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Regulatory Framework

Stiff curbs on wilful defaulters on the anvil

Promoters and entities that have been tagged as wilful defaulters will not be able to access the capital market to raise debt or equity and will be barred from taking over other listed companies.

This move is part of a set of curbs proposed by the market regulator, Securities and Exchange Board of India (Sebi), to deal with wilful defaulters.

However, these entities may be allowed to make a rights issue or private placement to qualified institutional buyers, with full disclosure in the offer document about their ‘defaulter’ status, Sebi said in a discussion paper issued on Monday.

“It is a welcome step, we need to have strong regulatory action against willful defaulters, who are a risk to the financial system,” said Vidya Rajarao, partner for forensic services at Grant Thornton India. “It is a balanced rule that Sebi is proposing, which seeks to bar wilful defaulters from accessing the capital market, thus protecting new investors, but will be allowed to raise funds from existing investors through rights issue.” The paper has been released for comments from all stakeholders till January 23, after which the market regulator will issue the final norms.

The restriction on fund raising through issue of equity or debt, including by way of IPOs or FPOs, would apply to the existing listed companies, their promoters, group companies and directors of entities that fit into the category of ‘wilful defaulter’ as defined by the Reserve Bank of India.

Sebi said the ‘wilful defaulter’ tag broadly covers those borrowers who deliberately avoid payment of dues despite having adequate cash flow and good net worth and those who siphon off funds or financed assets that have either been not purchased or sold and proceeds misutilised to the detriment of the defaulting unit.

RBI had defined the term ‘wilful defaulter’ in a master circular issued on July 12, 2012.

Sebi and RBI will be working closely to prevent wilful defaulters from accessing the capital market The central bank and the Credit Information Bureau (India) (Cibil) will forward a list of such wilful defaulters to Sebi.

Besides, existing listed companies or their promoters, group companies or directors of an entity declared as ‘wilful defaulter’ will not be allowed to take control of any other listed company, the discussion paper said.

In case of a hostile bid from another entity, such companies or individuals can make a counter offer, since capital market dealings would involve outgo of funds rather than raising of capital by a ‘wilful defaulter’.

Barring wilful defaulters from taking over listed companies will protect more listed companies from such entities and the measures are expected to further enhance protection of investors in the securities market, it said.

Restrictions on access to capital market by way of rights issue may negatively impact operations of a listed company, which will also be a negative for its share price. Such a measure may not be in the interest of the shareholders of the listed company, Sebi said.

“Theoretically, shareholders should infuse funds if a company is in trouble. Shutting down finance even from own shareholders appears to be unreasonable,” Sebi said.

If a hostile bid is made on a listed company controlled by a person categorised as wilful defaulter, restricting such wilful defaulters from making a counter offer may not be legally tenable.

It should be allowed to make a counter offer since capital market dealings would involve outgo of funds, rather than raising of capital by a ‘wilful defaulter.’

The article appeared in the Financial Chronicle. The article can be found here.