The National Company Law Tribunal (NCLT) permitted the government on Monday to seize control of infrastructure finance major Infrastructure Leasing and Financial Services (IL&FS) with its nominees. Section 241 of the Companies Act of 2013 permits the changing of the board if matters appear to be “prejudicial” to the “public interest”, and this has been correctly used by the NCLT in this instance. The government argued that the current directors had “failed to discharge their duties”, given that the company had so unexpectedly descended into fragility.
A string of unheralded defaults by the company and its subsidiaries over the past few weeks had caused downgrades to its credit rating, and a haste to sell equity in the company which in turn looked to spark contagion in the broader markets. Given that much of the overall debt was held by IL&FS’ complex system of subsidiaries, there was considerable uncertainty about who and what would suffer from future defaults. IL&FS needed a strong leadership and it was obvious that a discredited board, which was clueless about the mounting problems, had no moral authority to steer the rescue operations. This uncertainty is what was fuelling the concern that rippled through markets. Thus, the government stepping in to remedy the situation in the troubled infra major is the right thing to do.
Overall, this is reminiscent of the approach taken when it was revealed that the leadership of IT company Satyam, including its founder-chairman Ramalinga Raju, had been fudging its books. That mammoth fraud threatened the ongoing operations of Satyam, its many employees and the India information technology services story more generally; the government-appointed board disentangled the good from the bad and eventually sold the remnants to Tech Mahindra. Even though the IL&FS crisis is much larger than Satyam in terms of the sheer scale, the echoes of the Satyam move are visible in the constitution of the new board. The question is whether the new board, the members of which are of unquestionable integrity and competence, will be able to repeat the Satyam story for IL&FS.
On Sunday, IL&FS had announced a plan to raise more capital, including additional debt from the banks. Equity holders have also agreed to participate in the accompanying rights issue, including government-controlled Life Insurance Corporation of India, and big Japanese and Emirati funds. It is not yet clear if this process is going to be continued with under the reconstituted board. Either way, however, some quick remedial action from the new board would be welcome. The new board should fix responsibilities for the mess that IL&FS finds itself in. For example, the commercial paper of IL&FS Financial Services was swiftly downgraded from A1+ (strong degree of safety and lowest risk) to default status in just three weeks, suggesting that there were enough warning bells, which everyone seems to have ignored. Also, not only have concerns about IL&FS and the slide in the markets they caused wiped out many months’ gains for mutual funds, but the company is central to the Indian infrastructure sector and is the main operator for several crucial ongoing projects. Delays in these would cause mounting costs and have severe ramifications for the rest of the economy, and for the growth recovery.