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Shortchanging Commitments

Omkar Goswami


 “Fiduciary” is fundamental concept in corporate ethics, law and jurisprudence, and comes from the Latin “fidere”, which means trust. A fiduciary is bound either by law or by custom to act as a trustee for others who repose confidence in him. Unilaterally violating this trust is  a breach of faith. This is a story of such a violation. It isn’t an infringement in a strict legal sense; but it is a breach. And it involves the Industrial Financial Corporation of India (IFCI).


In 1997-98, IFCI issued five-year preference shares, offering a cumulative dividend of 10% per year. Most of this paper was purchased by public sector banks and financial institutions; a very small percentage was bought by individual investors. I know a person in the latter group — an ailing gentleman in his eighties, who invested Rs.41 lakhs in these shares. It constituted a very large chunk of his savings, and like many of his generation, his rationale was that IFCI was like a government institution and, therefore, this was as safe an investment as gilt-edged securities. How wrong he was.


For the first three years, IFCI paid the dividend. Thereafter, its non-performing loans started coming to roost. It not only began posting operational losses but also wiped out most of its  reserves. So, it didn’t pay dividends for 2001-02 and 2002-03. In fact, it wasn’t even in a position to redeem the preference shares when these fell due on 1 April 2003. In April, IFCI requested an extension of the tenor for a few years. The old gentleman — shocked as he was with IFCI’s inability to honour an implicit commitment — still had faith in the institution. “It’s like the government”, he told me. “How can they not pay?”


Now, IFCI has dealt the old man a body blow by sending another letter dated 8 October 2003. The gist of this epistle is this: (a) Sorry, can’t pay either unpaid dividends or redeem the preference shares. (b) Here’s what’s on offer: IFCI will redeem the preference shares in two equal instalments on 1 April 2008 and 1 April 2009. (c) However, the dividend is now being reset at 5% per year, with effect from 1 April 2002. (d) Either agree to these terms, or go suck your thumb!


In purely legal terms, IFCI is within its rights to stiff the old man. After all, unlike debentures or other debt instruments, preference shares can only be serviced out of distributable profits or redemption reserves. As a virtually bankrupt institution, IFCI has neither. So it can’t pay. Moreover, rolling over preference share capital is a part of its restructuring package — and if banks and FIs with crores in the kitty can agree to take a haircut, then who is an old individual with an exposure of a mere Rs.41 lakhs? In any case, the institutional investors, accounting for the vast majority of this liability, have toed the line. The old man’s views are of no consequence. He can be upset till the cows come home.


Is this a fiduciary breach? Yes, I believe so — in a broader ethical sense. To be sure, no keen observer of the financial sector would have invested in IFCI’s preference shares in the late 1990s. By then anyone in the know had a good sense of IFCI’s impending  troubles. But stop a bit, and think of an eighty-two year old. He had seen IFCI as one of three major all-India financial institutions — a government organisation that helped create the sinews of industrial India. In his mind, IFCI was no fly-by-night financial company. It was a financial organ of the State and, therefore, could never conceivably fail in meeting its obligations. I would argue that IFCI implicitly leveraged this image to raise capital in 1997-98, as it did earlier for its bond and debt issues.


Individual bond holders have got saved. The Central Government has transferred almost Rs.1,100 crore to enable IFCI to redeem these debt obligations. Unfortunately, preferences shares aren’t bonds. And so, the ailing old man will have to wait until 2008 and 2009 for his crumbs — if he lives that long at all. In a fundamental ethical sense, I call this a betrayal of trust. Don’t you?


Published: Business World, October 2003


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