Unregulated Deposits Scheme – An Analysis

The Banning of Unregulated Deposits Schemes Ordinance 2019 (‘UDS’) is a bold ordinance introduced to comprehensively ban illicit deposit taking schemes. The article has been divided into the following sections –

I. Background

The need of UDS

On the social media platforms, UDS is being viewed as a law to restrict raising of unsecured loans by individuals and businesses. This is incorrect interpretation. The real reason of bringing up this law is rising instances of people being defrauded by illicit deposit taking schemes in the various parts of the country. Did it require enactment of such bold legislation? Well, let us have a look at some data[1] of the past 4 years –

This is the kind of the menace which unregulated deposit taking companies or entities pose. We are aware of the Saradha Chit Fund Scam which has wiped out savings of so many small and marginal investors.

[1] As per the details provided by Secretary, Department of Financial Services to the members of the Standing Committee on 26^th September 2018

Present Regulatory Structure

The Indian non-banking financial sector is large, diverse and complex. Non-banking entities are allowed to raise deposits from the public under the provisions of various statutes enacted by the Central Government and the State Governments. For instance –

Despite such diverse regulatory framework, schemes and arrangements leading to unauthorised collection of money and deposits fraudulently are still operating in the society. This is done by inducing public to invest in uncertain schemes promising high returns or other benefits. Hence, it is apparent that the regulatory framework for deposit taking activity at present is not adequate, effective and seamless.

Why Ordinance route?

The Twenty-First Report of the Parliamentary Related Standing Committee on Finance (Sixteenth Lok Sabha) titled as Efficacy of Regulation of Collective Investment Schemes, Chit Funds, etc. highlighted the regulatory gap. The said Committee in its Report has recommended the above-referred requirement of appropriate legislative provisions, coupled with effective administrative and enforcement measures in order to protect the hard-earned savings and investments made by millions of people. In line with these recommendations, our Hon’ble Finance Minister in his Budget Speech 2017 mentioned that bill to curtail the menace of illicit deposits will be introduced. He also acknowledged the urgent need to protect the poor and gullible investors from set of dubious schemes, operated by unscrupulous entities who exploit the regulatory gaps. Post this; the UDS Bill was introduced in Lok Sabha on 18^th July 2018. It was referred to the Standing Committee of Finance on 10^th August 2018 and was finally passed in Lok Sabha on 13^th February 2019. It could not be passed in the Rajya Sabha as the house is not is session; it has been introduced as an Ordinance.

II. Important Sections

Important sections which are elementary to the law are analysed below –

Section 2(4) – Definition of Deposit

Deposit is defined in such a manner that deposit takers are restricted from camouflaging public deposits as receipts, and at the same time not to curb or hinder acceptance of money by an establishment in the ordinary course of its business. It includes money received and not commodity. Say someone accepts gold or silver as deposit, then it will escape this definition.

Section 2(6) – Definition of Deposit Taker

Deposit Taker includes all possible entities (including individuals) receiving or soliciting deposits, except specific entities such as those incorporated by legislation and banking companies.

Section 2(14) – Definition of Regulated Deposit Scheme read with First Schedule

Regulated Deposit Schemes (‘RDS’) are the ones which are permitted to accept and solicit deposits. An exhaustive list of RDS has been specified in the First Schedule to the Ordinance. The list has specified all the present schemes regulated by various regulators for accepting deposits.

Section 2(17) – Definition of Unregulated Deposit Scheme

This definition is the backbone of the Ordinance. Accordingly, let us first read the entire definition, then break it down and analyse it –

(17) “Unregulated Deposit Scheme” means a Scheme or an arrangement under which deposits are accepted or solicited by any deposit taker by way of business and which is not a Regulated Deposit Scheme.

• UDS means a Scheme or an Arrangement

To qualify as UDS, it should first be a Scheme or an Arrangement. Now what is a Scheme or an Arrangement? Since these are not defined in the Ordinance, let us have a look at its definition in the Oxford’s Dictionary.

Scheme Large-scale systematic plan or arrangement for attaining some particular object or putting a particular idea into effect.

Arrangement A plan or preparation for a future event.

So can a one-off transaction be considered as UDS? No.

• Under which deposits are accepted or solicited by any deposit taker by way of business

Deposit taker should accept the deposit by way of business. This is a critical phase which mandates accepting of deposits should be by way of business. Definitions of ‘by way of’ and ‘business’ as per Oxford’s Dictionary are reproduced below –

By Way Of  So as to pass through or across; Constituting; By means of

Business  A person’s regular occupation, profession, or trade; Commercial Activity

Therefore, it should be the business of deposit taker of accepting deposits. This means that it should be the regular occupation of deposit taker of accepting-repaying deposits and providing something in return for the same (like an unregistered financial or banking entity). Accepting money for conducting say trading business is not considered as a business of accepting deposits and is hence not considered as UDS. Accepting loans by individuals, firms, etc. for conducting their normal business activities (except financial or banking) are not considered as Unregulated Deposits.

