India: The Government takeover of IL&FS is unlike Satyam's: Here is why

Last Updated: 9 October 2018
Article by Piyush Joshi
  • The takeover has resulted in decision paralysis, IL&FS continues to be tied in debt, suffer from cash flow issues, defaulting on loan obligations, with the potential sale of assets stalled.
  • This makes it only the second time in history of corporate law in India, that the Government of India has taken over a non-government company using provisions of the Companies Act.
  • The Government of India should use this opportunity to create a specific framework under the IBC/RBI Act for infrastructure sector and provide an enabling framework for restructuring of debt of infrastructure projects developed on PPP basis.

In the action-comedy classic "Indiana Jones and Last Crusade" Indiana Jones (Harrison Ford) and his father Dr Jones (Sean Connery) end up held captive and tied to a chair. Indy, in trying to burn the ropes using his father's lighter, ends up setting fire to the entire room, kicking a secret lever that makes the chair move in circles resulting in a very non-plussed Sean Connery giving a highly memorable one liner "Our Situation Has Not Improved".

The immediate and surprising take-over of the management of IL&FS by the government of India, purportedly in the "public interest", appears to be resulting in a similar situation. The takeover has resulted in decision paralysis, IL&FS continues to be tied in debt, suffer from cash flow issues, defaulting on loan obligations, with the potential sale of assets stalled due to the SFIO inquiry causing potential buyers to defer decisions in hope of lower valuation of IL&FS's infrastructure projects; while the new board is still trying figure where they have landed.

The NCLT Order

The Mumbai Bench of the National Company Law Tribunal (NCLT), vide its order dated October 1, 2018, exercised powers under s. 242 of the Companies Act, 2013, acting upon a petition made by the government of India, directed the removal of the majority of the existing Directors of the IL&FS Board), and replaced them with nominees of the government of India. IL&FS is a designated Systemically Important Non-Deposit Accepting Core Investment Company (CIC-ND-SI), which is a category of "Core Investment Companies" registered with the Reserve Bank of India. in reconstituting the Board of Directors of IL&FS by. The NCLT ruled that this decision was being taken in the "public interest".

This makes it only the second time in history of corporate law in India (i.e., since the enactment of the first Companies Act, 1913), that the government of India has taken over a non-government company using provisions of the Companies Act (all other actions have been through nationalisation, the era for which ended with liberalization in the 1990s). The first instance of action under the Companies Act was that of Satyam Computer Services Limited, whose entire board was changed by the then Company Law Board, within a few days of the promoter confessing to having committed fraud on the company to the tune of Rs 7,000 crore.

Any generic comparison of IL&FS with Satyam, however, overlooks critical legal differences, which cannot not be ignored. It also overlooked more efficacious options available under the applicable legal regime.

The Satyam case: No Parallel

The legal basis for change in management under the Satyam case was s. 388B of the Companies Act, 1956 (the earlier law), which permitted such intervention on the specific ground of the person concerned with the conduct and management of the affairs of the company is, or has been found guilty of fraud. In the Satyam case, since the promoter had confessed to perpetuating fraud on the company, Section 388B was directly attracted. Interestingly, the Companies Act, 1956 (under s.401, read with s.397), also had a separate provision that granted overarching powers to the government to intervene on grounds of "public interest", but that has never been resorted to.

This makes the case of IL&FS the very first instance since the inception of corporate law in India, wherein the government has sought to takeover a non-government company on the ground of "public interest".

The Companies Act, 2013 and the Case of IL&FS

Under the Companies Act, 2013, s. 241 grants sweeping powers to the government on account of 'public interest'. S. 241(2) stipulates that if the government "is of the opinion that the affairs of the Company are being conducted in a manner prejudicial to public interest, it may itself apply to the Tribunal for an Order under this Chapter", i.e., Chapter XVI which is titled "Prevention of Oppression and Mismanagement". The relevant orders that can be sought under section 241, are those provided in section 242.

The test for granting an order under s. 242 comprises of two elements: (i) a finding that the company's affairs have been or are being conducted in a manner prejudicial or oppressive to any member or members or prejudicial to public interest or in a manner prejudicial to the interests of the company; and (ii) that to wind up the company would unfairly prejudice such members or members but that otherwise the facts "would justify the making of a winding up order on the ground that it was just and equitable that the company be wound up".  Under s. 242 (4), the NCLT can, on an application by a party to the proceedings, make such "interim order" as it thinks fit "for regulating the conduct of the affairs of the company upon such terms and conditions as appear to it to be just and equitable".

NCLT's Order on Takeover of IL&FS

The NCLT's Order dated 1.10.2018, prima facie, does not appear to meet any of the criteria provided for under s. 242(4) or s. 242. The order simply assumes that there is a matter of public interest, but does not provide the reasons for the same. There is also no finding in relation to the second mandatory element of the test under s. 242, which is whether there is a justification for winding up of IL&FS, but such winding up would unfairly prejudice shareholders that have been subjected to prejudicial or oppressive conduct by the manager.

