FINANCING PROJECTS IN INDIA
Subcontracts India has been at the forefront of several project financing transactions across various sectors of the Indian economy. Our project financing services are particularly beneficial to Startups, shovel ready greenfield projects as well as brownfield and green shoot projects.
The last few years have witnessed increased government focus on urban development, which, experts believe, is expected to increase by 75% by 2030. Health and sanitation, mass transit and waste-to-energy will be focus sectors particularly for project financing activities. With traditional lenders such as banks and non-banking finance companies already facing a liquidity crisis and struggling under the impact of COVID19 pandemic, lenders are taking more calculated and nuanced risk calls, based on industry-wide issues faced by project developers (for instance, the tariff renegotiation of the renewable energy projects in Andhra Pradesh).
Funding structures and new sources of lending are being constantly and vigorously explored (such as InvITs, alternative investment funds and so on). The government has looked to significantly liberalize offshore lending to encourage Indian developers to reduce dependence on Indian banks and NBFCs.
India’s rapid urbanization coupled with incoherent urban policies and inadequate urban infrastructure have made its cities among the most vulnerable to climate change. The outbreak of the COVID-19 pandemic has already shown how global shocks can further unearth the evils of decades of mismanagement of cities. Ironically, but not surprisingly, urban residents of slums and squatter settlements bear the maximum brunt and this, in turn, exacerbates existing socio-spatial gaps in Indian cities. So, cities need to change as they grow. Of late, green infrastructure has been viewed as a development priority, especially with respect to the creation of livable, environmentally sustainable and efficient cities for all citizens. Green infrastructure is conceptualized as “the network of natural and semi natural features, green spaces, rivers and lakes that intersperse and connect villages, towns and cities” and when appropriately planned, designed and managed, they have the potential to mitigate and adapt the effects of climate change.
We have the necessary expertise to approach numerous Banks, Investment Bankers, Non Banking Finance Companies (NBFCs), Financial Institutions (FIs), Venture Capitalists (VCs), Private Equity Investors (PE), Ultra High Net Worth Individuals (UHNWIs), Family Businesses, Hedge Funds, Pension Funds, Underwriters, Insurance Providers, etc. with great speed and efficiency. We understand how these fund providers and investors work and what are their main areas of interest. Targeting the right source is not just important but also crucial for achieving successful financial close.
Subcontracts India offers:
Identification of projects with a Cash Flows Generating component and bankability potential;
Support of project development to achieve bankability;
Preparation and structure of transaction by leveraging our consulting, financial and legal expertise;
Finding the right investor and achieving financial close;
Support to the client through the project execution and construction phases.
We can be present with our services across the entire project lifecycle:
Strategy and planning: Assisting long-term planning of individual projects or a portfolio by focusing on feasibility, alignment with corporate objectives and governance procedures in order to maximize return on investment.
Financing and procurement: Raising project finance; establishing and managing the procurement process to acquire services, material or equipment to deliver the project, and prioritizing capital allocation between projects.
Project organization, execution and construction: Setting up the project for success and strengthening client capabilities to deliver on time and to budget.
Operations and maintenance: Assessing ongoing lifecycle costs and providing insights around optimizing the performance and value of assets in operation.
Asset recycling, concession maturity & decommissioning: Determining when and how to discontinue investing in an asset, and transaction advisory services for investors in infrastructure assets.
Projects in India are typically financed by way of:
External commercial borrowings (ECBs).
Domestic term and working capital lending.
FDI into the special purpose vehicle (SPV) developing the project.
Financing may also be obtained through debt instruments, such as debentures, and availing of credit from the Export Import Bank of India. In the recent past, financing has also been obtained by infrastructure companies by way of issuance of rupee denominated bonds (popularly known as "masala bonds" and "green bonds").
Specific requirements may apply, depending on the nature of entity proposing to finance the project. For example, foreign portfolio investors may subscribe to unlisted non-convertible debentures only if the issuing company is in the infrastructure sector.
The key reasons for the underdevelopment of project financing lie in insufficient project maturity and inability to develop projects to the level necessary to achieve bankability. Access to finance is one of the main reasons that infrastructure projects are not developing faster and the key stakeholders sometimes do not see a business case for financing. Moreover, lack of know-how and competence of key stakeholders require a complex multidisciplinary approach in order to guarantee project execution.
