Rigors of The Banning of Unregulated Deposit Scheme Ordinance, 2019 – realignment of financial transaction

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Rigors of The Banning of Unregulated Deposit Scheme Ordinance, 2019 – realignment of financial transaction

The Banning of Unregulated Deposit Schemes Ordinance, 2019 (Act)

Deposit schemes are of two types:

  1. Unregulated Deposit Scheme
  2. Regulated Deposit Scheme

Unregulated Deposit Scheme – Banned

  1. The Act comes in force at once with effect from 21st February, 2019 (Section 1(3)). This will mean that the Ordinance shall not have retrospective application and shall not apply to transactions which have taken place prior to the Act coming in force which shall continue to be governed by the law as it existed prior to the Act coming in force.
  2. Section 3 prohibits all Unregulated Deposit Schemes. It states that

no Deposit Taker shall,

directly or indirectly, promote, operate, issue any advertisement soliciting                             participation or enrolment in

or accept Deposits

in pursuance of an Unregulated Deposit Scheme.

  1. Therefore, the Act shall not apply to a Regulated Scheme. A synopsis of a regulated scheme as it appears in First Schedule of the Ordinance is attached at Appendix A. Interestingly, all of the schemes covered in the said list inherently involve entities which are primarily in the business of receiving deposits and deploying them by way of lending and other wise.
  1. The provisions of the Act shall apply only to an Unregulated Deposit Scheme which is defined by section 2(17) as follows:

A Scheme or an arrangement (either)

under which

           deposits  (defined separately) are

           solicited or accepted ( mutually exclusive words)

by a deposit taker (defined separately)

          by way of business ( not defined anywhere and most critical) and

which is not a regulated scheme (as specifically defined in the Ordinance)

  1. The definition of an Unregulated Deposit Scheme is critical and the following test has to be passed by a transaction for it to be covered by the Act:

(i) It is a scheme or an arrangement. As per Law Lexicon, the term ‘scheme’ shall mean a plan, or a proposal. As per Oxford dictionary, a ‘scheme’ shall mean a systematic  arrangement, plan or an outline. It will therefore, involve a proposal for  several persons. However, an ‘arrangement’ can even be between two parties not necessarily involving  multiple persons.

(ii)The transaction is unregulated i.e. not a ‘regulated scheme’ as enlisted in the First Schedule to the Act. All Regulated Schemes are outside the purview of the Act.

(iii)The transaction involves solicitation or acceptance of Deposit. Both  solicitation (whether received or not), and acceptance (whether solicited or not) are                covered.

The term Deposit is defined in section 2(4) of the Act as follows:-

An amount of money

received by way of an advance or loan or in any other form

by a Deposit Taker

with a promise to return (any non-refundable amount shall not be deposit)

whether after a specified period or otherwise,

either in cash or in kind or in the form of a specific service (shall exclude payments                made under clause l(i)),

with or without any benefit in the form of interest, bonus, profit or in any other form.

(iv)Transactions not treated as Deposit

If a transaction of loan or advance does not fall in the definition of Deposit as per the exclusion clause of section 2(4) of the Act as follows, the provisions of the Act are              not attracted:

(a) Loan from a scheduled bank, co-operative bank or a banking company defined in the Banking Regulations Act, 1949;

(b) Loan or financial assistance from a public financial instauration or an NBFC as defined in section 45- I (f) of RBI Act, 1934 and registered with RBI. It shall also include any regional financial institutions or insurance companies;

(c) Amount received from government or a government guaranteed source or any statutory authority;

(d) Amounts received from a foreign government, foreign banks, multi-lateral FIs, foreign government owned DFIs, foreign export credit collaborators, foreign bodies corporate(OCBs), foreign authorities or foreign citizens or persons residing outside India subject to FEMA, 1999;

(e) Capital contribution by partners of a partnership firm or LLP (loan from a partner is a Deposit);

          (f) Loans received by individuals from relatives and loans received by a                     firm from the relatives of any of its partners.

              The definition of relatives is adopted from the Companies Act, 2013 (section 2(77) which states as follows:

  1. Members of an HUF;
  2. Husband & Wife;
  3. The following persons are relatives as per the rules framed for this purpose by the Central Government vide Rule 4 of Companies (Specification of Definitions Details) Rules, 2014
Father Mother
Brother SELF Sister
Son & Daughter In Law Daughter & Son in Law

In all cases it shall include ‘step’ relations except step daughter.

