Lord Swraj Paul, who passed away recently, left an indelible mark on the Indian corporate psyche.
While his Caparo group set up business in the auto-component industry post-liberalisation in the 1990s, his claim to fame has nothing to do with that.
In the early-1980s, he sent shivers through many Indian promoter groups with a daring act never witnessed earlier.
In the 1982 Union Budget, seeking to invite foreign exchange into the country, the then finance minister, Pranab Mukherjee had announced a scheme of portfolio investment allowing non-resident Indians (NRIs) and entities controlled over 60% by the NRIs, in listed companies.
Reserve Bank of India (RBI) followed it up with the regulations for the portfolio investment scheme in early-1983 that allowed an individual NRI or an eligible entity to invest up to 1% in individual Indian listed companies.
Neither the government of India (GoI) nor the businesses realised that the 1% limit could be used by multiple entities which, cumulatively, could add up to a sizeable stake. As soon as this danger dawned on the system, a 5% ceiling for the cumulative investment by NRIs in any single company was made effective from 5 May 1983.
But before the 5% limit was enforced, 13 of the Swraj Paul controlled Caparo entities mopped up through the stock exchange shares in two Indian companies that had a very low promoter holding, namely, Escorts and DCM. The investments happened between February 1983 and 5 May 1983.
Caparo’s acquisition in Escorts Ltd and DCM (Delhi Cloth Mills) triggered an unprecedented sequence of events which had no parallel in the corporate chronicles of the country. It constituted a true watershed in some key principles in the realm of corporate laws being tried and tested before the Indian judicial system.
This article is a peek into the past; a rewind to those intellectually interesting times for the professionals who functioned in or advised promoter-owned companies; and, hopefully, of some nostalgic value for those who have heard the story but cannot remember the details!
The structure of the Caparo group was that the investing entities were the subsidiaries of a holding company in which a family trust held more than 60%. Swraj Paul and his family members were the beneficiaries of the family trust.
Punjab National Bank (PNB) was the authorised dealer (AD) designated by the purchasers to route the money. The purchases were made by a registered sharebroker. It was the era of physical shares, demat being a few years away.
To keep the narration short and uncomplicated, certain details of the actual process of remittance of money and the effectuation of the purchases are kept out.
When PNB approached RBI for the necessary permission for the buyers to invest in the two entities, RBI took the stand that the structure through which the investments took place did not satisfy the ownership condition.
Even as the approval process was pending, the stockbroker submitted the shares to Escorts for effecting the transfer in the name of the buyers.
Escorts rejected the transfer, stating that in its view the investment did not comply with the law as the prior permission of RBI had not been obtained for the purchase and that the buyers did not satisfy the condition of the notification on the ownership requirement. They also brought in an additional reason, that the broker bought the shares before the inward remittance was received.
Parallelly, RBI, at the instance of the buyers, referred the issue of ownership to the finance ministry for clarification. The ministry held that the structure was compliant. Incidentally, the RBI governor at that time was Dr Manmohan Singh!
The ministry also clarified that there was no need for prior permission and it could even be sought post the purchase of the shares, provided the amount was duly remitted in foreign exchange, before the purchase.
Escorts was held nearly 52% by Life Insurance Corporation of India (LIC) and other governmental financial institutions. The decision of the Escorts’ board to reject the transfer of the shares was not taken kindly to by the said institutions as possibly they were under the instruction of the government to facilitate the investment which had been cleared by the ministry.
There was a standoff between the promoter, HP Nanda, and the institutional nominees. The promoter, meanwhile, sought to dilute the shareholding of the institutions and proposed various transactions which acted as a red rag to the institutions already upset by the stance of the company.
Thus, multiple issues surfaced like a Hydra’s head! The institutions, RBI, and the government were formidably ranged against the promoter who had about 5% holding in the company.
Having no footing to deny the registration of the shares once the decks were cleared by RBI, Escorts filed a writ petition before the Bombay High Court (HC) challenging the post facto approval given by the regulator and its conclusion that the Caparo entities were eligible to make this investment.
The writ was filed by the company with no discussion with the institutional nominee on the board or with any approval. Clearly, ticked off by this, LIC took the extreme step of calling for an extraordinary general meeting (EGM) to remove the entire board, other than only the two managing directors, HP Nanda and his son. They wished to stuff the board with their nominees.
The company amended the writ to also challenge the move to call for an EGM. Though the company had made the Caparo entities as respondents along with RBI, government of India (GoI), LIC and others, those entities did not appear to argue their case. Only RBI and GoI contested the petition to defend their interpretation of the law and to allow the investment.
Escorts succeeded in the HC which ruled that the permission under the Foreign Exchange Regulation Act (FERA) can only be a prior permission and not a ratification. The HC also viewed the move of LIC to call for an EGM as colourable and mala fide.