Projects, however, are funded solely on their merits. Although we do not make claims of 100% success rate in our pursuit of project finance, with our expertise and experience, our clients enjoy a definite advantage in terms of getting their projects successfully funded.
Non-recourse Project financing in India is much different from what exists in the more evolved developed economies. This is because the regulatory requirements governing lending require promoter guarantees and undertakings, as well as other recourse outside of the relevant project. As a result, there is no complete reliance on project and project revenues, and the term 'project financing' in India has morphed to refer to any form of financing of infrastructure projects generally. Furthermore, financing of infrastructure projects is primarily undertaken by banks, which are public sector undertakings (PSUs), controlled by either the government of India or state governments.
The 2020 Union Budget (2020 Budget) has sought to create higher incentives for investments in the infrastructure sector by creating a framework for 100 per cent tax exemption for sovereign wealth funds of foreign governments in respect of their interest, dividend and capital gains income from investments made in infrastructure, on the condition that such funds are invested for a minimum period of three years.
The 2020 Budget has also announced a National Infrastructure Pipeline that intends to comprise of over 6,500 infrastructure projects to boost infrastructure development. The details of these projects are awaited and are expected to be disclosed in the near future.
In an acknowledgement of the increasing importance of natural gas in the Indian Energy basket, the 2020 Budget has announced that the national gas grid will be expanded from 16,200 kilometres to 27,000 kilometres and a national level natural gas exchange will be developed.
Another important element of the 2020 Budget was the announcement of future public–private partnership (PPP) expansion of Indian railways to enable expansion of freight transportation and the development of a national cold supply chain for perishables such as meat, milk and fish and equipping freight trains with refrigerated coaches.
The 2020 Budget also prioritised inland waterways for development to enable economic development along rivers.However, because of the inherent risks in investing in India, the general trend has been for project developers predominantly taking on the role of executing projects as contractors or sub-contractors, where there is revenue certainty and a buffer from the risks to which infrastructure development is exposed to in India. Strategies for mitigating legal risks has always been a core function of a project finance lawyer. This has been gaining higher significance in India in view of 'public interest litigation' (PILs) against infrastructure projects. Judicial rulings resulting from PILs may lead to uncertainty of enforcement of long-term contracts. As a result, a project finance lawyer in India needs to be adept at developing strategies for handling dispute resolution scenarios and advising on long-term risk mitigation measures
Please read the below section to understand how project financing in India works.
Generally in India, security for project finance is created over the following asset types: immovable property; movable fixed assets; current assets; shares; assignment of rights in project and insurance contracts; and a charge over the project bank accounts. The charge over immovable property is typically created by executing an indenture of mortgage or by undertaking a deposit of title deeds for the property. On the other hand, security over movable assets (both fixed and current) is created by executing a deed of hypothecation. Security over shares is created via a pledge, which requires possession to be transferred by way of deposit of the share certificates, or if the shares are in dematerialized form, by recording the same with the depository of shares. An assignment of rights (such as rent receivables) arising out of project contracts is done via a deed of assignment. The charge over immovable property, movable property and an assignment of rights can be clubbed together under a single indenture.
Lenders typically have security over real property, plant, machinery and equipment. If the land leasehold property, permission may be required from the lessor for the creation of charge. If the security is created via an indenture of mortgage, it is necessary to register the same with the local registrar of companies (RoC). The charge created over movable/immovable properties is also required to be registered with the Central Registry Of Securitization Asset Reconstruction and Security Interest of India (CERSAI)
Security may be taken over receivables without the express consent of the debtors. However, such charge over receivables or other current assets (which is a floating charge) crystallizes into a fixed charge only upon occurrence of an event of default.
Typical project financing security package involves the creation of security over the project specific bank accounts. The procedure to be followed in this case mirrors that of any other movable assets. A notice of such a charge is given to the bank.
