The Hindu Business Line : Fx derivatives: Sundaram Brake, Rajshree Sugars await ruling

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Fx derivatives: Sundaram Brake, Rajshree Sugars await ruling

Nearly a dozen cos move court; banks say contracts are legal

Our Bureau

Chennai, April 8 Sundaram Brake Linings Ltd, a member of the TVS group, and Rajshree Sugars & Chemicals Ltd, based in Coimbatore, are among the nearly dozen companies that have filed cases in the Madras High Court against their banks for losses suffered by them in foreign exchange derivatives contracts. The companies have argued that the contracts the banks entered into with them were illegal, in violation of RBI guidelines, opposed to public policy and unenforceable, and not binding on them.

Judgments are awaited on the Sundaram Brake Linings and the Rajshree Sugars cases, while proceedings have not begun on the others, according to reliable sources.

The banks have contended that the contracts are legal and have argued that the Madras High Court does not have the jurisdiction to entertain the suits, as they had agreed that for any disputes, the jurisdiction would be Mumbai. The banks have argued that the contracts they had entered into with the companies are legally enforceable and in conformity with the various guidelines.

The companies have sought permanent injunctions from the court to restrain the banks from proceeding with the contracts and from taking any action to recover the amount from them.

Sundaram Brake Linings

(Defendants are Kotak Mahindra Bank; Mr M.S. Subramanian, Financial Controller and Secretary, Sundaram Brake Linings; and Mr G. Manikandan, Senior Manager (Finance), Sundaram Brake Linings)

Turnover of Rs 189.83 crore for the year ending March 31, 2007. Executes export orders to the tune of Rs 54 crore annually on an average mainly to Europe and to the US. Imports raw materials mainly from Canada to the tune of Rs 23 crore annually. The total foreign exchange exposure is about Rs 77 crore.

The company hedges foreign currency transactions only to manage its foreign currency transactions in a prudent manner. RBI guidelines prohibit any speculative trading in foreign currency, derivative transactions and in general any foreign exchange transaction not involving an underlying actual exposure in the form of an export or import order of the company.

As on November 6, 2007 the second and third defendants had transacted 52 unauthorised derivatives cross currency deals with banks, out of which nine were current and the rest closed. All the deals were totally beyond the Memorandum and Articles of Association of the company, unauthorised, violative of several provisions of statute as well as circulars issued by the RBI, completely suppressed from the company management.

The provisions of the agreement dated February 18, 2006 are illegal and do not bind the plaintiff. All the speculative cross currency, leveraged derivative transactions, known as “exotic forex options” are also illegal and will not bind the plaintiff.

Defendants 2 and 3 have illegally wagered away a substantial portion of the company’s net worth.

The total value even on mark-to-market basis of just two contracts would be a loss of Rs 33.5 crore whereas the net worth of the company was only Rs 64.91 crore as on March 31, 2007.

The company discussed these revelations at its board meeting on November 16, 2007 when it was decided to have a complete and thorough and independent audit of these 52 derivative transactions.

Rajshree Sugars & Chemicals Ltd

(Case against Axis Bank Ltd)

The company started entering into foreign exchange derivative transactions in 2004 solely for the purpose of hedging its risk or genuine underlying exposure in respect of fluctuation in the market.

The board has passed resolutions between March 2004 and January 2007 for entering into derivative contracts only for the purpose of hedging currency fluctuations and reducing cost of borrowings. Since 2004, certain forward contracts and derivatives transactions (currencies swap and interest swap) were entered into between the company and various banks to manage the risk of foreign currency fluctuation and FCNR-B loans and also to hedge interest rates.

Board authorised its Chief Financial Officer and Company Secretary, Mr P.K. Viswanathan, to deal with all matters concerning derivative transactions.

Turnover of Rs 404 crore for year ending March 31, 2007 and an export order of Rs 111 crore for the nine months ending December 31, 2007. Company also imported goods and machineries to the tune of Rs 5.8 crore. It has foreign currency loans to the tune of $ 30 million as on December 31, 2007.

Totally 10 transactions were entered into by the CFO with the defendant bank. Of this, nine were undertaken to reduce the cost of rupee loans as underlying or hedge the export receivables as underlying. Only one transaction, which is under dispute, is totally un-connected with the business and entered into by CFO without any authority.

This transaction – Contract No. OPT 727 – is an exotic transaction based on the probable fluctuation of dollar and Swiss Franc. There is no rupee loan swap or a hedge against export in this deal thereby making it purely speculative. Out of the 10 transactions, eight are totally closed and they are all duly covered.

The contract was purely speculative and the company was lured into a wager or a gamble on the movement of dollar-Swiss Franc by entering into the contract.

The contract is an agreement to wager and is void under Section 30 of the Indian Contract Act, 1872.

Conflict of interest for the defendant bank as it also advises the company on forex matters and hence owes a fiduciary duty to the plaintiff.

The company would incur a minimum loss of Rs 14.2 crore.

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