Mumbai: The legal battle over the selling of exotic derivatives contracts has taken a new turn with banks going on the offensive against their clients. ICICI Bank Ltd has filed a criminal suit against Sundaram Multi Pap Ltd, which had earlier moved court against India’s largest private sector lender alleging “mis-selling of certain foreign exchange derivatives contracts for speculative purposes”.
In a related development, the Institute of Chartered Accountants of India (Icai), which regulates the audit business in India, on Saturday asked all companies to disclose and provide for losses on derivatives contracts from the current financial year, which ends Monday. This could raise the pitch of the legal battle between companies and banks.
ICICI Bank has also moved the debt recovery tribunal (DRT) in Mumbai against Sundaram Multi Pap to recover dues from the company. “A few other banks may follow the ICICI Bank example. Once the companies move court, you cannot expect banks to keep quiet,” said an official with a law firm that is advising many banks on such cases and who did not wish to be identified.
ICICI Bank filed the criminal suit after a cheque, issued by Sundaram Multi Pap, bounced. The bank submitted the cheque for clearance to recover part of the losses that the company had suffered from the derivatives contracts, but declined to pay.
“No bank likes to take to litigation, but when a firm takes legal course, it becomes unavoidable. We did it to safeguard our interest,” said an ICICI Bank official, who did not wish to be identified. “In the DRT proceedings, we have got an injunction against the company that bars any of its directors from leaving the country without the court’s permission,” the same official added. The criminal case will come up for hearing this week.
Sundaram Multi Pap suffered total losses of Rs2.92 crore from four exotic derivatives contracts that were closed before they matured to cut losses.
According to a Sundaram Multi Pap executive, who didn’t wish to be identified, the company had given a cheque of Rs1.52 crore to ICICI Bank as “security”, but issued a “stop payment” instruction when it found out that the bank was submitting the cheque for clearing. The Sundaram Multi Pap executive also insisted that the bank was required to consult the company before submitting the “security” cheque for clearance.
The ICICI bank official said that the bank had asked the company to ensure that there were enough funds in the account before sending the cheque for clearance. “Also, when a bank takes a security cheque from a company, no document states that we have to consult the firm before submitting the cheque for clearing,” the bank official added.
Mint first reported on 17 March that many banks that sold derivatives to Indian companies over the past few years are gearing up for legal battles with their clients who are now questioning the legality of such products.
The list of firms that have gone to court against their banks that sold such derivatives includes Sundaram Brake Linings Ltd, Rajshree Sugars and Chemicals Ltd, NCS Sugars Ltd and Sundaram Multi Pap. It is a list that is likely to grow.
Law firms see the Icai development resulting in more lawsuits—and business.
Berjis Desai of J Sagar and Associates said Icai’s move would escalate the legal war. “If the firms are to disclose their mark-to-market losses and provide for them in their balance sheets, they would certainly rush to courts and there will be more and more lawsuits (against banks),” Desai added.
If the firms file suits and get a stay from courts, they can convince their auditors to show their mark-to-market losses as contingent liabilities and escape having to make provisions for them. Contingent liabilities do not affect the profit and loss account.
ICICI Bank, Yes Bank Ltd, Kotak Mahindra Bank Ltd, Axis Bank Ltd, HDFC Bank Ltd and a few foreign banks, including Citibank and Standard Chartered Bank, have aggressively sold such derivatives products to their clients. Amarchand and Mangaldas and Suresh A Shroff and Co., AZB and Partners and Juris Corp. are the legal advisers of banks, while J Sagar Associates, a crack team at audit firm KPMG India and independent risk management consultants such as A.V. Rajwade are advising the firms, mostly medium and small enterprises that have lost substantial money by taking exposure to complex options and structured products that were originally bought to protect them from the risk of currency fluctuations. At the core of the issue is whether these products were sold for hedging or speculation.
According to a “plaint” filed by Sundaram Multi Pap in the Bombay high court, the company had informed the bank that the objective of the hedging to be undertaken was to cover export risks to the extent of Rs1.52 crore on export revenues up to Rs25 crore.
“The total forex contracts entered by the defendant (ICICI Bank) was $14.5 million, i.e. Rs57.64 crore, at an exchange rate of Rs39.75 per dollar. The total of Rs57.64 crore has far exceeded the total export turnover of the plaintiff (Sundaram Multi Pap). This shows that all the forex contracts entered by the defendant are purely speculative in nature and has got no relation with the export business of the plaintiff,” the plaint adds.
Sundaram Multi Pap is an exporter of paper and stationery; its average annual exports are around Rs20 crore and the company does not have any exports to the US, European Union and other Western countries, according to the document filed with the court.
Rajshree Sugars, which filed a case against Axis Bank, has secured a “status quo” order against Axis Bank from the Madras high court.
Meanwhile, auto parts maker Amtek Auto Ltd on Friday said the recent volatility in the currency markets could expose the company to potential losses of $18 million (approximately Rs71.82 crore) over the next two years.
Details of the foreign exchange derivatives exposure of Indian companies started coming to light in late November, when software firm Hexaware Technology Ltd said it had made provisions of $20-25 million (Rs78.8-98.25 crore then) to cover exposure from unauthorized deals, that involved derivatives, entered into by an employee.