Project Finance 2019 Second Edition

Last Updated November 04, 2019

Nepal

Law and Practice

Authors



Neupane Law Associates is a leading law firm in Nepal, specialising in corporate transactions and dispute resolution. Its lawyers have extensive experience and expertise in banking, foreign investments, M&A, and project development and finance. It is the firm of choice for banks, financial institutions and multinational corporations, and its internationally educated team has extensive experience in advising on high-value, complex and innovative matters.

Nepal has seen a lot of legislative changes in the last year. The new Muluki Civil Code 2017 (“Muluki Civil Code”) came into effect on 17 August 2018, overhauling commercial laws including those for lending, security and guarantees. It also introduced major changes to laws relating to torts, product liability and civil procedures.

The Foreign Investment and Technology Transfer Act 2019 and the Public Private Partnership and Investment Act 2019 have replaced the previous Foreign Investment and Technology Transfer Act 1992, the Private Financing in Build and Operation of Infrastructure Act 2006 and the Investment Board Act 2011, and introduced various changes to foreign investment, overseas commercial borrowing, and public-private partnership regimes.

The introduction of the Hedging Regulation 2019 is another important change to the project finance market, under which power projects with capacity above 100 MW, transmission projects above 220 KVA and 30 km, railway and metro projects longer than 10 km, fast track roads longer than 50 km and other projects approved by the Government of Nepal are eligible to hedge their foreign exchange risk on foreign currency loans with the central bank of Nepal, Nepal Rastra Bank (“NRB”). This hedging facility will be provided for up to ten years.

In the energy sector, Nepal has seen changes driven by the Electricity Regulatory Commission Act 2017. Following the introduction of new regulations in 2019, the newly formed Electricity Regulatory Commission recently issued the Power Purchase Terms Bylaw 2019, which requires certain power purchase agreements to be approved by the Commission. This will pave the way for the Nepal Electricity Authority to undertake new power purchase agreements. Prior approval from the Electricity Commission will now be required to buy or sell more than 5% shares of unlisted companies holding an electricity generation, distribution or business licence, or for mergers, acquisitions and takeovers of such companies.

Project financing has generally been limited to power projects. Two USD-NPR mixed currency power purchase agreements for two hydropower projects – Langtang Bhotekoshi (120 MW) and Upper Trishuli-1 (216 MW) – have recently been signed by the Nepal Electricity Authority. It is understood that both projects are seeking to arrange financing from international banks and development finance institutions. Upper Karnali (900 MW) Hydropower Project is working towards undertaking cross-border power purchase arrangements in India and Bangladesh. Upper Arun (900 MW) Hydropower Project has started construction works and is seeking financing from Indian and Nepalese lenders.

The government has also licensed a new infrastructure development bank, with participation from both the private and public sectors to finance large projects. The Nepal Infrastructure Bank Limited started its operation in February 2019 with a paid-up capital of NPR20 billion, and is expected to take the lead in meeting the financing needs of energy and infrastructure projects in Nepal.

Various new laws affecting project finance in Nepal are being proposed. The Environment Protection Bill 2019, a Bill amending the Land Act 2019, the Industrial Enterprise Bill 2019, the Forest Bill 2019 and the Insurance Bill 2019 are currently tabled and under discussion in the Federal Parliament. The Ministry of Energy, Water Resources and Irrigation is also undertaking consultations on the draft Electricity Bill 2019.

Sponsors of large projects in Nepal include companies from China, India and Nepal, although investors from western countries and Japan have shown interest in developing projects in Nepal. Typical lenders are development finance institutions, such as IFC, ADB, FMO, Chinese banks in projects involving Chinese sponsors, and Nepalese commercial banks. In addition, the Employee Provident Fund, the Citizens Investment Trust, the Hydroelectricity Investment and Development Company, and Nepalese insurance companies are also able to participate in financing syndicates pursuant to Directive No. 11/2075 for bank and financial institutions issued by the NRB.

The Public Private Partnership and Investment Act 2019 (“PPPIA”) is the key piece of legislation for public-private partnerships in Nepal. It has been in effect since 27 March 2019, replacing the Investment Board Act 2011 and the Private Financing in Build and Operation of Infrastructure Act 2006.