(g) Credit received from a seller by a buyer on sale of any movable or immovable     property;

(h) Amount received by an Asset Reconstruction Company (ARC);

(i) Amount accepted by a political party under Representation of People Act, 1951;

(j) Any periodical payment made by members of self help groups within prescribed ceilings;

(k) Any other amount collected for such purpose and within such ceilings as may be prescribed by the State Government (to be notified);

(l) An amount received in the course of or for the purpose of business and bearing a genuine connection to such business

(i) Payment, advance or part payment for supply or hire of goods or provision of services, repayable in the event of goods or services not being sold, hired or provided;

(ii) Advance received towards consideration of an immovable property under an agreement or arrangement where the advance is adjusted against the said immovable property as per the agreement or arrangement;

(iii) Security or dealership deposit;

(iv)Advance under a long term project for supply of capital goods.

Provided that

  1. If amount becomes refundable in any of the above situations, it will be deemed to be deposit on the expiry of 15 days from the date of becoming due for refund;
  2. If the amount becomes refundable due to the Deposit Taker not obtaining necessary permissions or approvals under the law as required, the amount thus collected  shall be deemed  to be deposits.

(v) Definition of Deposits in some specified cases:

  1. In case of a company, the definition of Deposit shall be as per the meaning of Deposit under the Companies Act, 2013. Therefore, the extant provisions of the Companies Act, 2013(including the rules framed thereunder) are referentially  incorporated in the Act and whatever transactions are excluded from the definition of  Deposit under the said Companies Act,  2013 by a company shall be likewise excluded under the Act as well in so far as it relates to a company.

As per section 2(31), Deposit shall include any receipt of money by way of deposit or    loan or in any other form by a company but does not include such categories of amount as may be prescribed.

Rule 3(c) of Companies Acceptance of Deposit Rules, 2014 provide for several exclusions from the definition of Deposit as follows:-

  1. Amount received from government or a government guaranteed source or any local or statutory authority;
  2. Amounts received from a foreign government, foreign banks, multi-lateral FI’s, foreign government owned DFIs, foreign export credit collaborators, foreign bodies corporate(OCBs), foreign authorities or foreign citizens or persons residing outside India subject to FEMA, 1999;
  3. Loan from a scheduled bank, co-operative bank or a banking company defined in the Banking Regulations Act, 1949;
  4. Loan or financial assistance from a public financial instauration or an NBFC as defined in section 45- I(f) of RBI Act, 1934 and registered with RBI. It shall also include any regional financial institutions or insurance companies;
  5. Amount received against commercial paper or any other instrument issued as per RBI guidelines;
  6. Any amount received by a company from any other company (important).
  7. Amount of subscription towards any security, share application, provided that non-refund of the amount within 15 days after the expiry of 60 days from the date of the receipt of the amount where allotment is not made in 60 days, shall make the refund in to a deposit.
  8. Amount received from a person who was a director of the company when the amount was received provided that it is not from funds borrowed or deposits from others.
  9. Amount from bonds or debentures secured by first or first pari passu charge on the tangible assets of the company with security cover of at least 100%, except CCDs convertible within 5 years.
  10. Security deposit from employee not exceeding his annual salary.
  11. Any non-interest bearing amount held in trust.
  12. Any amount received in the course of or for the purpose of business of the company:
  1. a) Payment, advance or part payment for supply or hire of goods or provision of services, repayable in the event of goods or services not being sold, hired or provided;
  2. b) Advance received towards consideration of an immovable property under an  agreement or arrangement where the advance is adjusted against the said immovable property as per the agreement or arrangement;
  3. c) Security or dealership deposit;
  4. d) Advance under a long term project for supply of capital goods..

Provided  the if the amount comes refundable due to the company not having necessary permissions or approvals  under the law as required, the amount thus collected shall be  deemed to be deposit. (The first proviso of extant provision in the Act making the refund remaining unpaid within 15 days of become due as deposit does not appear in the company  law)

  1. Amounts brought in by the promoters or their relatives as unsecured loans pursuant to stipulation of lending FI or bank to contribute such finance and exemption will be available only till the loans are repaid.
  2. 14. Amounts accepted by a Nidhi Company.
  3. In case of an NBFC, the definition of Deposit appearing in section 45-I (bb) of RBI Act, 1934 is referentially incorporated in the Act and whatever transactions are excluded from the  definition of Deposit under the said RBI Act, 1934 shall be likewise excluded under the Act as well in so far as it relates to an NBFC.

