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Bluebook 20th ed.

Sharath Chandupatla & Manal Shah, Peer-to-Peer Lending and Equity-Based Crowd Funding
- Status Quo and the Leap Forward, 9 Nirma U. L.J. 97 (2019).

ALWD 6th ed.

Sharath Chandupatla & Manal Shah, Peer-to-Peer Lending and Equity-Based Crowd Funding
- Status Quo and the Leap Forward, 9 Nirma U. L.J. 97 (2019).

APA 6th ed.

Chandupatla, S.; Shah, M. (2019). Peer-to-peer lending and equity-based crowd funding
status quo and the leap forward. Nirma University Law Journal, 9(1), 97-118.

Chicago 7th ed.

Sharath Chandupatla; Manal Shah, "Peer-to-Peer Lending and Equity-Based Crowd Funding
- Status Quo and the Leap Forward," Nirma University Law Journal 9, no. 1 (December
2019): 97-118

McGill Guide 9th ed.

Sharath Chandupatla & Manal Shah, "Peer-to-Peer Lending and Equity-Based Crowd
Funding - Status Quo and the Leap Forward" (2019) 9:1 Nirma U LJ 97.

MLA 8th ed.

Chandupatla, Sharath, and Manal Shah. "Peer-to-Peer Lending and Equity-Based Crowd
Funding - Status Quo and the Leap Forward." Nirma University Law Journal, vol. 9, no.
1, December 2019, p. 97-118. HeinOnline.

OSCOLA 4th ed.

Sharath Chandupatla and Manal Shah, 'Peer-to-Peer Lending and Equity-Based Crowd
Funding - Status Quo and the Leap Forward' (2019) 9 Nirma U LJ 97

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 PEER-TO-PEER LENDING
AND EQUITY-BASED
CROWD FUNDING

-
STATUS QUO AND THE
LEAP FORWARD

Sharath Chandupatla*
Manal Shah**
ABSTRACT

This paper intends to evaluate the modern-day concepts of public fund

raising under the aegis of 'peer-to-peer lending' and 'equity-based
crowdfunding' and to highlight their importance in the current world
market scenario. It traces the evolution of crowdfunding and highlights its
practicalfunctioning with noteworthy illustrationsand statisticalanalysis.
This paper intends to address the dire needfor regulationof these activities,
by bringing to light the deficiencies and lacunae in the extant laws and
suggested solutions thereto. In furtherance of the said objective, a double-
faceted approach is taken. First, the paper examines the parallel
internationalpracticesof such regulations in the United States of America,
United Kingdom, China, France, New Zealand, Korea etc. and then it
evaluates extant Indian laws. The paper has also dissected the attempts
made by regulatory bodies in India, such as the Reserve Bank of India's
Non-Banking Financial Company - Peer to Peer Lending Platform
(Reserve Bank) Directions, 2017 and the Securities and exchange Board of
India's Consultation Paper on Crowdfunding in India, 2014 which aim to
regulate these activities. The paper recognizes the dire need for a
meticulous regulation of equity-based crowdfunding and for this purpose

* Fifth-Year BA LLB (H), The National University ofAdvanced Legal Studies, Kochi. The
authorcan be contacted at chandupatlasharath@gmail.com.
** Fifth-Year BA LLB (H), The National University ofAdvanced Legal Studies, Kochi.
98 Nirma University Law Journal: Volume-9, Issue-1, December-2019

concludes with suggestions. The paper highlights the need for introduction
of interest cap on peer-to-peerlending, introduction of a 'cooling-offperiod
for investments by retail investors in Equity crowdfunding, additions to
investor education and risk undertaking by investors, strengthening
suggested valuation standardsetc.

Keywords: Crowdfunding, Crowdfunding in India, Peer-to-peer lending,

equity-based crowdfunding, SEBI Consultation Paper on Crowdfunding,
Legality of Crowdfunding in India.

I. INTRODUCTION

Crowd sourced funding is a means of raising money for a creative project (for
instance, music, film, book publication), a benevolent or public-interest
cause (for instance, a community based social or co-operative initiative) or a
business venture, through small financial contributions from persons who
may number in the hundreds or thousands. Those contributions are sought
through an online crowdfunding platform, while the offer may also be
promoted through social media.'

One of the earliest known examples of crowdfunding is that of Irish Loan

Funds (1700s) which was created by one Jonathon Swift to lend small
amounts of money to low-income families with less access to credit for short
periods." This led to many other programs in Ireland. Dr. Mohammad Yunus
envisaged a similar concept in Bangladesh (1976), along with his graduate
students, lent small amounts of money to the poor to become self-employed
and sustain these businesses.' By 1981, it had more than 30,000 members
and in 1983 it became 'Grameen Bank'.' Dr. Yunus and the bank won Nobel
Peace Prize in 2006 for their work in economic and social development.'
Crowd Based Equity Funding - Discussion Paper - Corporations and Markets Advisory
Committee, Australia, September, 2013.
Crowdfunding History, https://www.fundable.com/learn/resources/guides/crowdfunding/
crowdfunding-history (last visited Apr. 16, 2019).
Id.
Bill Clark, The History and Evolution of Crowdfunding, https://mashable.com/2011/09/15/
crowdfunding-history/#SHlxdkn5t8qd (last visited Apr. 16, 2019).
1 Id.
PEER-TO-PEER LENDING AND EQUITY-BASED CROWD FUNDING... 99

Crowdfunding is not a new concept in India either. Places of worship are

built with the charity collected from the people. Among instances for fund
raising by businesses, a finest case in point is the story of the conglomerate
Reliance Industries founder Dhirubhai Ambani whose textile business was
originally crowdfunded by communities across Gujarat.'