The PPPIA has defined a public-private partnership as an arrangement between the government entities (ie, the federal government, the provincial government and local governments) and private investors to distribute resources, proceeds and risk in order to implement infrastructure development projects and the operation, reconstruction or flow of public services. The legislation defines infrastructure very broadly to include roads, bridges, cable cars, railways, sky-railways, airports, hospitals, energy generation, processing plants, parks, special economic and industrial areas, agriculture, financial market infrastructure, stadiums, power plants, cold storage, stock house, electricity transmission, fun parks, exhibition halls, industrial parks, hotels and tourism infrastructures, and all other infrastructures. However, projects that do not transfer financial, technical or operational risk to the private sector (such as general construction or service procurements) and national security sensitive projects cannot be implemented under the public-private partnership model. All projects implemented as a public-private partnership should be transferred to the government upon the end of the concession term.

All projects requiring investments above NPR6 billion (approximately USD54 million) are required to be approved by the Investment Board provided for in the PPPIA. Projects with lower value can be implemented directly by the relevant government entities with jurisdiction to implement such projects under federal law. Energy projects with capacity below 200 MW can be implemented by the Federal Ministry of Energy. The Investment Board also has the power to provide recommendations to the Government of Nepal and the departments concerned to provide financial or non-financial incentives to the project companies.

Public-private partnerships can be implemented by way of various modes, such as build, operate and transfer; build, own, operate and transfer; build, transfer and operate; lease, operate and transfer; lease, build, operate and transfer; reconstruct, operate and transfer; and others. The general method of granting a project concession is by inviting a public request for proposal. The sponsors have an option to make unsolicited proposals to public authorities, but unsolicited bids can only be granted through a Swiss Challenge. Projects for which there have been no preferred bidders at least twice, projects incorporating new technology, national priority projects, and projects not suitable to be granted by public bidding can be granted by negotiation to the sponsors.

Key issues that need to be considered in developing and financing projects in Nepal are as follows:

  • Project documents: in energy projects, the concession agreement and the power purchase agreement are negotiated separately with the Ministry of Energy, Water Resources and Irrigation or the Investment Board and the Nepal Electricity Authority. Government authorities are not very familiar with bankability issues, which could make it difficult and time-consuming to negotiate bankable project documents. Power purchase agreements also require approval from the Electricity Regulatory Commission prior to execution.
  • Land acquisition: land needs to be privately acquired. The government will only acquire land for a private sponsor if the sponsor is not able to acquire private land required for the project. Permits are required to obtain land above the land ceiling threshold.
  • Lease and assignment of government land: government land can only be leased to the project company for the purposes of the project. Forest land is only available on lease for national priority projects with no alternative. Furthermore, there is a requirement that forest land used for a project must be replaced by the project company. The structuring of lender step-in rights in the lease agreement is key to negotiating a bankable lease agreement.
  • Land mortgage and security: only 50% of land above the land ceiling acquired by the project company can be mortgaged. Special permits from the Council of Ministers are required to mortgage land directly in the name of foreign lenders. A recent amendment to Foreign Exchange Directive No. 23/2074 dated 29 November 2018 issued by the NRB has recognised the practice of appointing local commercial banks as security agents for foreign lenders.
  • Currency risk: in the power sector, mixed currency power purchases with a maximum 80% tariff in USD are only available for a maximum period of ten years.
  • Delays: developing and financing projects in Nepal requires compliance with various laws, obtaining various permits and undertaking agreements with government authorities, all of which are prone to delays and need to be factored into the project timeline. Signed loan agreements also need to be submitted to the NRB to obtain approval to borrow from foreign lenders.

The Muluki Civil Code has recognised three categories of security interests in real estate and immovable property in Nepal:

  • mortgage of land (dristibandhak);
  • mortgage-in-possession of land (bhogbandhak); and
  • re-mortgage (lakhabandhak).

The mortgage is the most common form of security interest over immovable property, where the ownership and possession stay with the debtor while the creditor has the right to auction the property upon the failure of the debtor to make payments of the debt and interest within the agreed period.

