What are the Aspects of Legal Due Diligence of NBFC

Non-Banking Financial Company

Non-Banking Financial Company (NBFC) is an essential segment in the financial sector.They are registered under the Companies Act and regulated under the RBI Act. NBFC is used as an alternative for the source of funds for deploying funds to MSMEs, infrastructural projects, etc. other than banks and financial institutions.

The RBI Act governs the functioning of NBFC; despite being registered under companies act 2013 (earlier 1956). It deploys the funds to micro-sized enterprises and small and medium-sized businesses. They operate on similar trends of traditional banks with certain exceptions in rules. For a better understanding of NBFC along with its due-diligence, we are going to discuss in brief henceforth in an article. 

What is Due-Diligence

Due-diligence is a process of a thorough understanding of the firm and access to the company’s capabilities and financial performance. It is the reasonable precaution or steps taken in advance to avoid any future discrepancies or default.

Due-diligence, when carried by Investor Company, is a process of investigation or audit of potential investment and to review the financial records for assuring themselves about their investments. Due-diligence is a comprehensive appraisal of operations and activities undertaken by a company. NBFC due-diligence is based on the business market and the industry which an organization under audit is a part of.  The fair valuation of an organization gets ascertained due to the comparison between similar organizations operating within the market.  

Following four types of due-diligence are:

• Legal due-diligence:It involves investigation of legal matters concerning contracts, agreement, legal transactions, pending litigations, etc.
• Commercial due-diligence: It involves the market study in which the company operates. It includes communication with potential customers, competitors, and other relevant concerned entities.
• Financial due-diligence: It involves the financial assessment including financial transactions and other matter incidental to such as assets, liabilities, cash flows, debt, equity, loans, etc

Checklist for Due-Diligence

Before conducting a thorough study of a company, one should prepare a brief checklist inclusive of key-points for analyzing the information under following heads for informed decision making:

• Corporate matters.
• Minutes of the Board meeting, General meetings, and annual general meetings.
• Agreements and contracts of material nature.
• Regulatory matters such as RBI compliance records.
• Financial transactions
• Human resource and management
• Taxation aspects and its compliance.
• Intellectual property rights such as trademark, copyrights, etc.
• Registration under FIU-IND
• Statutory auditor certificate
• Nominated counsel in Delhi high court
• Membership of Credit Information Company.
• Compliance with the norms of creation of statutory reserve at 20% of the profit.

Due-Diligence of Compliances of Legal Regulation by NBFC

Following are the specific regulations that are applicable on NBFCs which they have to comply mandatorily are inspected and investigated thoroughly during due-diligence of NBFCs:

• As per section 45-IC of the RBI Act, NBFCs have to create Statutory Reserve at 20% of the profit.
• NBFC has to get done the KYC of its directors, promoters, big investors, etc.
• NBFC has to get itself registered with the Financial Intelligence Unit- India for keeping the records of transactions of NBFCs.
• NBFC shall get registration with Information Utility set up under Insolvency and Bankruptcy Code 2016.
• RBI vide its circular in 2008 has made it compulsory to formulate auditor reports to the director that should be in line with the issuance of statutory auditor certificate.
• NBFC has to obtain the membership of Credit Information Company.
• NBFC has to publish the 30 days notice to the public in case of any change in control as per the compliance of RBI guidelines.
• NBFC shall maintain the necessary documents under different legislations which are checked during due-diligence for its authenticity and legality:
  • Incorporation certificate
  • VAT registration
  • GST registration
  • PAN
  • TAN
  • Any publication made by such NBFC
  • Documents submitted before RBI, MCA, GST, etc.
  • Any other registration acquired by NBFC under any prescribed statutory law.
  • Minutes of resolutions passed
• NBFC has maintained the records of the last three years’ financial statements, including indebtedness.
• Inspect and inquire about the cases whether civil or criminal pending against NBFC and the status of the case such as decision was against or in favor of NBFC that leads to payment liability or benefits accrued to NBFC, as the case may be.
• Investigate its borrowings from promoters and investments made such as FDI, Indian Overseas Investment, etc.
• Investigate the documentation relating to any legal contracts entered into by NBFC.
• Check the documents and property papers relating to the mortgage, encumber, charge over the property.
• Check the HR policies maintained by NBFC along with EPF and ESI compliances and returns.

Source of available information for Inspection

For conducting due-diligence, the most important question arises of availability and sources of information along with the reliability and accuracy of information. Apart from legal documents and records, necessary information about the entity can also be gathered from customers, employees, Business news, market data, directors, etc.

Expert’s Guidance

Proper due-diligence report of NBFC needs a thorough and in-depth study that can be exhaustive, and time-consuming work and one wrong decision or step taken can lead to the entire working go waste. Therefore, there should be expertise involvement for minute inspection of every record.