The crowdfunding of present day is Internet Crowdfunding. The first

successful crowdfunding on the internet was when a British Rock band
Marillion raised money from fans to fund its tour through ArtistShare
(1997).8 It was followed by Kiva.org in United States of America ("USA")
(2006) a 'microlending' source.9

According to Securities Exchange Board of India ("SEBI"), "crowdfunding is

solicitation of funds (small amounts) from multiple investors through a
web-based platform or social networking sitefor a specificproject, business
venture or social cause".o The online crowdfunding platforms function as
intermediaries between the investors and the entrepreneurs. There are
different ways in which these platforms work. While some platforms raise
the fund as a whole and fund individual projects after review by the
intermediaries, certain others facilitate the entrepreneur to present his
project on the website which would attract the investors. Currently, some of
the famous crowdfunding platforms in India are Milaap, Ketto, Wishberry,
Lets venture and so on. There has been a substantial upsurge in the usage of
these platforms to fund projects with a simultaneous increase in its
appreciation among people.

6 Alok Patnia, Crowdfunding- An Indian Perspective, https://yourstory.com/2013/11/

crowdfunding-indian-perspective/ (last visited Jul. 16, 2018).
7 Will Kenton, Crowdfunding, https://www.investopedia.com/terms/c/crowdfunding.asp (last
visited Apr. 16, 2019).
' Jack Preston, How Marillion pioneered crowdfunding in music, https://www.virgin.com/
music/how-marillion-pioneered-crowdfunding-music (last visited Apr. 16, 2019).
' Steve Hargreaves, Be a global financier...shoestring, https://money.cnn.com/2006/ol/17/Pf/
kivamicrofinance/index.htm (last visited Apr. 16, 2019).
"SEBI, Consultation Paper on Crowdfunding in India, https://www.sebi.gov.in/sebi-data/
attachdocs/14o3005615257.pdf (last visited Jul. 16, 2018).
Crowdfunding - Statistics & Facts, https://www.statista.com/topics/1283/crowdfunding/
(last visited Apr. 16, 2019).
100 Nirma University Law Journal: Volume-9, Issue-1, December-2019

According to IOSCO, crowdfunding has four subcategories: Donation

crowdfunding, reward crowdfunding, peer-to-peer lending ("P2P lending")
or debt based crowdfunding ("DBC") and equity based crowdfunding
("EBC"). 2 P2P lending and EBC are forms of market-based finance and are
collectively referred to as 'financial return crowdfunding'." P2P lending
involves a loan given by investor to entrepreneur through the platform. Here,
the entrepreneur is liable to pay the principal amount along with the interest
according to the agreement between the parties. In EBC, the investor is
allotted equity shares in the company.

II. NEED FOR CROWDFUNDING

In the wake of 2008 financial crisis, the financial institutions have been
skeptical to fund nascent business ventures. It is also vastly difficult for small
enterprises to raise funds in the light of the strict RBI and SEBI regulations.
Considering these circumstances, crowdfunding is much needed to diversify
the wealth and put it to clever use. Increase in the working capital accelerates
GDP and helps the growth of economy. One report claims that if every
American family gave one percent of their investable assets to crowdfunding,
$30o billion (a lox increase) would come into venture capital."

Crowdfunding enables start-ups and small & medium sized enterprises

("MSME") to raise funds in small amounts from retail investors. The
business proposals are advertised through an online platform. Unlike public
funding, the issuing entity does not circulate a prospectus, nor does it have to
undergo the rigorous processes laid down by SEBI like valuation, etc. This
reduces the cost of capital for the entity. It also provides for a new
investment avenue to small retail investors for diversification of portfolio. It
helps in funding good ideas which do not fit the pattern required by

" Eleanor Kirby & Shane Worner, Crowd-funding: An Infant Industry Growing Fast,
https://www.iosco.org/research/pdf/swp/Crowd-funding-An-Infant-Industry-Growing-
Fast.pdf (last visited Apr. 16, 2019).
Ibid.
Ki Mae Heussner, Gigaom: What crowdfunding means for the VC business,
https://gigaom.com/2012/05/o8/fred-wilson-what-crowdfunding-means-for-the-vc-business/
(last visited Jul. 16, 2018).
PEER-TO-PEER LENDING AND EQUITY-BASED CROWD FUNDING... 101

conventional financiers to break through and attract cash through the

wisdom of the crowd. The platform provides for communication between the
investors and the entrepreneurs so that the investors have better knowledge
and understanding about the details of the project.

