Sunday, 28 December 2014

A bullet point analysis of SEBI's MVL decision under SEBI CIS regulations

Following is a bullet point analysis of the recent SEBI decision in the matter of MVL Limited under the SEBI CIS Regulations, holding that MVL was guilty of operating a collective investment scheme without adequate registrations as per the applicable regulations and Section 11AA of the SEBI Act. This decision is of high importance for real estate developers, investors in real estate sector and also for public at large.
Specific issues identified with the documentation

1.   Application form

a.    Plans are tentative and subject to change;
b.   No specific unit identified;
c.    No option for buyback/lease by the allottee.

2.   Assured return agreement

a.    No specific unit identified either by unit number, floor or otherwise.

3.   Other issues

a.    Layout, plans, maps and charts not part of the agreements;
b.   MVL shall manage the maintenance and upkeep;
c.    Search for competent tenant for first lease by MVL only;
d.   Buy back was found to be not an option but was applicable for all allottees;
e.    High returns promised of up to 96%;

Condition-wise analysis

1.   Condition 1:

The contributions, or payments made by the investors, by whatever name called, are pooled and utilized solely for the purposes of the scheme or arrangement

                                         i.    No unit identified, location not identified;
                                       ii.    Floor not specified;
                                      iii.    Manner of possession, sale etc. by allottee not specified;
                                      iv.    Total project cost was Rs. 216 crores and loan taken was 128 crores.
                         Therefore, the balance was funded by the monies collected from allottees .

Therefore, first condition satisfied, since money taken was used for the scheme.

2.   Condition 2:

The contributions or payments are made to such scheme or arrangement by the investors with a view to receive profits, income, produce or property, whether movable or immovable from such scheme or arrangement

                                         i.    MVL offers assured return;
                                       ii.    No unit identified;
                                      iii.    Allottees invested for profit only.

Therefore, second condition satisfied

3.   Condition 3:

The property, contribution or investment forming part of scheme or arrangement, whether identifiable or not, is managed on behalf of the investors;

                                         i.    MVL manages and carries out construction;
                                       ii.    MVL shall manage maintenance;
                                      iii.    The possession will be handed over only after sale deed.

Therefore, third condition satisfied

4.   Condition 4:

The investors do not have day to day control over the management and operation of the scheme or arrangement

                                         i.    Construction managed by MVL;
                                       ii.    Allottee cannot lease etc. Without consent of MVL.

Therefore, fourth condition satisfied

Other Important Factors

1.      The projects were uniformly priced at different locations and floors which is not possible in a real estate transaction;

2.      MVL continuously defaulted in making assured return payments to allottees and even suggested them to cancel the allotment. SEBI received a number of complaints.

Multiple investments in companies carrying on same business activities by Strategic Investors would require CCI approval

The Competition Commission of India (CCI) has recently opined[1] that “an acquisition of shares or voting rights, even if it is of less than 25 per cent, may raise competition concerns if the acquirer and the target are either engaged in business of substitutable products/services or are engaged in activities at different stages or levels of the production chain. Such acquisitions need not necessarily be termed as an acquisition made solely as an investment or in the ordinary course of business, and thus would require competition assessment, on a case to case basis, under the relevant provisions of the Act”.

Though the aforesaid order appears to have the effect of limiting the exemptions granted in Schedule I of the CCI (Procedure in regard to the transaction of Business relating to Combinations) Regulations, 2011 (“Combination Regulations”), in fact it has only provided clarity to the provisions of point 1 of Schedule I of the Combination Regulations.

Point 1 of Schedule I of the Combination Regulations exempts from the requirements of merger control filing (which otherwise would qualify the threshold limits prescribed under the Act)  an acquisition of shares or voting rights, solely as an investment or in the ordinary course of business in so far as the total shares or voting rights held by the acquirer directly or indirectly, does not entitle the acquirer to hold 25% or more of the total shares or voting rights of the investee company or in accordance with execution of any document including a shareholders’ agreement or articles of association, not leading to acquisition of control of investee company.
Thus, even as the provisions stand today or prior to the aforesaid order, an acquisition of “control”, whether by way of shareholding of more than 25% of the paid up capital of the investee company or by exercising any rights under an agreement would tantamount to exercise of control over the affairs of the investee company would not be exempt from the requirement of a merger control filing. The term “control” is not defined in the Competition Act, 2002 (the “Act”) or the Combination Regulations. However, it appears that the definition of the term “control” as adopted by various other regulators such as SEBI, DIPP/FIPB and MCA would be relevant here. Accordingly, “control” would include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of a shareholders agreements or voting agreements or in any other manner.