Deposit includes and shall be deemed always to have included any receipt of money        by way of deposit or loan but shall not include:

(i) Share capital or capital of partners of a firm;

(ii) Amounts received from a schedule bank, co-operative bank or any other banking company, SFC, FI or any other institution as may be specified;

(iii) Amounts received as security deposit, dealership deposit, earnest money or advance against orders in ordinary course of business;

(iv)Amount received from an individual or firm or AOP not being a body corporate which is registered under any enactment relating to money lending in force in any state; &

(v) Subscription of chit.

(vi) Deposit Taker (as defined in section 2(6) of the Act) being a person who receives or solicits Deposits and shall mean

  1. Any individual, group of individuals or a proprietary concern;
  2. A registered or unregistered partnership firm or a LLP;
  3. A company;
  4. An AOP;
  5. A private trust or a public trust (whether registered or not);
  6. A co-operative society or a multi-state co-operative society;
  7. Any other arrangement of whatsoever nature (which means any other entity whatsoever in nature).

(vii) The Deposit should be accepted or solicited by a Deposit Taker through a deposit scheme which is not regulated, “by way of business

The term “by way of business” is not defined. However, all Regulated Schemes indicate that the entities involved therein are in the business of mobilization of funds and  deployment thereof.

Therefore, a very important question arises whether a business entity which solicits or accepts Deposits (which are not excluded from the definition of Deposit in the Act)  shall be said to be doing so “by way of business”. As per the principles of interpretation of statutes, the statutes should be so read as not to render any part thereof otiose or redundant.

Hence, if we take a narrow interpretation of a Deposit Taker of a person whose principal business is taking Deposits and deployment thereof, only financial companies shall be covered by the Act.

This may be counter to the intent of the Act. Firstly, the Act does not include the word ‘principal’. Secondly, the definition of Deposit and Deposit Taker is more generic. The definition  of Deposit Taker only excludes a statutory corporation or a banking company or a co-operative bank under Banking Regulation Act, 1949.  Thirdly, the definition of Deposit expressly excludes several kinds of financial transactions. It also excludes transactions in the course of and for the purpose of business and bearing a genuine connection to the business. The definition of ‘Business Transactions’ is inclusive and not exhaustive. In fact, it expressly  mentions several such transactions as were initially treated as business transactions  but  later get classified as Deposits in certain circumstances.

Therefore, the term “by way of business” shall be ‘transaction specific’ and not limited to a ‘certain categories of entities’. For instance, a non-financial entity soliciting or accepting deposit (not excluded from the definition of Deposit in the Act) and deploying the said deposit in its business shall be covered by this Act. Such an entity shall fictionally comprise two undertakings. One, which is accepting  deposits and deploying them for the other undertaking by way of business, and the other which is utilizing the said deployment for its non-financial business.

In this context the provision of Maharashtra Protection of Interest of Depositors (in financial establishments) Act, 1995 (MPID) is instructive and lends support to the above interpretation. The term Financial Establishment means ‘any person accepting deposits under any scheme or arrangement or in any other manner excluding a statutory corporation,  co-operative society owned or controlled by a government or a banking company’.

We have also come across a tweet by the Department of Financial Services, Ministry of Finance, Government of India stating that “banning of Unregulated Deposit Ordinance, 2019  exempts individual, firm, companies & LLP for taking loans and deposits for their course of business as per section 2(4)e, f & l and other provisions”. The said sections set out very  specific conditions which if fulfilled, the transaction will not be treated as Deposit. Otherwise, the rigors of the Act will apply.

