Tata-Mistry spat: Supreme Court verdict is a boost for 'promoters'

The Supreme Court handed down its judgement on the Tata-Mistry spat last month. The Tatas are clear winners. 

The judgement makes clear that, on every point of law, the Tatas are in the right and Cyrus Mistry in the wrong. My analysis of the verdict appeared in BS today. It is reproduced in full below.

One of the striking features of the judgement is the excoriation of Mistry's conduct consequent to his removal. I given below a few extracts from the judgement so that you get a flavour of how clearly the SC comes down on the side of the Tatas.

Many of the observations in the judgement pertain to Tata Sons as a private company and a holding company that does not have any business activity of its own. But my apprehension, as I indicate in my analysis in BS, is that this judgement will be construed as favouring promoters in general. The temptation to use holding companies with their nominee directors to control group companies while being exempt from the strictest standards of governance is bound to strong.

 Excerpts from the judgement:

 i. On Mistry's allegations of questionable business decisions and transactions of the past:

An appeal from the Order of the NCLAT to this Court under Section423 is only on a question of law. Considering the nature of the jurisdiction conferred upon NCLAT, it is clear that the findings of the NCLT, not specifically modified or set aside by NCLAT should be taken to have reached finality, unless the parties aggrieved by such non-interference by NCLAT have approached this Court, raising this as an issue. Though SP group has also filed an appeal in C.A. No.1802 of 2020, the grievance aired therein, as seen from para 3 of the memorandum of appeal, is limited to the failure of NCLAT to grant certain reliefs. The failure of NCLAT to specifically overturn the findings of fact recorded by NCLT, is not assailed in the SP group’s appeal. Therefore, we have no hesitation in holding that the allegations relating to

(i) transactions with Siva and Sterling Group of Companies;

(ii) Air Asia;

(iii) Transactions with Mehli Mistry;

(iv) the losses suffered by Tata Motors in Nano car project;

and

(v) the acquisition of Corus

reached finality.

ii. On Mistry's conduct consequent to his removal 

The subsequent conduct on the part of CPM in leaking his mail dated 25102016 to the Press and sending replies to the Income Tax Authorities enclosing 4 box files, even while continuing as a Director, justified his removal even from the Directorship of Tata Sons and other group companies. A person who tries to set his own house on fire for not getting what he perceives as legitimately due to him, does not deserve to continue as part of any decisionmaking body (not just the Board of a company). 

iii. On Mistry's allegations of oppressive conduct on the part of Tatas

 The subsequent conduct on the part of CPM (Cyrus P Mistry) in leaking his mail dated 25102016 to the Press and sending replies to the Income Tax Authorities enclosing 4 box files, even while continuing as a Director, justified his removal even from the Directorship of Tata Sons and other group companies. A person who tries to set his own house on fire for not getting what he perceives as legitimately due to him, does not deserve to continue as part of any decision making body (not just the Board of a company). It is perhaps this realisation that made the complainant companies give up their original prayer for restraining the company from removing CPM and singing a different tune seeking proportionate representation on the Board.

iii. On governance at Tata Sons

The requirement under Section 149(4) to have at least

One-third of the total number of Directors as independent Directors applies only to every listed public company. Insofar as Tata Sons is concerned, the Articles of Association of the Company continue to contain the prescribed restrictions which make it a private company within the definition of the expression under Section 2(68). Therefore, the provisions discussed above do not apply to Tata Sons.

Yet Tata Sons has a Board packed with many people who are ranked outsiders. If the idea was to run Tata Sons purely as a family business, RNT need not have stepped down from the Chairmanship. Today nobody wants to step down from any office, except if afflicted by brain stroke or sun stroke.

iii. On the relationship between Tata Trusts and Tata Sons

Affirmative voting rights for the nominees of institutions  which hold majority of shares in companies have always been accepted as a global norm. As a matter of fact the affirmative voting rights conferred by Article 121 of the Articles of Association, confers only a limited right upon the Directors appointed by the Trusts under Article 104B. Article 121 speaks only about the manner in which matters before any meeting of the Board shall be decided.If it is a General Meeting of Tata Sons, the representatives of the two Trusts will actually have a greater say as the Trusts have 66% of
shares in Tata Sons.

.....Therefore, if we apply Section 152(2) strictly, the Trusts which own 66% of the paid up capital of Tata Sons will be entitled to pack the Board with their own men as Directors. But  under Article 104B, only a minimum guarantee is provided to the two Trusts, by ensuring that the Trusts will have at least 1/3rd of the Directors, as nominated by them so long as they hold 40% in the aggregate of the paid up share capital.

 

I will stop there and urge you to read the judgement in full.