Furthermore, it appears from the Order that the CCI has further clarified that the assessment of acquisition of “control” would become more relevant if the acquirer and the target are either engaged in business of substitutable products/services or are engaged in activities at different stages or levels of the production chain. Thus, if the acquisition of “control” by the acquirer over the target is within the same or similar industry/business sector, the likely hood of an appreciable adverse effect on competition in the relevant industry/ business sector is higher and accordingly the same would require an assessment by the CCI.

The principle outlined in the aforesaid Order would, amongst others, largely regulate strategic investments by private equity firms focusing investment in a particular industry/business sector, as also mentioned in certain press statements made by the Chairman of CCI. As per recent news articles[2], “According to the Competition Commission of India (CCI), chairman, Ashok Chawla now the firms will need CCI approval while making multiple investments in a sector, even if the transactions don't breach the prescribed thresholds.”

The aforesaid appears to be a concerted effort by the CCI to restrict growth of monopolistic environment in a particular industry/business sector, which could be an outcome of acquisition of “control” by a single investor in multiple companies operating within the target sector.

Authored by:
Nidhi Arora

RBI November 2014

Notification/Circular no. Date Subject Amendment
DCBR.CO.BPD .(PCB). No 1/14.01.062/2014-15

November 05, 2014 Designated Director – Amendment to Section 13(2) of Prevention of Money Laundering Act (PMLA) In an earlier circular, UCBs were advised that they may nominate a Director on their Boards as ‘Designated Director’ to ensure compliance with the obligations under the Prevention of Money Laundering Amendment Act, 2012. In this connection, it is clarified that UCBs can also designate a person who holds the position of senior management or equivalent as a ‘Designated Director’. However, in no case, the Principal Officer should be nominated as the ‘Designated Director’.
DNBR (PD) CC.No. 002/03.10.001/2014-15
November 10, 2014 Revised Regulatory Framework for NBFC With an intent to review the entire regulatory framework for the NBFC sector over time, certain changes to the regulatory framework are sought to be made to a) address risks wherever they exist, b) address regulatory gaps and arbitrage arising from differential regulations, both within the sector as well as vis-a-vis other financial institutions, c) harmonise and simplify regulations to facilitate a smoother compliance culture among NBFCs, and d) strengthen governance standards. In doing so, certain important recommendations made by the Working Group on Issues and Concerns in the NBFC Sector (Chairperson: Smt. Usha Thorat) and the Committee on Comprehensive Financial Services for Small Businesses and Low Income Households (Chairman: Dr. Nachiket Mor), have been drawn upon. The changes now introduced to the regulatory framework are delineated in the said circular.
DNBR (PD) CC.No. 003/22.10.91/2014-15
November 10, 2014 Review of the Non-Banking Financial Company – Factors (Reserve Bank) Directions, 2012  It has been decided that an NBFC for registering as NBFC-Factor shall ensure that its financial assets in the factoring business constitute at least 50 per cent of its total assets and its income derived from factoring business is not less than 50 per cent of its gross income.
FEMA.326/RB-2014 November 12, 2014 Foreign Exchange Management (Transfer or Issue of any Foreign Security) (Fifth Amendment) Regulations, 2014 The Reserve Bank of India has amended the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004
A.P. (DIR Series) Circular No. 38
November 20, 2014 Acquisition/Transfer of Immovable property – Payment of taxes It has been observed that doubts persist regarding requirement of payment of taxes while undertaking property transactions under Foreign Exchange Management (Acquisition and Transfer of immovable property in India) Regulations, 2000. In this connection, it is clarified that transactions involving acquisition of immovable property under these regulations shall be subject to the applicable tax laws in India.
FEMA.327/RB-2014 November 24, 2014