Security over shares is a prevalent for of security creation in India. Typically, a pledge agreement is entered into with a power of attorney to enforce the pledge which is also executed by the pledger upfront. If the shares are in certified form, the share certificates are physically deposited along with a share transfer form. If the shares are in dematerialized form, certain forms (indicating the agreement number, closure date of the pledge, quantum of shares pledged, etc.) will be required to be submitted at the relevant share depository.
In India, stamp duty on security documents varies from state to state. In some states, stamp duty is uncapped, whereas in others the liability is capped. Additionally, all indenture of a mortgage must be registered with the local registrar of assurances. In some states, a mortgage created via a deposit of title deeds is also compulsorily registrable; however, in most states such registration is optional (viz., powers of attorney and affidavits) are required to be notarized by a notary public, at a nominal charge.
The time taken to register a mortgage with the local registrar of assurances may vary drastically, depending on the efficiency of the local bureaucracy. Similar to stamp duty, registration fees payable also vary from state to state, as some states have ad velorem charges whereas others have capped limits. Filing/ registration with the RoC and AERSAI are required to be done online and is neither time-consuming nor expensive.
For the creation of security over freehold land, no consents or regulatory approval is required unless it has been reserved for a specific purpose (such as forest land, coastal land) by the government. If the land over which the security is created is leasehold in nature, typically prior consent of the lessor would be required. However, with respect to pipelines (once embedded in the earth), the land over which pipelines for the transport of petroleum, minerals or gas are laid are not transferred to the borrower, who merely acquires the rights of a user over the land. Such right of way may also be assigned to the lenders.
The “trust” structure is recognized and the tights and obligations of the security trustee is typically recorded in a security trustee agreement. Such security trustee agreements grant the trustee the right to sue, on behalf of all the lenders cumulatively, for the enforcement of the security and to apply the proceeds to the claims of all lenders. A security is trust is recognized in India, so the security trustee can sue for the enforcement of the security and can apply the proceeds to the claims of all lenders. There is also no bar on any lender suing for enforcement independently.
ENFORCEMENT OF SECURITY
The timelines for enforcing security may depend on the nature of security held by the lender. To illustrate, enforcement of a pledge created over shares, which are in dematerialized form, is relatively simple and does not require a decree of a court of competent jurisdiction. Enforcement of a mortgage may require a decree of the court under the Civil Procedure Code, 1908 or enforcement action under the securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. In a scenario where an insolvent company is subject to proceedings under the IBC, a publicly solicited bid process is undertaken wherein bidders are required to submit resolution plans that are required to be inter alia approved by the committee of creditors. In assets in regulated sectors (e.g. airports, telecommunications, roads) the enforcement process is done through a “substitution” of the defaulting company by an entity nominated by the lenders, with the consent of the relevant regulatory authority.
Under Indian law, a foreclosure suit in respect of a mortgage may be filed by a mortgagee to debar the mortgagor of his right to redeem the mortgaged property in the event that the mortgagor is unable to pay the amounts due to the mortgagee. While foreclosure proceedings may be initiated under the Foreign Exchange Management (Acquisition and transfer of immovable property in India) Regulations, 2018, from transferring any immovable property in India, unless permitted by the Reserve Bank Of India (RBI). Additionally, foreclosure suits may only be filed under the Transfer of Property Act, 1882 by a mortgagee by conditional sale or a mortgagee under an anomalous mortgage. However, if the mortgage creation is by way of an English mortgage, foreclosure suits may not be filed.
BANKRUPTCY AND RESTRUCTURING PROCEEDINGS
The IBC is the primary legislation governing insolvency of corporate entities today. The initiation of a corporate insolvency resolution process (CRIP) against the project company (which would ordinarily last at least 180 days, extendable by another 90 days, exclusive of any time spent in litigation). Accordingly, the project lender will be unable to enforce or exercise any rights in respect of its security during this period.
In the event of a successful CIRP, the IBC permits the resolution plan to provide for, inter alia, the modification and release of pre-existing security interests created by the corporate debtor. In case a successful resolution plan (approved by at least 66% of voting share of committee of creditors and the National Company Law Tribunal (NCLT)) provides for any such modification/release, the project lender will lose its right to enforce its security related rights post approval of the resolution plan.
