SC does well to reject the forced NSEL-FTIL merger

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Published: April 30, 2019 8:18:35 PM

It went against the principle of limited liability, didn’t satisfy the criterion of ‘public interest’ & attached assets covered the liability.

Jignesh Shan and NSEL may have broken several laws, and need to be punished for that, but another company cannot be punished as collateral.

Even when the government first mooted the idea of merging the Jignesh Shah-promoted FTIL – now called 63 Moon Technologies – with its subsidiary NSEL, the move made little sense and was fraught with danger. While NSEL was a spot exchange, instead of being used for buying and selling commodities, it was being used to do illegal lending using paired contracts and, at the time things fell apart, investors found Rs 5,700 crore of their funds had got stuck, with the borrowers not repaying this and with inadequate collateral with NSEL to make good the shortfall. Since NSEL didn’t have the money to make good the amount, the government felt that the cash-rich FTIL could be tapped since, in any case, it was the parent company. There were, however, several problems with this argument. For one, in an exchange, the exchange cannot guarantee settling of transactions beyond what is collected in a dedicated fund out of the members’ contribution; eventually, since one member had transacted with another, he was responsible for the payment.

Also, modern business is organized around the principle of limited liability where an investor’s liability is restricted to the equity investment in a firm. Once this principle was given the go-by, assets of promoters or parent companies could be attached at will; most infrastructure investments, for instance, are made using SPVs to insulate the parent company. There was also the question of who was liable for the loss since the 24 brokers who got clients to invest on NSEL were likely to have known the scheme was illegal. The parallel of RBI forcing bank mergers was made in this context, that the central bank forces a merger with another bank to protect the interest of innocent depositors; if it was okay in that case, it was okay for FTIL-NSEL.

The problem with these arguments, as the Supreme Court verdict quashing the forced merger points out, is that they pre-judged guilt, apart from other mistaken assumptions. So, SC said that while such forced mergers were allowed in the Companies Act – Section 396 has only been used twice so far, to merge PSUs several decades ago – to safeguard “public interest”, it could only see “the private interest of the investors/traders who have been allegedly duped”; and it said the issue of who duped whom was yet to be established by courts. Also, if NSEL’s 13,000 investors comprised the ‘public’ who were duped, surely FTIL’s 63,000 shareholders also comprised the ‘public’? As for the other reason given by the government for the merger, to restore “public confidence” in forward contracts and exchanges which are an integral and essential part of the Indian economy, SC said this “does not obtain as there were only three commodity exchanges in the country, all of which were shut down w.e.f. September 2014 …no similar exchanges have been created subsequently …in any case, the business done at such exchanges cannot be said to be an integral and essential part of the Indian economy”.

The SC raised another issue, of the urgency. While the government spoke of an “emergency situation” when it first planned the merger in 2014, SC said this had “been largely redressed without amalgamation” since when the final order was passed – in February 2016 – it recorded that, as compared to the Rs 5,700 crore that was due from 24 defaulters who traded on NSEL, injunctions against the assets of defaulters worth Rs 4,400 crore had already been obtained, court decrees worth Rs 1,233 crore had been obtained against five defaulters and assets worth Rs 5,444 crore belonging to the defaulters had been attached. Hopefully, given what the SC judgment has said, the government will examine how a decision was taken on the merger despite it being patently unfair. Jignesh Shan and NSEL may have broken several laws, and need to be punished for that, but another company cannot be punished as collateral. Such arbitrary action only serves to further spook investors.

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