I have been working on the lending side of a bank’s business for over a decade now. And, it’s been a really mentally invigorating and hugely satisfying experience for me. The real life cases added a new dimension to the knowledge I had gained from the studies for my professional qualification.
I plan to jot down a few instances of financial shenanigans of business units that I had come across in the course of my work. At the outset, I would like to clarify that these cases were not illegal / fraudulent acts per se, but ones that were somewhat uncomfortable/non-prudent from a banker’s point of view. And, for the sake of privacy, I will not take any names either. The objective of this exercise is to bring these acts to the notice of others like me, so that everyone can be alert to such things.
Case 1: Purchase of land from promoter-director
ABC Finance Limited is an NBFC and is closely held. Its source of funds for onward lending include capital & reserves, bank finance in the form of working capital limits and funds raised from issue of debentures which are listed on the BSE. For the sake of simplicity, let’s assume that bulk of source was the debentures, followed by bank finance and then by capital & reserves.
Now, the promoters had to comply with the regulatory norms regarding capital adequacy, necessitating infusion of capital. What did they do? They adopted a rather roundabout way for this.
The company decided to buy a large tract of agricultural land from the promoter-director, valued at ~Rs.12 cr! The funds to finance this purchase came from the proceeds of the debenture issue, the terms of which, rather conveniently, included ‘Any other corporate purposes’. I don’t recall whether the Memorandum of Association was amended just prior to this, but the ‘Objectives’ clause empowered the company to engage in agricultural activities too! The company then issued new equity shares on fully paid-up basis for the same amount to the promoter-director who was also the CMD of the company.
To summarize, the capital base of the company got enhanced using the funds given by the investors in debentures for on-lending, without any ‘real’ fund infusion by the shareholders. No effective cash flow happened.
Though there is nothing illegal in this whole matter, from the perspective of corporate governance, there were serious lapses/shortcomings. I still wonder how the independent directors could remain silent regarding this Related Party Transaction (RPT) and ‘sham’ issue of shares. The debenture investors were short-changed, in my opinion.
As a banker, of course, there isn’t much one can do on this, but a case like this reminds us that monitoring of RPTs should go beyond sales to /purchase from associated entities. The Credit rating system should have some mechanism to penalize the company for such weaknesses in its systems. The covenants for lending should be made stronger.
I’ll return with another case shortly.
IDIOSYNCRATIC RUMINATIONS 