Of Archaic Laws & Booby Traps

ANTI-MINE ACTIVISTS and organisation around the world should include India in their list of contaminated countries. Not because the Naxalites are reportedly booby-trapping large swathes of Chhatisgarh with these subterranean explosives. The expertise of anti-mine activists in weeding out live UXOs – or, unexploded ordnances – might come in handy for defusing large chunks of Indian corporate legislation. Many Indian Acts are full of landmines and present potential threats to enterprises and investors.

Look at the Securities (Contracts) Regulations Act. There is a provision in the Act that forbids two parties from entering into a private deal on futures and options. All such contracts have to be transacted on the designated stock exchanges. Therefore, if you have an agreement with your partner to buy back his shares three years hence at a price determined now, which is a kind of an options deal, the courts can rule that the agreement is null and void, ab initio. This absurd rule, otherwise known as Sec 18A, states: “Notwithstanding anything contained in any other law for the time being in force, contracts in derivative shall be legal and valid if such contracts are—(a) traded on a recognised stock exchange; (b) settled on the clearing house of the recognised stock exchange, in accordance with the rules and bye-laws of such stock exchange.” But for the provision to kick in, the courts have to intervene. And for that to happen, somebody (ideally one of the partners) has to go to court.

Ideally, a shareholders’ agreement is like a contract and once two parties sign on it, it becomes binding on both. But, hey, wait a second…here’s an escape route called Sec 18A, provided courtesy GOI and free of cost. And the crucial words are: “Notwithstanding anything contained in any other law for the time being in force…” So, if you signed a deal with your JV partner in a hurry, and want to extract more out of him now, you now know where to look.

Add to this another joker in the pack, Foreign Exchange Management Act, and the Indian corporate landscape resembles a veritable war zone, pocked with undetected landmines. FEMA states that in the case of unlisted shares, the “fair value” has to be worked out as per the erstwhile Controller of Capital Issues. This is strange on two counts: one, the Reserve Bank (which administers FEMA) insists on flogging CCI, which was abolished way back in 1991-92! Also, if it’s an unlisted company, why should anyone bother?

The recent Vodafone purchase of Hutch almost came unstuck because of these rules. Vodafone, after buying out Hutch’s 52% in its Indian operations, wanted to buy out the 12.26% held by Asim Ghosh and Analjit Singh for $430m, according to a pre-determined valuation. Immediately, there was pressure on the government to stop the deal. Reason: its pre-determined prices are essentially null and void. FEMA also kicked in. Fortunately, the Foreign Investment Promotion Board (FIPB) cleared the deal on Friday.

Here’s another interesting case. A few months ago, Narotam Sekhsaria sold off his stake in Gujarat Ambuja to Swiss cement company Holcim. As part of the deal, Mr Sekhsaria also made Ambuja sell off its stake in Ambuja Cement India, an SPV that held Gujarat Ambuja’s stake in another cement major ACC. Under the agreement, Ambuja is to sell off its stake in ACIL in three tranches of 9,53,7500 shares each. The first transaction, completed in the first quarter this year, was struck at Rs 55 per share. Now comes the clincher: the pricing for the next two tranches (to be completed on April 30 this year and April 30 next year) too has been determined (at Rs 56 and Rs 61 per share, respectively). This is like an options contract and can be taken to court by Gujarat Ambuja minority shareholders.

The pact between Holcim and Ambuja for transfer of ACIL shares, at pre-determined prices at a future date, constitute an options contract and can be held to be null and void. The lawyers would have surely wrapped the contract with overseas arbitration clauses and guarantees from various multinational banks. But the minority shareholders might not take to this too kindly. Especially since Gujarat Ambuja had to bear huge interest costs on loans taken to fund the ACIL equity during the ACC acquisition. Now that cement stocks are doing well, they end up with peanuts.

But, guess, who is making the most of all this confusion? It’s a breed called lawyers.

A Case Of Mixed Ethics At Mint Street

IN THE FINANCE ministry or the Reserve Bank of India, rules for banks are decided on the basis of their shareholders. In other words, parentage determines the rules for a particular bank.

True, this is not applicable for all banking operations. Stuff such as the mandatory liquidity ratios, provisioning norms and risk weightages for different asset classes are uniform for all banks. So are a host of other operational details. But the bullet starts biting when it comes to corporate governance norms. One of the areas with the widest divergence is the role and designation of chief executives and the selection of bank directors. Two recent examples highlight the discrepancy in bank governance norms.

First, the government recently asked all listed public sector banks to halve the number of shareholder directors and replace them with government-nominated ones. The second example is the recent public —and rather petulant —exchange between UTI Bank CMD PJ Nayak and RBI. Here’s the spat in short: The bank’s board wanted to re-appoint Mr Nayak as CMD, but RBI put its foot down and said the post had to be split into two — a chairman and a MD. At this point, Mr Nayak told the board that he would continue only as CMD, since “having spent 7.5 years as CMD, it would not be possible for him to function in a different and lesser capacity in the bank and he will, therefore, cease to be associated with the bank after July 31”. This was stated in an announcement to BSE.