III. PARALLEL INTERNATIONAL PRACTICES

In the wake of 2008 economic crisis, many countries have realized the
importance of crowdfunding. The period between 2010-2015 has seen many
countries regulating crowdfunding. USA which has been actively taken steps
towards increasing crowdfunding is notable in this regard. Below are some of
the noteworthy regulations rolled out in other jurisdictions.

A. United States ofAmerica

For the lending-based crowdfunding, the general lending legal framework

applies. However, for equity-based crowdfunding, Jumpstart Our Business
Startups Act ("JOBS Act") has been enacted in 2012. The JOBS Act also
provides for the basic framework that regulates other forms of
crowdfunding. The Act has established a statutory legal framework to
exempt securities offerings conducted solely through registered brokers and
funding portals. The objective of the Act is to increase American job creation
and economic growth by improving access to the public capital markets for
emerging growth companies." It has various thresholds for both investor and
the organization seeking investment. The JOBS Act 6 places caps on
maximum permissible amount that can be raised ($1,070,000 in a 12-month
period) and capital requirements and limitation on individual investors. It
further requires the issuer to make regular disclosures to U.S. Securities and
Exchange Commission ("SEC"). It has specified that the role of
intermediaries is restricted to providing the platform. They cannot offer

" Jump Start Our Business Act, Pub. L. No. 112-106, 126 Stat. 306 (2012).
6 Regulation Crowdfunding: A Small Entity Compliance Guide for Issuers,
https://www.sec.gov/info/smallbus/secg/recomplianceguide-o51316.htm (last visited on Jul.
16, 2018).
102 Nirma University Law Journal: Volume-9, Issue-1, December-2019

investment advice to the investors and cannot solicit transactions for

securities offered.

B. United Kingdom

The Finance Conduct Authority ("FCA") has issued separate regulations for
DBC and EBC platforms. Under these regulations," DBC platforms are
placed with obligations such as minimum holding norms, disclosure
requirement to be made to the FCA. Further, they are under an obligation to
the investors to adequately highlight all risks and to refrain from marketing
of misleading products. Also, investors have an option to cancel their
agreement within a period of 14 days if the firm does not provide access to a
secondary market. In such case, there shall be no penalty attracted.

In addition to the above regulations, EBC regulations" permit only a class of

investors eligible to invest (retail investors who are advised, classified as
corporate finance contacts or venture capital contacts, certified as
sophisticated or high net worth). The rules also provide for an upper limit
than an investor can invest (lo% of their net investible assets).

C. France

The French regulators, "Autorit6 des march6s financiers" ("AMF") and

"Autorit6 de Contrble Prudentiel et de R6solution" ("ACPR"), have issued
regulations with respect to crowdfunding in October 2014.2 These
regulations address three kinds i.e. DBC, EBC and donation-based. The
regulations recently, have been liberalized. The requirement of an external
audit has been removed. The mandatory disclosures requirement however
continue.

7 Jump Start Our Business Act, Pub. L. No. 112-106, § 304, 126 Stat. 306 (2012).
Crowdfunding and authorization, https://www.fea.org.uk/firms/authorisation/when-
required/crowdfunding (last visited Jul. 16, 2018).
" Retail intermediaries and authorization, https://www.fea.org.uk/firms/authorisation/how-to-
apply/retail-intermediaries (last visited Jul. 16, 2018).
20
JD Alois, French Crowdfunding Laws Now in Force, http://www.crowdfundinsider.com/
2014/10/51484-french-crowdfunding-laws-now-force/ (last visited Jul. 16, 2018).
PEER-TO-PEER LENDING AND EQUITY-BASED CROWD FUNDING... 103

D. Analysis

To understand the reality of crowdfunding, it is necessary to know its

statistics. In the USA, where crowdfunding is well-regulated, there has been
a rise in the investment graphs." The regulations for crowdfunding were put
in place only in 2017 and the market has already grown by 267% from 2016

to 2017. The average success rate of offerings, as of 2017, was 66.7%.

Revenues for the issuers who filed annual reports increased by 131% between
2016-17. Thus, the trends show that the crowdfunding market grows rapidly,
if well-regulated.

UK has seen a similar rise in investments after FCA introduced the

regulations for crowdfunding in 2014. Despite the decrease in the number
platforms since 2014, studies show that the amounts raised continue to
grow.2' There is a '3x' increase in the investments through crowdfunding in
2014, as compared to 2013.4 Studies also show that crowdfunding is an
emerging alternative for the investors. Platforms have dominated investor
rankings in 2016 in UK.

On the contrary, China saw closure of more than 200 P2P lending platforms
this summer due to issuer defaults. This is due to its poor regulation by the
Chinese Government. Due to the lack of proper regulation in place, the
platforms allowed undeserved borrowers to receive financing which made
the investments riskier. China has now put stringent regulations such as

2 Salvandor Briggman, Equity Crowdfunding Statistics 2018, https://www.crowderux.com/

equity-crowdfunding-statistics/ (last visited Jul. 16, 2018).
22 2017 State of Regulation Crowdfunding Report, http://crowdfundcapitaladvisors.com/2017-

2state-regulation-crowdfunding-report/ (last visited Jul. 16, 2018).

