The Securities and Exchange Board of India (Sebi) has moved swiftly to plug abuse of section 391 of the Companies Act by amending the listing agreement of stock exchanges. This will stop companies from using the court ordered “scheme of arrangement” to push through mergers and share buyback and circumvent Sebi rules that mandate fair treatment of investors. But plugging the section 391 loophole is only the beginning. Something needs to be done about Debenture Trustees who collect trusteeship fees but refuse to fulfill their fiduciary duty of protecting investors.
Every passing day brings fresh reports about the lack of accountability and gross abuse of fiduciary duties by Debenture Trustees. Yet, neither the Department of Company Affairs (DCA) nor Sebi have figured out a foolproof way of making them more accountable. The latest I hear, is about a dispute between various financial institutions over repayments by JK Synthetics Ltd. Three years ago, Infrastructure Leasing & Financial Services (IL&FS) had moved the Allahabad High Court against ICICI Bank (then ICICI Ltd) to force it to fulfill its role as debenture trustee. It was one of many legal actions initiated by IL&FS against ICICI in the past few years to force it to fulfill its duties as debenture trustee. Further litigation was filed by those involved before the debt recovery tribunal and the sick industries legislation. It led to JK Synthetics depositing nearly Rs 100 crore in a no-lien escrow account controlled by ICICI Bank and Industrial Development Bank of India (IDBI).
The relevant part of our story pertains to IL&FS’s effort to have the money in the no-lien account distributed to debenture holders. And here is the surprise.
Papers available with me say that the “title deeds” to various mortgaged assets are missing. The missing title deeds pertain to properties at Kota, Jhalawar, Gotan and Nimbahera complexes and ICICI has been asked to apply for a fresh set of title documents. The same papers also mention that Central Bank of India, another lender, has only been able to locate some title deeds for assets pledged with it, while the “main documents” pertaining to SSF and the Tyre Cord plants at Kota in Rajasthan were “missing”.
Similarly Housing Development Finance Corporation, says in the letter dated 28th April 2003, “has to confirm regarding titled deeds pertaining to land on which the colony (housing colony) has been constructed at Jhalawar. Despite their assurance, we have yet to receive the same”.
I learn that missing title deeds is not an unusual occurrence. In fact, there are cases where banks have sanctioned and disbursed loans based on photocopies of title deeds and security documents and forgotten to collect the originals. It is reliably learnt that a lending institution, which is locked in a bitter litigation with a Gujarat based company has lost the original title deeds in connection with its security and is covering it up with bluff and bluster.
The discussions documented in the letter pertaining to JK Synthetics also reveal that institutional debenture holders, being far more powerful, conduct a separate stream of negotiations to have their investment released without bothering about retail investors. This brings us to several key issues. For instance, how safe are secured debentures if the breach of fiduciary responsibility by Debenture Trustees is not severely punished? Secondly, although section 118 of the Companies Act allows debenture holders to obtain a copy of the Trust deed, they have no way of knowing whether the original title deeds are indeed in the possession of the Debenture Trustee. Thirdly, as far as debenture investments are concerned, it would seem that institutional investors are as helpless as individuals. For instance in October 2001, Unit Trust of India (UTI) chairman M Damodaran prepared a list of all companies that were defaulting on debenture interest. He then wrote to the chairman of every institution, which was the Debenture Trustee, providing it with a list of its defaulting companies and asked what action had been taken to protect UTI’s investment.
Most institutions did not bother to reply, safe in the knowledge that there were no penal consequences to their inaction. Interestingly, only when UTI wrote to ICICI Bank, which was the biggest debenture trustee and had the longest list (123 companies) of defaulting companies that it discovered that its entire portfolio was transferred to The Western India Trustee And Executor Co. Ltd (WITECO).
Thanks to ICICI Bank, WITECO now claims a debenture/bond portfolio of a whopping Rs 30,000 crore. This includes the 123 defaulters inherited from ICICI Bank. WITECO proclaims that “Total Trust” is its motto, but it is a tiny company and probably in no position to fight big corporate defaulters. Moreover, no investor would have invested in the debentures if WITECO were originally appointed as guardian angel.
Yet, in a year and a half after UTI’s desperate attempts to protect its debenture investments, neither Sebi nor DCA have moved to amend debenture trustees regulations. In fact, the first serious meeting on the subject seems to have been held on April 22, 2003 by Rajiv Mehrishi, Joint Secretary, DCA at which Debenture Trustees, investor activists and representatives of Sebi were present. Ironically, there were two representatives of ICICI Bank at the meeting, even though it has sold its debenture trustee portfolio and has the worst record of letting down investors. The meeting, after detailed deliberations made the following recommendations.
Imposing monetary penalties for failing to create valid security against debentures; Amending the law retrospectively to proceed against trustees for failing to create security and creating the power to recall debentures for such failure; Provision for special audits to examine utilisation of funds by companies; Empowering Debenture Trustees to approach the National Company Law Tribunal in case of defaults in redeeming debentures; Holding an obligatory meeting of debenture holders and use of postal ballot for deciding issues relating to debentures; Providing for disqualification of directors of defaulting companies under section 274(1)(g) of the Companies Act when there is an unrectified default; Allowing winding up proceedings against defaulting companies; And finally, taking steps to make the debenture redemption reserve safer (today it allows companies to utilise the reserve funds).
All these are steps in the right direction. The DCA not only needs to implement them urgently but it should additionally mandate that auditors of the Debenture Trustees should certify that they possess original title deeds as well as a valid security.
-- Sucheta Dalal