Mumbai: Diageo Plc said it will review its shareholder agreement with Vijay Mallya, chairman of its United Spirits Ltd unit, after an internal inquiry suggested financial irregularities and legal violations at India’s largest liquor firm.

Mallya must step down from the board of United Spirits, which makes McDowells and Bagpiper whiskies, till the allegations of financial improprieties and the wilful defaulter tag given to him by banks over Kingfisher Airlines are cleared, proxy advisory firm Institutional Investors Advisory Services (IiAS) said separately on Monday.

The internal probe conducted by United Spirits with the help of audit firm PwC prompted the company’s board to seek the resignation of Mallya, who refused to quit and criticized the probe as “severely flawed". The board said it would go to shareholders to seek Mallya’s removal and recommended Diageo review its pact with the liquor tycoon.

The probe at United Spirits alleged that the company may have understated the amount it was owed by United Breweries (Holdings) Ltd (UBHL), the parent company of UB Group. During the duration of the alleged financial irregularities at United Spirits, Mallya was chairman and sole promoter.

“Diageo notes the recommendation of the USL board and will now consider its position under its agreements with Dr Mallya and UBHL in light of the inquiry report and materials provided to it," Diageo said in a statement.

Diageo and UBHL entered into the shareholders’ agreement as part of a deal announced on 9 November 2012, which came into effect on 4 July 2013 when Diageo completed the acquisition of its initial 25.02% shareholding in United Spirits.

Diageo agreed to support Mallya as non-executive director and chairman of United Spirits as long as UB Group or Mallya held at least 1% in the firm, subject to certain other conditions, according to this pact. UB Group owns roughly 5% of United Spirits while Diageo is the majority shareholder with a 54.78% stake.

The terms of the pact aren’t available to the public. If Diageo changes the terms, analysts expect Mallya to challenge them, possibly in court.

Following the probe, some analysts have also questioned the quality of Diageo’s due diligence when it bought a controlling stake in United Spirits and later raised it. Since Diageo completed buying a 25.02% stake in United Spirits in July 2013, the Bengaluru-based firm has paid nearly 20 crore in compensation to chief financial officer P.A. Murali, a company veteran known to be close to Mallya, and approved several related-party transactions with Mallya’s UB Group, at least one of which was flagged in the PwC report.

In 2013, Diageo named Murali as one of its nominees on the board of United Spirits. Last week, Murali resigned from the firm ahead of the announcement of the internal probe’s findings. Two other board members appointed by Diageo had resigned when the investigation began in September.

“What compelled Diageo to not run a thorough due diligence, and miss asking the obvious questions? Why did Diageo vote its shares in favour of reappointing Mallya at a time when he was named as a wilful defaulter? What prompted Diageo to nominate Murali to the board as their representative? If Murali was Diageo’s representative, can Diageo claim they were not in the know?" proxy firm IiAS asked.

The inquiry, which suggested that fraud happened at United Spirits, was conducted with the help of accounting firm PwC, which was also the company’s auditor in at least one of the years when these activities took place. PwC was United Spirits’ auditor for more than five years until August 2011, and it gave a clean chit to United Spirits’ accounts in these years.

United Spirits and UBHL entered an agreement in July 2013 when the companies agreed to convert all loans by United Spirits into a single loan deal of 1,337 crore. United Spirits got this agreement cleared by shareholders in January, but the company is now suggesting the amount may be higher.

Separately, capital market regulator Securities and Exchange Board of India (Sebi) has plans to examine whether there were any violations at United Spirits and other UB Group companies. Sebi is expected to examine the roles of individuals, including Mallya, in this inquiry.

A Sebi spokesperson declined an immediate comment.

News agency PTI on Sunday reported that the alleged lapses, including about fund diversion, amount to violation of the companies law and that the issue could also be separately probed by the corporate affairs ministry, while accounting watchdog Institute of Chartered Accountants of India may look into the auditors’ role to ascertain whether there were any lapses on their part.

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