Having lost their case in the HC, LIC, RBI and the GoI, took the matter to the Supreme Court. The Caparo entities did not enter the scene even at that juncture!
For a matter not involving any questions on the Constitution or being an issue where conflicting Supreme Court decisions existed, the formation of a five-judge bench to deal with it was, perhaps, unique.
The unanimous decision of the five judges was written by justice O Chinappa Reddy, a judge with a distinctive style of writing the orders, employing a sharp and expressive language, wishing to leave a mark wherever possible.
The Court held that there was no scope to interpret the FERA provisions with regard to this facility for investment by the NRIs in a restrictive way and the language of the section requiring RBI’s permission nowhere indicated that it had to be prior to making the investment.
The responsibility to make the application for permission to invest rested with the bank, in this case, PNB. PNB’s conduct in handling this investment was roundly criticised as sloppy and RBI was directed to investigate their role.
Reverting to the main issue, the Court conclusively rejected all the arguments relying on the wording in the forms, which were involved in seeking the approval as being completely irrelevant to construe the express provisions of the law having regard to the object of allowing this facility to the NRIs.
The paragraph below provides some insight into the thinking of the Court in interpreting an economic legislation:
The Foreign Exchange Regulation Act is, therefore, clearly a statute enacted in the national economic interest. When construing statutes enacted in the national interest, we have necessarily to take the broad factual situations contemplated by the Act and interpret its provisions so as to advance and not to thwart the particular national interest whose advancement is proposed by the legislation. Traditional norms of statutory interpretation must yield to broader notions of the national interest. If the legislation is viewed and construed from that perspective, as indeed it is imperative that we do, we find no difficulty in interpreting “permission” to mean “permission”, previous or subsequent, and we find no justification whatsoever for limiting the expression “permission” to “previous” only. In our view, what is necessary is that the permission of the Reserve Bank of India should be obtained at some stage for the purchase of shares by non-resident companies.
With the major hurdle out of the way, the issue of whether multiple entities could each buy 1% was also held permissible, as Mr Paul’s family members could have individually bought the shares but, instead, chose the vehicle of the companies.
The legacy of this judgement remains relevant and resonates even as of date with regard to the action of the LIC in seeking a vote to replace the directors with its nominees.
It was argued that LIC, as an instrumentality of the State, needed to act with fairness and could not arbitrarily use its voting might to change the board. The Court found as a fact that Escorts filed the writ petition against the government and RBI without the approval of the board and behind the back of the institutions.
The entire plank of LIC being an instrumentality of the State in its character was rejected as irrelevant when it accessed its rights as a shareholder, as any other investor would do. This indefeasible right of the shareholders to exercise their votes to achieve their ends was invoked in subsequent cases and the more recent high-profile one is that of Tata Sons vs Cyrus Mistry.
The attribution of mala fide to RBI and the LIC, as acting under the dictates of the political masters to favour Mr Paul, was dismissed as being mere allegations with no substance.
The Court came down heavily on PNB for its sloppy administration of its foreign exchange department and on the Caparo group for shooting over the shoulders of the government, RBI and LIC and making them fight its battle. Both PNB and Caparo were ordered to pay costs along with Escorts!
Mr Paul’s foray to acquire companies in India was a case of the operation successful, but the patient, dead! The atmosphere of litigation and protracted bureaucratic tangles left him disillusioned and he did not join the board of Escorts but sold his shares and the Nandas managed to retain their control!
A different sort of takeover threat was triggered by another NRI, using the same portfolio investment scheme.
Manu Chabbria, a Dubai-based NRI, was accumulating shares in L&T around the 1988-89 period. L&T, with no ostensible promoter, largely held by LIC and Unit Trust of India (UTI) panicked and looked around for a white knight to thwart Mr Chabbria’s threat.
Dhirubhai Ambani’s Reliance Industries Ltd (RIL) entered the scene and quickly accumulated over 10% in the company. Mr Chabbria backed off but the camel had entered the Arab’s tent in this process.
The L&T board was restructured with the induction of the father and the two sons. There came a stage when the cash reserves of L&T became sufficiently attractive for Reliance to cast its lustful eyes!
The situation was the reverse—a possible takeover of an Indian entity by another Indian entity which was not to the liking of the professional management of L&T.
In an unusual step, the government of the day (1989), through the financial institutions, forced the three out of the board and finally Reliance sold its entire stake to Grasim which later took over L&T’s cement business.
Mr Paul’s impact is felt to this day, where the Indian promoters are fearful of takeovers and seek to maintain a very high level of shareholding which they have achieved in many convoluted ways!
(Ranganathan V is a CA and CS. He has over 44 years of experience in the corporate sector and in consultancy. For 17 years, he worked as Director and Partner in Ernst & Young LLP and three years as a senior advisor post-retirement, handling the task of building the Chennai and Hyderabad practice of E&Y in tax and regulatory space. Currently, he serves as an independent director on the board of four companies.)
