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FTIL + NSEL = Public Interest?

Published on Fri, Oct 31,2014 | 21:10, Updated at Mon, Nov 03 at 14:45Source : CNBC-TV18 |   Watch Video :

Last week the government for the first time ever sought to invoke an extraordinary power under Section 396 of the Companies Act, 1956. It proposed  the merger of collapsed commodity exchange NSEL with its parent company Financial Technologies or FTIL. Prompted by an FMC proposal, bolstered by the support of investor groups, the MCA said ‘Whereas the Central Government is satisfied that to leverage combined assets, capital and reserves, achieve economy of scale, efficient administration, gainful settlement of rights and liabilities of stakeholders and creditors and to consolidate businesses, ensure co-ordination in policy, it is essential, in the public interest that FTIL and NSEL should be amalgamated into a single company.’

Hello & Welcome to The Firm – this week we break tradition and invite on the show the 2 opposing sides. Representing FTIL is Berjis Desai of JSA and representing NSEL investors is Shuva Mandal and well known counsel Tushad Cooper joins us with an independent point of view!

21st October, 2014
MCA issues Draft Order of Amalgamation of NSEL with FTIL
Order under Section 396 of Companies Act, 1956
MCA Draft Order
‘Whereas the Central Government is satisfied that to leverage combined assets, capital and reserves, achieve economy of scale, efficient administration, gainful settlement of rights and liabilities of stakeholders and creditors and to consolidate businesses, ensure co-ordination in policy, it is essential, in the public interest that FTIL and NSEL should be amalgamated into a single company.’
Doshi: It has to do with the argument that has made headlines over the last week or so in the media that invoking Section 396 in this fashion goes against the very core of limited liability which is at the very core of any corporate structure. May I argue that limited liability is the norm, but doesn’t Section 396 give the government extraordinary powers to deal with an extraordinary situation and isn’t an Exchange collapse an extraordinary situation in which 396 can override the norm of limited liability?

