Pre-Disbursement Compliance: Expired EC, Sanctions Hit and Pledge Breach
During pre-disbursement due diligence for a ₹1,800 crore highway SPV, the compliance team finds four issues. First, the project's environmental clearance expired four months ago and the renewal application is still pending with the regulator; site work has continued. Second, a tolling subcontractor appears on the UNSC 1267 sanctions list under a name match that has not been resolved. Third, the sponsor pledged 26% of the SPV's shares to another lender without the DFI's prior written consent, which the loan agreement treats as an event of default. Fourth, the EPC contract is with a promoter-group company, and the borrower has already paid ₹45 crore as mobilisation advance against a ₹300 crore contract without independent engineer certification. The business team wants to release the first ₹250 crore tranche this week to avoid a penalty under the concession agreement.
1. Advise whether to disburse. Identify the issues in order of severity, the immediate holds, and the escalation you would require.
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Do not release the ₹250 crore tranche. The issues are not equal: the expired environmental clearance is a legal-compliance breach, the sanctions match is a potential AML/CFT breach, the share pledge is a contractual event of default, and the related-party advance is a governance red flag.
Sequence: (i) place the loan in disbursement hold and document the decision; (ii) obtain a written legal opinion on the EC status and stop-work exposure; (iii) resolve the sanctions match through the DFI's screening process before any payment; (iv) issue a notice to the borrower on the pledge breach and require either prior consent or a remedy; and (v) commission an independent engineer review of the ₹45 crore advance. Escalate to the CRO, compliance head, and MD/board as per policy.
The concession penalty is a commercial pressure tactic; it does not override regulatory compliance. If the DFI disburses with knowledge of an expired EC and an unresolved sanctions match, it accepts reputational and regulatory risk that cannot be cured by pricing.
2. What regulatory and compliance actions are required for the sanctions match and the expired environmental clearance?
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Sanctions: the name match must be dispositioned by compliance, not the business team. If it is a true match, freeze the subcontractor's payments, do not tip off, and report through the DFI's sanctions escalation channel and to the relevant authority under the UNSC/UAPA framework; file a suspicious transaction report with FIU-IND if the transaction is suspicious. The DFI should also check whether the borrower or EPC contractor has any ownership link to the listed entity.
EC: prior environmental clearance is mandatory for the project under the EIA Notification; construction without a valid EC is a violation. The DFI should require the borrower to stop work, obtain renewal, and provide a regulator's acknowledgement. The credit file should record the legal opinion. If the EC cannot be renewed, the loan should be restructured or cancelled, not disbursed. The compliance team should also review whether the DFI's own ESG/safeguard policy requires disclosure and a corrective action plan.
3. How should the DFI treat the related-party EPC contract and the ₹45 crore advance in credit and compliance terms?
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The EPC contract is with a promoter-group company, so it is a related-party transaction. The DFI should require: (i) identification and disclosure under Ind AS 24/Companies Act; (ii) arm's-length pricing certified by an independent valuer or benchmarked to a competitively bid EPC contract; (iii) SPV board and shareholder approvals, with interested parties abstaining; (iv) independent engineer certification before any further advance; and (v) recovery or adjustment of the ₹45 crore advance against certified milestones.
The advance is 15% of the ₹300 crore contract, which is high for a mobilisation advance without security; require a bank guarantee or adjustment mechanism. In credit terms, related-party EPC increases completion and leakage risk. Add a covenant restricting related-party transactions above a threshold, a right to inspect contractor books, and an event of default for undisclosed related-party payments. If the sponsor refuses, treat it as a governance issue and reprice or decline the exposure.