Foreign Exchange Management (Deposit) (Amendment) Regulations, 2014 The Reserve bank of India has further amended the Foreign Exchange Management (Deposit) Regulations, 2000
A.P. (DIR Series) Circular No. 41
November 25, 2014 Routing of funds raised abroad to India It has come to our notice that some Indian companies are accessing overseas market for debt funds through overseas holding / associate / subsidiary / group companies. It has also been reported that such borrowings are raised at rates exceeding the ceiling applicable in terms of extant FEMA regulations and that the funds so raised are routed to the Indian companies which accounts for sole/major operations of the group. Different modalities/structures are resorted to for channeling such funds for Indian operations including investment in rupee bonds floated by the Indian company. On review of the matter in light of the existing regulatory framework, certain clarifications in this regard has been issued by the Reserve Bank of India.
DCBR.BPD.(PCB).Cir No.3/12.05.001/2014-15
November 27, 2014 Supervisory Action Framework for Urban Co-operative Banks (UCBs) Supervisory Action Framework (SAF) for UCBs was introduced. Having regard to the improvements witnessed by the sector and the need for ensuring more timely supervisory responses, it has been decided to review and revise the supervisory action framework. The main features of this revision are as indicated in the said circular.
_____ November 27, 2014 Guidelines for Licensing of Payments Banks The Reserve Bank of India has released Guidelines for Licensing of payment banks with an objective to increase financial inclusion by providing small savings account and remittance services to migrant labour workforce, low income households, small businesses etc. The eligibility criteria, scope of activities and other such conditions relating to payment banks are outlined in the said guidelines.  
_____ November 27, 2014 Guidelines for Licensing of Small Finance Banks in the Private Sector The Reserve Bank of India has released Guidelines for Licensing of Small Finance Banks in the Private Sector with an objective of setting up small finance banks. The eligibility criteria, scope of activities and other such conditions are contained in the said guidelines. 

MCA November 2014

Notification/Circular no. Date Subject Amendment
G.S.R. 772(E) November 03, 2014 Company Law Board (Fees on Applications and Petitions) Amendment
Rules, 2014. 
The Central Government has further amended the Company Law Board (Fees on Applications and Petitions) Rules, 1991 
General Circular 42/2014 November 12, 2014 Clarification on matters relating to the Companies(Cost Records and Audit) Rules,2014 The Government has received clarification as regards Rules 5 (1) and 6 (2) of the Companies (Records and Audit) Rules, 2014 regarding maintenance of cost records and filing of notice of appointment of the Cost Auditor in Form CRA-2 in electronic mode. In this regard, it has been clarified that considering delay in availibility of Form CRA-2 in electronic mode, it has been decided to extend the date of filing of the said Form without any penalty/late fees  upto 31st January, 2015. It is also clarified with regard to the Companies who have already filed Form 23C need not file fresh form CRA-2 for the financial year 2014-2015. 
General Circular 43/2014 November 13, 2014 Issue of Foreign Currency Convertible Bonds (FCCBs) and Foreign Currency Bonds (FCBs) - Clarification regarding applicability of provisions of Chapter III of the Companies Act, 2013. It has been clarified that the issue of FCCBs and FCBs by companies is regulated by the Ministry of Finance's regulations contained in Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipts Mechanism) Scheme 1993 and RBI through its various directions/regulations. Accordingly, unless otherwise provided in the said Scheme or the directions/regulations issued by RBI, provisions of Chapter III of the Companies Act, 2013 shall not not apply to an issue of a FCCB or FCB made exclusively to persons resident outsde India in accordance with the abovementioned regulations.
General Circular 44/2014 November 14, 2014 Extension of Company Law Settlement Scheme,2014 (CLSS-2014) up to 31/12/2014. The Company Law Settlement Sheme, 2014 (CLS-2014) has been extended upto 31st December, 2014.  
General Circular 45/2014 November 18, 2014 Extension of time for holding Annual General Meeting (AGM) under section 96(1) of the Companies Act, 2013-Companies registered in State of Jammu and Kashmir. The extension of time has been granted to the Companies registered in the State of Jammu & Kashmir who could not hold their AGMs (other than first AGM) owing to unprecedented floods and the devastation caused thereof  for the financial year 2013-14 to hold their AGM upto 31/12/2014.