Companies Act, 1956
Section 396
(1) Where the Central Government is satisfied that it is essential in the public interest that two or more companies should amalgamate, then, notwithstanding anything contained in Sections 394 and 395 but subject to the provisions of this Section, the Central Government may, by order notified in the Official Gazette, provide for the amalgamation of those companies into a single company…
Desai: Sec 396 indeed can be used in an extraordinary situation. Our contention is that this is not an extraordinary situation; this is a pure contractual, commercial dispute which is pending adjudication in the High Court. The matter is sub judice and there is no reason why the government should pre-judge the issue and make a complete mockery of the limited liability principle.
If every parent company is going to be made liable for its subsidiary, any investor investing in a listed company knowing fully well that there are ring-fenced subsidiaries for which they will not be liable, if prejudging the issue and short circuiting the judicial process if the government is simply going to merge National Spot Exchange Limited (NSEL) with Financial Technologies India Ltd (FTIL) and make the liability of the subsidiary the liability of the parent company-which foreign investor is going to come into this country?
Doshi: Whether I agree with what the government is doing or not, I do believe that the collapse of an Exchange - even if it is the small commodity Exchange - is an extra ordinary situation and therefore would you say that it does allow for the government to invoke 396 and put limited liability aside just for this one situation. We are not killing the concept of limited liability across the country.
Mandal: The question of 396 is about public interest. So the question is- is there a public interest involved here. There is vast body of investors for whom contracts, the settlement has been delayed. Clearly there is an Exchange failure here. What also has to be juxtaposed, along with the Exchange failure, is that there is a perceived sense of fraud here. There is a case where the risk management in the Exchange didn’t work, there was no appropriate settlement guarantee processes. The underlying commodities which were the bases of the trades were not there in the warehouses; so there is the larger basis.
There is a second point here and I think Berjis is fully right when he says that there is a parent, there is a subsidiary - the relationship needs to be respected. However one needs to see this relationship because its fact specific and you know the Supreme Court… (interrupted by Anchor)
Doshi: Before you get into the details of that I will come to why the corporate will should be lifted in this case if at all it should.
Mandal: In addition to 396- 396 is not the sole repository of this power. So if you see the entire scheme of the Companies Act 1956, there was the 408 of the Companies Act under which you could step in and replace management. There was Schedule 11 read with Section 542 where the Companies Act clearly recognizes that if the affairs of the company are conducted in a manner which is fraudulent or for a fraudulent purpose, any persons in knowledge of that and who participated in that business activity are going to be liable.. (Interrupted by Anchor)
Doshi: But neither of those Sections are the Sections that the government has applied.
Mandal: They have not yet invoked. So the limited point is the Companies Act clearly has a framework where it is rightly said that limited liability can be broken.
Doshi: Would you agree with that limited liability is the norm but this is an exceptional situation and hence 396 can be invoked?
Cooper: No, what I would say is that limited liability is the norm. Whether the facts in this case meet that exceptional circumstance is debatable. It is necessary to consider 396 in the context of 391 to 396a which provides for mergers, amalgamations etc. 396 was an enabling provision which enabled the government to bypass the procedural requirements otherwise required for amalgamations which required High Court sanctions etc, sanction of shareholders and said that where it felt in public interest it could short circuit that procedure, it could in public interest, direct this to be done; that was one. In fact this was I believe exercised in 1989 but that was in the case of two consenting companies.
Doshi: But nowhere does it say in that Section and its sub-sections that this is actually an exemption to 391 to 395.
Cooper: It doesn’t.
Doshi: It says where the Central Government is satisfied that it is essential in the public interest that two or more companies should amalgamate, then, notwithstanding anything in Sections 394 and 395, the Central Government may, by order notified etc, order the amalgamation. So it is not an exemption of any sort; it is an absolute power.
Cooper: The key is that notwithstanding anything set out in 394, 395. So it is relatable. One would say you have to construe it in the context of 394-395; that is one.
The second question which you raised is that lifting of the veil is permitted in extraordinary circumstances. Now ordinarily a lifting of the veil is permissible even where there are effectively what you call one man companies, the veil is not necessarily lifted. You have to satisfy certain other conditions. The company was conceived in fraud, it was set up with a design to defraud creditors etc.
Now I am not sure whether in this case, the establishment of NSEL was fraudulent in inception. The ground which you have set is namely the breakdown of the Exchange and the consequent public interest which would be jeopardised does not find mention in the order. So if that is the ground on which the government wishes to proceed, it ought to have at least mentioned that in the order.
Doshi: I am not sure that is correct because the order does talk about how NSEL has run out of resources to put up a suitable legal defence, the order does lay out that. Besides laying out why it thinks FTIL was involved in the mismanagement of NSEL, it also lays out how NSEL has run out of people resources, money resources to put up an adequate legal defence. The company is left with no business model whatsoever and therefore FTIL being the strong parent should be the one held responsible for meeting all these requirements. It has said so in the order.

Merger Rationale
FMC Merger Proposal to MCA
-          NSEL has paid only 6.7% of dues to creditors/investors
-          High employee attrition at NSEL
-          NSEL has no financial resources to meet legal expenses
Merger Rationale
FMC Merger Proposal to MCA
‘NSEL does not have enough resources to successfully recover the dues to investors. Nor is it left with any viable, sustainable business while FTIL has the necessary resources to facilitate speedy recovery of dues..’