The common forms of security interest over tangible movable property are hypothecation and pledge. A hypothecation is created in favour of working capital banks and lenders over book debts, receivables, stocks, raw materials and works in progress. The pledge is the most common form of security interest available over financial instruments, shares and cash deposits.

Contractual and intangible rights like leases, receivables and bank accounts require the consent of the counterparty in order to be assigned. In respect of land leases, lenders require a direct agreement with step-in rights to be undertaken between the security agent and the lessor. The receivables and cash flow of a Nepalese company can be assigned to the lenders or their agent. Banks and financial institutions generally do not take intellectual property (trade marks, copyrights, patents, designs, etc) as collateral for projects, but security interests can be granted over intellectual property through assignment. Security over licence depends upon the licence concerned, as it requires the prior permission of the granting authority.

Mortgages over land should be registered at the relevant Land Revenue Office of the place where the land is situated, in order to be valid. All foreign creditors have to seek approval of the Council of Ministers of the Government of Nepal pursuant to section 451 of the Muluki Civil Code to create security interests over land and immovable assets. However, such approval may not be required if local banks provide agency services to foreign creditors or act in the capacity of lead bank under the consortium lending structure.

Security over movable and intangible property can be perfected by taking possession of the collateral or by registering information at the Secured Transaction Registry. A pledge of shares of a private project company requires approval from the company and must be recorded in the shareholder’s registry. A pledge of shares of a public company must be recorded in the shareholder’s registry or dematerialised (d-mat account).

Contracts or deeds for security must be in writing. The deeds should be affixed with a signature or thumbprint or the company stamp of the grantor, and should be witnessed by two persons. Mortgage deeds are undertaken in the Nepali language and printed in a Nepali paper.

Nepalese law does not recognise a floating charge. However, the Secured Transaction Act 2006 provides that assets arising in the future can also be covered by the security, provided that they are adequately identified.

A Mortgage registration fee of NPR50,000 is payable when granting mortgages for banks licensed in Nepal. The average registration fee for the registration of a collateral security interest to a person or entity not licensed as a bank in Nepal is 1% of the loan amount. This may vary from state to state as it is set out in the Finance Act of the relevant state where such registration is to be made. A fee of NPR500 per notification should be paid at the Secured Transaction Registry.

It is recommended that all collateral that can be individually identified is so identified in the security documents. However, a general description is also sufficient to create security, provided that such assets can be identified with certainty.

The prior approval of the Government of Nepal must be obtained for the granting security over immovable assets in the name of foreign persons. Creating a pledge over shares by foreign lenders and obtaining corporate guarantees or personal guarantees from shareholders also requires separate approval from the NRB, pursuant to the notice of Foreign Exchange Management Department of the NRB dated 21 May 2017.

The Land Revenue Office records any form of security interest or lien over immovable assets such as land and buildings. The security interests are mentioned on the land title certificate. The lenders can assure themselves of the absence of other liens on their collateral by a review of the land title certificate and cross-verification with the Land Revenue Office concerned.

The Secured Transaction Registry registers security interests over movables and intangibles, and can provide lenders with information on the existence of liens on the movables and intangibles.

The creditors must release security upon the payment of the principal and interest due by the debtor. The following specific formalities apply if the parties wish to release security:

  • Mortgage over land: the creditor should provide a letter of release or a deed of release to the Land Revenue Office. Following this, the Land Revenue Office will remove the record of security interest from the registry.
  • Hypothecation and pledge of movables:the creditor must execute a letter of release and file a statement of termination at the Secured Transaction Registry.
  • Shares:additionally, a notification to a dematerialised account is required for the release of security in shares of public companies. In the case of private company shares, companies should also be notified that they will need to release the pledge notification from the shareholders' register.

Any assets of which the creditor retains possession should also be provided to the debtor upon release.

There are two modes of enforcing security interests under Nepalese law:

  • first, the out-of-court fast-track procedure of auctioning secured assets applicable to licensed banks under the Bank and Financial Institutions Act 2017 (“BAFIA”); and
  • second, the court auction procedure under the Muluki Civil Procedure Code 2018 to recover liabilities due under the Muluki Civil Code or any other laws imposing liabilities.