SEBI November 2014

Notification/Circular no. Date Subject Amendment
CIR/MRD/DP/31/2014  November 12, 2014 Consolidated Account Statement (CAS) for all securities assets Pursuant to the Interim Budget announcement in 2014 to create one record for all financial assets of every individual, SEBI had extensive deliberations with the Depositories, AMFI and RTAs of Mutual Funds (MF-RTAs) to implement it with respect to financial assets of securities market. As a first step in this direction, it has been decided to enable a single consolidated view of all the investments of an investor in Mutual Funds (MF) and securities held in demat form with the Depositories. The Depositories and the Asset Management Companies (AMCs)/ MF-RTAs shall put in place systems to facilitate generation and dispatch of single Consolidated Account Statements (CAS) for investors having MF investments and holding demat accounts. AMCs/ RTAs shall share the requisite information with the Depositories on monthly basis to enable generation of CAS. The manner in which such consolidation of accounts shall be done is also specified in the said circular.
G.S.R. 819(E) November 19, 2014 Securities Contracts (Regulation) (Third Amendment) Rules, 2014  The Central Government has further amended the Securities Contracts (Regulation) Rules,1957.
CIR/IMD/FIIC/ 20 /2014  November 24, 2014 Conditions for issuance of Offshore Derivative Instruments under SEBI (Foreign Portfolio Investor) Regulations, 2014 With a view to align the applicable eligibility and investment norms between Foreign Portfolio Investor (FPI) regime and subscription through the Offshore Derivative Instruments (ODI) route, certain clarifications and conditions subject to which FPI shall issue ODIs have been prescribed. 

"In other words......" - Foreign investment in e-commerce business in India

With the rapid growth of e-commerce business in India, the sector has caught the eyes of the regulators off late. Where, on the one side e-commerce business appears to be one of the most promising sectors in India for foreign investors, as also supported by the Google's annual online shopping growth trends report envisaging the online shopper base in India to reach 100 million by 2016, on the other hand the regulators are harping on whether the existing players are compliant of FDI policies.

The regulator's attention has been attracted mainly due to two reasons, one being the more than required importance given to the question whether retail sector of our country should be thrown open for foreign investment or not and second, whether those who are waiting for it to open would use e-commerce as a via media to bank on the opportunity that exists in our country as far as retail sector is concerned. This has lead to creative structures which the e-commerce companies follow in order to take advantage of the business opportunities which exists in the market and yet remain compliant with the prevailing laws.  

As per the FDI Policy of the country, “e-commerce activities refer to the activity of buying and selling by a company through the e-commerce platform”. Such companies are permitted to engage only in Business to Business (B2B) e-commerce and not in retail trading. The FDI Policy further clarifies that the existing restrictions on FDI in domestic trading are applicable to e-commerce as well.

Foreign investment in retail trading in India is categorised under two heads viz. “single brand product retail trading” and “multi-brand product retail trading”. Foreign investment in single brand product retail trading though permitted up to 49% under the automatic route, it entails compliance of certain conditions. For instance, products to be sold should be of a ‘single brand’ only (i.e. products which are branded during manufacturing), products to be traded in India should also be sold under the same brand internationally, etc. As regards foreign investment in multi-brand retail trading, the same is permitted only up to 51% under the government approval route. In addition to seeking the government approval, certain conditions are also required to be met with, such as minimum foreign investment must be USD 100 million, at least 50% of total FDI brought in the first tranche must be invested in back-end infrastructure within three years, restriction on areas in which sales outlets can be opened etc. Certainly, one can imagine the difficulty of an ecommerce venture being complaint with such conditions.

With such regulations governing retail trading in India which are also applicable on domestic retail trading through e-commerce, it is intriguing how the existing foreign funded e-commerce companies (appearing to be engaged in multi-brand product retail trading) have structured their existence. Broadly, there are two models that have been adopted by these companies in India - Marketplace Model and Inventory Model.