Merger Rationale
MCA Draft Order
‘…to leverage combined assets, capital and reserves for efficient administration and satisfactory settlement of rights & liabilities of stakeholders and creditors of NSEL it will be essential in public interest to amalgamate NSEL with FTIL’
-          NSEL management & affairs controlled by FTIL & its KPMs
-          Non-compliances of various provisions of Companies Act, 1956
Cooper: The ground set out in the order are that NSEL has collapsed that it doesn’t have adequate resources to recover its money, or to carry on business. But the point which has been made is that the collapse of an Exchange has a public interest element- that has not been mentioned.
Doshi: I agree and actually the reason why I brought that up because a lot of the debate over the last few weeks or a few days in the media has been about whether the interest of the creditors of NSEL can supersede the interest of the shareholders of FTIL. But I don’t see that as the public interest situation. To me, if at all there is a public interest situation, it is that an Exchange has collapsed and therefore I am arguing it that way, I don’t know if that is what will fly in the face of the court.
Mandal: Let us go back to the point that Berjis has made that are we short-circuiting the legal process that has been already set in motion to address this so called fraud. According to me this is a very binary situation. So let us assume for a minute the merger goes through. So NSEL has subsumed into FTIL and at the end of the legal process the determination happens that NSEL was not liable for the contracts. And at the end of it if the legal process does determine that there is liability at NSEL, should the defence be that NSEL does not have the resources to pay for it. That would not be appropriate. So all this merge does is it breaks that wall.
Doshi: I love how easily you said breaks that wall whereas actually breaking that wall is the big issue.
Mandal: But that does not short circuit the legal process.
Desai: I think what the government is doing it is getting into the business of insuring risk. It is effectively saying that you can trade in these products and NSEL has not raised any public finance, it has not raised deposits or debentures from the public. There were not some economic illiterates, they were consciously trading in these contracts, 90 percent of them in value were high net worth individuals. And therefore it is not protecting some victims of some scam or protecting a vast body of public depositors. Why should the government get into the business of insuring risks?
Doshi: I don’t know how you can say that because the FMC order and therefore this draft order by the MCA also put out how FTILs promoter which is Jignesh Shah was on the board of NSEL that they did share common board members Joseph Massey being yet another example. So FTIL was in the know of what was going on in NSEL and that in the know included the fact that there were thinly capitalised traders, that the auditor of NSEL was a relative of Jignesh Shah, they were in the know of all this, they allowed for this to happen.

