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SC ruling to aid banks in forex derivatives’ defaults

Dec 12 2012, 01:31 IST
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SummaryA Supreme Court ruling on Tuesday, to the effect that non-payment of dues against a foreign exchange derivatives contract by a company will qualify as wilful default, will arm banks with greater powers to deal with such cases.

A Supreme Court ruling on Tuesday, to the effect that non-payment of dues against a foreign exchange derivatives contract by a company will qualify as wilful default, will arm banks with greater powers to deal with such cases. In 2008, several companies posted losses on derivatives contracts and dragged banks to court claiming these had been mis-sold to them.

Companies had argued that since a derivatives contract was not a loan, they could not be categorised as ‘wilful defaulters’ even if there were outstandings against such contracts.

However, a bench headed by Justice AK Patnaik upheld a similar ruling by the Bombay High Court in August 2011, setting aside the Calcutta HC’s order of September 2009 which said a Reserve Bank of India (RBI) circular, issued in 2010, was not applicable to forex derivatives.

“Bankers are relieved that they can now take steps to recover their dues,” said Dipak Gupta, joint MD, Kotak Mahindra Bank. “The ruling clarifies that a wilful default is not just on a loan but also on a derivatives product.”

Added Ashish Parthasarathy, head of treasury at HDFC Bank, “It is a payment obligation towards a bank whether it’s loan or a derivative, which is what the court has ruled.”

Senior counsel Bhaskar Gupta said: “The order implies that the companies will be forced to pay up.”

The SC order related to three different petitions challenging the contrary findings of high courts.

Kotak Mahindra Bank had challenged the Calcutta HC’s judgment while Emcure Pharmaceuticals and Finolex Industries, the two companies classified as willful defaulters by their lender banks, appealed against the Bombay HC order.

“If the banks did not have any procedural lapse and presented scenario analyses to clients, then ethically, clients should pay up,” said KN Dey, director, Basix Forex & Financial Solutions.

Several of the cases have already been sorted out between banks and their customers. For instance, Rajshree Sugars and Chemicals, which had entered into derivatives contracts, one of them in Swiss Francs, ultimately paid Axis Bank Rs 25 crore in an out-of-court settlement. Sundaram Brake Linings also resolved the issue through an out-of court settlement. In 2009, after Finolex Industries refused to pay Deutsche Bank, the bank approached the Debt Recovery Tribunal DRT alleging it was a willful defaulter. ICICI Bank had declared Emcure Pharmaceuticals a willful defaulter for not paying up on a derivatives deal. In the Calcutta HC, Hindustan National Glass had challenged Kotak Mahindra Bank’s decision declaring it a willful defaulter.

The companies argued that the RBI covers only defaults in “borrower-lender transactions” and that derivatives transactions did not involve a borrower-lender relationship. As such, they did not fall within the purview of the RBI circular. Companies also felt that once termed as a willful defaulter, they might find it difficult to access credit from other banks.

The genesis of the spurt in derivatives contracts lay in the increasing use of the Japanese yen and the Swiss franc as ‘carry trade’ currencies given that interest rates in these countries were relatively low. However, the sharp depreciation in these currencies against the dollar resulted in mark-to-market losses on these contracts. In July 2010, the RBI issued guidelines for currency options and banned exotic derivatives. Currency options have ever since remained subdued and are still avoided by companies. “Options are becomig popular, but it is a slow process,” said P Mukherjee, head of treasury at Axis Bank.

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