My analysis in BS:

FINGER ON THE PULSE

T T RAM MOHAN

A comprehensive win for Tatas

They stand vindicated in the Mistry saga, but what is legally sound may not conform to the best standards of governance

In October 2016, Cyrus Mistry was removed as executive chairman of Tata Sons, the holding company of the Tata group. A huge controversy erupted thereafter.

Mr Mistry claimed that he was removed because he was trying to set right many things that were wrong with the Tata group, including questionable business decisions and transactions of the past. He said his removal as executive chairman without any notice and without any explanation was illegal.  

Mr Mistry moved the National Company Law Tribunal (NCLT) in the matter. In July 2018, the NCLT dismissed Mr Mistry’s petition. He then moved the NCLT Appellate Tribunal (NCLAT) against the NCLT order. In December 2019, the NCLAT granted Mr Mistry’s appeal and ordered that he be restored as executive chairman of Tata Sons.

Last month, the Supreme Court (SC) ruled in the matter. It set aside the orders of the NCLAT and  rejected all the substantive contentions of Mr Mistry/the Shapoorji Palonji  (SP) group. The Tata group could not have asked for a more comprehensive win. However, the implications of the verdict for important questions of corporate governance are somewhat unclear.

The SC’s verdict may baffle many who have watched the long drawn-out battle between Ratan Tata and Mr Mistry. Common sense suggested that some of Mr Mistry’s complaints, especially the one about his summary removal as executive chairman, had substance. Alas, common sense is no guide to the law. The SC’s 282-page, rigorously argued order is worth reading. It makes clear that the law is emphatically in favour of the Tatas. Students of company law will especially find the references to the evolution of company law and judicial precedents compelling.

In its petition to the NCLT, the SP group had made serious allegations about various transactions and business decisions of the Tata group, such as those related to the Sterling group of companies, the acquisition of Corus in the UK and the Nano car project.  The NCLT rejected these allegations. The NCLAT did not overturn the findings of the NCLT on these points. Nor did the SP group, in its appeal to the SC, question the failure of NCLAT to do so. The SC takes the position, therefore, that the NCLT findings in respect of the allegations made by the SP group are final.  

One of the key issues in the tussle between Mr Mistry and Mr Tata was the suddenness of Mr Mistry’s ouster as executive chairman in October 2016. There had been no indication of any dissatisfaction with Mr Mistry’s leadership until then. The Tata group had performed well under his stewardship. The Nominations and Remuneration Committee of the board of Tata Sons had endorsed his performance and recommended a pay hike. Mr Mistry contended that the manner of his removal was oppressive and unfairly prejudicial to minority shareholders.

The SC’s response to this point is interesting. It suggests that if there had been oppressive conduct on the part of the Tatas, the group could not have done well under Mr Mistry’s stewardship. Nor could the board members and Mr Mistry have formed themselves into a “mutual admiration society” until his ouster.

The lay person may well ask: How did the “mutual admiration society” dissolve all of a sudden in October 2016? What exactly were the grounds for Mr Mistry’s abrupt removal? The Tatas told the SC they had lost trust and confidence in Mr Mistry. At what point did this happen and why? We do not have an answer.  

The SP group contended that no advance notice was given to Mr Mistry regarding his removal nor did the item figure on the agenda of the meeting in which he was removed. The SC takes the view that, according to the Articles of Association of Tata Sons, advance notice is required only where a director wants to raise a particular matter at a board meeting. There is no such requirement for the board taking up an agenda. A sense of unease remains. The abrupt removal  may have been in conformity with the law. But can we say that it conforms to the best standards of governance?  

The relationship between Tata Trusts and Tata Sons has been very much in the limelight. Two Trusts of the Tatas have the right to nominate one third of the directors on the board of Tata Sons. At Tata Sons, matters that required the approval of the majority of board members required the affirmative votes of the directors nominated by the Tata Trusts. In effect, the two Tata Trusts exercise veto powers on the board of Tata Sons. The SP group argued that such a situation was against the norms of good governance. But the norms of good governance under the Companies Act 2013, the SC points out, apply to public and listed companies. A private company such as Tata Sons is not subject to these norms.    

The SP group had argued that the nominees of Tata Trusts on the board of Tata Sons were conflicted between their obligations to the Trusts and those towards Tata Sons. The SC thinks that the conflicting obligations of Tata Trusts’ nominee directors are inevitable and not inconsistent with the statutes.

The SC notes that Tata Trusts are charitable trusts. Tata Sons is a holding company and is not engaged in any business activity. The nominee directors of Tata Trusts on the board of Tata Sons are thus not on the same footing as a company’s directors appointed at a general meeting of the company. The SC goes so far as to suggest that it may not be practical to expect all directors on a board to exercise independent judgement. If they did so, there would be no need for a category called “independent directors”! 