FMC Order Against Jignesh Shah…
- FTIL controls constitution of NSEL board
- All minutes of NSEL board meetings were tabled in FTIL board meetings
- FTIL board was aware of NSEL internal auditor observations, insufficient commodity stock, mis-utilisation of margin money, favour to defaulting members…
FMC Order Against Jignesh Shah…
-FTIL cannot shy away from its role & duty as a parent company
- FTIL cannot seek to take refuge behind the corporate veil so as to unjustifiably isolate itself from the fraudulent actions that took place at NSEL…
Desai: We are discussing over here the merits of the draft notification, whether the power is correctly exercised or is going to be exercised. We are not going into the merits of the case. The merits of the case are before the High Court, if we go into the merits of the case we will be sitting here for 10 days.
Cooper: Berjis is right; if the merger goes through- the objections are raised, the government nevertheless goes through and pushes the merger. Once the merger takes place, it is not a question of whether FTIL was responsible for the losses caused in NSEL because the order itself provides that all the liabilities of NSEL automatically gets transferred to FTIL.
Doshi: But if there are no liabilities, if the court says there was no scam and therefore NSEL cannot be held responsible for repaying these dues, then FTIL is not responsible either right?
Cooper: Even if there was no scam there may still be contractual liabilities of NSEL which would have to be met. There would still be tax liabilities of NSEL which would have to be met by FTIL. Now what FTIL is contending is that why should I be responsible for these liabilities whether they be contractual, whether they be statutory, why am I being made liable at this stage, how do I reverse the situation if the courts ultimately absolve it. That may be a different preposition whether they will get absolved. I am not holding any brief for FTIL, nor am I saying that they are correct. All I am saying is that it would result in an irreversible situation if this merger was permitted to go through.
Mandal: There is a point of whether the Exchange has counter party guarantee for the contracts which were traded on the Exchange. That is a very limited point which is at the heart of this issue. The contention of NSEL is that there was no counter party guarantee because the settlement guarantee fund is all that you have.
Doshi: Which by the way in itself was also close to zero.
Mandal: Which was wrongly maintained even though a fee was collected for that. So the contention of the investor and the broking community is very clearly that the rules of NSEL clearly provide for counter party guarantee, there are limited exceptions which counter party guarantee cannot be - true in any Exchange- those conditions are not satisfied. The concern that the investor body has and it is a very valid concern that at the end of the legal process if there is counter party guarantee established, who is liable? It is a thinly capitalised company with no resources. What this order does is it solidifies the legal process through which should that liability be established, there is a substantial bank account, a substantial asset profile that can backup that guarantee. That is the limited point of this order.
Menaka: This is an Exchange collapse which in itself is fairly special if I may use special situation in the country and which must be dealt with in a special way. Would you concede with that?
Desai: Absolutely not. This is a spot Exchange. This is not a commodity Exchange. It is very much incorporated as a company when the investors or so-called investors were investing or trading in this product, they were fully aware.
Menaka: Would you concede that the FTIL board and the promoter Jignesh Shah was in the know of what was going on at NSEL and the government orders states that in great degree of detail as does the FMC order which holds Mr. Shah unfit and improper to run an Exchange, which I know is also being contested. I know all of this is being contested but my point is that they seem to be convinced, the government says so very clearly, that FTIL was in the know that FTIL should have been more responsible as the parent company, FTIL did not do all of this, NSEL does not have the resources and therefore FTIL should step-up?
Desai: We should get an opportunity to explain to the government, which we will do and we will establish to what extent is so-called ‘in the know’ was there or as Shuva has pointed out that there was a fraud. Let’s establish a fraud and then by all means lift the corporate veil.
Mandal: This principle that a parent is liable for the subsidiary, it's not a concept we are discussing today. It was 30 years ago in LIC's case, it has been well established that if the statute provide for it you can break the veil. So parental liability has been established in this country. The important point is - let's take the real grievance; the real grievance is of FTIL's small shareholders because the case being that we were minority investors, we did not know, we were not party to this. Well there are few counters to that - one FTIL has disproportionate portion of its income and a value profile if you may say has come from NSEL in its hay days. So you obviously also take account to the liabilities. It is not the bottom-line alone; there is also a cash profile, there is also the technology fees that have come in so there are income streams that have come into FTIL.
Desai: Insignificant as compared to the balance sheet of FTIL.
Mandal: There is a substantial flow there. The way NSEL was set up by FTIL almost as a special purpose vehicle, let’s just take a step back. Here you have a FTIL a technology company already with MCX a regulated Exchange - anybody would say if there is an Exchange business, it should be in the same entity. Here is the promoter that says here is the regulated entity MCX and we are to now set up a special purpose spot trading unregulated business. I am going to have a warehouse settling business which was the National Bulk Handling Corporation- so if you see the way the activities have been carried out, the way systematically it was started from 2008, the way the volumes picked up -  it was all a designed.
Doshi: No but that’s your allegation and it has not been proven in court. So Berjis’ point that based on an allegation which is yet to be proven in court and drawn its own consequences, can you go ahead and decide to merge these two companies. I have a question I want to put to Mr. Cooper on this. I am not sure that the governments order does it justice or justifies why the government is invoking 396. Simply because while I can make the argument that the Exchange collapse is the matter of public interest, the government has not articulated it; that’s one.
Secondly they have quoted from an FMC order which is also being contested in court right now. Thirdly they have quoted from investor representations that say slightly naive things like FTIL shareholders benefited from an increase in market capitalisation that can be attributed to NSEL’s business over two to three years. If they have benefited from the reward, then they should also bear the risk. I don’t know if such an argument will fly or will be enough to justify the lifting of a corporate veil which is like you said an extraordinary situation.

Merger Rationale
Investor Representations
-          FTIL shareholders have enjoyed benefits like higher dividend, capital appreciation…at the time of higher profits of the company which were derived from NSEL operations
-          If FTIL shareholders enjoy benefits they also have to bear risk associated with acts of omission and commission by parent company
-          FTIL owned up some responsibility for NSEL payment crisis when it loaned Rs 179 cr to NSEL

Cooper: I quite agree with you - in fact all the three points which you have raised are exceedingly substantial points. Point number one which you rightly pointed out was that it may be a factor which would perhaps help strengthen and bolster the governments order. However that is not the ground on which the order has been passed which renders this order infirm; if infact it goes through.
The arguments put forward by Shuva to say that they shared the profits, so they must share the losses which you also pointed out was one of the arguments which the investors groups are supporting is ridiculous. There are many companies which will reap benefits in good times does it means that in bad times I have to share the pain of the company with which they have been doing business.
Doshi: Has the order met the public interest standard. You have the power when it’s in public interest but has this order the way it’s worded- does it meet the public interest standard?
Cooper: I agree with you absolutely and the other point to be borne in the mind is that the fraud which would be otherwise available for piercing the corporate veil is the fraud of Jignesh Shah. I do not think that FTIL has been accused for fraud; that is point number one. Even the charge sheet has been filed against the Jignesh Shah not against the FTIL... (Interrupted by Anchor)
Doshi: I am not sure about that because they have said that FTIL board knew of what was going on at NSEL or the NSEL minutes of Board meetings were placed at the FTIL board - they were in the know.