Jonathon Bone & Peter Baeck, UK crowdfunding platform trends, https://www.nesta.org.uk/
blog/uk-crowdfunding-platform-trends/
24
(last visited Jul. 16, 2018).
A review of the regulatory regime for crowdfunding and the promotion of non-readily
realisable securities by other media, https://www.fea.org.uk/publication/thematic-
reviews/crowdfunding-review.pdf (last visited Sep. 16, 2018).
25The Deal Equity Investments in UK, https://www.bundesverband-crowdfunding.de/wp-

content/uploads/2017/03/The-Deal-Full-Year-2o16-w.pdf (last visited Sep. 16, 2018).

Lessons for investors following China's P2P lending nightmare, https://www.theonlinecitizen.
26

com/2018/o8/2o/lessons-for-investors-following-chinas-p2p-lending-nightmare/ (last visited

Jul. 16, 2018).
104 Nirma University Law Journal: Volume-9, Issue-1, December-2019

need for a custodian bank to hold investor-borrower funds, etc. making it

highly difficult for crowdfunding platforms to sustain themselves. The above
facts and circumstances unambiguously demonstrate the need for a well-
regulated crowdfunding market in light of the increase in its demand,
volume and popularity.

IV. REGULATORY REGIME SURROUNDING ONLINE

PEER-TO-PEER LENDING

The Reserve Bank of India ("RBI") notified27 that a non-banking institution

that carries on 'the business of a P2P lending platform' shall be a Non-
Banking Financial Company ("NBFC"). It has a step forward by describing
'the business of a P2P lending platform'. RBI defines it as "the business of
providing under a contract, the service of loan facilitation, via online
medium or otherwise, to the participants who have entered into an
arrangementwith that platform to lend on it or to avail of loan facilitation
servicesprovided by it".

P2P lending enables investors to lend funds directly to borrowers via an

online platform. Whilst platforms facilitate the lending, undertake credit
assessments and other risk management, they do not act as a counter-party
to the loan and contract and direct between the investor and the borrower.28

A. Non-Banking Financial Company - Peer to Peer Lending

Platform (Reserve Bank) Directions, 2017

The RBI vide Notification No. DNBR.o45/CGM (CDS)-2017 dated August

24, 2017 categorized a non-banking institution carrying on 'the business of a
peer-to-peer lending platform' as Non-Banking Financial Company. In order
to regulate the activities of P2P lending platforms, RBI issued the Non-
Banking Financial Company-Peer to Peer Lending Platform (Reserve Bank)
Directions 2017. These Directions permit only a company to carry out the

27Master Directions - Non-Banking Financial Company - Peer to Peer Lending Platform

(Reserve Bank) Directions, 2017 RBI/DNBR/2017-18/57.
" What is peer-to-peer (P2P) lending?, https://p2pfa.org.uk/ (last visited Jul. 16, 2018).
PEER-TO-PEER LENDING AND EQUITY-BASED CROWD FUNDING... 105

business of a P2P platform and no other legal personality can legally operate
such platforms.2 ' An NBFC-P2P must have a minimum net owned fund of Rs.
2 crores or higher as would be notified by the RBI.

1. Conditionsfor Operating an NBFC-P2P

In order to operate a business in P2P lending, the operating company must

obtain a Certificate of Registration ("CoR") from the RBI.`o It grants the CoR
after ensuring to its satisfaction that the company is incorporated in India;
has the essential scientific, entrepreneurial and managerial assets to extend
such services to the public; has satisfactory capital structure to undertake the
business activities; the promoters and directors of the company are able and
competent; that the entity has submitted a competent strategy or has
implemented a robust and secure information technology system; that the
character of the management is not prejudicial to the public interest.

Already working P2P platforms were granted time to become compliant with
the Regulations and to procure a CoR. 2 The Regulations have also laid down
grounds for cancellation which include non-compliance of any condition
3
under Master Directions or any directions issued by the RBP . the grounds of
cancellation include the failure to maintain accounts, publication and
disclosure of the financial position in accordance with requirements of any
law would also be a ground of cancellation."

2 Direction 5(1) of the Master Directions - Non-Banking Financial Company

- Peer to Peer
Lending Platform (Reserve Bank) Directions 2018.
3 Ibid.
" Direction 5(2)(ii)of the Master Directions - Non-Banking Financial Company - Peer to Peer
Lending Platform (Reserve Bank) Directions 2018.
32 Direction 5(2)(vii)of the Master Directions - Non-Banking
Financial Company - Peer to Peer
Lending Platform (Reserve Bank) Directions 2018.
" Direction 5 (2)(vii) of the Master Directions - Non-Banking Financial Company - Peer to Peer
Lending Platform (Reserve Bank) Directions 2018.
34Ibid.
106 Nirma University Law Journal: Volume-9, Issue-1, December-2019

2. Scope of PermissibleActivities"

The scope of permissible and prohibited activities has been delineated. These
platforms are required to undertake documentation of loan agreements and
other related documents and to provide assistance in disbursement or
repayment of the loan amount. The platform must provide a service for
recovery of loans originated on their platform. The Regulations permits only
clean loans.