If foreign banks finance a project company where a local bank is appointed as the security agent, then foreign banks can also participate in the licensed bank enforcement procedures, and can have their share in security enforcement proceeds received by the security agent.

Licensed Bank Enforcement Procedures

A licensed bank can request the relevant office with jurisdiction over assets to create security over the assets of the borrower or to transfer the auction-secured property to the highest bidder, and the office or registrar is bound to comply with such request.

Licensed banks can auction the secured property if the borrower is in default of the loan agreement, fails to pay interest or principal within the timeline as agreed to in the agreements or deeds, or is found to be abusing or misappropriating the loans issued. Any surplus after the auction should be provided to the relevant person, firm or company. The bank can transfer the secured asset to itself only if the auctioned property is not bought by anyone in the auction process.

In practice, banks issue multiple notices to the borrower asking them to pay the loans, including in national daily newspapers, and warning the borrowers of the possible auction. The property is auctioned if the borrower fails to comply with the notice or fails to negotiate an arrangement with the bank. Problems do not arise if the secured properties are successfully auctioned and raise enough to recover the loans and other liabilities. If the auction does not raise a sufficient amount to cover the loans and other liabilities, and further, if the winning bidder offers less than the property valuation undertaken at the time of processing the loan, the borrower may sometimes choose to litigate.

The borrowers often bring legal claims stating that the banks are estopped from auctioning the property for the valuation less than accepted by them. The same problem would arise when there is no bidder in the auction, and the bank transfers the property to itself after the revaluation of the property which is less than that stated in the first valuation report.

Ordinary Enforcement Procedure

Muluki Civil Procedure Regulation 2018 provides for a security enforcement procedure for non-banking institutions. The security enforcement is undertaken through the District Court in the event of the debtor's failure to honour the final order of the court to pay debts.

Section 242(7) of the Muluki Civil Procedure Code 2017 provides that the auction process is applicable if the debtor does not pay liabilities held by the court (“duniya ko bigo”).   

In order to enforce debt when a loan is subject to foreign arbitration, the award has to be final and should follow the procedures of the Arbitration Act 1999. Following an application submitted to it within 90 days of the conclusion of the foreign arbitration, the High Court sends the award for enforcement to the District Court, upon the satisfaction of legal requirements.

The property has to be valued by the court under rule 57(5) of Muluki Civil Procedure Regulation 2018 in order to obtain a valuation that reflects a minimum price for which the property could be sold ("panchakirte mol"). The valuation should be witnessed by one representative from the local authority and one from the nearest government office. 

If the first auction does not successfully sell the property for more than the valuation, it has to be auctioned for a second time. If the second auction is also unsuccessful, the creditor has the option to take the property for the valuation. It may take an estimated one to two years, from the date of the arbitral award, to enforce and auction the secured assets.

A choice of foreign law as the governing law of the contract will be recognised. Under the Muluki Civil Code, the parties can choose the governing law of the contract. The Muluki Civil Code also contains rules on private international law, which recognise the submission to a foreign jurisdiction, subject to the fulfillment of certain legal formalities and exceptions. Courts in Nepal may also hear disputes even when the parties have chosen foreign courts in a contract if it is appropriate and equitable to hear such disputes in Nepal.

For the enforcement of a foreign judgment of a civil nature, the party concerned must file an application at the High Court along with the certified and translated copies of the foreign judgment for its enforcement. If the High Court is satisfied with the application, it will forward the judgment to the District concerned for enforcement. The judgment must be made by the competent court of the jurisdiction concerned and it must be final, binding and enforceable in the country concerned.

The foreign judgment will not be recognised and enforced in Nepal under the following conditions:

  • if there are procedural lapses in judgment;
  • if the same case is sub judice in the court of Nepal;
  • if the same case has been decided by a court of the third country in the same matter and has already been recognised  and enforced or is in the process of enforcement in Nepal;
  • if there has been no fair representation of one or more parties in the judgment; and
  • if the enforcement of the judgment would be contrary to public order.

However, it should be noted that Nepal is not a party to the Hague Convention on the Recognition and Enforcement of Foreign Judgments in Civil and Commercial Matters 1971.

