Draft Guidance Note – FAIS 430 : Loans Or Borrowings

Guidance Note for Forensic Accounting and Investigation Standard No. 430 on Loans or Borrowings outlines the approach for Professionals to prepare and execute work procedures when implementing the requirements of this Standard during a Forensic Accounting and Investigation (FAI) engagement. The objective of this guidance note is to assist Professionals in conducting FAI engagements related to loans or borrowings in compliance with the Standard. This involves understanding the circumstances surrounding disputed transactions in this area, determining the validity of the disputes, and gathering evidence to confirm or refute the concerns or allegations. Work procedures are developed to gather evidence regarding funds flow and asset tracing to support the achievement of relevant objectives. The guidance note also provides examples and illustrations of cases to help Professionals apply similar work procedures that are relevant to the specific circumstances of the engagement.

Digital Accounting Assurance Board
The Institute of Chartered Accountants of India
1st June, 2023

GUIDANCE NOTE FOR FORENSIC ACCOUNTING AND INVESTIGATION STANDARD NO. 430 LOANS OR BORROWINGS

EXPOSURE DRAFT Approved by DAAB (On 1 June’23)

This Guidance Note provides technical clarifications and implementation guidance on how to prepare for and conduct work procedures on Forensic Accounting and Investigation Standard Number 430, on “Loans or Borrowings” issued by the Institute of Chartered Accountants of India (ICAI) and should be read in conjunction with all the Standards relevant to the topic. The contents of this Guidance Note are recommendatory in nature and do not represent the official position of the ICAI. The reader is advised to apply best Professional judgement in the application of this Guidance Note considering the relevant context and prevailing circumstances.

1.0 Introduction

1.1. FAIS 430 on “Loans or Borrowings” is a specialised Standard related to disputed transactions of loans or borrowings. Both fund based and non-fund based loans or borrowings are covered, (including personal loans or borrowings) extended by banks as well as non-banking finance corporations. The Standard also provides an illustrative list of these disputed transactions (refer para 4.1).

1.2. This Standard expects the Professional to recognise the basis on which such transactions get disputed when providing Forensic Accounting and Investigation (FAI) services to help resolve these disputes.

1.3. The requirements of this Standard are expected to be implemented through:

(a) Studying the nature of these transactions and why they are being disputed;

(b) Developing work procedures to identify the basis on which the agreements and arrangements may have been violated;

(c) If the mandate requires, conduct a study of the flow of funds and whether they comply with the utilisation provisions; and

(d) Where the objectives are to seek recovery of funds and assets, execute the same with due precautions.

2.0 Objectives

2.1. This Guidance Note (GN) outlines the manner in which the Professional prepares and executes work procedures when implementing the requirements of this Standard during the course of a FAI engagement.

2.2. The objective of this GN is to assist the Professional conducting FAI engagements in the area of loans and borrowings to comply with the requirements of the Standard on the subject, in the following manner:

(a) Understand the circumstances leading to disputed transactions in the area of loans or borrowings;

(b) Identify whether these disputes have any merit and gather evidence to confirm or deny the concerns or allegations; and

(c) Develop work procedures to gather evidence in the area of funds flow and asset tracing to help achieve relevant objectives.

2.3. This GN also provides examples and illustrations of cases to help the Professional apply similar work procedures which may be relevant to the circumstances of the engagement.

3.0 Procedures

3.1. Loans or Borrowings transactions are of a contractual nature wherein the purpose of the loans, along with the terms and conditions of performance are stipulated. These transactions are generally governed by provisions of various laws such as Companies Act, Co-operative Societies Act, Income Tax Act etc and are also regulated under the regulatory provisions of Reserve Bank of India (RBI). Therefore, such type of engagements requires the Professional to have basic understanding of regulatory, statutory and contractual provisions of loans or borrowings and apply them in the work procedures to undertake the review.

3.2. The Professional would understand the nature of loans or borrowings and get a background of the transactions under dispute through a communication with the Primary Stakeholders. A set of basic documents for review would also be available from them, such as the following:

(a) Loan Application.

(b) Project Reports, including financial projections if any.

(c) Loan Appraisal.

(d) Loan Sanction Letter.

(e) Loan Agreement.

(f) Security Agreement.

3.3. For additional information the Professional may reach out to many other sources as these would provide an opportunity to corroborate information received beyond accounting and legal records:

(a) Compliance submissions made with the regulators, registrar of companies, the entity or organisation, etc.

(b) Legal and tax filings and submissions with the relevant authorities.

(c) Open-source intelligence (OSINT) and/or public domain searches to extract various databases and gather relevant information. OSINT refers to undertaking searches on publicly available information across various platforms, databases etc.

3.4. The Professional is expected to understand the Objectives of Engagement on the basis of the nature of dispute. For example,

—   The dispute may be related to violation of legal, regulatory or contractual provisions.

—   The dispute may be related to violation of loans or borrowing sanctioning process.

—   The loans or borrowings may be obtained by submitting fake documents.