NBFC-P2Ps are legally disabled from raising deposits, lending on its own;
providing or arranging any credit enhancement or credit guarantee; to
facilitate or permit any secured lending that may be linked to its platform.
The funds received from borrowers for servicing loans cannot reflect on its
balance sheet. Cross selling of any product except for loan specific insurance
products are prohibited. Finally, the norms prohibit international flow of
units.

6
3. PrudentialNorms3

Prudential Norms require these NBFCs to maintain a leverage ratio not

exceeding two. Besides placing a cap of Rs. 50,000 on exposure of a single
lender to the same borrower. The Regulations have placed caps of Rs.
o,oo,ooo each to be maintained at any time across all P2P Platforms on:
i. the aggregate exposure of a lender to all borrowers, and
ii. the aggregate loans taken by a borrower.

4. OperationalNorms'

The company must sine qua non have a Board approved policy elaborately
outlining the eligibility criteria for its participants, for determination of

" Direction 6 of the Master Directions - Non-Banking Financial Company - Peer to Peer Lending
Platform (Reserve Bank) Directions 2018.
3 Direction 7 of the Master Directions - Non-Banking Financial Company - Peer to Peer Lending

Platform (Reserve Bank) Directions 2018.

1 Direction 8 of the Master Directions - Non-Banking Financial Company - Peer to Peer Lending

Platform (Reserve Bank) Directions 2018.

PEER-TO-PEER LENDING AND EQUITY-BASED CROWD FUNDING... 107

pricing of services provided by it and laying down the rules for matching
lenders with borrowers in an equitable and non-discriminatory manner. The
Regulations have laid down that no loan must be disbursed unless individual
lender(s) have approved the individual recipient(s) of the loan and all
participants have signed the loan contract.

5. Obligations

The Company must necessarily process all data relating to its activities and
participants on a hardware located within India" and undertake due
diligence on the participants, undertake credit assessment and risk profiling
of the borrowers and disclose the same to their prospective lenders." It must
request prior and explicit consent of the participant to access its credit
information.

B. Analysis

The Regulations have set infrastructure requirements, qualifications and

compliances for an entity to set up as P2P which will ensure entry of
competent platforms and create a safer lending environment.

The RBI missed an opportunity to envision a secondary market dedicated to

the trading of P2P loans as it would have had the effect of boosting liquidity
of these loans. In Malaysia for example, crowdfunding operators can choose
to establish a secondary market as an avenue for investors to exit
investments. In China, some P2P platforms have already done so. Korea
established a secondary market that caters only to crowdfunded securities
and various matching funds to provide additional funding to the
crowdfunding issuers as well as to buy back individual investors'. 0

" Direction 6(i)(x) of the Master Directions - Non-Banking Financial Company - Peer to Peer
Lending Platform (Reserve Bank) Directions 2018.
" Direction 6(2)(i) of the Master Directions - Non-Banking Financial Company - Peer to Peer
Lending Platform (Reserve Bank) Directions 2018.
40
IOSCO Research Report on Financial Technologies, https://www.iosco.org/library/pubdocs/
pdf/IOSCOPD554.pdf (last visited Jul. 16, 2018).
108 Nirma University Law Journal: Volume-9, Issue-1, December-2019

The lending cap (Rs. 1o Lakh) has been criticised by High Net worth
Individuals ("HNI") as they would be hindered from participating in money
making. However, it is a noteworthy step ahead which will benefit middle
income citizens. Through these platforms, lenders gain higher returns
compared to bank deposits whereas the borrower incurs comparatively lesser
return to what it would have to pay back the bank. Thus, the functionality of
P2P lending with assistance of the RBI Regulations make is safer and easier
to transact for all parties involved.

Among the concerns, the biggest is the safety of investors which arises from
absence of cap on interest rates. The same should be added by a subsequent
amendment. Other concerns include the financial sustainability of the entity
which arises from the prescribed minimum net owned fund read along with
the prohibition from raising deposit or lending on its own, providing or
arranging credit guarantee, cross selling etc.

V. REGULATORY REGIME SURROUNDING ONLINE

EQUITY BASED CROWDFUNDING

Per the Companies Act, 2013 and SEBI Regulations, there are two ways in
which equity shares are issued. First being private placement as governed
under the Companies Act 2013 and second, Public Offer governed by the
SEBI. In absence of an exclusive legal framework for EBC in India, the same
has been restricted to the parameters of private placement norms.