FMC Order Against Jignesh Shah…
- NSEL cannot be said to be independent from control of parent co FTIL
- Huge fraud perpetrated by NSEL despite 2 FTIL board members on NSEL board

Cooper: I take your point if in fact FTIL connived in the fraud and if FTIL indeed benefited thereby from the tradings of NSEL, there would be remedy of tracing which would be otherwise available to the creditors to move against FTIL and say that their moneys can be traced.
Doshi: So let the connection in the fraud be proven first.
Desai: So far no money trail has led to FTIL Group or to Jignesh Shah - the entire money trail has been traced back to the 14 defaulters whose assets have been attached, whose assets have been liquidated - go against them.

Doshi: But those defaulters were permitted to be a part of the NSEL story by the NSEL management which was drawn from the FTIL board.

Desai:  Where is the question of being permitted; it was a trading platform.
Doshi: The point is this you may have a fairly strong argument for why public interest is at the heart of this and therefore 396 should be invoked and therefore a merger should be called for. However do you think this government order does your case justice?
Mandal: I think it does because it may not be articulating in as clear words but it clearly emphasizes the fact that here was the spot market, here was the an Exchange, there were investors trading on it, here is the case where recoveries have been zilch, here is a case we need to make sure that the liabilities the counter party guarantee of the Exchange is respected and therefore the merger.
Doshi: My second point to you is this if the merger does go through, for whatever reason, despite of the objections on the other side, does FTIL have the wherewithal to discharge the Rs 5,600 crore of dues that NSEL still has or are you at the end of the day going to end up beleaguering FTIL in the process of trying to pay off NSEL’s creditors and do nobody any justice in the process.
Mandal: It may or may not; we cannot judge this question. As I said this is step one. Step two that it has to go beyond FTIL into the promoters and that’s what the Companies Act does provide today. If ultimately the liability is established, it is established that NSEL was setup for fraudulent purposes and the business was conducted in a fraudulent manner- all person in the know has to be held liable.
Desai: The normal judicial process will establish exactly what Shuva is trying to say and I entirely agree with his propositions but let happen in a court of law. Don’t short circuit the process.
Doshi: If the merger does go through despite your objections and submission etc. what recourse do you have - will you challenge it in court, how do you think that will turn out?
Desai: We are obviously going to make representations, ask for personal hearing and convince the government. Particularly we are very confident as I said of convincing this government that this is a wrong order; forget public interest, it is in private interest and a private contractual dispute is been alleviated and forget FTIL episode for a moment, see  the Pandora’s box this is going to open.

NSEL, FTIL & their shareholders & creditors have 2 months to submit comments/objections to MCA
Doshi: If Berjis’ side was to challenge this in a court of law do you think based on the way the government is articulated as of now this will hold up to being in public interest therefore deserving of lifting the corporate whale?
Cooper: Objectively, my answer would be no but ultimately when these matters go to court, a subjective element does creep in to what should be an objective decision. So I can’t comment on what the court will ultimately do. My independent view after taking to account what you are saying with no sympathy for either side is that this is not a fit and proper case for the exercise of 396.
Mandal: I am not sure whether the order is appealable. That’s what I would disagree on this one and that would be my look at it. Clearly he has a right of hearing - that’s part of the procedure and he can give reasons but once the government forms an opinion- the recent order is an administrative function -  it is not for the courts to apply its mind once the process has been followed..(Interrupted by guest)

Desai: That’s astonishing. There is remedy of writ.. (Interrupted by Anchor)

Doshi: Gentlemen, we’ve run out of time. Thank you for joining us. We’re sure some of these arguments will play out in the court and continue to make headlines.


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