Madras High Court gives a Fighting Chance to NBFCs: Opportunity to Reinstate License lost due to Insufficient Capital

The Reserve Bank of India (RBI) sought to regulate the activities of NBFCs through the Reserve Bank of India (Amendment) Act, 1997.

Section 45-IA was added to the RBI Act which makes it mandatory for NBFCs to obtain a Certificate of Registration (CoR) and to maintain a Net Owned Fund (NOF).

“Keep in mind- The Act prescribes maintenance of NOF of a minimum amount of twenty-five lakh rupees (25 lakh). But on the counterpart it also allows the RBI to prescribe revised minimum amount of NOF through a notification in the Official Gazette. Such minimum amount must, however, not exceed two hundred lakh rupees (2 crores).”
– Kritika Chabbra (Market Analyst, MUDS Management Pvt. Ltd.)

At the time when the amendment act was passed, all existing NBFCs were required to maintain a minimum NOF of 25 lakh rupees. Section 45-IA provided a period of three years (3 years) to NBFCs to meet the requirement of having a 25 lakh NOF, during which they could continue to carry on the NBFC business despite not meeting a mandatory licensing condition.

Furthermore, the section also provided that RBI, after recording the reasons for its decision in writing, may extend above period of 3 years to maintain required NOF. However, the total extended time should not exceed six years (6 years).

“This effectively allows RBI to use its discretion to extend the time given to NBFCs to meet the NOF requirement by a maximum of 3 years. This is in addition to the 3 years already given to NBFCs by the statute.”
— Isha Malik (Company Secretary, MUDS Management Pvt. Ltd.)

The RBI has the authority to cancel the CoR of an NBFC which fails to comply with the NOF requirement.

The RBI had issued a notification on 27 March 2015. As per this notification, the NBFCs are required to maintain an enhanced NOF of 2 crore rupees to continue their business. The same notification allowed NBFCs time till 1 April 2016 to raise their NOF to 1 crore and eventually to 2 crores by 1 April 2017.

A recent Madras High Court order passed on 29 January 2019 comes as a welcome relief for NBFCs struggling to meet the NOF requirement and thereby facing license cancellation. In the case of M/s.Nahar Finance and Leasing Limited and ors. v. The Regional Director, RBI, and ors, the Court has interpreted the procedure under Section 45-IA and the options which RBI must give to NBFCs when imposing enhanced NOF requirements.

Nahar Finance and Leasing Limited and 3 other NBFCs were issued Show Cause Notices (SCN) on 23 April 2018, proposing to cancel their CoR’s for non-compliance with above notification. The companies filed replies to SCN’s stating that due to changes in the economy and Government policies like demonetization and implementation of GST, etc., the NBFC sector was recovering from setbacks.

The companies sought for extension of time till 31 March 2019, to comply with the enhanced NOF requirement. Post this, the RBI passed orders to cancel CoR’s of all four NBFCs. These orders were sought to be quashed through writ petitions filed by NBFCs.

The Court quashed the orders of RBI canceling the CoR of NBFCs, on two grounds:

Ground #1

Violation of principles of natural justice- Section 45-IA requires that before cancellation of CoR’s, RBI must first enable the NBFCs to fulfill the prescribed requirements. If NBFCs fail to meet them, they are to be given a reasonable opportunity of being heard before the cancellation of CoRs, which was not done.

Ground #2

Violation of Section 45-IA where the statute itself prescribes time extensions to meet enhanced NOF requirement. The Court ruled that 3-year extension given to meet the 25 lakh NOF requirement is applicable to all notifications enhancing NOF requirements.

Additionally, RBI may extend the 3-year period by another 3 years. The RBI can afford NBFCs time to meet NOF requirements till 31 March 2021. This, of course, is the maximum scope of extension, which is also subject to RBI’s discretion.

“Therefore, it is now possible for NBFCs with canceled licenses to reinstate their license and file for additional time to increase their capital. MUDS Management Private Limited is set to facilitate such reinstatement.”
–Shweta Gupta, Founder, and CEO, MUDS