SEBI issued notices in 2016 and 2017 to investors warning them about the
risks of investing in unauthorized electronic platforms not governed by any
securities law since these platforms are allegedly violating private placement
norms. The notice states that such platforms are in contravention of the
Securities Contracts (Regulation) Act, 1956 ("SCRA") and the Companies
Act, 2013 for facilitating investment in nature of private placement. These
shares are not listed on any platform of any recognized stock exchange.
PEER-TO-PEER LENDING AND EQUITY-BASED CROWD FUNDING... 109

A. Regulations Surrounding Issue ofShares

1. PrivatePlacement Norms

Companies issuing shares by way of private placement need to comply with

the Companies Act, 2013 and the Rules made thereunder. The Companies
(Prospectus and Allotment of Securities) Rules, 2014 lay down that a Private
Placement Offer ("PPO") invitation can be made to a maximum of 200
persons in aggregate per financial year, excluding the Qualified Institutional
Buyers ("QIB") [e.g. Mutual Funds ("MF"), Foreign Portfolio Investor
("FPI"), Alternate Investment Fund ("AIF"), Scheduled Commercial Bank
("SCB")] and employees under the ESOP Scheme.

Such offer has to be made through a PPO letter addressed and sent
specifically to the person to whom the offer is made within thirty days of
recording his name. No person other than the person so addressed in
application form is permitted to apply through such application. Non-
conformity to this condition shall be render the process invalid. It is
pertinent that the proposed offer includes prior approval by the shareholders
of the Company by Special Resolution for each of the offers or invitations, as
the case may be.

Companies offering securities through private placement as under Section

42, the Companies Act, 2013 are restricted from releasing any public
advertisements; or utilizing any media, marketing or distribution channels
or agents to inform the public at large about such an offer.

Non-compliance of above mentioned provisions would render such offer a

public offer. Consequently, all provisions of the 2013 Act and the SEBI Act,
1992 surrounding public offer would become applicable. Further the non-
compliance attracts penalty extending to the amount involved in the offer or
invitation or Rs. 2,00,00,000 whichever is higher, and the company has to
refund all moneys to the subscribers.
110 Nirma University Law Journal: Volume-9, Issue-1, December-2019

2. Public Issue Norms

Companies making public issue of securities need to comply with public

issue requirements in Companies Act, 2013, the Rules made thereunder and
the SEBI Regulations. The SEBI (Issue and Listing of Debt Securities)
Regulations 2008 prescribe indispensable requirements which include
company to make listing application, filing of prospectus with the Registrar
of Companies, appointment of merchant banker and registrar to issue, etc.
The laws also prescribe certain eligibility requirements such as track record,
minimum promoter's contribution etc. It is also mandatory to have
debenture trustee, credit rating, disclosure requirements etc. as per the SEBI
(Issue and Listing of Debt Securities) Regulations, 2008 ("ILDS").

B. Issues for Crowdfunding

While private placement and public offer are governed by the regulatory
regime discussed above, SEBI issued the notice to the portals and investors
in 2016 and 2017 respectively thereby narrowing the scope of raising funds
to private placements. Crowdfunding is the practice of funding a project or
venture by raising money from a large number of people who each contribute
a relatively small amount, typically via the Internet." It is a vital
characteristic that large number of persons are involved in the process
rendering it outside the scope of a private placement. Should this follow, the
company would have to follow comply with public listing norms. Public
listing norms are also contradictory to the essential character of
Crowdfunding as they weigh down the start-ups and SME enterprises which
find it difficult to fulfil the requirements and bear the high costs of listing.

Angel investors, Private Equity and Venture Capital Funds now have a
systematic regulation prevailing in the form of the SEBI (Alternative
Investment Funds) Regulations, 2012, Seed and Angel investors are also
regulated under the Companies Act, 2013 and the SEBI (Issue of Capital and
Disclosure Requirements) Regulations, 2013. However, it can be very well be

4 English Oxford Living Dictionaries, https://en.oxforddictionaries.com/definition/

crowdfunding (last visited Jul. 16, 2018).
PEER-TO-PEER LENDING AND EQUITY-BASED CROWD FUNDING... 111

said that the law pertaining to Crowdfunding is a gray area and requires
regulation.

VI. NEED FOR REGULATION

Whereas crowdfunding has many advantages, unregulated crowdfunding has

its own drawbacks. Without a regulatory framework, the likelihood of misuse
of funds becomes elevated. The investors are not provided with prospectus,
and in reward-based and donation-based crowdfunding there is virtually
nothing that the investor gains. Hence the likelihood of misuse of funds is
fairly high.

A large section of Indians is yet to trust online transactions. E-commerce

hardly weighs in to the economy, contrasted to the offline market." A well-
regulated crowdfunding market, coupled with awareness among the people
would instill confidence among the population to trust online transactions.
For an investor, this would be a golden chance for money laundering.
Information asymmetry is also another disadvantage with crowdfunding.
Information asymmetry means where one party transacts based on the
information available to him which is not available to public. This is due to
lack of any law to disclose the same. This is similar to insider trading which
is prohibited by SEBI.

