FTIL-NSEL merger: Bad in law and policy?

Reports are abuzz with the ministry of corporate affairs (MCA) actively considering merger of the National Spot Exchange Ltd (NSEL) with its listed parent Financial Technologies India Ltd (FTIL).

Reports are abuzz with the ministry of corporate affairs (MCA) actively considering merger of the National Spot Exchange Ltd (NSEL) with its listed parent Financial Technologies India Ltd (FTIL).

To look back a little, MCA had issued the draft order of merger on October 21, 2014, based on the recommendations made by the Forward Markets Commission (FMC). The constitutional validity of Section 396 of the Companies Act, 1956, was challenged and, in turn, the legality of the draft order was challenged by FTIL before the Bombay High Court. Status quo was directed to be maintained on November 27, 2014, which was vacated on February 4, 2015, when the Solicitor General of India assured the court that it was merely a “draft” order—that MCA had taken a prima facie view—hence all parties concerned can raise their objections to the draft order before MCA, which will be considered in all fairness. Then, MCA will take the final decision whether to go ahead with the merger or not?

The order of February 4 has given MCA a “golden opportunity” to go back to the drawing board and reconsider a step taken in haste, which may have far-reaching implications for the business and investor sentiment in India. The forced merger will destroy the concept of “limited liability” and may lead to global and local investors losing confidence, given that FTIL has FDI and FII investments. It will set a precedent, opening floodgates of PILs seeking merger of companies facing financial problems with their solvent parent or holding or group companies.

The forced merger will have an adverse impact on FTIL’s market capitalisation. It may even erode its net-worth by fastening unproven and sub judice liabilities of more than R5,000 crore of NSEL onto FTIL, thereby harming not just its thousands of shareholders but hundreds of employees, creditors, vendors and other stakeholders of FTIL too, which is against the spirit and purpose of Section 396. It can hardly be said that Section 396 was meant to fasten third-party unproven liabilities on a healthy company with a view to adversely affect the stakeholders of such healthy company, its creditors and employees. This is clear from Section 396(3), which mandates that if the rights and interests of shareholders of both the companies are adversely affected, then they are to be compensated by the resulting company. Hence, any use of Section 396 which is against the interest of its shareholders, creditors, employees, and which (if proved) not to be in the essential public interest may annihilate the shareholders and creditors of a company, thereby affecting the government’s focus on ease of doing business.

On the merits of the matter, first, MCA’s proposal to merge NSEL with FTIL is based solely on FMC’s recommendation. It is, however, unclear whether FMC’s recommendation is based on its own in-depth independent enquiry and whether—as required under Section 396 (1)—FMC has been able to establish that it is “essential in public interest” to merge NSEL and FTIL or its recommendation is merely based on the (1) financial health of FTIL, (2) FTIL’s shareholding in NSEL, (3) representations made by traders and brokers who may be interested parties, and (4) lack of human and financial resources with NSEL for recovery from defaulters.

Second, the “corporate veil” between NSEL and FTIL cannot be lifted until “parental fraud” by FTIL is proven in a court of law. The issue is currently sub judice before the courts in civil suits filed by trading clients who allegedly lost monies. Relying on the observations of the Bombay High Court in its order dated August 22, 2014, no money trail seems to have been found against NSEL, FTIL or their promoters. In these circumstances, MCA may be clearly prejudging the issue if it goes ahead with the merger while proceedings are pending in the Bombay High Court (of course unless it’s been otherwise directed by courts). The forced merger will make FTIL liable irreversibly even if it is held as innocent by the courts later on.

Third, MCA’s own circular dated April 20, 2011, for compulsory merger of government companies under Section 396 requires that the companies concerned and an overwhelming majority of their shareholders and creditors must be consenting to the merger. In this case, FTIL, NSEL and thousands of shareholders of FTIL (constituting 80% of its capital) have opposed the merger. In view thereof, to go ahead with the merger will clearly be discriminatory vis-a-vis government companies.

Fourth, if the merger is being forced on FTIL to ensure recovery for trading clients, then MCA needs to first consider that R542 crore has already been paid off. Additionally, NSEL has made substantial recovery efforts by filing over 150 cases against defaulters, obtaining R1,233 crore of decrees, and R3,428.86 crore of injunctions. The Economic Offences Wing has attached assets worth R5,000 crore of the defaulters under the Maharashtra Protection of Interest of Depositors Act. The Enforcement Directorate has attached assets worth more than R1,200 crore.

Therefore, the claims of the trading clients are more than adequately secured, thereby obviating the need for merger. The genuineness and entitlement of the alleged 13,000 trading clients is under investigation by the High Court Committee in view of complaints from certain trading clients against their brokers alleging client code modification, forgery and benami transactions. Pending all this, a forced merger is clearly premature.

Fifth, the statutory powers granted to MCA under Section 396 are to be exercised only in “essential public interest”. In the instant case, it is argued that majority of the claims belong to certain HNIs and corporates who traded with eyes open to risks and rewards. Claims of small claimants have been fully or partially redressed. Predominantly what may remain is essentially a “private dispute” involving HNIs and corporates, which our courts are more than capable of adjudicating. Given such circumstances, it may be difficult to see any real “public interest” in forcefully merging NSEL with FTIL. To the contrary, not allowing FTIL to defend itself in the court may be viewed as antithetic to “public interest” in the long run.

All one can hope is that MCA will take an informed and objective view of the matter and will consider all aspects in totality whilst considering the idea of forcefully merging NSEL with FTIL and uphold the “rule of law”.

The author is senior partner, Crawford Bayley & Co, Mumbai. Views are personal

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