Mumbai: The potential for systemic disruption and an incipient financial sector meltdown has forced the government to seize control of Infrastructure Leasing and Financial Services (IL&FS) and its units by superseding the current board.

The move sends multiple signals. One, with the government now in control, it is a clear reassurance to lenders that their outstanding loans to IL&FS will be repaid. Two, it will go some way in quelling rumours that debt mutual funds had started facing redemption pressures from jittery investors. Three, it effectively stops the spread of systemic instability in an inter-connected financial system, especially as panic had started spreading across the financial, money and capital markets. Finally, there is clarity on the way forward: finalization of a restructuring plan, identification and valuation of assets, sale of the assets and repayment of outstanding loans.

The government’s drastic step, the second time in 10 years (the last time was Satyam Computer Services in 2009), was prompted by rumours and an edgy financial system. A shaky financial system in an election year is a recipe for disaster.

The government superseded the IL&FS board under section 241(2) of the New Companies Act, 2013. This section enables supersession of a company’s board to prevent it from further mismanagement in order to protect public interest. The ministry of corporate affairs moved the Mumbai bench of National Company Law Tribunal (NCLT) on Monday under the same section for overhauling the board and replacing it with its nominees.

The tribunal, presided over by M.K. Shrawat and Ravi Kumar Duraisamy, approved the names of six directors, including Uday Kotak, managing director of Kotak Mahindra Bank; G.N. Bajpai, former chairman of the Securities and Exchange Board of India; G.C. Chaturvedi, chairman of ICICI Bank Ltd; former bureaucrats Vineet Nayyar (also a former vice chairman of Tech Mahindra); Malini Shankar and Nand Kishore.

The government also committed to arrange adequate liquidity for IL&FS to obviate future defaults and ensure smooth implementation of infrastructure projects.

The government said in its release that the supersession of the IL&FS board and its replacement by a new board are the necessary first steps towards restoring the confidence of the financial market.

“The new six-member board will meet before 8 October to decide the chairman of the board. Also, the newly constituted board must devise a plan for the group and file its response to the NCLT by 15 October," said the tribunal, posting the matter for further hearing on 31 October.

“Fresh funds will be infused when the new board comes up with a revival plan," said Sanjay Shorey, joint legal director in the ministry of corporate affairs, who was representing the government before the tribunal. “We have identified a few people who have credibility." The government further argued that the new board should be empowered to change the boards of IL&FS subsidiaries as well.

Shorey said any collapse of IL&FS would have a cascading impact on mutual funds and other financial institutions. “About 1,500 small non-banking financial companies could see their licences being cancelled due to the capital shortage in the wake of the IL&FS crisis," the counsel argued.

Shorey also informed the tribunal that the Serious Fraud Investigation Office (SFIO) had initiated an investigation into the matter.

“Ravi Parthasarathy, along with CEOs and CFOs, was painting a rosy picture of the company deliberately despite knowing the truth," argued Shorey. He added that the difficulties of the company could create issues for the financial sector as a whole and that was why the government wanted to change the board.

This is the second major firm where the government has taken control to salvage the situation. In 2009, authorities took control of the affairs of Satyam Computer Services.

“We will have to see how the board and government pull out a rabbit from the hat," said Krishnava Dutt, managing partner of law firm Argus Partners, arguing that the problems of IL&FS were much larger than those of Satyam. “Someone will have to take the heat while salvaging the situation, the question is who will take and how much," said Dutt.

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Just after NCLT pronounced its order, the government said in a release that the financial mismanagement of IL&FS was apparent from the rapid debt build-up and misrepresentation of the state of financial fragility, which is being reflected in the ratings downgrade from highly rated to a default category.

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