From a legal point of view, SEBI has been endeavoring to strike the balance
between the investor protection and the role of equity market. The tangible
question at hand is whether EBC be considered as a private placement or
public offer? Because per the extant Companies Law, a company cannot issue
shares to more than 200 persons in a year through private placement. If it is
a public offer, the company shall have to comply with SEBI's regulations with
respect to issue and listing of shares. This also hints us to the question of the
jurisdictional gray area between the SEBI- Ministry of Corporate Affairs
("MCA"). Under the Companies Act, MCA regulates the private placements
while SEBI regulates the listing of securities. Therefore, India needs a
E-commerce and Online Shopping in India - Statistics & Facts, https://www.statista.
42

com/topics/2454/e-commerce-in-india/ (last visited Apr. 16, 2019).

112 Nirma University Law Journal: Volume-9, Issue-1, December-2019

comprehensive legal framework regulating crowdfunding because, as stated

above, it aids the country's economic growth.

Lack of regulations and the existence of gray areas encouraged the

commission of a corporate fraud affecting the lower and middle-income
groups of the Country.

A. Past Corporate Frauds

1. The case of Sahara."

Sahara duped 23 million people to invest about Rs. 24,000 Crores by

issuance of Optionally Fully Convertible Debentures ("OFCD"). In order to
elude the surveillance by SEBI, it averred the issuance as that of private
placement and claims that OFCDs are not securities. The Supreme Court
observed that though it was stated that its OFCD scheme was a kind of
private placement and encompassed only selective clients, the evidence is
unblemished in showing that millions of people invested, bringing it under
SEBI's jurisdiction. It further observed that Sahara could not corroborate
vide documents that it had some relation with the company. Thus, it does not
qualify the claim of the investment being a private placement. The Apex
court ordered the refund of entire deposits collected by it through Red
Herring Prospectus at an interest.

2. The case of Saradha"

Saradha group issued redeemable bonds and secured debentures to collect

money from investors promising high profits for small investments. In
furtherance, local agents were hired in West Bengal and incentivized with
huge cash payouts from the deposits to expand faster. It eventually formed a
conglomerate of over 200 companies to launder money. 2013 was the fall of

4 Securities Exchange Board of India v. Sahara India Real Estate Corporation Ltd., 2013 (1) SCC
173-
'Aparajita Pande, Corporate Fraud in India - Case Studies of Sahara and Saradha,
https://sevenpillarsinstitute.org/corporate-fraud-india-case-studies-sahara-saradha/ (last
visited Jul. 16, 2018).
PEER-TO-PEER LENDING AND EQUITY-BASED CROWD FUNDING... 113

this scheme causing an approximate loss of 5 billion dollars with the low-
income investors emerging as the biggest losers, some going bankrupt. SEBI
challenged Saradha for non-compliance of the requirements of filing a
prospectus and taking SEBI's permission as the market regulator. The group
continued to expand the number of companies trying to evade the money
and confuse SEBI. Eventually in 2012, it resorted to novel fundraising
activities such as Collective Investment Schemes (CIS) duping many
investors into thinking they were investing in chit funds.

VII. CONSULTATION PAPER ANALYSIS

The authors have analysed the SEBI Consultation Paper on Crowdfunding in

India published in 2014 for comments, views and suggestions. The authors
concur with the proposal laid down and have supplemented and
complemented the same with their suggestions.

1. Limiting Investment Opportunities

According to a report published by IBM,` 90% of Indian start-ups failed in

their first five years. As emphasised above, there is a need to place certain
restrictions limiting investment opportunities only to accredited investors
considering the high-risk factor. In this regard, SEBI suggested" limiting this
opportunity to QIBs, companies with minimum net worth of Rs. 20 crores
and HNIs with minimum net worth of Rs. 2 crores. In addition to these, the
paper suggests extending this opportunity to Eligible Retail Investors
("ERI") with more than Rs. lo Lakh minimum annual gross income with
mandates such as receiving professional investment advice, having
satisfactory track record.

2. Investment Limits

SEBI rightly suggested placing the minimum and maximum limits for
investments by the above- mentioned investor classes as this will keep a

4 IBM Study: Innovation Key to Startup Success in India, https://www-o3.ibm.com/press

/in/en/pressrelease/52424.wss (last visited Sep. 16, 2018).
114 Nirma University Law Journal: Volume-9, Issue-1, December-2019

check on hoarding of shares by any particular class of individual as also to

balance out the risks. As a result, if these suggestions are executed a QIB, an
eligible company, an HNI and an ERI will mandatorily have to purchase at
least '5x', '4x', '3x' and at least the offer value respectively. The Paper further
suggests maximum investment for ERIs (Rs. 60,ooo in one issue) and
maximum investment in a year (io% of ERI's net worth)." In addition, the
"cooling off' period can be introduced for ERIs to withdraw investments
made, this has already been in place in countries such as Chinese Taipei,
Malaysia and Korea."

3. Mode of Payment

SEBI proposed that the mode of payment be limited to cheque, demand draft
or any other banking channel and that the issue is carried out only in Demat
form" which would act as a deterrent to money laundering. The suggestions
would bar the issuer from using multiple platforms in twelve months or to
advertise their offering to the general public. Such issuer has to mandatorily
route all crowdfunding issues through a registered platform and has to
necessarily provide for oversubscription provisions. 0 This will ensure ease in
regulating and supervising these activities.