The public airing of differences occurred because of the varying rules that exist for different banks. Take public sector banks first. The board composition of these banks is determined by the Banking (Nationalisation and Acquisition) Act, 1970 and 1980 — two archaic pieces of legislation that were drafted for a specific purpose at a particular period in time (mass-scale nationalisation of private banks in two tranches). The Act has undergone several amendments, but one feature remains unaltered: all PSU banks must be headed by a chairman-cum-MD. The only exception is State Bank of India, which is governed by its own Act. For a variety of curious reasons, the government, as the largest shareholder of PSU banks, and RBI (as regulator of banks) have refused to split the posts.

On the other hand, all private banks have to compulsorily appoint a non-executive chairman and an executive CEO or MD. There could be legal reasons for this — these banks are not governed by the antiquated Act mentioned above, but by the Banking Regulation Act. If you look at the boards of most new private sector banks, the chairmen are usually appointed in a non-executive capacity (and are mostly retired senior RBI officers) while the chief executive is the main executive for driving the bank’s growth.

The story is completely different with foreign banks. To start with, foreign banks are regarded as branches of their parent organisations. For example, American banks in India are usually branches of their parent organisations in the US. This peculiar structure is to make the parent liable for any big risk event here. The parent’s capital is then directly committed to the bank’s operations in India, which acts as a safety cushion. This also has a bearing on the board structure. Foreign banks, since they are not incorporated as legal entities, do not have a legal board. They are allowed only an advisory board, which is headed by a non-executive chairman, usually a senior retired bureaucrat.

RBI appointed two committees in recent times to take a look at corporate governance in banks and financial institutions. The first, headed by RH Patil, among other things said: “…any steps to improve corporate governance in the Indian economy would remain incomplete and half-hearted unless public sector units are also covered in this exercise”. The second panel, headed by former HLL chairman AS Ganguly, in fact, went a step further and noted, “It would be desirable to separate the office of chairman and managing director in respect of large-sized public sector banks. This functional separation will bring about more focus on strategy and vision as also the needed thrust in the operational functioning of the top management of the bank”.

However, despite suggestions and the evident infraction of ‘desirable’ governance norms, the government and RBI soldier on in their belief that the goose and the gander need separate sauces.

In Quest For An Eternal Knot

USUALLY people look skywards when exclaiming Good Heavens! Maybe because people feel heaven is located somewhere in the far reaches of a remote galaxy. In any case, it must be somewhere up there in space. Logically, therefore, marriages made in heaven should usually denote unions solemnised in mid-air. No wonder, the owners of a Mumbai jewellery chain got their son married in an aircraft some years ago. They hired an aircraft, yanked out all the seats to accommodate guests, got the aircraft to circle over Mumbai for two hours while the priest tied the groom and his bride into an ‘eternal’ knot.

Sure, people do crazy things to get married. Another Mumbai-based couple first got engaged in mid-air, suspended by ropes 50ft above ground level, and then got married underwater in a local swimming pool. The ceremony, which lasted over 36 minutes, was sanctified by a priest, the bride's father and sundry relatives. The dress code: scuba gear!

The Jet-Sahara now-on, now-off wedding — though redolent of a mid-air fender-bender — leaves behind the acrid smell of burnt gunpowder on the ground. So, was it a shotgun wedding where the suitor doesn't have much of a choice? In the classical sense, the bride's father forced a ‘shotgun wedding’ upon the groom, to protect the family and the girl's reputation. But over time, the term has come to signify any condition under which the groom is forced to walk down the aisle. It could even be external forces, such as competition or to pre-empt impending industry consolidation. Alliances, mergers, sell-outs are all prompted by a variety of reasons, some forced upon companies, some strategic in nature.

When Ramesh Chauhan sold India's leading soft drink brand Thums Up to Coke in the early nineties, there was quite a to-do in Indian industry about Chauhan selling out, capitulating to western forces, not having the stomach to stay in the field and slug it out, and so on. The fact is Chauhan saw the writing on the wall and sold off his brand from a position of strength. That is not always the case. Hindustan Lever sold off Dalda, the iconic vanaspati brand, to foods company Bunge, because it had ceased to deliver high margins in a market that had evolved in tastes and transformed intrinsically. In fact, Levers also sold its fertiliser business — a low-margin business strategy devised to keep the government happy in the notorious anti-MNC days — to Tata Chemicals when it had outlived its utility.