These observations raise interesting questions. Can promoters operate through trusts, holding companies and nominee directors and render themselves exempt from conflicts of interest? Can directors other than independent directors in non-holding companies allow their obligations to promoters to override those towards other shareholders? Can the government’s nominee directors on public sector companies claim a similar exemption?

Mr Mistry had asked for proportional representation on the board for his group. The SC makes it clear that there is no such provision under law for a company, whether public or private. At the most,  small shareholders in a listed company can be enabled to elect one director.

 The Tatas stand vindicated in the matter.  They will find most gratifying the SC’s point that Tata Sons has been well ahead of the legal curve in respect of the functioning of its board. But what is legally sound does not always conform to the best standards of governance. Many will wish the Tata group to stay ahead of the governance curve as well. One way to do so may be to unilaterally subject Tata Sons to even higher standards of governance by making Tata Sons a public, listed company.

 

 

 

Medium term economic impact of the Covid crisis

The world economy will bounce back from the Covid shock of 2021. The IMF estimates global growth at 6 per cent in 2021 consequent to the decline of 3.3 per cent in 2020. But the effects of the shock will linger over the medium term. Global output in 2024 will be 3 per cent below what it had been projected before the pandemic struck.

The good news is that the impact of the Covid shock is far less than that of the global financial crisis (GFC). The IMF estimates (in World Economic Outlook, April 2021), global output was down by 10 per cent over a similar period, consequent to the GFC. I may be allowed to pat myself on the back a little bit: I had said in a post a few months ago that the pandemic shock- touted as the 'worst in a century' (or even centuries)- was likely to prove far less lethal than the GFC. The reasons the IMF gives are the ones I had given: the financial sector had not collapsed and the policy response had been stronger than in the GFC.

Chapter 2 of WEO is worth reading. It gives a good account of how exactly the pandemic has impacted economies and how the impact of recessions in general tend to linger and impact mediium-term output.

As is well recognised by now, the pandemic impact economies on both the supply and demand sides:

• On the supply side, lockdowns reduced effective productive capacity. Some businesses also experienced lower productivity because they had to reorganize production to increase the physical distance between workers. These initial sectoral supply shocks spilled over to affect supply in other sectors through links in production networks.  
• Demand fell due to reduced mobility and as precautionary savings rose amid heightened uncertainty. The initial supply shocks also propagated to a decline in demand. This propagation was amplified in many cases by liquidity-constrained households and firms forced to cut back on outlays, leading to more layoffs and further declines in private spending.

 How do recessions, in general, result in permanent damage to economies. The WEO explains:

• First, unemployment may remain high even after the recession (Blanchard and Summers 1986) and couldresult in a smaller labor force as discouraged workers exit. Human capital accumulation and future earnings can be affected by skill deterioration during extended periods of unemployment, delayed labor market entry for young workers, and negative effects on educational achievement in the longer term.

• Weak investment could result in slower physical capital accumulation and affect productivity through slower technology adoption. 
• Productivity could also be permanently affected by the loss of firm-specific know-how as a result of bankruptcies and their spillovers (Bernstein and others 2019), the effects of a decline in research and development and innovation during the recession,and an increase in resource misallocation (see, for example, Furceri and others 2021).

 Two other points are worth noting. There are ordinary recessions, pandemic recessions and financial crises- induced recessions. These follow an ascending order of severity of impact on the economy. Secondly, in the Covid crisis, advanced economies are likely to be less impacted than developing economies. One reason is that advanced economies have been able to provide stronger policy support (perhaps because rating agencies are willing to tolerate higher debt in advanced economies) and they have had better access to vaccines and therapies. 

 

Indian fiscal policy: should we switch to primary deficit as the sole target?

India has missed its fiscal policy targets mandated under the FRBM Act more often than one cares to recall. Arvind Subramanian and Josh Felman argue  in an article in the Indian Express that India needs a new fiscal framework that focuses simply on one indicator: the primary deficit. 

The authors say that India's primary deficit (PD) has been more than offset by negative interest rate -growth rate differentials (IRGD). However, we can't bank on this:

If the interest-growth differential consequently turns unfavourable, as occurred during the previous period of high debt in the early 2000s ..., then debt sustainability could only be preserved by shifting the primary balance into surplus. 

Such a shift would be hugely disruptive and hence not easily accomplished. So what is the way to protect ourselves against the IRGD turning unfavourable? We need to rein the primary deficit. They propose (based on a paper that has Olivier Blanchard as co-author) that the Centre commit to reducing the  PD by half a per cent of GDP on the average each year (the average would be calculated over buoyant years for the economy and lean years). 

There is a corollary suggestion that is worth noting:

...any future framework should not be fixated on specific numbers. Around the world, countries are realising that deficit targets of 3 per cent of GDP and debt targets of 60 per cent of GDP lack proper economic grounding. In India’s case, they take no account of the country’s own fiscal arithmetic or its strong political will to repay its debt.

