Nepal Needs Secured Transaction Law

Gandhi Pandit, attorney at law and founding partner of Gandhi and Associates

July 27, 2015, 5:45 p.m. Published in Magazine Issue: Vol: 09 No. -3 July. 24- 2015 (Shrawan 08, 2072)

Known for his specialization on corporate law, Gandhi Pandit, attorney at law and founding partner of Gandhi and Associates, spoke to New Spotlight on various issues regarding the corporate law and investment climate in Nepal. Excerpts:

What do you say about foreign investment in Nepal?

We don't have enough laws to guide foreign investment. There are two aspects to investment. The first aspect is related to equity investment and the other is lending. The developer can invest as equity and lending comes from banks. Mega projects like hydropower plants, airports and roads require huge amount of money. They need to maintain the debt and equity ratio. In every mega project, the debt could be 80 percent and equity could be 20 percent.

How can a banker lend money?

There are two ways to borrow money -- in government sector and private sector. Government borrows the money through government agencies, multilateral and Exim banks. When government borrows the money, it automatically gives sovereign guarantee to the banks. In this case, the lender is relying on the government's commitment not on the project. Nepal has been following this for almost forty years. Most of the projects in Nepal are funded by foreign loan through sovereign guarantee by the government.

How about the private sector?

Private sector gives collateral of property and project to the bank to get the loan. If there is big money involved, one has to go to foreign banks. However, no foreign bank can lend money to private sector in the present circumstances. This results in a lack of investment in mega infrastructure projects.

If the private sector cannot get the money, what is wrong for the government to get involved in building mega infrastructure projects?

As the government has many priorities, it cannot spend all of the money on hydro and other mega infrastructure projects. The government has to invest money in schools, health facilities and social welfare schemes. As the government has less money, it needs the private sector investment to fill the gap.

How can the resource gap be overcome?

In order to overcome the problems of resource gap for mega projects, the new concept of public and private partnership is necessary. This policy is also adopted by Nepal. However, the government is now relying on policy and the law is yet to come. The government is now working to prepare a PPP Law to govern the public private partnership.

Don't you think the policy is enough?

What is missing in the PPP policy is that it is not focusing at the need of the lenders or banks. Before lending any money to Nepal's mega infrastructure projects, foreign banks want a credible legal regime to get safety to their investment and want legal guarantee for repatriation of their investments. Lenders' interest in Nepal is that they want their money can be easily transferred to Nepal for investment and they also want easy repatriation.

Why do banks want more security?

If the company defaults in payment, the lender wants to take control of the project. Lenders want complete legal guarantees in their investment in Nepal. Because Nepal does not have the Act to protect investment, they are concerned about safety of their investment. Thus, no major and reputed banks have come to invest money in private sector infrastructures. Just showing approval license from the government to start industry is not sufficient to them. No bankers can risk their money.

What do foreign banks want?

When they want to lend money for private sector projects, they want to control collateral - which is movable or immovable property. In case a borrower defaults, the lender should have sufficient power to capture the property and allow other party to operate the project.

Is it possible in Nepal?

If it is possible in other countries, it is also possible in Nepal. For that we need laws. The law is known as secured transaction law which gives comfort zones to the lender. By this secured transaction law, a foreign lender or banker would be able to control on movable property.

What is movable property?

For example if a developer is developing hydro project, a developer can sign Power Purchase Agreement (PPA) with NEA or with government. Then, a PPA is movable property. Once you have a secured transaction law, the lenders have right to control over PPA in case borrower defaults. In that scenario, a lender can jump in and ask NEA not to pay money to the operator or developer. He can claim that he has secured rights to claim it which gives protection to lender's money.

Why is the security transaction law important?

Security transaction law gives priority right for lender. Even if other party claims, the lender can have priority right. It is unfortunate that the security transaction law is there in Nepal but it has not been made effective.

What happens if the law is not there?

A developer can misuse his collateral and goes to different lender taking PPA as collateral.  If the system is not governed by such law, there may be a single collateral and several lenders.

What are other lacunas in Nepal's legal system?

Nepalese law is restrictive and limited creating mortgage in immovable property by foreigners. As Civil Code is in place, it has various restrictive clauses on foreign investment.

Why is it so much negative?

It is prepared a long time back in a different set of circumstances. The law does not visualize the concept of consortium. Some of the directives of Nepal Rastra Bank do not allow consortium investment in Nepal.  For example, if a bank wants to invest huge money in Nepal, they can look for a consortium of banks as one bank cannot do it alone. If a London-based bank wants to invest in Nepal, they want consortium in Germany or Switzerland where they sign collaborative agreement saying that they want to invest in Nepal. As per Civil Code (Muluki Ain) of Nepal, any agreement signed outside Nepal in regard to Nepal's project is not enforceable.

How do you see the issue of enforcement?