Look at some of the other forced alliances in India Inc. The Tatas had to sell Tomco to Hindustan Lever, when they realised they had a losing business on their hands. All the brands were steadily losing market share, margins were headed south and the company lacked the expertise to rejuvenate the brand portfolio. Even Balsara had to be sold to Dabur for similar reasons.

But alliances can also happen because of strategic reasons. Citigroup tied up with Travellers Group, because the insomniac bank wanted a lucrative piece of the retail banking, such as broking, insurance business. Even if that subsequently resulted in the exit of Citi CEO John Reed. Speaking of which, Jamie Dixon, who moved to Citi with his fellow Traveller boss, quit in a huff, joined Bank One, convinced JP Morgan for a merger and became boss of the combined entity.

Interestingly, current day JP Morgan (before it merged with Bank One) had gathered bulk through a series of historic mergers. On one side was Chemical Bank, which in 1991 joined forces with Manufacturers Hanover (lovingly called Manny Hanny by bond and currency dealers) and merged with Chase Manhattan in 1996. Finally, in 2000, this post-merger giant merged with JP Morgan. Look at the outcome — four of New York's oldest and largest financial institutions (Chemical, Manny Hanny, Chase and JP Morgan) were all now under the same roof. In 2004, Bank One (another product of serial mergers) merged with JP Morgan Chase to create one of the world's largest banks.

Mergers, alliances, or even outright takeovers — unlike marriages — are made mostly in boardrooms or on the floor of stockmarkets, but rarely in mid-air.

India Inc Wakes Up To Pre-nups, But Can They Salvage JVs?

TILL her recent death, Anna Nicole Smith (she of the fabled physical virtues) was constantly reminded how she should have signed a pre-nup before marrying billionaire oil tycoon J Howard Marshall. On his death, the former Playmate felt she was done out of her rightful share of Marshall's estate by his son from an earlier marriage. Marshall, 63 years her senior, had not left Smith anything behind and this resulted in a lengthy suit, which is still continuing.

This seems strange in a land where pre-nups have become synonymous with celebrity marriages. Pop singer Britney Spears has been complimented for having presciently signed a pre-nup before marrying Kevin Federline. So, when they split, the guy got only $300,000 of her $100m assets. Michael Douglas and Katherine Zeta Jones brought respectability to pre-nups during their high profile wedding. Ditto for the Tom-Kat nuptials.

Legally, though, there's a debate whether pre-nups can actually be enforced. While pre-nups may be a legal contrivance to avoid the messy, post-split sharing of assets, they may not still represent the final word in a court of law. And, yet, most wealthy couples tying the knot stateside prefer to incur huge legal expenses to hammer out the tiniest details about who is to get what, including pets, in the event of a divorce. Clearly, getting hitched has become an expensive affair.

Actually, so has the cost of entering into a joint venture in India. Pre-nups of a different nature are being signed by prospective JV partners every day, thereby increasing the cost of doing business in India manifold. JVs forged before 2005 had one uncomfortable thorn in their side, a strange beast called Press Note 18. The note, a policy document, essentially required a foreign partner wanting out of a JV, so that he could set up his own 100% venture, to first get the JV's board to provide him with a no-objection certificate. Many Indian promoters sensed excellent business opportunity and sighted future revenue flows in this arrangement.

Increasingly, as the foreign partner realised that it was time to strike out on his own — whether it was because the foreign investment rules had been relaxed, or the Indian partner could no longer provide any capital or useful entrepreneurial input, or because he had outlived his utility — the NOC became a stumbling block. Worse, it acquired a price tag. Strange as it may sound, the government had provided Indian promoters a monetary protection, or an insurance policy. Predictably, many Indian promoters reaped rich dividends from this.

After substantial lobbying, the government realised this did not fit in with its pro-reforms, pro-FDI image with global investors. Say hello to Press Note 1 (2005 Series). This has two parts. The first says that if a foreign partner wants to set up an independent unit in the "same" field as the JV, then it would need prior government approval. But proof would have to be furnished to the government by both parties — again a form of insurance policy — that the new venture "would not in any way jeopardise the interests of the existing joint venture".

The second part is even more interesting. The note suggests that JV agreements "may embody a 'conflict of interest' clause to safeguard the interests of joint venture partners in the event of one of the partners desiring to set up another joint venture of a wholly owned subsidiary in the 'same' field of economic activity." Hence the hectic signing of pre-nups before JVs are set up.

The only guys who seem to be gaining from all this are lawyers. Scores of them are employed by both sides to draw up an appropriate pre-nup, which minimises the risk, since it cannot be totally eliminated. "Conflict of interest" could mean anything and prenups have to be very specific. For example, a pharma pre-nup has to specifically mention what's a potential conflict — bulk drugs, generics, branded OTC products or life saving drugs. And yet, as lawyers and JV partners point out, the courts can still have the last word. All this adds to the cost of doing business in India.

Pre-nups alone are inadequate for salvaging either joint ventures or marriages.