The Delhi High Court on September 15 ruled that Payment Aggregators (PAs) fall under the definition of Payment Systems and can therefore be regulated by the Reserve Bank of India (RBI). The order was pronounced by a division bench of Justice Rajiv Shakdher and Tara Vitasta Ganju in the case filed by Lotus Pay Solutions, which challenged certain clauses of RBI’s Guidelines on Regulation of Payment Aggregators and Payment Gateways issued on 17 March 2020.
Why does this matter? Until the 2020 guidelines went into effect, payment aggregators and gateways were primarily regulated by a 2009 circular, which was less stringent. With the 2020 guidelines, RBI introduced a more comprehensive and uniform regulation, which is also more burdensome. The guidelines contain many provisions that payment aggregators and merchants have raised concerns about. One such provision is the prohibition on payment aggregators and gateways from storing debit and credit card details of customers, which could severely disrupt online payments. The Delhi HC ruling in favour of RBI backs the central bank’s powers to frame such regulations and lends it credibility in any future challenges from payment aggregators and gateways.
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Which rules were challenged by Lotus Pay?
Lotus Pay, which provides recurring payment solutions for businesses in India via the National Automated Clearing House (NACH), challenged the following clauses of RBI’s 2020 guidelines:
- Authorisation requirement: Clause 3 mandates non-banking entities that offer payment aggregation services to obtain authorisation from RBI to continue their operations.
- Net worth requirement: Clause 4 requires PAs that were existing on the date of issuance of the guidelines to achieve a net worth of Rs. 15 crores by end of September 2021, and to have the same scaled up to Rs. 25 crores by the end of March 2023. New PAs are required to have a minimum net worth of Rs. 15 crores to apply for authorisation and must scale it up to Rs. 25 crores within three years of receiving authorisation.
- Escrow account requirement: Clause 8 mandates that all non-bank PAs place the amount they collect in an escrow account, maintained with a scheduled commercial bank.
Importantly, the above clauses are only applicable to payment aggregators and not payment gateways (PGs) because the latter are considered “technology providers” or “outsourcing partners” of banks or non-banks.
Lotus Pay’s challenges, RBI’s response, and Delhi HC’s analysis
Challenge to the authorisation requirement
Lotus Pay is an intermediary and not a Payment System: The requirement under Section 4 of Payment and Settlement Systems (PSS) Act, 2007 that no entity shall operate a payment system without authorisation issued by RBI does not apply to Lotus Pay as it operates as an intermediary, the PA claimed. Lotus Pay further stated that the PSS Act makes a clear distinction between “payment system”, “system participant,” and “system provider” and since the company only provides an intermediary tool, which is used by the payment system to facilitate the remittance of payments received from the customers to the merchant clients, PAs are, in effect, “system participants” and not “payment systems.”
- RBI: Lotus pay, “while acting as a PA provides services of aggregation in the online payment space, which inter alia involves collecting, netting and making payments. The term ‘payment system’ as defined in Section 2(1)(i) of the 2007 Act captures the aforesaid activity. The provision defines a payment system as a system, that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service, or all of them, but does not include a stock exchange.”
- Delhi HC: The PAs “not only provide, an integration system but also handle the funds of the customer. The definition of a PA, according to us, would include this work function,” the HC noted in its order. “Therefore, in our view, the answer to the poser, as to whether PAs fall within the ambit of the definition of payment system can only be in the affirmative.”
Beyond the powers conferred to the RBI: Lotus Pay alleged that the 2020 guidelines go beyond the powers conferred upon RBI by Section 18 of the PSS Act. The provisions in the act do not “invest power in the RBI to mandate the requirement for PAs to secure authorisation from RBI to carry on their business and/or lay down criteria for issuance of such authorisation.”
- RBI: “Under Section 3 of the 2007 Act, RBI has been declared as the “designated authority” for regulating and supervising payment systems.”
