Tighter law needed to check corporate loan frauds

Companies Act, 2013, fails to put a bar on inter-corporate loans and guarantees

Diageo, which acquired United Spirits from Vijay Mallya and a clutch of companies owned by him, must be ruing its decision. Every acquirer gets a thorough due diligence done by a renowned firm of accountants to ensure that there are no encumbrances on the properties of the company acquired or any burdensome contract. Diageo must have been let down badly by the firm that did the due diligence in the run up to the acquisition of United Spirits because it turns out in retrospect that the wily Mallya had taken generous loans and guarantees from United Spirits with the beneficiaries invariably being companies ensuring for his sole benefit. In fact, this has been the leitmotif of most of the corporate frauds in the country for long. Yet, our company law is blase about it.

Section 372 A of the Companies Act 1956 and Section 186 of the Companies Act, 2013, are too liberal - a company can give loan or guarantee or invest in shares of other companies up to 60 per cent of its net worth or 100 per cent of its free reserves, whichever is greater. This is not the end of the story. Loans and guarantees in excess of these limits can be given with the special resolution of the shareholders, which has never been a big deal unless it is mandated to be taken at a meeting where interested shareholders are out of bounds. Be that as it may, the liberal regime entices promoters to siphon the funds of big companies, mostly listed, through inter-corporate loans and guarantees. That inter-corporate loans, guarantees and investments can be made only with the unanimous approval of the board of directors is not a serious impediment for buccaneer company promoters.

Sebi is reportedly worried about this menace and seems to be contemplating vide its own corporate governance code special resolution of minority shareholders for such loans and guarantees. It might be just what the doctor has ordered for halting the buccaneering promoters.

It is curious that the makers of the Companies Act, 2013, did not learn lessons from the inadequacies and liberality of the predecessor law. Apart from the liberal limit, the following two deficiencies have been allowed to percolate into the new law that in any case is yet to be notified:

* Public financial institutions will act as conscience keepers in this regard only if the loans and guarantees require special resolution of the shareholders and that too when there is a default in servicing their own loans to the company. This is a self-centred provision whereas public financial institutions must be mandated to act in altruistic interests of everyone.

* Loans and guarantees to other companies cannot be given when there is a default in servicing deposit holders of the company. While deposit holders do merit the indulgence of the law, what about our poor banks burdened by and large with non-performing assets (NPAs)? The law must unequivocally put a bar on inter-corporate loans and guarantees when the company concerned has been remiss in servicing its own loans from banks. Banks are victims of soaring NPAs due to, among other things, diversion of funds by company promoters.

The author is a chartered accountant based in New Delhi