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How an NRI’s attempt to take over 2 Indian firms led to LIC turning invincible

In 'Fifteen Judgments', Saurabh Kirpal talks about the events leading up to the LIC judgment that made the company a pillar of the Indian economy.

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Hostile takeovers are the stuff of movie legends. Marauding corporate raiders attempting to take over family-owned businesses only to sell their assets have us on the edge of our seats. While life rarely mimics cinema, the case of Swaraj Paul’s attempted takeover of two large Indian conglomerates in the 1980s is one such exception. Business, politics and law made a potent cocktail; resulting in a landmark judgment of the Supreme Court in the case of Life Insurance Corporation v. Escorts Ltd (‘the LIC case’).

The case concerned a failed attempt by a non-resident Indian (NRI) investor to take over the rather sleepy businesses of the day. The matter saw many ups and downs. The government was split down the middle, with some institutions favouring Swaraj Paul while other authorities and politicians took a protectionist line, seeking to safeguard the interests of Indian-owned businesses. Even the courts were divided. The Bombay High Court initially handed a big win to the Indian owners. However, when the matter was carried to the Supreme Court, a bench of five judges unanimously held in favour of Paul. This was, however, to prove to be a pyrrhic victory, as ultimately, the takeovers fell through.

While the takeover was unsuccessful eventually, the legacy of the judgment is being felt even today. The LIC judgment has enshrined the principles of shareholder democracy, defined the concept of corporate personality and clarified the role of the Reserve Bank of India and financial institutions. These principles, which form the bedrock of corporate governance, are deployed to date, including, most recently, in the fight between Cyrus Mistry and the Tata Group. Hence, while the history of the dispute does make for a tantalizing read, a careful examination of the LIC judgment would prove to be far more beneficial to any student of law and industry.

Faced with dwindling foreign exchange, the government had brought into force the notorious FERA in 1973. The idea was to ‘Indianize’ industry and to ensure foreigners could not own vital sectors of the economy. Coupled with the licensing regime, the economic environment of India was anything but free. One natural effect of this was that the Indian companies that did manage to survive faced virtually no competition and were mollycoddled. Promoters of large concerns, facing no competition, diluted their equity. Large portions of the equity were held by public financial institutions.

Promoters could, with the tacit consent of the institution, run large industrial conglomerates with equity of as low as 5 per cent. This cozy arrangement between the promoters and the financial institutions was soon to be shaken by the new legal regime.


Also read: Was there an ‘original meaning’ to Article 21? Supreme Court judgment holds the answer


Two Delhi-based conglomerates were particularly vulnerable because of the low promoter holding. The first was Delhi Cloth and General Mills (DCGM), which was founded by Lala Sri Ram. A self-made man, Lala Sri Ram made the company grow from owning just a cloth mill to a large conglomerate having interests in sugar, chemicals, machine parts and many other areas. In 1980, its turnover was a staggering Rs 420 crore,8 the equivalent in today’s money of about Rs 8000 crore. However, the family owned only about 10 per cent of the total equity in the company. The rest was either publicly held or owned by the institutional investors. The other corporation was Escorts Ltd, promoted and controlled by the family of H.P. Nanda. Escorts, at that time, was a giant in the manufacture of tractors and other industrial equipment. Even though its turnover was around Rs 240 crore, worth about Rs 4500 crore today, its promoters owned only 5 per cent of its shares!

Sensing the frailty of DCGM and Escorts, the wily NRI investor, Swaraj Paul, decided to move in. Swaraj Paul was born in Jalandhar but had moved to the UK where he had made a large fortune with his Caparo group of industries. Paul decided to use the new regime to take over the companies and appointed Punjab National Bank as his bankers. He instructed
the bank to write to RBI seeking its approval for the opening of thirteen non-resident external (NRE) accounts for the purposes of ‘conducting investment operations in India’. These thirteen companies were fully owned by one Caparo Group Ltd.9 61.6 per cent of the Caparo Group Ltd was, in turn, owned by the Swaraj Paul family trust. In a strict understanding of the law, therefore, the conditions of the circular had been complied with, with NRIs owning over 60 per cent of the shares of the companies through which investments were made.

Swaraj Paul also appointed one Raja Ram Bhasin & Co. as his stockbroker in the Delhi Stock Exchange. The Caparo companies gave instructions in January to the brokers to commence purchase of shares of DCGM. Similarly, the Caparo companies started buying the shares of Escorts around February. Paul had begun his attempted takeover of the companies even before RBI permission had been formally obtained.

The promoters of DCGM and Escorts would initially have been unaware of this attempted takeover. It was only when the share prices of the two companies started surging that there was some concern. The prices of DCGM shares surged from about Rs 35 at the end of January to almost Rs 80 by the end of April, a rise of 130 per cent. The case was similar in the case of Escorts, whose share prices rose from about Rs 40 to Rs 70 in the same period, a rise of about 75 per cent.

The two industrialists were probably surprised at this abrupt and unusual rise in their share prices. They made inquiries about this sharp rise, only to discover that Swaraj Paul had begun buying large chunks of their companies’ shares. Not ones to simply cede control over their companies, the promoters began to push back, by taking recourse to both political as well as legal avenues.

The first few rounds seemed to have gone the way of the Indian promoters. Under the Companies Act, 1956, the board of directors of any company had the power to refuse to register shares. When Swaraj Paul asked for his shares to be registered, the two companies called for board meetings. At the meetings, the boards claimed that the shares had been bought in contravention of Indian laws and that there were serious irregularities involved in their purchase. The boards accordingly refused to register the shares. The nominee directors of the financial institutions either abstained in the vote or did not attend the meeting. Clearly, this could not have been done without at least some tacit support from the institutions.

Even the government appeared to initially support Indian industry. A group of industrialists went and met the finance minister and asked him to intercede in the ongoing battle. Captains of industry, including J.R.D. Tata, had a meeting with Pranab Mukherjee in April 1983 shortly whereafter even Rajiv Gandhi made a statement in favour of Indian industry, 11 saying that NRIs should be prevented from actions that might destabilize well-run
Indian industries.

The appeal appears to have had an effect. The government stepped in and sought to limit the amount of shareholding Swaraj Paul could buy. On 16 May, RBI issued a fresh circular. The effect of this circular was to put a cap on the total shareholding that could be acquired through the portfolio investment scheme at 5 per cent of the total paid-up equity capital of the company. Paul could not acquire more shares of the company to overtake the shareholding of the promoters. The only question was whether he had already managed to purchase sufficient shares in the companies to make the ban moot.

While this round seemed to have gone the way of the industrial houses, the next victory would be that of Swaraj Paul. Sensing that things were not going his way, Paul made a visit to India in July where he addressed large crowds of the then social influencers—stockbrokers, investors, journalists and members of Parliament. His argument was persuasive as it was based on sound economic policy. He pointed out that by refusing to transfer the shares in his name, the owners of large companies had created a virtual fiefdom for themselves. The reins of management passed down from generation to generation even though the owners had virtually no stock holding themselves. He also accused the managements of using public sector funds to bolster their own
positions.

This excerpt from ‘Fifteen Judgments’ by Saurabh Kirpal has been published with permission from Penguin India.

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