Government going bania comes at a cost

A majority decision by an arbitral tribunal adjudicating a comm-ercial dispute with the Government of India seems to have revived a public debate about whether an owner of shares of a public limited company has the right to agree not to sell them. While the decision of the arbitrators should have no precedent value at this stage, and it is only binding among the parties to the dispute, the dispute raises a much larger issue about the nation’s governance and investment policy. 

In 2001, Sterlite Industries (India) Ltd. (Sterlite) won a bid in response to an auction by the Government of India, the ownership of 51 per cent of Bharat Aluminium Company Ltd. (Balco), an unlisted public limited company. As was the wont of the government’s disinvestment programme, the government retained the res-idual stake in public sector companies when it sold a controlling stake, hoping to sell the balance shareholding at a fair market value at a fut-ure date – the government negotiated call options and put options whereby such shares could be acquired by the private buyer either at such buyer’s option, or at the government’s option.

 

It was the government’s way of telling its critics that it was not selling cheap; it was only selling out so that the companies could be run efficiently with new ownership. The retained stake would help the government profit from any future value accretion arising out of the company being operated by its new owners. The government successfully defended attacks on its disinvestment programme, conveyed the political message well, and raised a lot of money by selling public sector companies to private players using the agreement used in Balco as a set precedent – more so, after the Supreme Court approved the Balco sale, when the transaction was challenged.

Now, when it is time to honour the agreement and sell shares upon the private buyer having exercised the option to acquire the residual sha-res, the government is act-ing like an unprincipled bania – a term bureaucrats use to distinguish petty commercial behaviour of the private sector from the insti-tutional process-driven approach that they in government adopt.

The government has claimed that the agreement that it signed is unenforceable. The shares of a public limited company are meant to be freely transferable, it argued, and therefore, provisions in the shareholders agreement that could impose fetters on transferability are void. The government argued before the arbitrators that the provisions that require it to conserve the shares without frittering them away, and the obligation to deliver the shares to be transferred upon exercise of the call option, are void in law.

Worse, this argument was not adopted as a matter of principle. The government did not show that some realisation that it had done something wrong in the past had dawned on it. The government adop-ted this stance after disputes arose over the value that Sterlite should pay the government for the residual sha-res – a strange measure for a sovereign that has signed numerous agreements of an identical nature.

This stance, accepted by two of the three retired chief justices sitting on the arbitral panel, has implications for dealings with the Government of India. First, every agreement signed as part of the disinvestment programme would be void in this regard. A number of the public sector companies involved were listed companies. A number of counterparties who participated in the disinvestment programme are also listed companies. They should all tell their shareholders that price discovery for their shares on the stock market, has been flawed.

Second, even if the government does not raise such a claim in any other case, no lender, including inves-tors in the bond markets, would lend to finance the acquisi-tion of the residual stake from the government. Worse, the next time the govern-ment really wants funds through such a programme, lenders will not lend if there is no assurance of adherence to contract.

Third, in cases where the government would want to exercise a put option to get the private buyer to forcibly acquire the residual shares, depending on the terms of the agreement, it can be foisted on its own petard with a stance that the shareholders agreement is not enforceable.  

Fourth, the government forgot that it even arm-twisted the Securities and Exchange Board of India into amending the Takeover Regulations to provide that the second sale of listed shares of the public sector company through a put option or a call option should not trigger the mandatory open offer to the public shareholders. The regulations provide a detailed framework to support this regime, which the government has very facetiously trampled upon.

Audits by the Comptroller and Auditor General do not cover propriety audits, and cannot measure the long term damage and losses such actions occasion to the economy. Therefore, such short-sightedness would never be regarded as “scams”.

(The author is a partner of JSA, Advocates & Solicitors.  The views expressed herein are his own.)

Email: somasekhar@jsalaw.com