• And which is not a RDS

If the scheme is covered under the RDS, it will not be considered as UDS.

Section 3 imposes a blanket ban on UDS. It also bans deposit taker to promote, operate or solicit directly or indirectly any investment in unregulated deposit scheme.

Section 4 prohibits committing fraudulent defaults in repayment of deposit or rendering specified service promised while accepting deposits.

Section 5 prohibits any person other than deposit taker to induce someone to participate in an UDS. Deposit taker is already prohibited for soliciting u/s 3.

Section 7(3) authorizes Competent Authority to provisionally attach the deposit obtained by deposit taker vide UDS. It also allows attaching property, if any acquired out of the deposits accepted.

Section 9 enables the Central Government to designate authority for creating, maintaining and operating an online database for information on deposit takers operating across the country. The present regulators and officers empowered under this law may also be required to share information on deposit takers with the database maintaining authority.

Section 16 authorizes the Court to attach the properties in case the Court is of the view that the deposit taker has transferred the property with a fraudulent intention. Laws of natural justice will be followed while attaching the properties transferred to such malafide transferees.

III. Understanding the Ordinance

Applicability

This is a prospective law made applicable from 21^st February 2019. It would apply to the whole of India except the State of Jammu and Kashmir. For all the deposits before 21^st February 2019, the regulatory framework at that point of time would continue to apply.

Targeting Unregulated Deposit Schemes

UDS contains a substantive banning clause which bans Deposit Takers from promoting, operating, issuing advertisements or accepting deposits in any Deposit Taking Scheme which is not regulated. The principle is crystal clear that this Ordinance bans unregulated deposit taking activities altogether, by making them an offence ex-ante, rather than the existing legislative-cum-regulatory framework which only comes into effect ex-post with considerable time lags.

People of the western regions of the country may not understand and appreciate the importance of this law. But when we see the investment patterns of the households of the southern region of the country and even some eastern parts, the investment in such deposit schemes like chit funds are huge. And these marginal and gullible investors are the real victims of the illicit deposit schemes.

Prescribed Offences

The Ordinance broadly prescribes three different types of offences and prescribes severe punishment and heavy pecuniary fines for the same. The offences are –

• Running of Unregulated Deposit Schemes;
• Wrongful inducement in relation to Unregulated Deposit Schemes; and
• Fraudulent default in Regulated Deposit Schemes.

Administrative Segment

The Central Government will establish an online database for maintaining records of deposit takers. All the deposit takers pan-India have to provide the information on the database portal regularly. Time and form of reporting has not been prescribed yet. This online portal once made accessible to all, people can verify the genuineness of the deposit takers and substantially reduce the flow of money to illicit deposit schemes. Further, any violation of provisions related to reporting on online database by deposit takers would invite penalty of up to INR 10L.

Deposit takers covered under Regulated Deposit Schemes are allowed to accept and solicit for obtaining deposits. However, any fraudulent default in repayment or servicing of deposits would invite fine of higher of INR 5L; INR 25 cr.; or thrice the amount of profits made on such default. This will be in addition to imprisonment which may extend to 7 years.

Unregulated Deposits have been declared an offence ex-ante. In case where unregulated deposits vide any schemes are still raised, the law provides for attachment of assets and subsequent realisation of assets for repayment to depositors. Clear-cut time lines have been provided for attachment of property and restitution to depositors. Fines and punishment prescribed for offences related to unregulated schemes are as follows:

 Major Beneficiaries

• Poor and gullible people who are being duped by illicit deposit schemes launched by rapacious operators. This law will protect them by altogether banning unregulated deposit taking schemes.
• Deposit raising entities which are regulated by and accountable to the Government or Regulators, by increasing public faith in them.

Myths

A lot of misinformation has been spread using the social media platforms related to this Ordinance which has resulted in clamor among the people. It is being circulated that one cannot obtain personal loans; loans for business can be obtained only from relatives, etc. These claims are results of incomplete reading coupled with preconceived notions. I have tried to clear the same in the next section of FAQs.

IV. Frequently Asked Questions – Myth Breakers

Q1. Mr. X has a function in his house. He borrows INR 1L from his friend Mr. Y. Will this be considered as illegal under this law?