Under the IBC, “insolvency resolution process costs” and “liquidation costs” are accorded the highest priority. Besides this, the payment of workmen’s dues for the period of 24 months preceding the liquidation commencement date is ranked pari passu with the dues of the second creditors that have relinquished their security interests to the liquidation estate. The IBC also contains protections in favor of creditors against antecedent transactions entered into by the corporate debtor during specified look-back periods (calculated backwards from the insolvency commencement date). Such provisions are equally applicable to transactions relating to security interests created over the assets of the company as well.
Under the IBC, these include transactions that are “preferential” in nature (and pertain to an antecedent liability owed to a creditor, surety or guarantor), those that are “undervalued” (including gifts), those that defraud creditors (which must necessarily pertain to undervalued transactions, which were entered into with the deliberate intention to defraud creditors), and such credit transactions that are “extortionate” in nature.
Further, the Income Tax Act, 1961 provides for transfers or charges to be void against any tax claim where it is created during the pendency of any tax proceeding or outstanding tax demand, without prior permission of the tax department.
While the IBC provides for and governs bankruptcy of individuals, partnership firms, limited liability partnerships and corporate entities in India, the provisions pertaining to bankruptcy of individuals have not yet been made operational. The regime, however, does not extend to the bankruptcy of financial service providers, which continue to be governed under the Companies Act, 2013. The Banking Regulation Act, 1949 governs the winding up of banking companies.
Post the initiation of the CIRP under the terms of the IBC, creditors are prohibited from enforcing their security interests and seizing the assets of a company. However, outside the IBC framework, there are several ways in which a creditor can enforce its security and seize the assets of a project company out of court. To illustrate, a creditor having security by way of an English mortgage has the right to sell such mortgaged property by way of private sale. Similarly, in respect of security by way of pledge, a creditor is entitled to enforce such a pledge without resorting to court proceedings, and to effect the sale of the pledged goods, after having given due notice to the pledgor.
Under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2001, banks, notified financial institutions, asset reconstruction companies, debenture trustees and certain notified NBFCs are conferred with private enforcement rights in respect of their security interests, other than in respect of pledges and liens. However, such rights do no extend to foreign creditors.
There are certain mechanisms that are available to companies to achieve a restructuring of its debts, outside of the formal insolvency regime provided for under the IBC, including the cramdown of its dissenting financial creditors. On February 12, 2018, the RBI had issued a circular titled “Resolution Of Stressed Assets- Revised Framework” (which resulted in an overhaul of all previous restructuring schemes issued by the RBI), under which lenders were obligated (either singly or jointly) to formulate a resolution plan which may provide for the change in ownership or restructuring of the corporate debtor, the moment there is a default in the company’s account. However, the said circular was struck down by the Supreme Court of India on April 2, 2019. The RBI Governor has, on April 4, 2019, issued a statement stating that the RBI will take necessary steps, including issuance of a revised circular, as may be necessary, for expeditious and effective resolution of stressed assets.
In July 2018, a large majority of Indian banks have also entered into the Inter-Creditor Agreement for Resolution of Stressed Assets as part of Project Sashakt upon recommendations of the Sunil Mehta committee. Under the framework, the lead lender shall be authorized to formulate the resolution plan, which shall be presented to the other lenders for their approval. The decision-making shall be by way of approval of majority lenders, that is, the lenders with 66% share in the aggregate exposure. Once the resolution plan is approved by the majority, it shall be binding on all the lenders that are a party to the inter-creditor agreement.
Under the IBC, upon the initiation of the CIRP against the corporate debtor, it is the resolution professional that takes on the role of the management of the company, and the powers of the board of directors remain suspended during this period. In terms of section 66(2) of the IBC, directors may be held personally liable to make contributions to the assets of the corporate debtor (on an application made by the resolution professional to the NCLT), if such director knew or ought to have known that “there was no reasonable prospect” of avoiding the commencement of the CIRP against the corporate debtor under the terms of the IBC, and did not exercise the due diligence in minimizing the potential loss to the creditors during this period.
