Mohan Lavi

Chinks in IL&FS

Mohan R Lavi | Updated on October 04, 2018

Early detection was clearly possible

Satyam happened in 2009. Most of Sahara’s financial misadventures were discovered in 2012. With a view to prevent a recurrence of such corporate collapses, a new Companies Act was passed in 2013. To many, the alternate name for the Companies Act could have been the ‘Satyam and Sahara Act’ since many provisions in the Act were reactions of the government to the lessons learned from the Satyam and Sahara sagas.

Yet, IL&FS has happened in 2018. Much has been written on it, but one question that needs to be asked is: “Could the glaring issues have been detected and a resolution attempted earlier? Unfortunately, the answer to this question is Yes. Earlier detection could have done by either the rating agencies or the independent directors — both are clearly guilty of turning a blind eye to developments that happened in front of their eyes.

Code of conduct

The Companies Act, 2013 formulated a separate code for independent directors (IDs) and created a new Schedule IV in the Act to incorporate this. A complete reading of the code would make one conclude that the only person who can qualify to be an ID would be, Superman.

Yet, the code lays down some specific duties that an ID has to do. Such as, “help in bringing an independent judgment to bear on the board’s deliberations especially on issues of strategy, performance, risk management, resources, key appointments and standards of conduct; to bring an objective view in the evaluation of the performance of board and management; to scrutinise the performance of management in meeting agreed goals and objectives...”

More importantly, the code asks IDs to “safeguard the interests of all stakeholders, particularly the minority shareholders, balance the conflicting interest of the stakeholders and determine appropriate levels of remuneration of executive director and the management”.

It is clear that the ID has to play the role of an independent observer to protect the interests of all stakeholders. Some of the former independent directors have come out with statements that they were aware that IL&FS was on the brink of defaulting in payments and that they have also sensitised the board on this.

If the IDs had to safeguard the interests of the minority shareholders, they should have made much noise about it when the board did nothing after they were sensitised. They could have also resigned from their positions, giving specific reasons for their resignation. They must have felt that the problem will resolve by itself.

One of the ways in which the Companies Act can force IDs to make a noise when necessary would be to penalise the IDs of IL&FS for dereliction of duty.

Every time such incidents occur, the role of rating agencies is questioned but forgotten soon. Since markets look upon ratings to make decisions, SEBI should come out with a mechanism through which rating agencies are not paid their fees by the companies they rate — maybe a fund can be created to which all companies that need a rating contribute. This could assist in rating agencies becoming truly independent.

It should be only a matter of time before IL&FS is bailed out. If the government wants to send a message that not all companies will be bailed out, they should ensure that a portion of the costs of the bailout is paid for by the persons who created the need for a bailout.

The writer is a chartered accountant.

Published on October 04, 2018

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