Important Conclusions:

  1. The Act has no bearing on loans and deposits from relatives or non-relatives alike for non-business purposes such as meeting personal or social commitments, medical or educational exigencies because even though such transactions are not covered by any Regulated Deposit Scheme, they are not ‘by way of business’ and therefore, are out-with the definition of an Unregulated Deposit Scheme which is sought to be banned by the Act.
  1. The Act does not have any retrospective application. There is no sunset clause either. Therefore, the transactions which took place prior to promulgation of the Act shall continue to be governed by the law as it existed before the promulgation of the Act.
  1. The definition of Unregulated Deposit Scheme refers to a scheme or an arrangement. While a scheme would generally involve several Depositors responding to a scheme formulated and/or propagated by the Deposit Taker, an arrangement may even be between a single Deposit Taker and a single Depositor. However, having said that, any sporadic instances of taking deposit and repayment thereof may not fall within the definition of ‘by way of business’. However, if the transaction is questioned, the burden of proving that the transaction is not hit by the Act shall be on the Deposit Taker.
  1. Most significantly, capital contribution by partners of a partnership firm or an LLP is excluded from the definition of Deposit. However, there is no mention of loan from a partner. A transaction between a firm or an LLP of one part and its partner of the other cannot be called a transaction ‘by way of business’ because the partner is lending to his own firm where he has a financial stake. Therefore, it may be argued that, loan by a partner to his firm or LLP, even if it is not excluded from the definition of Deposit, shall not be hit by this Act. However, we may add a word of caution that the language of exclusion of capital contribution by partners of a firm from Deposits has been picked-up from the para materia provision of MPID Act. Therefore, the issue may involve litigation.
  1. As per the Act, in case of a company, the definition of Deposit has been borrowed from the Companies Act, 2013 (Section 2(31) read with Rule 3(c) of the Companies Acceptance of Deposit Rules, 2014). Therefore, whatever is excluded from the definition of Deposit in the said Act and Rules shall be so excluded under this Act as well. The following important conclusions emerge:
  1. Any amount received by a company from another company (ICD) is excluded;
  2. Any amount received from a director provided it is from his own funds is excluded;
  3. Any amount brought in by the promoters or the relatives as unsecured loans as per  stipulation of lending FI or bank is excluded;
  4. Any advance for a specific purpose which is initially excluded from the definition of  Deposit say advance against immovable property shall not be treated as a Deposit even after it  becomes refundable except for the reason of the company not having necessary permissions or approvals for the purpose. This position is different from what will be applicable to   other Deposit Takers as per the Act wherein if any amount becomes refundable in the circumstances aforesaid and remains unpaid for  a period of 15 days, it shall be deemed to be a  Deposit on the expiry of the said  period of 15 days.
  1. Any amounts mobilized by a co-operative society other than share capital from its non-voting shareholders shall be hit by the Act.
  1. The government may notify further exemptions with such ceilings as may be prescribed to alleviate any unintended hardships.
  1. We shall now come to third party loans taken by non-companies for funding their business. The ratio of the Act as it emerges is as follows:-
  1. Any systemic raising of large number of loans from several parties through brokers  or otherwise shall be indefensible and are likely to attract the provisions of the Act.
  2. Any isolated transactions may not attract the provisions of the Act.
  3. Transactions accompanied by a bill of exchange or Hundi of more than Rs 3000 are outside the purview of the Maharashtra Money Lenders Act. However, the said Act is intended to protect the borrower and not the Depositor/lender. However,  such advance against a bill of exchange is more in the nature of discounting of the bill of exchange and it can beargued that it will not fall in the definition of Deposit.  However, in order to substantiate the said argument, the bill of exchange should be  adequately stamped. Besides, the amount    reimbursed by the discounter (lender)  should be the net amount after deducting the discount/interest from the face value  of the bill of exchange rather than periodical payment of   interest. The liability should be shown under the heading “Acceptances” and not “Unsecured Loans”. They will however continue to be short term liabilities for the purpose of    balance sheet classifications. Nonetheless, the matter is not an open and shut issue and may be subject matter of litigation.
  1. As seen above, ICDs between companies are outside the purview of the Act as they are outside the definition of Deposit under the Companies Act, 2013 which definition is also adopted in the Act. Taking a cue, all inter-firm deposits between two business entities (except where the borrowing entity is a company treated as a NBFC due to its financial assets and income from financial assets being more than 50% of its total assets and gross income respectively) need to be excluded from the definition of Deposit under the Act. The spirit behind the Act is to protect small depositors not capable of taking well informed financial decisions. This is not the case with a business entity and hence the same will not require any protection under the Act.