Separately under Section 66(1) of the IBC, such persons who are knowingly party to the carrying on of the business of the company during its CIRP or liquidation, in a manner that demonstrates their intent to defraud the creditors of the company, or for any other fraudulent purpose, may be held liable to make contributions to the assets of the corporate debtor (on an application made by the resolution professional to the NCLT).
FOREIGN INVESTMENT AND OWNERSHIP RESTRICTIONS
The foreign ownership of an Indian project company is subject to the Foreign Exchange Management Act, 1999 (FEMA) and the rules and regulations made thereunder. The Maser Direction on Foreign Investment in India read with the Foreign Exchange Management (Transfer or Issue of a Security by a Person Resident Outside India) Regulations, 2017 (FEMA Regulations, 2017) empowers the RBI to prohibit, restrict or regulate the transfer or issue of any security by a person resident outside India. FEMA Regulations, 2017 provides: (i) the limit of foreign investment in each sector in India which cannot be exceeded; and (ii) the entry routes for foreign investment in various sectors, which may be either automatic or with government approval. FEMA Regulations, 2017 also lists out the prohibited activities, which include real estate, agricultural activities, atomic energy and railway operations.
Further, from a tax perspective, where any taxpayer, including a foreign company, acquires any property, i.e. shares or other instruments which are characterized as security, then it must acquire such share or security at a “fair market value” as determined in accordance with a prescribed rule for valuation. If the consideration paid is less than such fair market value, then the difference would be subject to tax in the hands of the foreign investor as “income from other sources” at the rate of 40% (plus applicable surcharge and cess) in hands of a company or 30% (plus applicable surcharge and cess) in case of other investors.
There are several bilateral and multilateral investment treaties entered into by India with various countries in order to promote trade and commerce within the country. India also has comprehensive Double Taxation Avoidance Agreements (DTAA) with 88 countries, out of which 85 are presently in place. The Income Tax Act, 1961, provides for relief for two types of taxpayers. One is for taxpayers who have paid the tax to a country with which India has signed a DTAA, while the other is for taxpayers who have paid tax to a country with which India has not signed a DTAA. The rates differ from country to country. However, there are no treaties providing explicit protection to a foreign entity from restrictions on exchange control.
The provisions of the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 applies in relation to land acquisitions by the government for public purpose and compensation paid thereof. The Indian Constitution also grants the government the right to compulsorily acquire any property for a public purpose, upon payment of compensation. The rights on the projects undertaken through Public Private Partnerships (PPP) are automatically transferred to the concessioning authority at the end of the concession period.
GOVERNMENT APPROVALS/ RESTRICTIONS
Each infrastructure sector in India has one or more regulators that exercise jurisdiction over the particular sector. For example, the Airports Authority of India (AAI) and the Directorate General of Civil Aviation (DGCA) regulate the airports/aviation sector, while the roads sector is regulated by the National Highway Authority of India (NHAI) or the Ministry of Aviation and Ministry of Road Transport and Highways (MORTH), amongst others. Concession agreements or power purchase agreements, for example, may also be entered into with state-specific utilities/agencies.
Security documents are required to be filed and registered with certain authorities.
The government retains sovereign rights over ownership of natural resources, and the right to use such natural resources shall be subject to the terms of the licenses granted by the government. Land and licenses in respect of natural resources cannot be directly held by a foreign entity; however, it may be held by an Indian entity owned and/or controlled by such foreign entity, subject to the foreign investment thresholds specified by the government.
Royalties are payable for the extraction or export of natural resources, the amount for which will depend on the manner in which such concession was obtained and in accordance with the stipulations set out under the applicable law. Further, income tax is payable on income from extraction or export of natural resources.
Capital account transactions (which alter assets and liabilities), unless specifically permitted by the RBI or under FEMA, are prohibited. Specified routes are available for equity investment, borrowings, etc. Taxes on foreign currency exchange transactions would be levied depending on whether it results in income or deemed income in India. The actual transaction of foreign currency exchange may also be subject to the Goods and Services Tax (GST).