Nepal is a state party to the New York Convention on the Recognition of Foreign Arbitral Awards 1958. The foreign arbitral awards issued in the countries that are state parties to the New York Convention are enforceable under Arbitration Act 1999, subject to reciprocity. For the enforcement of a foreign arbitral award, an application has to be filed at the High Court along with the translated certified copies of the foreign award and arbitration agreement, within 90 days of the award. If satisfied, the High Court will forward the award to the District Court concerned for enforcement.

Foreign arbitral awards are recognised and enforceable in Nepal upon the satisfaction of the following conditions as prescribed in the Arbitration Act 1999:

  • the arbitrator concerned has been appointed and the award has been made according to the laws and procedure as mentioned in the agreement;
  • the parties concerned have been notified about the arbitration proceedings in time;
  • the decision has been taken according to the conditions mentioned in the agreement or the decision is confined only to the subject matters referred to the arbitrator(s);
  • the decision has become final and binding on the parties according to the laws of the country where arbitration proceedings have been conducted;
  • the laws of the state of the applicant or the state of the venue of the arbitration do not contain any provision under which an arbitration award rendered in Nepal cannot be enforced; and   
  • the application has been filed for the implementation of the award within 90 days of the date of the award.

However, foreign arbitral awards are not enforceable in Nepal if the subject matter of arbitration cannot be subject to arbitration proceedings under the laws of Nepal, or if the award is against public policy.

A foreign lender should be able to enforce its rights under a loan or security arrangement through the courts in Nepal, or by enforcing an arbitral award if it has complied with the legal formalities in the granting of the loan and fulfilled the legal requirements for perfection of the security.

An approval from the NRB must be obtained under the Foreign Exchange (Regulation) Act 1962 (“FERA”) for any loan transactions by foreign lenders. Entities with foreign shareholders also require a recommendation from the Ministry of Industry, Commerce and Supplies for foreign borrowing. The Foreign Investment and Technology Transfer Act 2019 has also removed loans by foreign persons from the definition of foreign investment, which has raised a question regarding the ability of locally owned companies to borrow from foreign sources. Nevertheless, the NRB has the power to permit foreign loans under FERA for locally owned companies. It remains to be seen how the new regulatory structure works in practice.

The NRB has issued a notice that it will not approve transactions with interest rates above one-year LIBOR + 5.5% for corporate borrowing. Creating a pledge over shares and providing guarantees to foreign lenders also require separate approval from the NRB.

Prior approval of the Council of Ministers is required in order to grant the security of immovable assets directly in the name of foreign lenders, pursuant to the Muluki Civil Code. The approval of the NRB is required in order to pledge shares or provide guarantees to foreign persons.

The Foreign Investment and Technology Transfer Act 2019 (“FITTA”) provides the framework for foreign investment in Nepal, which is permissible through investment in shares, the purchase of shares or assets of an existing company, investment in capital investment funds or the secondary stock market, investment by issue of securities in foreign stock markets and reinvestment of profits. FITTA also regulates technology transfers and leases by foreign entities. Technology transfers include the licensing of foreign intellectual property, franchising, technical expertise, user licences, management, advisory and marketing services. FITTA has also classified leases by foreign persons of airlines, ships, machinery and equipment and technology transfer as an investment.

Foreign investment is allowed in manufacturing, energy, banking, insurance, mining, construction, infrastructure, tourism, information technology and other sectors classified under the Industrial Enterprises Act 2017. Foreign equity investment is restricted in agriculture, small and cottage industries, personal service businesses, arms and ammunition, the purchase and sale of land and buildings, retail, foreign exchange and remittance services, local catering, local trekking, travel agency, trekking and mountaineering, rural tourism, mass media, movies of national language and professional consulting services such as management, accounting, engineering, legal services, and language, music and computer training.