This is, of course, an acknowledgement that the targets advocated by successive Finance Commissions and mandated under the FRBM Act were misguided, to put it mildly.

What do we make the proposal on primary deficit? 

Take a look at Chapter 2 in the Economic Survey for 2020-21. The Survey examines the sustainability of India's debt after factoring in the PD. The PD for 2020-21 is estimated at 6.8 per cent. It is pegged at 2.2 per cent thereafter. It is assumed to reach 1.5 per cent in FY 24 and stay at that level thereafter. In other words, there is a steep reduction of 4.6 percentage points in PD in FY 22 followed by an average reduction of 0.35 percentage points in the next two years. 

Under this assumption (and suitable assumptions about inflation and interest rates), India's debt remains sustainable even  if real growth averages a mere 4 per cent in the next 10 years! In other words, we need, at the most, to bring PD down to 1.5 per cent and no more. At growth rates of over 4 per cent, PD can be higher than 1.5 per cent. It makes no sense to keep driving it down to zero, as Subramanian- Felman seem to imply.

India's IRGD, as the Survey points out, has been the lowest among the major OECD economies. It averaged -3.9 per cent in the period 1990-2018. At this average, India can tolerate a higher PD than 1.5 per cent. However, a target of 1.5 per cent would provide safeguards against any adverse turn of events.

In short, if we go by the simulations of the Economic Survey, the Subramanian- Felman  prescription of an annual reduction of 0.5 per cent in PD looks onerous and uncalled for. To make the case for such a reduction compelling, they need to challenge the projections of the Economic Survey.

Archegos debacle: do banks know what risk management is?

There we go again. Archegos, a hedge fund, has blown up and it's causing huge holes in the balance sheets of banks that were exposed to it. Credit Suisse is due to disclose losses, running perhaps into billions of dollars, due to its exposure to Archegos (and a finance company, Greesnsill). The head of risk at Credit Suisse is among the executives who will depart, reports FT.

LTCM all over again? Well, it's not quite as catastrophic in its impact as LTCM but it does reflect poorly on risk management at banks.

As in the case of LTCM, banks were exposed to Archegos through loans and derivatives, with the difference that the loan and derivatives exposures were intertwined in this caes. Banks made large loans to Archegos. Archegos invested these in stocks and entered into a total return swap with banks. Under the arrangement, banks would be paid a fee plus interest on their loans. The capital gain on stocks would belong to Archegos. As long as the stocks appreciated, no problem. But if they didn't, there could be a problem.

As it turned out, the stocks owned by Archegos did lose value. Banks thought they were protected by cash collateral. They also thought they were protected because the stocks were highly liquid. But we do know from LTCM that when any one entity has a large exposure to a security, liquidity can vanish quickly. As the stocks lost value, banks demanded more collateral. Archegos tried to sell its stocks to raise cash but the positions were so large that the very act of selling caused prices to fall steeply. This meant more margin calls, more sales... and then bust. Exactly as in LTCM.

In LTCM, the problem was that banks did not know the cumulative bank exposure to LTCM. The reform that followed was that banks' exposure to Highly Leveraged Institutions came to be monitored closely. Why didn't that work here? It appears that Archegos was run as a family office and did not have the same disclosure requirements. But if that was the case and banks had no means of monitoring total leverage at Archegos or total counterparty exposure to Archegos, they should not have got heavily exposed to it in the first place. There can be no excuses for the lapse after the lessons said to have been learnt from LTCM.

Archegos represents a colossal failure of risk management. If 14 years after the worst banking crisis in a century, this is the state of risk management at the world's leading investment banks, one has to despair. The fundamental problem at private banks hasn't gone away: incentives are asymmetric. If gambles taken by bankers work out, they gain enormously. If the gambles fail, it's the shareholder- and, often, the tax payer- who is left holding the can. 

Why didn't I see this item in the Indian media?

 India moved one step closer to the completion of the world's highest bridge. It's being built over the Chenab:

The Chenab Bridge is part of India’s Udhampur-Srinagar-Baramulla rail link project (USBRL). The 1,315-meter-long bridge is being built at a height of 359 meters. Once completed, it will be the highest rail bridge in the world, and 35 meters higher than the Eiffel Tower.

I came across this item in Russia Today of all places, complete with a gripping video of the work that's going on and a tweet from Railways minister Piyush Goyal. I wondered why I had to see item in Russia Today and not in an Indian paper. A google search shows it's there at Indian news sites on the Net. But I'm afraid I didn't see in any of the print versions I get at home. If it was carried, it wasn't carried prominently enough.

Makes me wonder why it is that there is so  much negativity and gloom in the media and so little of celebration? The Chenab Rail Bridge deserved front page treatment in my view, along with photos. Is it all about man bites dog alone constituting news?