Sucheta Dalal :The hapless debenture holder and other issues (5 May 2003)
Sucheta Dalal

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The hapless debenture holder and other issues (5 May 2003)  



Section 391 of the Companies Act allows a company and its creditors or members, or any class of them, to enter into a ‘compromise’ or a scheme of arrangement under the direction of the courts. In the last couple of years, companies have discovered that Section 391 has many uses. It can be ingeniously tweaked to bypass stringent disclosure norms and investor protection measures introduced by the capital market regulator and the Department of Companies Affairs (DCA).

They have also discovered that Indian High Courts, less familiar with the recent developments regarding disclosure requirements and shareholder democracy, are lenient about investor protection measures. Hence, they can come up with anti-investor proposals that are hardly a ‘compromise’ and have them passed at shareholders’ meetings that very few retail investors can attend. As a result, a Sterlite Industries could use Section 391 to try and delist its shares and go private, while a defunct CRB Group could use the same section to plan a revival.

Now Essar Oil, which is already defaulting on interest payments on its 14 per cent non-convertible debenture (NCDs) is using the Section to slash the redemption payment to half the face value and no interest, or to stagger the repayment over a stunning 22 years until the year 2025, while slashing interest payment from 14 to 9.25 per cent.

To add insult to injury, this scheme was proposed only when the redemption became due. One investor says that he was expecting a redemption cheque (on April 20, 2003) but instead received a slap on the face. A further insult is the fact that the meeting is being held in Jamnagar when most of the investors are in Mumbai where its corporate office is located.

Under the law, the Company Law Board (CLB) can order the redemption of debentures by the payment of principal and interest due. And, if there is a default in complying with the CLB order, then every officer of the company could be punished with imprisonment of up to three years, and a fine of Rs 500 for every day of default.

But Essar Oil has been defaulting on interest payment since 1999, and it is avoiding legal consequences through the scheme of arrangement under Section 391.

Interestingly, Essar Oil’s equity holding is so fragmented that investors will get no help from institutional holders. According to Essar Oil’s latest stock exchange filing, 61 per cent of the equity is held by Indian and foreign promoters and persons acting in concert, and 25 per cent by the Indian public.

Mutual funds, insurance companies and banks hold only 6.45 per cent of the equity. One assumes that Essar Oil’s debenture holding pattern will be similar, since the non-convertible debentures (NCDs) are the residual portion of optionally fully convertible debentures.

Who can the debenture holders turn to help? Obviously, the Debenture Trustees. ICICI (the development finance institution) was the original trustee to the debentures since 1995, but it transferred the trusteeship to The Western India Trustee & Executor Company Ltd on 21 June, 2002. The new trustee seems to have done precious little despite Essar Oil’s interest defaults since 1999. The fact of debenture trustees evading their responsibility has been pending with the regulator for a long time.

In September 2000, SEBI, in a written communication to this writer (in connection with the Montari Industries case, where ICICI resigned as debenture trustee when the company turned sick), had agreed that responsibilities of debenture trustees needed to be tightened. It had just amended its rules to avoid conflict of interest by stipulating that lending institutions could not become debenture trustees.

It also amended its debenture guidelines to ensure that issue proceeds were kept in an escrow account until the assets were secured through a proper mortgage. But, as the Essar Oil case shows, neither the creation of security (in the Essar case a second charge over te refinery project), nor the existence of a Debenture Redemption Reserve (DRR) are any guarantee of repayment.

In fact, the concept of a DRR has been rendered meaningless by the fact that companies are allowed to dip into the reserve and spend it. As for the Debenture Trustees, they not only ignore their fiduciary responsibilities but also, what SEBI called their ethical obligations as per the Code of Conduct. Investors need to ask if SEBI has bothered to question Essar Oil’s debenture trustee about its ethical obligations.

Interestingly, the Naresh Chandra Committee has said that SEBI should not seek to tighten rules and reporting requirements through Clause 49 of the listing agreement of stock exchanges, instead it should seek an amendment to the Companies Act itself, when important changes are necessary.

The DCA itself has been debating ways to safeguard debenture holders interests. Among the issues discussed by it are: disqualification of directors, investigation and audit of funds utilisation, regular debenture holders’ meetings and postal ballot for such important decision and possible winding up action against defaulter companies.

All this is of course necessary. But what SEBI and the DCA need to do more urgently is to push for an amendment of Section 391 so that companies cannot use it to bypass provisions of the SEBI Act and other rules and legislation aimed at protecting investors. The amendments should make it mandatory for companies to hold all statutory meetings in cities that have the maximum concentration of shareholders including those under Section 391.

Moreover, every significant issue must be decided through a postal ballot so that shareholders who cannot attend the meetings have a chance to vote on the issue. But all this is in the intermediate future.

If Essar Oil is allowed to get away with its outrageous proposal, it will only encourage other companies lining up with similar schemes. What is most galling for investors is that the group, despite its bad performance and the repeated restructuring of its repayment obligations to financial institutions, continues to have the blessing of the political class.

One of its promoters remains on the Prime Minister’s advisory committee. And the Disinvestment Ministry thinks that its inability to pay back investors is no bar against its bidding for the best of Indian public sector companies such as Hindustan Petroleum Corporation or a Shipping Corporation of India. Is it any wonder then that Indian investors continue to shun the primary market?


-- Sucheta Dalal



 



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