An equity investment of 51% is permitted in consulting services except for the completely restricted sectors; 49% in domestic airlines; 80% in international airlines; 95% in aviation schools; 95% in aircraft repair and maintenance institutions; 80% in telecommunication services; and 20% to 80% in banks and financial institutions. The minimum amount for foreign investment has been fixed as NPR50 million (USD450,000), and there is no upper limit for maximum investment. All forms of foreign investments require prior approval from the approving authority. The Department of Industry grants the approval for any investment up to the amount of NPR6 billion (approximately USD53 million), and the Investment Board of Nepal provides statutory approval under the PPPIA for investment above this amount. An approval from the NRB is also required for foreign investment.

FERA governs foreign exchange transactions in Nepal, and implements very strict foreign exchange controls. Approval from the NRB is required for making equity and loan investments, advance payments, paying dividends, the repatriation of proceeds from the sale of shares, principal and interests, or payment of premiums on loans or bonds to parties in other jurisdictions. The investor is not allowed to repatriate the investment amount for the first year. Investors are allowed to repatriate investment in the form of an exchangeable foreign currency, which is regulated by the NRB. NRB approval is currently required for each transfer.

Generally, approvals are not required for payments or foreign exchange in relation to the import and export of goods and the export of services. Payment of up to USD10,000 can be made without the permission of the NRB for the import of services. For payments over USD10,000, the recommendation of the NRB is required along with valid invoices.

The payment of dividends must be authorised by a general meeting of the shareholders of the company, unless otherwise required in the memorandum of association of the company. The dividends can only be paid from the net profits.

Nepalese companies may open offshore foreign currency accounts in other jurisdictions, subject to the conditions laid down in the Foreign Exchange Directive No. 18/2074 issued by the NRB. However, the directive does not set out matters relating to accounts for project financing. Accordingly, ad hoc approval from the NRB is needed for a project company to maintain offshore foreign currency accounts.

Financing documents and project documents relating to foreign debt, equity or foreign management need to be filed with and approved by the relevant authorities. Financing documents may include loan, intercreditor and security agreements, while project documents may include joint venture, shareholders', management and technology licence agreements. Project documents are submitted for approval at the Investment Board or the Department of Industry, depending upon the investment amount. Financing documents are submitted to the NRB in order to obtain borrowing approvals if foreign lenders are involved.

Other project documents do not usually require registration or approval for validity, including offtake agreements and concession agreements. A deed of mortgage creating security interests over immovable assets must be registered at the Land Revenue Office of the place where the assets are located. Generally, financing and project documents are undertaken in English or in the Nepali language. Additional formalities such as stamping or notarisation are not required in order to ensure validity.     

Mortgage deeds need to be registered at the Land Revenue Office of the district where the land is located in order to perfect the security.

The Government of Nepal has ownership over natural resources, including oil and gas, minerals, water resources and national forests. Licences must be procured in order to exercise rights over natural resources.

Private parties may obtain licences under various laws or through concession agreements to exercise rights over natural resources. The licensees should comply with the law and the terms of the licences and concession agreements. There are no legal restrictions on foreign parties acquiring such rights, but they must usually be acquired by a local subsidiary of foreign investors.

Licensees are also required to pay the government licensing fees and royalties. Once a licence is granted, the royalties paid by companies for the exercise of such rights is divided between the federal, state and local governments in accordance with the Intergovernmental Finance Arrangement Act 2017.

The concepts of both agency and trusts are recognised in Nepal. Part 5 Chapter 10 of the Muluki Civil Code recognises agency, while the concept of trust is recognised under Part 4 Chapter 6 of the Muluki Civil Code. A person can appoint an agent to act on its behalf for any work to undertake a business, to conduct a transaction with a third party, to provide representation or to establish a relationship with another party. Trusts are not currently used in financing structures. It is market standard to appoint security and collateral agents.

The bank or financial institution that is the lead arranger of the lending consortium, called the “lead bank”, performs the role of agent or trustee pursuant to the Consortium Lending Directive No. 11/075 and the amendment of Foreign Exchange Directive No. 23/2074 issued by the NRB. The lead bank holds collateral on behalf of the project lenders.

These bank and financial institutions are licensed by the NRB to hold and enforce security on behalf of project lenders. Corporate entities other than licensed banks and financial institutions are not used as agents or trustees in financing transactions.