Tax is levied on remittances and repatriation of investment returns, levied by way if Income tax or capital gains tax, depending of the nature of the return. No tax is levied on the shareholder in the Indian project company for distribution of dividends under the law currently in force. However, the Indian company distributing dividend is subject to additional dividend distribution tax at the rate of 20.56% (including applicable surcharge and cess). Capital gains would be taxed as short term or long term depending on the period of holding the asset. Long-term capital gains arising on the sale of shares is generally taxable in the hands of a foreign investor at the rate of 10% (plus applicable surcharge and cess). Short-term capital gains would be taxed at the rate of 40% (plus applicable surcharge and cess). However, a lower rate of 30% is applicable on short term capital gains in the case of a foreign portfolio investor. Further, the short-term capital gains may be taxed at 15% only, if the gains are realized upon sale of the security on the stock exchange and the securities transaction tax paid, as prescribed.
Onshore and offshore foreign currency accounts are no permitted under applicable law, except in limited circumstances, as set out in the Foreign Exchange Management (foreign currency accounts bu a person resident in India) Regulations, 2015. For instance, an Indian project company receiving foreign investment under the foreign direct investment (FDI) route is permitted to open and maintain a foreign currency account with an authorized dealer in India, provided that the Indian project company has impending foreign currency expenditure. In the instance referred to hereinabove, the account is required to be closed immediately after the requirements are completed and is not permitted to be operational for more than six months from the date of the opening of such an account.
In addition to restrictions on declaration of dividend under the financing documents, the Companies Act, 2013 permits declaration of dividend only out of the profits of the Indian company and after maintaining reserves for depreciation. The payment of such dividend will be subject to the taxes mentioned above.
Depending on the nature and size of the project, project developers will be required to seek environmental clearances, approval of the resettlement and rehabilitation plan, consent to establish and operate, forest clearances and wildlife clearances, among others.
Any procurement by project companies may be governed by the terms of the bid documents and the subsequent concession agreements that may be signed by such a project company. That being said, in certain instances, additional taxes or duties may also be levied (for instance- the recently introduced safeguard duty on the import of solar panels from certain countries).
Finance for a Project in India can be raised by way of
(A) Share Capital
(B) Long‑term borrowings
(C) Short‑term borrowings
Both share capital and long‑term borrowings are used to finance fixed assets plus the margin money required to obtain bank borrowings for working capital. Working capital is financed mainly from bank borrowings and from unsecured loans and deposits.
Share Capital consists of two broad categories of capital namely equity and preference. Equity shares have a fixed par value and can be issued at par or at a premium on the par value. Shares cannot normally be issued at a discount. However, in exceptional circumstances issue of shares at a discount is permitted provided (a) the shares are of a class already existing, (b) the discount is authorised by the shareholders, and (c) the issue .is sanctioned by the Central Government. Normally the Central Government will not sanction a discount exceeding 10%.
The corporates are now allowed to raise resources for expansion plans. by issuing equity shares with differential voting rights. The main advantages of such category of shares are :
1. Equity can be raised without diluting stake of the promoters.
2. Companies can reduce gearing‑ratios.
3. The risk of hostile‑takeovers is reduced to a considerable extent.
4. The passing of yield in the form of high dividends to the investors can be ensured
The following are the general disadvantages
1. The cost of servicing equity capital will increase.
2. Poor corporate governance may be encouraged.
3. If issued at discount, they may raise the equity burden.
Preference shares carry a fixed rate of dividend (which can be cumulative). These shares carry a preferential right to be paid on winding up of the company. Preference shares can be made convertible into equity shares. Issue of preference is not a popular form of capital issue.
The issue of capital by companies is governed by guidelines issued by the Securities and Exchange Board of India (SEBI) and the listing requirements of the stock exchanges.
Apart, from equity, there can also be various forms of pseudo equity. The most common forms are fully or partly convertible debentures and debentures, issued with warrants entitling the holder to subscribe for equity. There can also be an issue of non‑convertible debentures.
Term finance is mainly provided by the various All India Development Banks (IDBI, IFCI, SIDBI, IIBI etc.), specialized financial institutions (RCTC, TDICI, TFCI) and investment institutions (LIC, UTI and GIC). In addition, term finance is also provided by the State financial corporations, the State industrial development corporations and commercial banks. Debt instruments issued by companies are also subscribed for by mutual funds and financing activities are also done by finance companies.