Enforcement is one of the big problems. As a lender I want to establish my right to Nepal If I invest. Every bank wants to control the project in case borrower fails to pay back and without any legal hassles. However, any one can file a law suit and create hassle easily and the court also holds the case for ten years. This is the reason lenders clearly want minimum sovereign guarantee to invest in Nepal.

How do foreigners invest in Nepal?

There are many restrictions in Nepal. In case they want to invest in Nepal, they do a review of legal aspects with due diligence or see how friendly Nepalese laws and regulations are in Nepal. After the due diligence, then they take the decision. Given Nepal’s current system, only a few genuine foreign investors will come.  As there is a lack of funds, Nepalese are mobilizing their own funds to develop several projects.

If this is the scenario, how have GMR and Satlaj signed agreement with Nepal Investment Board?

They have just signed Project Development Agreement. There is still a long way to go.  They complete fifty percent of their work in fifteen years and now they have another most difficult 50 percent of project development work needing to be complete. Once again the basic challenge is how to get the project financing.

Why are you saying this?

I don't want to give the name of my client because of confidentiality. When Nepalese and Indian companies got a license to develop a hydro project in Nepal with 10 billion rupees in capital, Indian banks denied investing money when they read the legal system of Nepal. Indians hired me as a lawyer. After listing me, they pulled our saying that they would not invest in non-recourse financing in Nepal.

What is recourse financing and non-recourse  financing?

The essential difference between a recourse and non-recourse loan financing has to do with which assets a lender can go after if a borrower fails to repay a loan. As a matter of principle, borrowers almost always favor non-recourse loans, while lenders almost always favor recourse loans.

                     

What differences does that make?

In both types of financing, the lender is allowed to seize any asset used as collateral to secure the loan. In most cases, the collateral is the asset that was purchased by the loan. For example, in both recourse and non-recourse mortgages, the lender would be able to seize and sell the house to pay off the loan if the borrower defaults.

The difference is that if the money is still owed after the collateral is seized and sold. In a recourse mortgage, the lender can go after the borrower's other assets or sue to have his or her wages garnished. In a non-recourse mortgage, however, the lender is out of luck. If the asset does not sell for at least what the borrower owes, the lender must absorb the difference and walk away.

Which one is preferable?

While potential borrowers might find it attractive to hold out for non-recourse loans, it is important to remember that they come with higher interest rates and are reserved for individuals and businesses with the best credit. Additionally, failure to pay off a non-recourse debt may leave other assets unharmed, but the borrower's credit score will be affected in the same way as a failure to repay recourse debt.

How do you see the state in Nepal?

Nepal is very unfamiliar with non-recourse financing. In fact our law and regulations are designed for recourse financing.  If you rely on project recourse financing , it is impossible to develop bigger projects. In India, China and other countries, when a big project is developed, they prefer non-recourse financing.  So Nepal should introduce the laws for based on the basis of non-recourse financing.

Are Nepalese capable to handle this kind of situation? Do we have financial and legal experts to deal with that?

Nepal does not have such hands. Even the bankers are not truly familiar with international project financing. Even they are unprepared for trade finance. Trade finance is based on bank guarantee or letter of credit under which banks lend billions of rupees. Nepalese banks are very naive about trade financing.

Where does Nepal suffer the most?

Nepal government is losing annually billions of rupees in international arbitration by failing to understand the sophistication of trade financing issues involved in it. The government is losing money because the government never hired private Nepalese or foreign lawyers in international dealing. As government lawyers are incompetent and don't have sufficient knowledge about this, the government often relies on its secretary and others in such important issues. Nepalese are repeating the same mistakes one after another. The law is the area of least concern for the government. The government officials consider they know everything about the commercial law because they know everything.

Nepal is in the process of launching massive reconstruction and rehabilitation projects and a high level committee has already been constituted. Given Nepal's present scenario, how easy is to carry out the work fast?

It all depends upon how Nepal wants to handle the situation. We are getting 4.5 billion dollars in foreign currencies for the reconstruction. It is not a matter of money but an issue whether the government of Nepal is capable or not. In other words the question is whether we have the mechanism to spend it. I am very skeptic.

Why are you asking about the capability?

Just one year ago Indian Prime Minister Narendra Modi visited Nepal and committed 1 billion dollars? How much money did we spend before the earthquake? We have not done anything for nine months. Do you think we have a lot of projects so we are unable to select them. If we could not decide on billion dollars fast, how can we decide to spend 4.5 billion dollars in two years. We have many projects in pipeline such as Nijgardh Airport and so many others. As long as the mechanism remains same and people remain the same, nothing can move. We cannot do anything by adding new institutions. For instance, Dr. Baburam Bhattarai brought Nepal Investment Board as a new institution to promote foreign investment in Nepal. Has it really promoted any foreign investment?  

How friendly are civil service or bureaucracy for foreign investment?