- Delhi HC: “Technology is changing at a rapid pace, and Courts have to keep that in mind at times, while examining the scope and ambit of legislation, such as the 2007 Act. There can be no dispute, that RBI, being the Central bank of our country, is inter alia responsible for regulating and supervising payment systems in India. […] Thus, the argument advanced on behalf of the petitioners, that the 2020 Guidelines, in particular, the impugned clauses are beyond the purview of the parent statute, is not tenable. Once it is accepted, that the work function performed by PAs comes within the definition of a payment system, then, as contended on behalf of RBI, it was well within its powers to frame the 2020 Guidelines”
Challenges to the minimum net worth requirement
Manifestly unreasonable and arbitrary: The minimum net worth requirements prescribed by the RBI are “manifestly unreasonable and arbitrary”, and hence violative of Article 14 of the Constitution of India, Lotus Pay alleged. Furthermore, the stipulations “do not conform to the object and purpose provided in the 2007 Act—which is, the regulation and supervision of payment systems in India.”
- RBI: “The net worth requirements contained in the said clause fulfil the twin objectives of providing safety to the customer and protecting the merchant client‟s interest. These two objectives can only be fulfilled by ensuring that the PAs are financially sound, and that their operations are viable. […] The PAs collect funds on behalf of the customers. They are obliged to pool the money and transfer the funds to the merchant clients, after the stipulated timeframe. Thus, the requirement to have a baseline net worth provides insurance against breach of such obligations undertaken by PAs, and shores up the confidence of the customers.” The requirements were framed after putting out a public discussion paper, RBI claimed.
- Delhi HC: “It needs to be emphasised, that when such eligibility criteria are fixed, or applicants who wish to venture into business are regulated by the State and/or its instrumentalities, there is an element of approximation. If such criteria are to be questioned, the only area, perhaps open for scrutiny would be: whether or not there was some application of mind and/or deliberation, before framing the impugned criteria. Once the State and/or its instrumentalities are able to show that a process was followed, and the issue was deliberated upon, it would leave very little scope for the Court to interfere in an Article 226 action. In this case, RBI has demonstrated, that before the 2020 Guidelines were issued, the same was put up in the public domain in the form of a Discussion paper.”
Stifle innovation and drive out the competition: The net worth requirement also “stifle innovation and drive out competition, by imposing a monetary condition which has no bearing on the functions carried out by a system participant. This requirement fails to take into account, that most innovative and progressive financial solutions have their origins in small businesses or start-ups. There is no evidence, that a high net worth requirement will improve the efficiency of the payments industry. Petitioner no.1 has been operating as a payment intermediary since 2016, with a capital of approximately Rs. 2 crores, without a single blemish,” Lotus Pay stated.
- Delhi HC: “In this context, the argument advanced on behalf of the petitioners, that the requirement to have a minimum net worth of Rs.15 crores would drive out small entrepreneurs and start-ups also, does not find resonance with us, the reason being that from a proposed net worth of Rs.100 crores, the RBI has brought it down to Rs.15 crores, which, as indicated above, would have to be scaled up to Rs.25 crores by the end of third FY. This step modulation was brought about based on the responses received by RBI to the Discussion paper published on its website. […] It is relevant to note that RBI has taken an emphatic stand in its counter-affidavit, that it had received 57 responses to its Discussion paper, and that out of the 57 respondents, only 19 objected to a minimum net worth requirement of ₹100 crores proposed in the Discussion paper.”
These provisions were meant for the stock market operators: The net worth requirements seem to be “duplicate provisions of various regulations provided by the Security and Exchange Board of India (SEBI)” which “has prescribed minimum capital requirements vis-a-vis intermediaries, which deal with securities. […] The stipulations were preceded by detailed deliberations carried out by the Bimal Jalan Committee,” Lotus Pay claimed. “RBI has, it appears, erroneously applied the same yardstick to digital platforms i.e., entities such as petitioner no.1, which act as intermediaries between the customers and its merchant clients,” the PA added.
