Due Diligence. Paying the price for unregulated deposits

There have been rising instances of unscrupulous people duping the greedy and gullible through illicit deposit-taking schemes.

The Banning of Unregulated Deposit Schemes Ordinance, effective from February, 21, aims to tackle such rapacious operators. It is a Central legislation to help deal with the menace of illicit deposit-taking activities, and overrides the existing State laws.

The ordinance imposes a complete ban on Unregulated Deposit Schemes (UDS) at inception. The offences as per the Ordinance are: (a) soliciting or accepting of deposits under a UDS, (b) fraudulent default under a Regulated Deposit Scheme (RDS), and (c) wrongful inducement under a UDS. All the offences under the ordinance are cognisable and non-bailable. The offences will attract severe penalties ranging from ₹2 lakh to ₹25 crore, and imprisonment of 1-10 years.

Coverage

A scheme or an arrangement of acceptance/solicitation of deposits “by way of business” which is not a RDS is considered as an offence.

Will a single transaction of accepting/soliciting a deposit be considered an offence? Since the definition of UDS includes the word “arrangement”, it would be difficult to exclude one off-transactions unless some clarification or notification is issued in respect of the same. Having stated that, such an erratic transaction may not fall within the definition of “by way of business”. The onus of proving that the transaction is not covered by the Ordinance is on the deposit taker, and hence, one needs to be watchful while interpreting the law in the initial days when precedents under the law are not available.

Challenges

Here are our views on its impact:

Individuals: Though the law prohibits acceptance of deposit by an individual or a group of individuals from any person other than relatives, it is pertinent to note that acceptance of loans for personal or social commitments, medical or educational exigencies is not prohibited, as the same is not solicited/accepted “by way of business”.

This fact has also been clarified by the Ministry of Finance in its tweet on banning of UDS with respect to individuals, firms, companies, LLPs, etc. Individuals who operate as a financial entity (such as a mini NBFCs without being registered) have to stop their activities immediately (these were prohibited earlier, too).

Finance brokers : They need to reconsider their roles and responsibilities as the risk may outweigh the rewards. In case of default, the broker is also liable along with the deposit taker.

Firms: Firms can accept loans from relatives of partners. In respect of accepting a loan from a partner, one can interpret that a loan transaction between a firm and its partner cannot be “by way of business” since the partner is lending to his own firm. Hence, such a loan transaction may not be considered an offence under the ordinance. A deposit given by one partnership firm to another partnership firm may attract the ordinance. However based on the argument that the deposit is for the purpose of business and hence view can be taken that ordinance would not apply to such inter-firm deposits.

Jewellers and real-estate firms : Schemes by such companies for their customers and investors will have to be evaluated on a case-to-case basis to determine whether the schemes can be continued or not. The pattern in which the initial transaction is concluded may also throw light on the intent of the original arrangement.

Despite ambiguities in its applicability, the ordinance is a saviour for investors who may not be financially savvy and are gullible to fancy and attractive investment schemes. The legislation has the potential to nip fraud schemes at an early stage and prevent widespread losses of the type we have witnessed in innumerable notorious schemes.

The writers are Partner and Senior Qualified Associate, respectively, at NA Shah Associates

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