THE MERGER While the ink on the merger agreement between these two entities was penned and announced back in 2021, the long-awaited

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ESG in Lending Decisions. What is in it for Banks?

Banking Law /

[By Dhanush Thonaparthi] The author is a student of NALSAR University of Law.   Introduction Economic Social and Governance (ESG) policy is a concept of growing relevance among business houses, replacing the more traditional Corporate Social Responsibility (CSR) concept. It is reflected in the legislative and policy space of the government, with the most prominent example of this being the introduction of the Business Responsibility & Sustainability reporting mandated by The Securities and Exchange Board of India (SEBI), for India’s top 1000 listed companies by market capitalization. In this context, the article argues that banks should incorporate the ESG performance of a company alongside other factors when considering a lending decision, with persuasive reasons for the same and examples as to how ESG is already becoming a key factor in credit ratings and lending decisions. What is ESG and how is it relevant for companies?  ESG includes three components, its pillars, namely Environmental, Social and Governance. ESG refers to a set of standards regarding a company’s activities and behavior concerning the components of ESG. These factors, in the corporate context, are used to look at the long-term sustainability of a company. With an increased global push towards environmental consciousness, respecting social considerations, and better governance in companies, this framework becomes important in evaluating a company’s future performance and opportunities. Achieving high ESG standards also becomes important for companies in the context of the stakeholder theory[1], which postulates that corporate success is not dependent only on shareholder and management satisfaction, but also on its relationships with its customers, the Government, creditors, and the public. The long-term survival and profitability of a company depend on it maintaining a good relationship with all its stakeholder groups. This is where ESG standards play an important role, considering that they address the environmental aspect, (which has been a major point of concern across countries and the public) the social aspect (mostly relating to the general public welfare, which is important for a company’s reputation and goodwill) and the governance aspect (better governance instills public and corporate confidence, meaning access to cheaper lending, more and better customers and more investment options). How is ESG relevant to banks when making lending decisions  Banks are financial institutions driven by profit motives and financial considerations. A major concern for banks is non-performing assets and delays in repayments by borrowers, reducing the profitability of the bank. This can lead to unrealized gains and/or unnecessary litigation for recovery, both of which any bank will want to avoid. Therefore, banks would want metrics that help determine whether a lending decision could translate into an unprofitable venture. A key factor that can be incorporated into such metrics is ESG. A review of the literature on ESG as a factor in corporate lending has found that better ESG performance may correlate with lower credit risk, legal risk, and downside risk.[2] Additionally, a survey by Morningstar indicates that better sustainable performance leads to better risk mitigation. We are currently undergoing the largest wealth transfer in history, with experts suggesting that nearly sixty eight trillion dollars of wealth will be transferred to the newer generations. We are in the middle of the largest wealth transfer in history. This is important for financial institutions as millennials fear climate change and would be willing to sacrifice financial benefits in favour of sustainability, and a company that is able to gain a leadership position in sustainability will be more preferred by millennials. Before delving into more specific reasons as to why ESG is important for banks in their lending decisions, we have to, first consider the Environmental pillar of ESG. Companies that are compliant with existing laws and regulations are less likely to be penalized and fined for any potential violation. The future outlook regarding environmental legislation is that it will be more protective of the environment, leading to more restrictions for a company, which translates into more potential liabilities for companies that do not comply and additional costs for compliance. For banks, this becomes important as a compliant company is less likely to incur these additional liabilities that add to the company’s costs. A company that goes beyond legally mandated environmental norms is more insulated from changes in regulation making it less susceptible to changes in legislation. Secondly, the Social pillar of ESG is important for banks, as it helps determine the brand value of the company and to assess how much public goodwill the company enjoys. If companies do not value the rights of people, it leads to public resentment and outcry, which forces the governments to intervene, leading to unnecessary interference and even litigation and reparations. An example in this regard is the case of Facebook. Facebook had to pay nearly 725 million dollars to settle a class action lawsuit after it disclosed that information relating to 87 million users (about twice the population of California) was improperly shared with Cambridge Analytica. Thirdly, Governance is an important pillar for banks to take cognizance of when lending, primarily because better governance means better company performance, a higher level of employee quality, and reliable company disclosures. If a company has bad governance practices, it can spell disaster for banks that choose to make lending decisions based on the company’s financials as disclosed by the company itself. A good example of bad governance translating into unreliable disclosures is the well-known Satyam scandal. In this case, the company had falsified accounts, inflated the share price, and invested enormous amounts in property. Upon admission by the company’s chairman, the fraud became known, leading to a collapse of the market’s reputation and confidence in the company. This is a prime example, demonstrating how dishonest and inefficient governance practices can lead to the collapse of a company, putting lenders at immense risk of their loans turning into non-performing assets or defunct loans. Fourthly, companies must be able to align themselves with the social values of the public and contribute towards the welfare of the society they operate in, because company perception plays

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