Immovable assets can only be mortgaged once; competing security interests are not recognised. In cases when a property is pledged to multiple lenders/creditors and when the pledge is insufficient to cover the debt amount of all the creditors, unless agreed otherwise in the contract of pledge, all the creditors will have an equal stake (pari passu) on the property and the claim so arising will be proportional for all the creditors. When other assets have competing security interests, the interest with prior security obtains the priority.

Contractual subordination is the common form of subordination in Nepal, as only one mortgage deed per immovable asset can be registered. Contractual subordination is implemented by undertaking an agreement between the senior lenders, the junior lenders, the security agent, and the borrower. All unsecured debt liabilities are treated equally under intercreditor agreements, and subordination provisions do not bind other creditors. Since secured assets in a liquidation are not available to the general body of creditors, contractual subordination between secured creditors is enforceable.

The business structures under Nepalese law include a sole proprietorship firm, a partnership firm, a private limited company and a public limited company.

There are no restrictions on concessions being granted to foreign companies. However, foreign companies undertaking project development and construction activities in Nepal are required to register a branch office in Nepal. The branch office structure is highly unusual. It is also unclear if a branch office of a foreign company can acquire land in Nepal.

Therefore, project companies are generally incorporated as private limited companies under the Companies Act 2006.

A company reorganisation process similar to the US-style Chapter 11 reorganisation is available in Nepal for the restructuring of insolvent companies. The company reorganisation procedures can be initiated only after an order of the court following the examination of a report submitted by the inquiry officer of the insolvent company, and if the reorganisation is agreed by a majority of the unsecured creditors. Other creditors can file an application in the court within seven days against the decision for a restructuring scheme as ordered by the court.

The restructuring scheme is binding on all shareholders and directors, except for secured creditors. The restructuring procedure does not affect the rights of the owner of any property used, possessed or owned by the company or the lessor of such property. The court appoints the restructuring manager, and the restructuring scheme is implemented by the company itself. The restructuring scheme can be amended by calling a meeting of creditors or if the court deems that the change is in the interest of creditors. The restructuring process ends after the implementation or on the basis of the application filed by the restructuring manager upon failing to execute the scheme. However, the court can order the liquidation of the company upon its failure to execute the scheme.

The Insolvency Act 2006 of Nepal provides that bankruptcy proceedings, including restructuring plans, will not affect the right of secured creditors to enforce the security interest or deal with the security, unless the secured creditors vote or agree in favour of the restructuring plan or there is a binding court order. The court might issue a binding order restricting a secured creditor from exercising the right if the court is satisfied that not granting the order will adversely affect the restructuring, and that the rights of secured creditors over secured assets are sufficiently protected.

Secured creditors can make a claim before the restructuring manager or liquidator to collect the debt. An approved insolvency application from the project company shall not affect the rights of secured creditors to enforce the security. While hearing an insolvency application, the court may grant an interim order to stop the auction of security or other assets of the company by lenders. When granted, any action by the lenders to enforce the security is automatically suspended, as lenders are only able to enforce their loans, guarantees or security by applying to the court in accordance with the Insolvency Act. Secured creditors are second in the order of the settlement of liabilities after settling the cost and remuneration of the interim administration of the company for the interim management of the company upon the issuance of an interim order by the court.

Section 57 of the Insolvency Act 2006 sets out the following order for the payment of creditors on account of the insolvency of the company: 

  • expenses relating to insolvency proceedings;
  • debts borrowed by the company during the investigation of the insolvency proceedings or during the restructuring programme of the company;
  • expenses associated with the liquidator; 
  • wages of the employees;
  • amounts payable to the employees for gratuity, provident fund, and leaves;
  • all other debts (and debts of secured creditors not covered by the market value of the security);
  • all expenses associated with the functions discharged by the liquidator and remuneration;
  • wages and remuneration due and payable to the workers or employees of the company at the time of the issue of the order to liquidate; and
  • amounts payable to the workers or employees of the company in consideration of home leave, sick leave, gratuity and employee provident fund, if any, at the time of the issue of the order to liquidate or restructure the company.

The liabilities are treated fully and equally. In the case of failure to settle the liabilities fully, they are settled proportionately.

