Rehabilitation and diversion of funds (3 June 2001)  

New York, June 2: Over a year ago, the beleaguered Arvind Mills Ltd, struggling under a humiliating Floating Rate Note default, sought the benevolent protection of the Bombay Relief Undertakings (special provisions) Act of 1958. But isn’t Arvind Mills an Ahmedabad-based company? Sure, but the Act, which is a relic of the days before the States were reorganised on linguistic lines, exists only in Gujarat.

Interestingly, the Bombay government repealed the BRU Act in 1960 and Maharashtra repealed it in 1964, but not Gujarat —there the Act continues to protect highflying companies such as the public sector Gujarat Telephone Cables Ltd or the highly pedigreed one-time blue-chip Arvind Mills. If the lending banks and institutions are enthused at reports suggesting an imminent repeal of the SICA (Sick Industries Companies Act) and scrapping of the Board of Industrial and Financial Reconstruction (BIFR), they may be in for some nasty surprises. There are clearly several State statutes under which defaulting borrowers can and will continue to seek shelter.

The BRU is fairly draconian in its application. Section 4 of the Act stays the enforcement of all rights, privilege, obligation and liabilities against a company that is notified under it and also suspends all proceedings relating to that company which may be pending before any court, tribunal or authority. Thus sheltered, Arvind Mills along with its lead institution ICICI has been using the opportunity to force through a rehabilitation scheme despite serious objections by some of its lenders. In the process it has also had the validity of the 12-month notification under the act (which was to expire next month) extended by another year to May 13, 2002.

Ironically, the BRU came into existence to mitigate the hardship of workers who may be thrown out due to the closure of an undertaking. Instead, it is now a shield for devious sick companies. In Arvind’s case, the lenders had three main objections to its rehabilitation package. First, that it regularises a ‘sale and lease back’ deal with ICICI involving sale of properties, which were already pledged against specific borrowings. They allege that ICICI, which was a trustee for these properties, was guilty of breach of trusteeship obligations by entering into a deal that benefits itself. It is also their contention that ICICI has protected its own lending at the cost of other lenders.

Secondly, the rehabilitation package worked out by ICICI very curiously puts the Union Bank of Switzerland, an unsecured lender, which is stuck with the bulk of Arvind’s FRN issue after its default, on par with secured lenders. And thirdly, that the rehabilitation package makes no attempt to force Arvind Mills to bring back over Rs 395 crore which has been diverted by it to subsidiary companies during the same period that it was defaulting to its creditors (1998-99 and 1999-).

These aggrieved lenders discovered that Arvind was not alone in seeking protection under the BRU. Gujarat Telephone Cables was ahead of it, and all three financial institutions, ICICI, IDBI and IFCI had filed legal action saying that they would suffer immense financial damage if Gujarat Telephones was sheltered by the BRU. Their action had led to further developments. The judge ordered the company to file an application under the Gujarat Bureau of Industrial and Financial Reconstruction (GBIFR). Gujarat Telephone is anything but small-scale but the orders had to be complied with. ICICI filed an appeal against the order wherein the judge had directed that putting the company back on its feet was to be the first priority of the GBIFR.

In the meanwhile, some of Arvind’s lenders decided to follow the Gujarat Telephones route. Their matter too was referred to the GBIFR. Ironically, while the three financial institutions are fighting sick Gujarat Telephones in similar circumstances, they are on the same side as sick Arvind Mills in this case. They presented and supported the rehabilitation package, worked out by ICICI – leaving a clutch of dissenting lenders (mainly angry foreign banks) in the lurch again. It remains to be seen if the foreign banks go along with what they consider an unfair rehabilitation package, but the two cases of Arvind and Gujarat Telephones raise several uncomfortable issues.

First, that scrapping SICA is not the end of the story. Several States such as Gujarat have their own versions of SICA or worse which have to be repealed simultaneously in order to make way for a single national Act which allows faster, smoother and merit-based winding up or rehabilitation of sick units. The Act should also prevent industries from misusing old statutes to hide from the lenders. Second, that lending institutions, particularly development financial institutions will have to be consistent in their approach to sick companies. So long as they fight a Gujarat Telephone Cables and support an Arvind Mills, it is difficult to take their loan recovery attempts seriously. In this case, there could even be suspicions of collusion. Sanjay Lalbhai was, until recently, a director of ICICI and ICICI had also acquired Anagram Finance, a finance company of the Lalbhai group which was in serious financial difficulties. Finally, the Gujarat judge’s decision to refer an appeal against the BRU to the GBIFR is worrying.

A few months ago, speaking at a convention on law and human rights, a sitting judge of the High Court had described how the decade of liberalisation had led to a gradual shift in the attitude of courts towards labour issues. Courts were no longer biased in support of organised labour or necessarily inclined to regularise contract work — the drain on the exchequer due to the massive losses and abysmal performance of public sector units have gone a long way towards changing their attitudes. A similar change is required in connection with sick industrial units also. Rehabilitation of companies that have gone sick due to diversion of funds is not right and they cannot be allowed to shelter under statutes such as the SICA or the BRU.