Bureaucracy is the worst. I don't know whether it is due to political system or other things. With this bureaucracy, I cannot expect much.  In Nepal, the law says you can invest in all the sectors, but there is another direction which forbids you to invest in Nepal. For instance, cargo business is not restricted by law but it is not possible in practice. Internal policies and rules are so closed and non-transparent. Bureaucracy is very non-cooperative. You cannot wake up anybody who pretends to be sleeping. If  a traffic police wants to give you trouble, they can do it.

Then why has the government been talking about foreign investment at all times as its mantra?

Nobody will come to invest in the country just on the basis of preaching. You need to build a conducive environment with legal assurance and guarantees  that everybody's investment is safe and secure in the country. It is very unfortunate that given the present circumstances, it is very difficult to lure any foreign investor with good reputation.

Exim banks from China and India want to invest money in Nepal. Why is their money not coming?

When Exim banks come to invest in the private sector in Nepal, the government is not going to give sovereign guarantees to them. If the government does not give sovereign guarantees, the law should be clear regarding the protection of their investment.  I have already explained  earlier that all laws are restrictive and old. Nobody is confident about the laws. If they invested the money with private sector without sovereign guarantees, they will have to face troubles.

Knowing that Nepal does not have a clear legal system, nobody is going to invest here.  By dealing with several multi-national clients, I have come to realize that Nepal is one of the most difficult countries for foreign investment. There is uncertainty about the policies as they change along with the change of the government. Genuine investors from India and China express similar bitter experience about Nepal. Indian clients used to say that Nepal is a more difficult place to invest in than Afghanistan, Iran or any African country.

If the situation is not appropriate, why has the government signed a number of agreements?

Only problem I see in Nepal is that we are not following the law. The question every one asks is whether Nepal wants to follow law or not? Second important issue is how transparent our system is? Lack of accountability is another issue. Because of these issues, foreign investors are unwilling to invest and return after a few months.

How would you create conducive environment?

You need to have one powerful department to deal with all the foreign investment issues. However, there are several departments and there is no coordination among them.  There is the need to have specialized staffs. This is also creating troubles. Sometimes, a person who has served in the department of postal services for years comes to foreign investment department. There will be the knowledge gap.

How can we ensure coordination?

Immigration and land revenue departments have their own ways of doing things. Foreign investors need to knock several doors to just for registration and the process is itself is so lengthy that no one can be sure what to do. Corruption is high though CIAA is vigorously campaigning against it. Sometimes, even CIAA is misled. For instance, Sugat Ratna Kansakar was sent to prison for his fair dealing with Airbus because somebody misused it. Although Kansakar was given a clean chit by the court, the person who took a free and fair decision to boost the national flag carrier got frustrated. Had he been allowed to function smoothly, Nepal Airlines would have two narrow bodied and a wide bodied Airbuses long time back. Due to the delay, Nepal Airlines suffered a lot.

 

How do foreign investors view Nepal?

Foreign investors' impression about Nepal is of a country without clear laws where it is very difficult to work because of ambiguity in legal interpretations. I have not seen any possibility of a genuine multi-national to come and invest in Nepal because of our current political and other environments.

As we have been saying Nepal has a great potential for foreign investment because of two big neighbors surrounding us, how do you look at this?

This will be just a myth till Nepal changes its current modality of working. Nothing will happen in the present circumstances. Without changing the mindset of our bureaucracy, nothing will happen. Nothing is moving in Nepal due to the present legal frameworks and bureaucratic set up. There is corruption in many countries but several things are moving. However, the situation in Nepal is different where nothing is moving with the prevalence of corruption.

Why are not even Indian companies coming?

Till the present scenario continues nobody will come to invest in Nepal and Indians are no exception. Why should they come when there are so many ambiguities and confusions. Un-clarity and uncertainty are the biggest problems. We are just superficial. Three Georges signed just an MoU, but we are taking it as if the project kicked off. All come to give false hopes. Cross-border transmission lines have not been done in 15 years. We are not capable, because we are unaccountable.  

How about Nepal's visa policy towards investors?

It is one of the most unfriendly towards foreign investors. It is difficult to get a visa in Nepal than in USA, Europe or any other part of the world. We can ask somebody to invest a billion dollars in Nepal but we decline visa for his associates. Nepalese psychology has a paradox as we think that many foreigners will come and work in Nepal if they become flexible and liberal on working visa issue. We have to understand that no one will come here for employment only. If that is the case a lot of Indians should have come to Nepal because they even do not require visa.  The government needs to change its shortsighted policy and should allow investors to bring their people. I don't understand why Nepal government issues visa for five months. Why not issue it for five years? If Nepal wants investment and business, the first thing Nepal needs to do is to liberalize its visa policy to genuine foreigners. It is alright for tourists but we should issue visa for five years. United States issues visa for five years and UK issues visa for ten years.

 

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