The government filed its petition on 01.10.2018 and NCLT issued the order replacing the Board of Directors of IL&FS on the very same day as an interim measure. It is arguable whether an order to change the entire Board of Directors can be given as an "interim measure", when it is actually one of the final reliefs that can be granted under s. 242(2)(h) of the Companies Act, 2013.

The NCLT order appears to be solely based on a short "Office Memorandum" issued by the Department of Economic Affairs, Ministry of Finance, to the Ministry of Corporate Affairs that makes a reference to the high leverage and "apparent mis-governance and mismanagement", and makes a recommendation to approach the NCLT under s. 242 to substitute the present Board with a new Board. There is no analysis of the business that IL&FS was in and the prima facie reason for the cash flow issue being disputes with various government authorities resulting in stalled payments for various projects being implemented.

The NCLT Order also makes a peripheral reference to an enquiry under s. 206 by the Registrar of Companies (ROC), that seems to have "prima facie concluded that mismanagement and compromise in corporate governance norms and risk management has been perpetuated on IL&FS and its group companies by indiscriminately, raising long term and short term loans/borrowings through public sector banks and financial institutions". This, however does not seem to be a report within the scope of s. 206.

There is also a lack of any adequate reasoning in the NCLT Order for allowing the exercise of such an extreme measure, particularly when the government itself, through various entities, namely Life Insurance Corporation of India, Central Bank of India, State Bank of India and the UTI, form a 40% block of shareholders of IL&FS. The government could have removed the management at any time through exercising its shareholder powers. Interestingly, at the IL&FS AGM, held just a few days before the NCLT Order, the shareholders had not exercised nor even sought to exercise any such right.

S.242: An overarching tool for exercise of Government's powers?

What makes the matter curious is that NCLT also failed to take note of the fact that on 28th August 2018, the Board of Directors of IL&FS had issued a statement that inter alia stated : "The Board took cognizance of the fact that this situation of over-leverage and illiquidity had arisen as a significant percentage of the Group's liquidity, aggregating to over Rs 16,000 crore, was stuck in claims and termination payments." It is a matter of fact that several of these claims are against government of India or authorities controlled by government of India or authorities of certain state governments.

Thus, effectively the NCLT has permitted a counter-party against which IL&FS has claims aggregating Rs. 16000 crore, to replace the management of IL&FS.

The concern that NCLT Order of 1.10.2018 raises is the ease and limited scrutiny with which the powers under s. 242 Companies Act, 2013 have been allowed to be exercised, when clearly alternate remedies were available. That a power which has existed for over a century, can be exercised with such casualness in a liberalized India, is cause for concern.

The action also opens up the government of India to potential investor disputes from the main foreign investors Orix (Japan) and Abu Dhabi Investment Authority (UAE) not only for takeover but also since the cash flow issue was caused due to disputes with government authorities under various contracts.

In the present circumstances a few other options are also open for due consideration, including:

Option Under RBI Act

An alternative, and arguably more prudent course of action would have been for the RBI to exercise its powers under the RBI Act over IL&FS, which is a CIC-ND-SI NBFC. The RBI, for instance, can exercise its powers under s. 45JA RBI Act, can have put in place a specific governing framework for IL&FS's restructuring. This can be used to create a framework for giving a moratorium on debt liability and enabling sale of assets and formulation and implementation of a restructuring scheme approved by the Shareholders. It can also enable all disputes with various government authorities to be consolidated and resolved either through mediation or time bound arbitration to enable freeing of trapped cash flows.

Option Under IBC, 2016

IL&FS, being core investment company, does not fall within the scope of the definition of "financial service provider" under s. 2(17) IBC. The definition of "financial service providers" in s. 2(18) IBC that specifies a "financial service provider" to be one that is "engaged in the business of providing financial services in terms of authorization granted or registration granted by a financial services regulatory". However, IL&FS undertook a complete restructuring in 2007-2008 whereby the entire "financial services" activity was transferred to IFIN and IL&FS become only a holding company and was registered as a "Core Investment Company" with RBI in 2012.

A core investment company can only invest or give loan to its group companies which activity does not fall within the scope of the definition of "financial service". ILFS would not, therefore, fall under the general exemption provided to "financial service provider" from being a "corporate debtor" for the purposes of CRIP under IBC, 2016.


The government of India should use this opportunity to create a specific framework under the IBC/RBI Act for infrastructure sector and provide an enabling framework for restructuring of debt of infrastructure projects developed on PPP basis. Infrastructure projects effectively require an enabling framework that enables regular restructuring of debt in light of the various issues such as land, delays in clearances, environmental issues, PIL's and litigation risks, that tend to constantly delay and change the basis of financing. The issues being faced by IL&FS are a reflection of the risks and symptoms faced by all infrastructure sectors across India. IL&FS is the holding company for companies implementing projects in the Energy sector, Transportation Sector, Urban Infrastructure, Social Sector, Environmental sector. The cash flow issue at the heart of the ILFS problem cannot be resolved without resolution of the sectoral issues and creation of specific framework to manage the same.

Originally published by CNBC TV18, October 2018

Piyush Joshi is partner at Clarus Law Associates, a firm specializing in Energy, Projects, Project Finance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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