Background- Reserve Bank of India (RBI) has, on 30 March 2011, prohibited Non-Banking Finance Companies (NBFC) from contributing capital to any partnership firm or to become and /or remain partners in partnership firms.  To give effect to above, RBI has amended following Directions with effect from 30 March 2011 viz.:

  • Non-Banking Financial (Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007; and
  • Non-Banking Financial (Non Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007.

Accordingly, the above regulations have been amended to provide that:

1.       No NBFC shall contribute to the capital of a partnership firm or become a partner of such firm.

2.       A NBFC, which has already contributed to the capital of a partnership firm or was a partner of a partnership firm, shall seek early retirement from the partnership firm.

Analysis

1. RBI has not explicitly stated the rationale for imposing the prohibitions except that this prohibition is due to “the risks involved in NBFCs associating themselves with partnership firms”. The prohibition is to prevent NBFCs from exposing themselves from an unlimited liability risk associated with being a partner in a partnership firm. The prohibition may not extend to become a partner in a Limited Liability Partnership [LLP] formed under the LLP Act, 2009, since partners in a LLP have limited liability. One would have to wait for a formal clarification from RBI in this regard.

2. The requirement of early retirement of NBFCs from the existing partnership firm may create certain peculiar situations as under:

a.       If a partnership firm has only 2 partners, it may be difficult for such a firm to be reconstituted;

b.       Early retirement from partnership firm may lead to a tax event which may not have been factored when parties set to carry on business as partners of a firm and would require them to rework on commercial understandings etc.

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