 

  1. The offences under the Act are threefold. Firstly, it is soliciting or accepting any Deposit. Secondly, it relates to committing any fraudulent default in repayment of Deposits taken under any Regulated Deposit Scheme. Thirdly, it relates to making any false, deceptive or misleading statement, promise or forecast of any material fact or deliberate concealment of any material fact to induce another person to invest in any Unregulated Deposit Scheme. Separate penal provisions are provided in each case.

 

  1. A view has been articulated that loans by a company to a firm or an individual shall not be called Deposit as they are permitted under section 185 of the Companies Act, 2013. We respectfully differ because the subject of (public) deposit is dealt with in special provisions under Chapter V of the said act whereas section 185 is general in nature and is also operates in a different field

Appendix A

Regulated Deposit Scheme (First Schedule Section 2(15)) – No restrictions

  1. Regulated Deposit Schemes under various regulators
  1. SEBI regulated 
  1. a) Scheme or arrangement under various regulations, eg

(i)SEBI (Collective Investment Scheme) Regulations 1999;

(ii) SEBI (Alternate Investment Funds) Regulations 2012;

(iii)SEBI (Portfolio Managers) Regulations 1993; &

(iv)SEBI (Share Based Employee Benefits) Regulations 2014 or any employee benefits permitted under Companies Act, 2013.

  1. b) Any other scheme or arrangement registered under SEBI Act, 1992.
  2. c) Any amount received by subscription to a mutual fund registered under SEBI (Mutual Fund) Regulations 1996.
  1. RBI regulated
  1. a) Scheme for accepting deposit by NBFC registered with RBI, defined in section 45- I(f) (or any other scheme or arrangement under RBI Act, 1934) having as its principal business the  receiving of deposits and lending. It will also include such other non-banking institution or class thereof with the previous approval of the Central Government and by  notification in the official gazette.
  2. b) Any scheme or arrangement by which individuals and others engaged by banks as business correspondents and facilitators for banks as per RBI guidelines.
  3. c) Any scheme or arrangement under which funds are received by system provider under Payments & Settlement Systems Act, 2007.
  4. d) Any scheme or arrangement regulated under RBI Act, 1934 or the guidelines of RBI.
  1. Insurance Regulatory & Development Authority of India regulated

An insurance contract pursuant to a registration certificate issued under Insurance Act, 1938.

  1. State Government & UT Government
  1. a) Any scheme or arrangement of a co-operative society registered under the Co-operative Societies Act, 1912 or registered or deemed to be registered under any law  relating to co- operative societies in force in any state or UT.
  2. b) Any scheme or arrangement of chit business with the prior permission of the State Government under Chit Funds Act, 1982.
  3. c) Any scheme or arrangement regulated by any enactment relating to money lending in force in any State or UT .
  4. d) Any scheme or arrangement by a prize chit or money circulation scheme under section 11 of the Prize Chits & Money Circulation Schemes (Banning) Act, 1978.
  1. National Housing Bank regulated

        Any scheme or arrangement for acceptance of deposits under NHB Act, 1987.

 

  1. Pension Fund Regulatory and Development Authority (PFRDA) Act, 2013 regulated

          Any scheme or arrangement under PFRDA Act, 2013.

 

  1. Employees’ Provident Fund Organisation regulated

        Any scheme, pension scheme or insurance scheme framed under the Employees Provident Fund & Miscellaneous Provisions Act, 1952.

  1. Central Registrar, Multi-State Co-operative Societies regulated

          Any scheme or arrangement for acceptance of deposits from voting members by a Multi-State Co-operative Society registered under the Multi-State Co-operative Societies Act, 2002.

  1. Ministry of Corporate Affairs, GOI regulated

          Deposits accepted or permitted under the provisions of Companies Act, 2013, section 73 to 76 relating to acceptance of deposits by companies.

  1. Other Schemes treated as regulated deposit schemes
  1. Deposit accepted under any scheme or arrangement registered with any regulatory body in India constituted under any statute.
  2. Any other scheme which may be notified by the Central Government under this ordinance.

Author – Mukesh Jain  assisted by Hitesh Jain & Muktesh Punamiya

(Mukesh Jain & Associates, Advocates, Mumbai)

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