4. Risk Undertaking

P2P platforms are legally disabled from providing or arranging any credit
guarantee for returns from transactions on its medium. SEBI has proposed
floating of 'Risk Acknowledgement' by ERIs and HNIs. In addition to the
suggestions, such a responsibility will be better shifted by adapting an
approach similar to the one taken by RBI in P2P regulations. An approach
similar to that of the Italian Consob Crowdfunding Regulation which was

46 Para 9.15, SEBI, Consultation Paper on Crowdfunding in India, https://www.sebi.gov.in/

sebi-data/attachdocs/14o3005615257.pdf (last visited Jul. 16, 2018).
47 Supra note 10 at para 9.4-1-1.

48 Supra note 12.

49 Supra note 10 at para 9.1.6.

oSupra note 10 at 9.2.6.

PEER-TO-PEER LENDING AND EQUITY-BASED CROWD FUNDING... 115

designed to ask online decision makers to read mandatory educative

information, sheets and fill in a questionnaire aimed at ascertaining the
understanding of characteristics and risks involved can be adopted in Indian
setup as well.

5. Issuer Compliance Requirements

In light of the high-risk nature of these investments, a company intending to

raise capital through EBC would need to have a clean track record and meet
with certain prerequisites. In this regard, SEBI suggested maximum capital
raising be limited to Rs. lo crores in a period of twelve months and that such
company cannot be more that 48 months old. Such company cannot be
promoted, sponsored or related to an industrial group which has a turnover
in excess of Rs. 25 Crores or have any established business.

6. Issuer Disclosures

The proposal lays down disclosure requirements for an issuer which is

crucial for an investor to make an informed assessment. The PPO Letter shall
contain information such as anticipated business plan, issue size, target
offering amount and intended usage of funds. It should also contain history
of the funding and prior refusal from any funding platform along with the
company's audited financial statements of one year. A novel suggestion has
been made of including grievance redressal and dispute resolution
mechanism such as arbitration. This becomes important considering the
high default rates.

It is indispensable to include a share valuation certificate certified by a

registered Chartered Accountant. If the issuer of security issues securities
without a proper valuation, it can lead to overvaluation, and ultimately harm
the subscribers. Hence the authors suggest to include the same. SEBI has put
forth the question of gauging and assessing start-ups, in this regard the
authors' hold the view that there cannot be any standards laid down as
crowdfunding is aimed at funding innovative start-ups and endeavors.

" Supra note 12.

116 Nirma University Law Journal: Volume-9, Issue-1, December-2019

Gauging and assessing would heavily weigh down the innovative aspect of
start-ups.

7. Continuous Disclosure

The issuing company is required to make bi-annual disclosures (including

details on utilization of funds raised, a view of current state of business with
progress made since last disclosure and any penalty, litigation or regulatory
action) to the platform. The authors suggest that in addition to this, any
changes that may affect the investor at any point during the interval should
be notified to the platforms for the prospective investors.

8. Platform OperatorRequisites

The proposal expresses the necessity to establish platform operator

requisites. It is the authors' suggestion that the platform must be registered
as a Company and must obtain Certification for operating the platform. SEBI
before granting the certificate must ensure that the company has adequate
infrastructure to conduct its business activities, must have a capital
structure, competent strategy and secure information technology system in
place and that the managers and directors are fit and competent.

9. Screening Committee

SEBI has sought suggestions on obligations of a Screening committee that

should be set up by the platforms. In this regard the authors recommend that
similar to the screening requirements prescribed by RBI for P2P lending, the
screening committee (if any is prescribed) should have to undertake due
diligence on the participants, undertake credit assessment and risk profiling
of the borrowers and disclose the same to their prospective lenders.

VIII. CONCLUSION

While some countries prohibit equity-based crowdfunding, several other

countries have regulations in place. It has been noted that in the latter,
PEER-TO-PEER LENDING AND EQUITY-BASED CROWD FUNDING... 117

higher activity was observed after regulations were put in place. Considering
the upsurge of these platforms, the nature of investors and the previous
corporate frauds, the authors conclude that there is a dire need for regulating
these entities. In furtherance of the need for regulation, suggestions to the
proposed framework have been catalogued.

Asserting the status quo, P2P lending platforms are well regulated as NBFCs
and fall under the ambit of RBI. While these extant norms are good step
forward they are not completely unblemished. As suggested above RBI
should gauge prescription of interest rate cap and envisage setting up of
secondary markets dedicated to trading of P2P loans.

EBC has to at present, necessarily comply with the private placement norms
under the company law until a framework is put in place (which is likely to
fall under SEBI's oversight). Despite coming out with a consultation paper
with a view to facilitate regulated EBC, SEBI is still silent in this regard. The
Consultation Paper rolled out by SEBI in 2014 has undertaken a multi-
faceted study and is a good step forward. However, in addition to the
suggestions made in the Consultation Paper, the authors are of the view that
the above-mentioned suggestions as well as addition of certain foreign
practices would work together to create a robust law on EBC.