Krati Gupta & Raj Shekhar
Analyzing the legality of nullifying shareholder equity and the significance of the LVB-DBS amalgamation in providing the much-needed stimulus to the RBI’s Wholly-Owned Subsidiaries (WOS) Model, 2013
The macro slowdown of the Indian economy since 2017, the Non-Banking Financial Company (NBFC) liquidity crisis, mounting Non Performing Assets encumbrances, and an inept managerial attitude over the years has created the perfect blend for systemic bank failures. After the defaults of DHFL, IL&FS and Punjab & Maharashtra Cooperative Bank, the recent decision of the Reserve Bank of India to impose a moratorium on Lakshmi Vilas Bank Ltd (LVB) and subsequently put forth a plan for its amalgamation with DBS Bank India Ltd., though laudable for harbingering a new era of competitive operational efficiency, has been at the center of criticism and speculation. The unexplained and prompt move by the central regulator in providing an unprecedented back door entry to a foreign lender by circumventing the bidding process and legitimizing the complete write off of paid-up equity share capital has put minority investors at great peril. Expectedly, the merger scheme has seen protests from concerned shareholders and major banking unions who are against the absolute capital wipe-out and the overall merger itself. In light of the above-mentioned issues, the authors seek to critically analyse the move by RBI and the legality of absolutely nullifying shareholder equity in the amalgamation process. Further, the authors also seek to explore possible alternatives to find a middle ground for protection of interest of investors and depositors alike.
Legality and Reasoning: Why did the RBI Opt for an Amalgamation?
The LVB-DBS merger was brought into effect by the RBI on the reasoning that the financial position which also included the liquidity, capital and other critical parameters of LVB was deteriorating rapidly without any credible plan for capital infusion in sight. Thus, the RBI in furtherance of ‘public interest’ and particularly the interest of the depositors, placed LVB under moratorium by an order of the Central Government dated November 17, 2020, in exercise of the powers conferred by sub-section (2) of Section 45 of the Banking Regulation Act (BRA), 1949. This provision empowers the RBI to apply to the Central Government for suspension of business by a banking company and to prepare a scheme of reconstitution or amalgamation. In furtherance of the same, RBI exercised its powers under sub-section (4) of section 45 of the BRA, 1949, and formulated the amalgamation scheme called ‘The Lakshmi Vilas Bank Ltd. (Amalgamation with DBS Bank India Ltd.) Scheme, 2020’.
Though the amalgamation scheme is a robust route for providing a safety net to the depositors, clause 7 of the scheme, which deals with the rights and liabilities of the members and creditors of the LVB, is shrouded in controversy. The decision of the RBI to write off the entire amount of paid-up share capital, reserves and surplus, including the balances in the share/securities premium account of the LVB has not gone down well with the shareholders who have been pushed to the brink of losing their entire equity holding. Section 237 of the Companies Act 2013 confers the right on investors and creditors of the transferor company to acquire the same rights and interest in the transferee company, however, the central regulator under Section 45 of the Banking Regulation Act, 1949 (BRA) can attribute to itself superseding powers to force a merger of banking companies in “public interest” or “in the interest of the depositors of the distressed bank.” Though this is the first time that in the exercise of this statutory authority, Tier II bonds have been completely written off, yet this in no way is the maiden instance when shareholders of a crisis-hit company have been handed a disappointing deal.
In the case of YES Bank, the shareholders witnessed a steep deterioration in the value of their investments coupled with a huge dilution in their equity post the capital infusion. Even though certain Tier-I bondholders were denied any payment, the majority of the shareholders were protected. On similar lines, the IDBI Bank was rescued without any damage to the stakeholders or their equity. There is no denying that there exists a plethora of examples, with the aforementioned ones being the most recent mergers carried out by RBI under Section 45 of the BRA, 1949.
Equity Risk vis-à-vis Investor’s Interest: Understanding RBI’s Justification
The chequered financial history of LVB had been in the public domain for long. With the capital adequacy ratio for the latest July-September quarter estimated at -2.85% far lower than the prescribed Basel III norms, and gross NPA at a colossal 24.45%, the bank had been posting continuous losses for the past several quarters. Further, governance issues plaguing the top management came to light when all seven board members including the MD and CEO were ousted from power in a boardroom coup. Notwithstanding the fact that the shareholders completely ignored these tell-tale signs of trouble anticipating a public sector bank rescue of the LVB similar to the Yes Bank bail-out; the RBI’s deviation from this conventional path without providing any reasonable explanation has imperiled investor trust.
The ‘equity risk’ justification given by the RBI in wiping off Basel III Tier II bonds, though legally sound, remains questionable. While it is true that equity shareholders undertake to bear the risk associated with the trade cycle, fluctuating business profits and even the prospective ventures of the company, the same certainly cannot be fathomed as investors’ acquiescence to the loss suffered by the company on account of misgovernance and untimely action by ineffectual regulators in which case they are themselves the victims.