Marketplace Model

In order to avoid huge entry cost of procuring government approval and complying with the minimum capitalisation requirements and other conditions applicable on multi-brand product retail trading, these companies enter the market as a “trading platform” rather than a trader. In this model, the company operates as a purely “online marketplace” which facilitates online sale of goods between buyers and sellers. Sellers enter into an arrangement with the company to canvass their products on the trading platform for securing the sale of their products through the company’s trading platform. In this model, the company also provides supporting services in the nature of advertising services, logistic services, management services etc. and earns ‘service fee’ from the sellers in the form of a commission on per sale basis or any other form of  agreed service fee.  In this model, though the entire sale process is channelized by the marketplace company, the title of the goods to be sold passes on directly from the seller to the ultimate consumers. Since there is no restriction in foreign investment in service sector (including technical services), these companies are operating well within the letter of the law. 

Inventory Model

This model is slightly more intricate and operates under a thin line of differentiating itself from multi-brand retail product trading. In this model, two distinct companies are set up where the promoters and directors of the two companies are completely unrelated. One of the companies is wholly owned and controlled by Indian individuals/entities and operates as the B2C entity. The other company, being FDI funded, operates as the “marketplace” company (as detailed above) and as a B2B wholesale company. The B2B entity procures inventory from various vendors and sells the same on B2B wholesale basis to the B2C entity. The B2C Company then utilises the “trading platform” services and other logistical services provided by the B2B Company for sale of products to the ultimate consumers.

The above model provides maximum value to the foreign investors of the B2B Company, as the revenues generated from wholesale trading as well as the trading platform services rest in the books of the B2B Company.

The two company model is also adopted by companies operating under the “marketplace model” where an “unrelated” retail entity is formed which utilises the trading platform services of the foreign funded company for sale of its products. In this case, the scope of services to be provided by the marketplace entity enlarges to a great extent as a facilitator of procurement of goods in the name of retail entity and sale of such goods to the ultimate consumers through the retail entity. The service fee charged by the marketplace entity in this model covers up nearly 80-90% of the revenue earned by the retail entity on sale of products.

Though the above models have been up and running for quite some time now and appear to be well within the “letter of the law”, the regulators are now probing into the legitimacy of these structures and are lifting the corporate veil to ascertain the bona fides of “unrelated” entities, arms’ length transactions etc.

One other aspect which is still obscure is “international retail trading” by FDI funded e-commerce companies in India. The FDI policy specifically states that “existing restrictions on FDI in domestic trading would be applicable to e-commerce as well”. A probable interpretation of the same could be that only the restrictions on FDI in domestic trading would be applicable to e-commerce activities and consequently there will be no restriction if the e-commerce activity is being carried out with respect to “international” trading.  Accordingly, though the number of companies which have entered into this market is less, such companies operate their international market place business through a separate entity incorporated in India and having a separate website under the same/similar “domain name” with certain suffixes to reflect the international character.

In this model, two separate companies are incorporated in India, each funded by similar foreign investors. One company operates the Indian marketplace website (under the models mentioned above) and the other company operates an international marketplace website. On placing a request for an international order, the Indian website directs the customers to the international website which clearly states that “deliveries of products will be everywhere in the world except India. Further, various terms and conditions on such international website clearly stipulate that orders on the website can be made only by a person resident outside India, for delivery outside India as well as all payments should be made in US Dollars only.

Plausibly, this business activity is not yet prominent as the same is an outcome of a very lenient and convenient interpretation of the provisions of the FDI Policy and basing a business structure on such interpretation may not be feasible in the long run. In light of the past instances of the DIPP and RBI rectifying such errors in the FDI Policy by merely ‘deleting’ certain words or providing express clarifications on certain erroneously mentioned words with retrospective effect, it may not be prudent to base a prospective business structure on such interpretation when the intent of the law is quite apparent otherwise.

At a very nascent stage and besides being under the scanner of regulators, the growing number of consumers resorting to “online shopping” demonstrates mounting projections for e-commerce industry in India.  The e-commerce industry of India is yet another example where the industry demands will shape up the regulations and require the regulator to take a pragmatic view and finally the policy and industry will speak the same language using same words.  

Authored by:-
Nidhi Arora

Akshat Pande