Unregulated Deposits: Government’s Attempt To Curb Ponzi Schemes Has Sharp Edges

Accepting money from public is a risky business, and because of this, a heavily regulated one, too. The RBI regulates non-banking lenders, state governments regulate chit funds, and the Ministry of Corporate Affairs oversees deposit taking companies other than the NBFCs.

Despite this, non-compliant companies and dubious individuals have time and again defrauded predominantly the poor and illiterate through illicit deposit taking schemes, notes the Standing Committee on Finance Report of 2019. The report cites nearly 1,500 cases of defrauding through illicit deposit schemes in the last 4 years alone. The cause for this is regulatory gaps and lack of strict administrative measures.

To tackle the menace of illicit deposit taking activities the government on Feb. 21 passed Banning of Unregulated Deposits Scheme Ordinance. Before this, the same bill was tabled in the parliament on July 18 last year and was referred to the Standing Committee on Finance. It received the assent of Lok Sabha but could not see the light of the day since parliament was adjourned.

What Is A Deposit?

Under the ordinance, a ‘deposit’ is an amount of money received by way of an advance or loan or in any other form, by any person or entity, incorporated or not, who/which promises to return it, either in cash or in kind, with or without interest.

As per the ordinance, under Section 2(4), the following transactions will not qualify as deposits:

1. Loan from a scheduled bank, cooperative bank or banking company
2. Loan or financial assistance from public financial institutions or NBFCs or foreign financial institutions and banks
3. Amount received from government or under a statute
4. Loan from relatives
5. Amount received in the course of, or for the purpose of business, provided it bears a genuine connection to such business

Since the above aren't considered deposits, they're not regulated by the ordinance, which categorises deposits into:

• Regulated Deposit Schemes: The ordinance lists down certain permissible deposits under Schedule 1. These include deposits regulated by Securities and Exchange Board of India, Reserve Bank of India, Ministry of Corporate Affairs, among others.
• Unregulated Deposit Schemes: All other schemes not included specifically in Schedule 1.

All unregulated deposit schemes are banned as on date of the ordinance. Advertising or promoting such schemes is also banned.

In addition to banning unregulated schemes, the ordinance also penalises entities that have issued a regulated deposit scheme but have fraudulently defaulted on repayment or returning the deposit amount on maturity—basically any deposit-taking entity that has not fulfilled its obligations.

However, the wording of the ordinance may impact legitimate business activities, experts point out.

Two specific issues have been identified in respect of the ordinance:

1. Lack of clarity on permissible transactions i.e. those which will fall within the exemption and hence will be not be affected by this ordinance, and
2. Tricky provisos which may hurt genuine transactions.

Permissible Transactions: Lack Of Clarity

While the intent of the ordinance is to ban unregulated deposits/Ponzi schemes and protect investors, the broad ambit of its provisions may have unexpected results, Moin Ladha, partner at law firm Khaitan & Co, told Bloomberg Quint.

The market is flooded with queries—can personal loans for education or businesses be taken by individuals from persons who aren't relatives? Are inter-corporate deposits or loans permissible?

Experts are divided on the intended effect and consequences.

Given the limited carve outs from the definition of the term ‘deposit’, genuine transactions between business partners and support from friends and distant relatives could be deemed unlawful under the ordinance, Ladha said.

According to Ladha some common corporate transactions that may fall foul of this law include inter-corporate loans/deposits between companies not in the business of giving loans, and loans to employees. Informal lending activities between acquaintances and distant relatives are also no longer permitted under this new law.

On the other hand, experts pointed to the intent of the law to say that even though the broadly worded provisions of this law may deem such common transactions unlawful, it’s unlikely that authorities will proceed against them.

“It's critical to bear in mind the intent of the ordinance while applying it to any situation,” said Punit Dutt Tyagi, executive partner of law firm Lakshmikumaran & Sridharan. “This ordinance specifically targets circumstances when persons or entities are soliciting deposits either fraudulently or without having requisite regulatory approvals.”

Tricky Provisos

Watch out, traders, businessmen and flat owners.

A provision to Section 2(4)(l) may hurt genuine transactions, experts point out.

Section 2(4) defines deposit and lists specific transactions that won’t fall within the definition of ‘deposits’. To reiterate, some of the exemptions include:

1. Loan from a scheduled bank, cooperative bank or banking company
2. Loan or financial assistance from public financial institutions or NBFCs or foreign financial institutions and banks.
3. Amount received from government or under a statute.
4. Loan from relatives.
5. Amount received in the course of, or for the purpose of business, provided it bears a genuine connection to such a business.

The proviso to the last exemption says that any amount which is received for the purpose of or during the course of conducting business, such as advance payment or “token” or security amount received before the sale of goods, services and immovable properties could become “unregulated deposit” if the transaction falls through and this amount isn't refunded within 15 days from when it becomes eligible for refund. Also, when it does become refundable, and if necessary consent and approval aren't taken, this amount will be deemed a deposit.

If you have taken money as advance to sell a property, for instance, that could be treated as a deposit, Tyagi pointed out.

Experts explained that there could be a situation where a builder has taken an advance from a buyer to eventually adjust this amount against the sale price, and assume for some reason, the builder doesn’t get a completion certification within the stipulated time, thanks to the proviso, the token amount could then be treated as a deposit in retrospect and the builder could be penalised.

Tyagi said there could be several instances where within 15 days of the amount being due, this amount isn't refunded. Immediately on the 16th day, the proviso will kick in, irrespective of any bad faith. Customers or other persons may complain when there are genuine cases, he explained, adding that it will take time to see how this situation pans out and the precedents these claims set.

Penalties

Non-compliance under the ordinance is a serious affair. It calls for establishing special courts to adjudicating matters arising out of it.

• Soliciting unregulated deposit schemes shall attract imprisonment of 1-5 years and fine of Rs 2-10 lakh.
• Accepting deposits would attract imprisonment of 2-7 years and fine of Rs 3-10 lakh.
• For accepting deposits in violation of the ordinance and then fraudulently defaulting on repayment shall attract imprisonment of 3-10 years ans fine not less than Rs 5 lakh but which may extend to twice the amount of aggregate funds collected from subscribers.
• Repeat offenders could be imprisoned for 5-10 years and penalised between Rs 10 lakh to Rs 50 crore.