3.5. The Professional may be required to develop hypotheses as per the nature of the dispute and accordingly formulate work procedures to gather relevant evidence. There could be multiple scenarios under which a certain dispute might have developed and although subjective, an indicative list of the nature of dispute and possible work procedures to test the same have been provided under para 5.0, Annexure of Cases.

4.0 Explanations with Examples

4.1. Explanation of work procedures and tests that could be performed by the Professional in order to review if the loan was extended or obtained through inappropriate means or not in conformity with the established procedures (indicative list):

4.1.1 The Professional may confirm the nature of documents submitted and its authenticity, wherever required and relevant. This could be done by cross verifying those documents with borrower’s information and other sources of information available with public authorities, such as GST department, Income Tax department and the ROC.

4.1.2 The Professional can corroborate those documents from other external sources such as confirmation from debtors /suppliers of borrowers, banks etc.,

4.1.3 The Professional may also verify the compliance level observed by the sanctioning authority.

NOTE: In case the internal loan appraisal procedures and documentary compliance is not observed, the Professional may take a note of it as a fraud indicator and may choose to gather evidences about such non-compliances. Professional may get additional support for this type of fraud indicator from Internal Audit, Concurrent Audit, Statutory Audit reports etc., of the bank. Further, the work procedure related to this area may require the need to revisit/reconfirm the scope agreed with the Primary Stakeholder.

4.2. There could be instances of assets offered as securities for loans are either not owned, not in existence or misappropriated without the knowledge of the lender and following could be the possible work procedures to review and test the same (indicative list):

4.2.1 Review of the documents to understand and test the authenticity of the same by taking the help of legal expert who may provide the legal search report or by taking the help of valuation expert in case of inflated valuation of property or any other asset offered as security.

4.2.2 The Professional may want to test the possibilities of Asset Stripping, which involves disposing of assets of an organisation leaving behind the debts.

4.2.3 The Professional may want to take help of an expert to identify the existence, ownership, valuation and quality of the secured asset by taking help of digital records.

4.2.4 The Professional may also undertake a search on the web portal or Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI) web portal etc.

4.2.5 Undertake searches to check if there is a particular charge on an asset for example (in the case of companies) charge with the Registrar of Companies.

4.3. Funds may not have been utilized as per contractual terms and conditions and loans or borrowings. Work procedures such as the following can be adopted (indicative list):

4.3.1 Understand the purpose of loans or borrowings through a review of loan sanctioning documents.

4.3.2 Understand the end use of the funds through an analysis of bank statements, accounting entries in the borrowers’ books of accounts, and attempting an asset trail.

4.3.3 Where stakeholder is not cooperating, it could be a significant matter to be communicated to the Primary Stakeholder at the earliest.

4.3.4 Undertake a review of transactions with related or connected parties to check if there are any transactions without underlying commercial substance.

NOTE: There could be diversion of funds through payment to related or connected parties without offering any services, without movements of goods or offering them at an abnormal price in comparison with Arm’s Length pricing. It may be possible that funds are also diverted through parties who are not directly related; in such case Professional may require to gather additional evidences to establish the connection between borrower and such parties. (e.g., a party may not be legally related to borrower but other indicators such as a common address, contact details, may point towards the ability of the borrower to exercise influence over the party).

4.3.5 Diversion of funds as per RBI Master Circular includes the following forms:

(a) Utilisation of short-term working capital funds for long-term purposes not in conformity with the terms of sanction.

(b) Deploying borrowed funds for purposes / activities or creation of assets other than those for which the loan was sanctioned.

(c) Transferring borrowed funds to the subsidiaries / Group / Shell companies or other corporates by whatever modalities.

(d) Routing of funds through any bank other than the lender bank or members of consortium without prior permission of the lender.

(e) Investment in other companies by way of acquiring equities / debt instruments without approval of lenders.

(f) Shortfall in deployment of funds vis-à-vis the amounts disbursed / drawn and the difference not being accounted for.

4.4. In cases where there are fraud indicators or suspicions that the borrower might have submitted false documents related to fund utilization, following work procedures can be performed (indicative list):

4.4.1 Documents such as loan and current account statements, supporting documents for the utilisation, and certificate for end utilisation, also to be analysed in detail to understand the end purpose and beneficiary vis-à-vis the permission purpose. Utilisation certificates can be externally verified through UDIN if the same have been signed by a Chartered Accountant.

4.4.2 In case of Project Specific Funding, detailed analysis of the project report and supporting documents such as Quotations, estimates may be required to evaluate. Further, the Professional may confirm whether the loan has been disbursed to the parties mentioned in the project report. The Professional may also choose to confirm the work done and rely on the work of technical expert in relevant cases.

4.5. Work procedures relating to disputes of timely repayment of interest and principal (indicative list):

4.5.1 Understand the repayment schedule and maturity period along with the concept of roll-over and penal interest.

4.5.2 Check if any other form of loans or borrowings have been re-paid, which is to a related party and detrimental to the interest of the secured lender.

