Derivatives: Madras court rules in favour of Axis Bank

Derivatives: Madras court rules in favour of Axis Bank

Mumbai: In a ruling that could set the precedent for at least a dozen cases between companies that bought complex derivative products and banks that sold them, the Madras high court on Tuesday ruled in favour of Axis Bank Ltd in a dispute between it and Coimbatore-based Rajshree Sugars and Chemicals Ltd (RSCL).

“The high court has held that the derivative contract is not a wagering contract, which means it is not illegal. It has also been held that amount due to the bank (Rs46-50 crore) is a debt as defined under the Debt Recovery Tribunal Act and hence the bank can approach the Debt Recovery Tribunal (DRT)," said a person familiar with the development, who did not want to be named.

Rajshree Pathy, chairman and managing director of RSCL, was in London and could not be reached for comment. Calls to the firm’s Coimbatore office weren’t answered.

“An order has been passed and the stay has been vacated," said Parthasarthy Mukherjee, president of treasury at Axis Bank, referring to the stay order that had been obtained by the company to prevent the bank from approaching the tribunal.

RSCL is one of several firms that entered into contracts with banks in an effort to protect themselves from fluctuations in the foreign exchange market. Many of these firms found themselves at the wrong end of the deal after the dollar depreciated sharply against the rupee and also against other currencies last year. These firms have alleged that they were “mis-sold" the products by the banks involved.

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RSCL had alleged that one of its 10 transactions with Axis Bank was based entirely on the probable fluctuation of the US dollar and the Swiss franc, and “there is no rupee loan swap or a hedge against export in this deal, thereby making it purely speculative". The firm had alleged that the bank “lured" it to enter into such an exotic contract “with misrepresentations and false promises".

Indian companies are allowed to hedge their exposure to foreign currencies on account of imports or exports, but the country’s laws frown on speculative hedging for the purpose of playing the market.

“The contract was entered into on 22 June 2007, when the rate was $1=CHF (Swiss franc) 1.2355. On 28 June 2007, the defendant bank paid $100,000 (Rs47.7 lakh today) to the plaintiff, which was duly credited to the plaintiff’s bank account. This was net inflow of premium which the plaintiff received for writing this option in favour of defendant bank," the firm said in its complaint

“The contract was purely a speculative contract and the plaintiff was lured into a wager or a gamble on the movement of dollar against Swiss franc by entering into the contract," the complaint added.

On 10 April, rating agency Fitch downgraded RSCL’s Rs60 crore commercial paper programme due to potential losses on account of its derivatives exposure and poor financial performance in the third quarter. “Ruling against the company will result in substantial fresh losses, and put further pressure on RSCL’s credit metrics beyond the current rating level," the agency said in a note.

RSCL’s net profit for the quarter ended 30 June rose to Rs8.67 crore, against Rs1.20 crore in the corresponding quarter last year. Revenue for the quarter dipped to Rs87.46 crore from Rs94.39 crore in the same period last year.

This is the second instance where Axis Bank has been permitted by a court to approach DRT to recover dues from a company. On 8 September, the Ludhiana district court allowed the bank to enforce its derivatives contract with yarn and steel maker Nahar Industrial Enterprises Ltd. Apart from Axis, several other private sector banks such as ICICI Bank Ltd, HDFC Bank Ltd, Kotak Mahindra Bank Ltd and Yes Bank Ltd are fighting similar cases across India. The value of a derivative is pegged to the value of an underlying stock, bond, currency or some other asset.

In a recent order, the Bombay high court asked Sundaram Multi Pap Ltd to pay ICICI Bank the dues arising out of contracts for structured derivatives the two had signed. The 15 September judgement, however, didn’t go into the legality of the instruments involved, or the motives behind their sale to firms by banks. It merely asked Sundaram to pay up.

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 the firm, bounced.

The Mumbai court is yet to hear a case filed by Sundaram Multi Pap questioning the legality of the instruments sold to it by ICICI Bank.