Understanding the gravity of the issue, the Madras High Court has urged the RBI to consider alternatives that are concurrent with the interest of all stakeholders: notwithstanding the statutory provisions allowing a freehand to the RBI, completely nullifying the equity cannot be done without ‘compelling reasons’. As the matter remains sub-judice, it will be interesting to note as to what ‘compelling reasons’ the RBI comes up with. However, the situation demands a retrospective lookout for alternative and viable solutions that have worked in the past and which could effectively tackle the interests of depositors without jeopardizing the interest of the investors.
Residual Shareholder Value Assessment: A Missed Opportunity?
The current conundrum has no precedents to rely upon. Though it is theoretically possible that, owing to mounting losses the share capital gets completely eroded, the move does not remain valid from a practical standpoint. The shares indeed lose their value, but the issue crops up due to the non-valuation of intangible assets like banking network, client trust and staff skills. This is where the RBI seems to have missed out on a probable recourse which could have compensated the shareholders. An analogy can be drawn between the present case and the time when private banks were being nationalized in the early 70s. The government instead of forcefully taking over the banking business, set up companies which eventually took over all the assets, liabilities and employees of the transferor bank. This meant that the transferor companies stayed in existence and adequate compensation was paid to them, which could be disputed, and the compensation so received could be used for the benefit of the shareholders.
On the same lines, even LVB could have been taken over without interfering with the overall bond and stock holdings. Post such a takeover, a due evaluation of the business could have been carried out and in case any residual value was admitted, the same could have been transferred to the shareholders so as to minimize the damage to their equity. This essentially would have meant a win-win situation for both the bank, which could have survived and the shareholders who would have had the opportunity to receive adequate compensation. Though this approach may seem very likeable, it’s also worth mentioning that the RBI being a sole regulator, was well within its domain to have chosen an alternative course of action. Nonetheless, a more detailed analysis of all possible alternatives before making a final move would have been more amiable for both – the investors and the depositors.
LVB-DBS Amalgamation: The much-needed stimulus for the Wholly-Owned Subsidiaries (WOS)
Be it backlash from the Banking Union, Cabinet Ministers or the general protests by parties, the LVB-DBS Amalgamation scheme remains in deep controversy. While the absence of transparency in the bidding process and the unusual fast-tracking of the issue have raised a lot of questions regarding the bona fide intent behind the merger, the prospects it offers are way too lucrative to be brushed aside. While it was being speculated that either the ICICI Bank or the Kotak Mahindra Bank would come to aid, the RBI took everyone by surprise with its move to amalgamate LVB with DBS India. The ‘compelling reason’ behind it still remains undisclosed but the potentials are lucid. By merging LVB with DBS and not with a domestic bank, the RBI has effectively refrained from saddling the capital deprived bank on already stressed public sector banks that unequivocally incentivise foreign banks to consider wholly-owned subsidiaries (WOS) for expansion of their footprint in India.
Foreign banking players have time and again complained of not having a ‘level playing field’ with their Indian counterparts and hence the present move could be seen as a game-changer. Not only does it allow for footprint expansion, it further incentivises foreign banks to set up WOS in compliance with the framework released by the RBI in 2013. This would mean that the RBI would get an upper hand in the regulation and mitigation of a spill-over crisis at the parent bank of these foreign banking institutions. The WOS was considered an ambitious idea, however with the current amalgamation, the RBI has put forth a lucrative deal before the foreign banks. It remains to be seen whether the novel approach laid out in the LVB-DBS merger ushers in a paradigm shift in the resolution process of the banking sector or goes down like a lead balloon, given the criticism of frittering away of domestic assets to foreign entities.
Thus, even though the DBS-LVB deal has indeed placed the shareholders’ assets and public trust in RBI at peril, not all seems to be lost. While it stands undisputed that RBI has lived up to its image of ‘guardian angel’ of the Indian banking sector, a better alternative could have been devised in the form of adequate compensation to the distressed investors following a thorough residual shareholder value assessment. The move seems to have reiterated RBI’s principle of ‘depositor’s interest first’, but the hasty move has disappointed a few experts. In light of the same, it would be too early to draw any further speculation, however, it is certain that the large foreign banks in the country which have primarily remained wholesale banks with niche retail presence would see this opportunity and work towards their footprint expansion to compete with the likes of HDFC and ICICI providing a conducive and much-needed push to the Indian banking sector, amidst the current global economic recession.
Krati is a second year law student at the Rajiv Gandhi National University of Law, Patiala
Raj is a second year law student at the National University of Study and Research in Law, Ranchi