4.5.3 Ever greening and its practical application: Professional may understand if the borrower has made an attempt to roll-over the loans or use funds availed through loans or borrowings for the repayment of defaulted loans or borrowings. The whole premise of ever greening is to avoid the classification of loans or borrowings as NPA.

NOTE: While applying the ever-greening criteria, the guidelines of the Reserve Bank of India on Loan Restructuring, Loan Rescheduling etc. may be considered.

5.0 Annexure of Cases

5.1. CASES: A few examples cases are presented here to show how certain work procedures can be undertaken in the area of loans or borrowings. However, these are just some possible scenarios, and the concept needs to be applied by the Professional more than the facts stated in these examples.

(A) CASE 1: Litigation Support in a Case of Fund Diversion

• Background: Party A had alleged that Party B has diverted funds which were infused by Party A in ABC Ltd.
• Appointment: The Professional was appointed to gather evidence to support the suspicion of fund diversion and then to provide litigation support to Party A.
• Work Procedures (indicative list): The Professional may undertake the following evidence gathering procedures:

—   From the ROC, identified the directors and shareholders of ABC Ltd.

— Using this, identified connected parties (other entities/organisations linked to the directors and shareholders).

— Perform OSINT and public domain searches to identify other potentially connected parties.

— Extracted the Financial Statements filed with the Registrar of Companies, and review the Notes / Disclosures on Related Party Transactions.

—   Undertook a detailed review of all those entities, formed a web of all these entities involved.

— Using the funds infused by Party A, as a starting point, and using related party transactions information as a basis, started to trace and match the transactions.

—   Prepared a timeline of events and back-to-back transactions between multiple entities.

• Outcome: Traced and matched the transactions in the related party entities then through a layer of 15+ entities, the funds were identified to have been invested into a foreign entity in form of debentures.

(B) CASE 2: Extortionate Credit Transactions

• Background: IBC case identified by a Resolution Professional, where Corporate Debtor had availed a loan at the rate of 48% from a private company to fund the losses and repayments of the institutional borrowers during the period within two years preceding the insolvency commencement date.

• Concerns: Chunk of charge free assets has been mortgaged for availing of this private loan. Also, the mortgagee had the option to convert the debt into equity at the face value if the servicing could not be done for 180 days continuously.
• Work Procedures (indicative list): The Professional may undertake the following evidence gathering procedures:

—   Review the loan agreements.

— Trace the funds movements and their utilization.

—   Assess the financial performance of the borrower and understand the necessity of loan at such a high rate of interest.

— Identify the relation of a private company to confirm whether it is a related or connected party by reviewing ROC documents, directors’ details, etc.

• Outcome: These terms could be classified as exorbitant and unfavourable to the existing financial creditor’s interest and could have been created knowingly to the situation, for defrauding the creditors and detrimental to their interest. There is reference and further guidance in Section 167(5) of Insolvency and Bankruptcy Code, 2016.

(C) CASE 3: Authenticity of Loan Disbursements.

• Background: Periodic payments are made to a named contractor by the borrower against a contract, stating that the work completion is 55% and accordingly, agreed instalment payment needs to be disbursed.
• Concern: Whether the work alleged to have been completed by the contractor actually undertaken and is the milestone of 55% an accurate claim.
• Work Procedures (indicative list): The Professional may undertake the following evidence gathering procedures:

—  Review the loan agreements.

— The contract may be studied in details to understand as to actually what are the milestones defined, and has the contract value changed or modified etc.

— Other forms of evidence expected to be corroborated with; i.e., as per the budgets, are other payment/expense line items in sync with the contractors’ payment.

— Trace of the funds to confirm whether it is routed back to borrower by verifying the borrowers’ banks accounts, books of accounts, etc.

—  Deploy services of an independent engineer and valuer to estimate the % completion and verify to the 55% claim.

• Outcome: The work completed by the contractor could not be verified and was estimated to be nowhere close to the claim being submitted based on % completion which in itself could not be supported by independent experts.

(D) CASE 4: Utilisation of Working Capital Credit

• Background: Cash Credit is availed with the purpose to utilise the same for working capital purpose. However, the bank has concerns whether they are deployed for the business working capital.
• Concern: Nature of utilisation of the credit needs to be reviewed. Funds could have been paid for the purposes as per the agreement, however there could be a refund of the same in another account or round tripping of the said funds to change the nature of the transaction, same can be a violation.
• Work Procedures (indicative list): The Professional may undertake the following evidence gathering procedures:

—  Verity the Loan sanction documents.

— Understand the nature of business of the borrower and working capital needs.

—  Trace the funds received by an analysis of the bank statements with different bank accounts of the borrower.

— Analyse the inventory records of the borrower and confirm the requirement of drawing power limit of cash credit.

— Analyse the financial performance of the borrower to identify the fraud indicator which may assist in asset trail.

• Outcome: A review of the flow of funds and its mapping with the dates and timeline, especially outflow from one account to a third party and inflow into another account from the same/another third party indicates mis-utilisation.