The Insolvency Act 2006 of Nepal ensures that the rights of lenders are sufficiently protected as secured creditors can only be bound by a restructuring plan if they agree to such plan or pursuant to a court order requiring them to be bound. Such an order will only be granted if the exercise of the rights of secured creditors adversely affects the restructuring of the company and if the rights of secured creditors over the secured assets and secured interests are sufficiently protected. However, secured creditors are not able to vote in creditor meetings.

Bankruptcy proceedings under the Insolvency Act 2006 are applicable to all companies incorporated in Nepal, pursuant to the Companies Act 2006.

Nepalese entities are required to insure with local insurers. Foreign insurance companies cannot currently directly insure projects in Nepal.

As for reinsurance, in practice insurance companies reinsure with foreign reinsurers. Under the Non-Life Reinsurance Directive 2008, insurance companies are required to reinsure any risk with at least three different reinsurers. Number 7 of the Directive elaborates on this point. AAA equivalent or higher rated entities can reinsure a maximum of 60% of the risk, while BBB rated entities can reinsure only 40% of the risk. Nepalese insurers are permitted to reinsure only with reinsurer companies that have credit ratings equivalent to BBB or higher.

Insurance policies over project assets can also be payable directly to foreign creditors. Furthermore, it is market standard to assign all insurance and reinsurance proceeds to the lenders. Inserting a cut-through clause in the reinsurance policy requires prior consent from the Insurance Board, which should be obtained by the insurance company.

The withholding tax on payments of interest or premiums on loans or bonds is 15% unless otherwise agreed in the relevant tax treaties between Nepal and other countries. Lenders insist on having a gross-up clause in the loan agreements, and this has become market standard. 

Gains on the sale of securities by foreign persons are subject to taxation at the rate of 25%. Withholding tax of 5% is applicable on the payment of dividends.

Tax is not applicable on foreign investments and loans. The registration fee has to be paid to the Land Revenue Office for the registration of mortgage and security deeds. The registration fee may vary across the various provinces within Nepal, but is currently around 1% of the loan amount.

The Muluki Civil Code has limited the maximum rate of interest that can be charged on lending transactions to 10%, although this limit is not applicable to banks and financial institutions.

The NRB sets the maximum interest rates that can be charged by foreign lenders. The current rates are as follows:

  • corporate borrowing from overseas: one-year LIBOR + 5.5%; and
  • banks borrowing from overseas: six-month LIBOR + 4%.

Interest or fees cannot be charged on personal loans or short-term shareholder advances.

Depending on its type, a project agreement may be governed by either Nepalese law or other foreign law. Generally, the Government of Nepal insists that Nepalese law should govern project documents such as concession agreements, domestic power purchase agreements and land lease agreements. In the case of large projects involving foreign investors and creditors, the Government of Nepal has entered into concession agreements governed by foreign law. English law is preferred among foreign laws.

Other documents are also frequently governed by English law in large-scale projects with foreign investment, such as engineering procurement construction agreements, operation and maintenance agreements, shareholders' agreements and consulting agreements.

Finance agreements such as common terms agreement, facility agreements, intercreditor agreements, sponsor support agreements and offshore security agreements for large projects involving foreign investors and creditors are usually governed by English law.

Local security documents such as security deeds and mortgage deeds are generally governed by Nepalese law, as assets are located in Nepal and require the fulfilment of formalities prescribed in the Muluki Civil Code.

Security documents such as security agreements, mortgage deeds and other security deeds for assets located in Nepal are typically governed by domestic law. Project documents and financing documents in projects involving Nepalese creditors and sponsors are usually governed by local law.   

Neupane Law Associates

2nd Floor, Central Business Park
Thapathali Road
Kathmandu 44600
Nepal

+977 1 410 1631

+977 1 410 1633

info@neupanelegal.com www.neupanelegal.com
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Neupane Law Associates is a leading law firm in Nepal, specialising in corporate transactions and dispute resolution. Its lawyers have extensive experience and expertise in banking, foreign investments, M&A, and project development and finance. It is the firm of choice for banks, financial institutions and multinational corporations, and its internationally educated team has extensive experience in advising on high-value, complex and innovative matters.

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