Mumbai: In a judgement that could have significant bearing on several ongoing cases between banks and companies on so-called exotic derivatives the latter bought to protect themselves against foreign exchange risks, the Bombay high court has asked Sundaram Multi Pap Ltd to pay to ICICI Bank Ltd the dues arising out of contracts for structured derivatives the two had signed.
The 15 September judgement is the first in the ongoing legal battle between Indian banks and firms. However, it doesn’t go into the legality of the instruments involved or the motives behind their sale to companies by banks. It merely asks Sundaram to pay up.
Also See Judgement (Document)
On 12 March, ICICI Bank filed a petition in the high court for the “winding up” of Sundaram Multi Pap for “non-payment of a sum of Rs2.94 crore”.
The bank filed the case after a cheque for Rs1.52 crore, issued by Sundaram Multi Pap, bounced. ICICI 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.
“The company is directed to deposit a sum of Rs2.94 crore within a period of eight weeks” failing which ICICI Bank will be allowed to advertise its winding up proposal in newspapers, the court order from a single bench, headed by Justice S.A. Bobde, said.
ICICI Bank’s general manager, corporate communications, Charudatta Deshpande, declined comment on the issue because he said the bank wouldn’t speak about “individual cases”.
Amrut Shah, chairman, Sundaram Multi Pap, said his company would file an appeal. “It is a disputed matter of exotic derivatives and the case filed by our firm is still pending in the high court.”
Sundaram Multi Pap suffered a Rs2.92 crore loss from exotic derivatives contracts that were closed before they matured to cut losses but it did not pay ICICI Bank which, it claimed, had mis-sold “certain foreign exchange derivatives contracts for speculative purposes”.
The company moved court in December 2007 against ICICI Bank.
Derivatives is a financial term used to describe an instrument whose value is a function of an underlying commodity, stocks, bonds or currencies and which is used as a risk management and mitigation tool.
Also See Significant Ruling (Graphic)
According to the petition filed by ICICI Bank in the high court, Sundaram Multi Pap entered into the agreement “to protect itself from losses arising out of adverse fluctuations in the rate of exchange in import and export transactions.”
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 court order, which has been reviewed by Mint, the Sundaram Multi Pap board passed a resolution enabling it to enter into the derivatives contract “on terms, regulations and conditions laid down” by ICICI Bank. It also executed the International Swaps and Derivatives Association or ISDA agreement, commonly used to document derivatives transactions.
Though Sundaram Multi Pap does not dispute the document and the contract between the two parties, it has issues with two transactions and “challenged” them as “illegal” and not binding on it. It had also said it entered into the ISDA agreement only for the purpose of exports and the resolution taken by the company is not in accordance with its article of association (a sort of statement of purpose that all companies file while being incorporated) as it exceeds its borrowing limit.
The court, however, didn’t find any merit in the company’s contention. According to the judgment, “there is no dispute that the resolution to enter into these derivative transactions and execute agreements...was passed by the company”. It also said that the mere filing a suit challenging the deals before the bank sent a notice claiming its dues, cannot make the company’s actions “bona fide”.
The judgement said that the “the truth or otherwise of the defence taken by the company (Sundaram Multi Pap) would be liable to be tested by the court in the suit or other proceedings filed by the petitioner (ICICI Bank) before the debt recovery tribunal”. It added that the observations made are “only prima facie and restricted to the present proceedings for winding up.”
“This will have a bearing on all other cases that many other firms have been fighting in various parts of the country,” said a consultant who have been advising some of the firms involved and who did not want to be named.
Several private sector banks such as ICICI Bank Ltd, Axis Bank Ltd, HDFC Bank Ltd, Kotak Mahindra Bank Ltd and Yes Bank Ltd are facing litigations related to the alleged mis-selling of foreign exchange derivatives to companies.
Among the companies that have gone to court against their banks that sold such derivatives are Sundaram Brake Linings Ltd, Rajshree Sugars and Chemicals Ltd, NCS Sugars Ltd and Sundaram Multi Pap.
The issue first came to light in late November last year, when software firm Hexaware Technology Ltd announced that it had made provisions of $20-25 million to cover exposure from unauthorized deals entered into by an employee that involved derivatives. The company later reported a net loss of Rs81 crore for the quarter ended December after the actual damage on account of these transactions ended up being Rs103 crore.
The derivatives involved include swaps and options that are a sort of insurance that firms with exposure to dollars or other currencies buy as a protection against any adverse movement in these currencies that can hurt their income (for exporters) or increase their liabilities (for those companies that have borrowed overseas).
Theoretically, a swap is a financial transaction in which two counterparties agree to exchange a stream of payments over time at an agreed price. An option is an agreement between two parties in which one grants to the other the right to buy or sell an asset under specified conditions.
Thus, in case of a currency swap, both parties have the right and obligation to exchange currencies. And in the case of options, the buyer has the right but no obligation and the seller, the obligation but not the right to exchange currencies.
Many firms have posted notional losses on account of derivatives contracts and the quantum of losses would have been much higher had dollar not started appreciating against other currencies. such as Japanese yen and Swiss franc. At the core of the legal battle is a debate whether these instruments were sold for hedging or speculation.
The banks say they were sold for hedging. The firms claim they were for speculation.