- RBI: “The provision in the 2020 Guidelines for a baseline net worth was put in after RBI had received feedback from various stakeholders vis-a-vis the Discussion paper uploaded on its website on 17.09.2019.”
Unnecessary trade barrier: In an RBI discussion paper dated September 17, 2019, the central bank “has accepted the position that it has not faced any major complaints regarding indirect regulation of intermediaries for at least ten years before the issuance of the 2020 Guidelines,” Lotus Pay pointed out. The company claimed that regulating them now with the 2020 guidelines would “lead to the closure of a large number of small business enterprises, as it unnecessarily creates a trade barrier.”
Challenges to escrow account requirement
PAs already functioning smoothly using nodal accounts: PAs currently collect funds from customers on behalf of merchants and place them in a special account known as a nodal bank account. The funds are remitted from the nodal bank account to merchants after a set number of days. “Clause 8 of the 2020 Guidelines, which obliges non-bank PAs to place the amount collected by them in an escrow account, disregards the fact that the PAs are presently functioning smoothly, by remitting the monies collected from the customers to the nodal accounts,” Lotus Pay claimed.
- RBI: This provision was included “after a comprehensive and detailed discussion and examination of the issue by the Board for Regulation and Supervision of Payment and Settlement Systems. Under the 2009 Directions, PAs were allowed to open a nodal account, which was an internal account of the concerned bank. The nodal account was shown as a liability of the concerned bank and was not included in the balance sheet of the PAs. The PAs and/or merchant clients had no beneficial interest in the amount retained in the nodal account. Therefore, it was considered prudent to manage the funds collected by the PAs on behalf of the customers through an escrow account, while providing a return on the core portion of the money retained therein. The PAs not only have a beneficial interest in the escrow account but are also entitled to interest on the core portion of the money retained in the escrow account.”
- Delhi HC: “The alternative put in place by the RBI, in our opinion, is a more robust mechanism which protects the interests of all stakeholders i.e., the customers, merchant clients and PAs.”
No beneficial interest in money held: The condition also “ignores the fact, that the core function of PAs is limited to providing a technical interface, and therefore does not need to have a beneficial interest in the money held on behalf of their merchant clients,” Lotus Pay stated. “RBI’s stand, that by opening an escrow account, the amount credited to the said account remains safe from the vagaries of liquidation and acts of fraud is untenable, for the reason that the PAs have no direct access to funds, which are retained in the nodal accounts. At present, banks which maintain nodal accounts are mandated to make pay-outs to merchant clients automatically, within three days of the conclusion of the transaction in issue, thereby eliminating any security risk concerning monies that are available in the nodal accounts,” the PA added.
- RBI: The intention is to protect the funds collected, which is in the interest of the customers. The guidelines mandate “the utilisation of the amount held in the escrow account, only for discharging the liability of the customers, or for repaying the customers. Thus, even if a PA, such as petitioner no.1, were to undergo liquidation, the funds collected from its customers would remain protected and can be utilised only for discharging their liability or for repaying monies to them,” RBI explained.
Nodal accounts are safer because we can spread risks: “The impugned Clause 8 has a myopic approach. At present, every PA operates multiple nodal accounts, and thus spreads the risk. If nodal accounts are done away with, it will expose the PAs to operational risks, which shall be detrimental to their business interests, as it has the potential of causing financial instability,” Lotus Pay claimed.
- RBI: Based on a circular issued on 17 November 2020, PAs are now allowed to maintain one additional escrow account in a different scheduled commercial bank. “Therefore, the argument advanced on behalf of the petitioners, that maintaining nodal accounts in different banks diversifies risks, and addresses business continuity concerns is answered by the issuance of the circular,” RBI stated.
- Delhi HC: The RBI circular from November takes care of the concerns put forth by the PA to some extent.
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