Ans. Mr. X being an individual is covered under the definition of deposit taker. Accepting loan from friend is squarely covered in the definition of deposit. However, accepting deposits is not the business activity of Mr. X and hence, not considered as Unregulated Deposit Scheme. It is not illegal under this law.

Q2. Mr. A had individually started an unregistered chit fund on 1^st January 2019. He gathered 1000 participants to contribute INR 5k every month. He had received instalments on 5^th January 2019 and 5^th February 2019. Will the instalments already collected be considered as illegal under this law? Can he collect the instalment due on 5^th March 2019?

Ans. It is crystal clear that this is a prospective law applicable from 21^st February 2019. Hence, deposits accepted prior to this law will be governed by the respective legislations in force at that point of time.

Mr. A being an individual falls under the definition of deposit taker. Accepting money from non-relatives falls under the definition of deposit. Also, this is an entire arrangement of chit fund which is not registered. Therefore, it is UDS and Mr. A’s scheme is illegal from 21^st February 2019. He cannot collect the instalment due on 5^th March 2019, if he does, he would invite severe punishment coupled with heavy pecuniary fines.

Q3. Mr. X, a software engineer wishes to invent business software based on block chain technology. Mr. Y, his friend agrees to give him a loan of INR 15L. Now, Mr. Y is of the view that Mr. X cannot accept the loan according the provisions of UDS? Is the view of Mr. Y correct?

Ans. Obtaining loans for the purpose of business bearing a genuine connection is exempted from being considered as deposits. Further, accepting deposits is not the business activity of Mr. X and hence, not considered as Unregulated Deposit Scheme. The view of Mr. Y is incorrect.

Q4. ABC Pvt. Ltd. advanced INR 5L for supply of polymers to XYZ Pvt. Ltd. The time period for supply of goods was one month. It has been 2 months since the amount was advanced, but XYZ has neither supplied the goods nor it has refunded the amount due. What are the implications under UDS?

Ans. Advancing money for supply of goods in the normal course of business is not considered as deposits. However, when such advance becomes refundable, it will be considered as deposits if not repaid within 15 days of it becoming refundable. INR 5L has qualified as deposits in the hands of XYZ Pvt. Ltd. but since it is not its business activity of accepting deposits, this transaction will not be considered as Unregulated Deposit Scheme.

Q5. M/s Hari Bros., a partnership firm is DCA-cum-Super Stockist of HUL. HUL delivers the goods to the customers of Hari Bros. as per their instructions. The customers of Hari Bros. receive bill from HUL and Hari Bros. receive commission from HUL. HUL provides credit period of one week. Not all the customers of Hari Bros. are able to pay up in the credit period provided. Hari Bros. pay on their customers’ behalf and charge them interest. Is the credit provided by Hari Bros. prohibited under UDS?

Ans. The amount paid by Hari Bros. to HUL on behalf of its customers is advance in the normal course of business. Hence, it is exempted from being considered as deposits and accordingly, allowed under UDS.

Q6. Mr. A wants to individually start a chit fund (without getting it registered). He has decided to get 1000 participants in his scheme. The monthly contribution decided is 5 grams of silver per participant. He will accordingly fix the monthly prize too. Is this Scheme prohibited under UDS?

Ans. Mr. A being an individual is covered under the definition of deposit taker. Starting a chit fund is a Scheme. However, the definition of deposit covers only receipt of money and not any commodity. Accordingly, since the receipt of silver is not covered under the definition of deposit, this scheme will not be prohibited under UDS.

This is the space where the Government should verify as to whether it wanted to allow such Schemes or it is lacunae in the law which needs to be amended.

V. Conclusion

 An exhaustive list of Regulated Deposit Scheme is provided. Therefore, the enumeration of Unregulated Scheme is left for residual interpretation or extrapolation by default. It hence leaves wide, unfettered and rather open-ended scope for subjective or arbitrary decisions by the authorities.

Although there would be an online database but execution on ground will be in the hand of the officers. There are heavy pecuniary fines prescribed with punishment. Manual handling supported with harsh legal provisions certainly leads to increasing corruption on ground. A law drafted for protecting the money of small, marginal and gullible investors may to a certain extent end up filling the pockets of the so called law enforcers.

With these few challenges we may face practically, this law is the need of the hour especially in the regions where the investment quantum is enormous in such Ponzi schemes. Government may come up with further clarifications on the law because of the misinformation spread across social media. One should wait for it.

It is the style of this government to bring in laws which impose blanket bans with huge penalties. One such example is the Black Money Law. This may help create a fear in the minds of the people and hence discourage the illegal transactions. However, at the end of the day, it should not end up hampering the lives of small people, unintentionally.