This post is authored by Devansh Parekh and Yuuvraj Vaidya, students of Government Law College, Mumbai, studying in their 4th year of the BLS. LL.B Course.
1. WHAT WENT WRONG?
Established in the 1920s, Lakshmi Vilas Bank (“LVB”) was started to promote trade in Western Tamil Nadu. However, one can say that presently, it is following the footsteps of Punjab & Maharashtra Co-operative Bank (“PMC”) and Yes Bank – in terms of accumulation of bad debts/Non-Performing Assets. Subsequently, in the present case, this led to the shareholders of LVB voting against the senior management due to an increase in value erosion and uncertainty of the future of the bank. Not to forget, their condition has been worsening for the past 3 years. The accumulation of bad loans began in 2017 when they shifted their focus from SMEs to big companies and shelled out huge loans to companies namely – Ranbaxy and Fortis Healthcare.
It was in 2018 that Religare Finvest, an arm of Religare Enterprises Limited (REL), filed a case at the Economic Offences Wing (“EOW”) against a Delhi-branch of LVB to recover fixed deposits worth about Rs. 800 crore that the bank had advanced to Ranbaxy as loans.[i] As per the investigation and examination of bank officials, along with the analysis of inquiry report and documents, it was concluded that bank officials, in collusion with promoters Malvinder Mohan Singh and Shivinder Mohan Singh, deliberately or knowingly ignored the formalities which are mandatory for the loan transaction.[ii]
2. FAILED MERGERS
2.1 Amended and finalized scheme
To bail themselves out, the board of LVB approved a scheme with certain amendments in the previously approved scheme by the LVB board and Indiabulls entities. The structure of the transaction was modified, wherein Indiabulls and its wholly-owned subsidiary, Indiabulls Commercial Credit Limited (“Indiabulls Commercial”), as the transferor companies would be amalgamated into LVB as the transferee company on a going concern basis. The share exchange ratio was decided at 1 equity share of Indiabulls of the face value of Rs. 2 each: 7.143 equity share of LVB of the face value of Rs. 10 each.
The proposed scheme of amalgamation described the rationale behind it as allowing Indiabulls Housing Finance Limited to access the deposit book of LVB, and LVB’s strong presence in south India. The amalgamation of Indiabulls Commercial was intended to utilize the capital available with it more efficiently rather than as a standalone entity. The scheme would have substantially capitalized the LVB, along with compensating for the handicap caused due to consecutive net losses from 2017 to 2019, and because of the overall poor performance of the bank, where LVB’s capital adequacy ratio fell lower than regulatory requirements.[iii] Going by the scheme, the capital supplement would have arrived from the Indiabulls balance sheet, which had a strong net worth of ~Rs. 19,000 Cr and healthy liquidity and cash balances of over Rs. 18,000 Cr.[iv] Further, the scheme would have been a strategic move to enter into the banking sector for Indiabulls, which had been vying for an independent banking license previously.[v]
However, the Reserve Bank of India (RBI) refused to accord approval to the proposed merger, exercising its powers under the RBI (Prior Approval for Acquisition of Shares or Voting Rights in Private Sector, Banks) Directions, 2015, and the RBI (Ownership in Private Sector Banks) Directions, 2016. Further, the Clix Group had preferred a non-binding amalgamation offer with LVB, whereby an infusion of Rs. 1500-1700 crore was being contemplated with the Clix Group holding 74% of the stake.[vi] However, the deal did not materialize in time.
2.2 RBI Restrictions
The RBI, in mid-November 2020, imposed a 30-day moratorium on LVB till December 16, 2020, under Section 45 of the Banking Regulation Act, 1949 (“Banking Act”) because almost a quarter of LVB’s advances had turned into bad loans, leading to the creation of a negative net worth, coupled with the failure to generate additional capital to maintain the requisite balance. This meant that the bank’s depositors could not withdraw more than Rs. 25,000 till the said date. However, some relief was granted as the government allowed certain depositors in exceptional cases to withdraw more than the limit of Rs. 25,000 for medical treatment, cost of higher education, marriage expenses, or unavoidable emergency. LVB is the third bank, followed by PMC and Yes Bank since September 2019, that has been placed under a moratorium and the Prompt Corrective Action (PCA) framework.
Since there was no viable strategic plan, the temporary plan notified by the RBI was to help revive the bank from its current position to protect the depositors’ interest and in the larger interest of financial and banking stability. The LVB depositors have complained time and again that these restrictions have caused a tremendous amount of trouble, especially amidst the pandemic. This has led to a significant downfall of LVB’s share price in the market.
2.3 Merger with DBS
Much to the depositors’ relief, on November 17, 2020, the RBI proposed a merger of LVB with DBS Bank India Ltd (“DBIL”), which is a subsidiary of Asia’s leading financial services group- DBS Group Holdings Limited (“DBS Bank”), and has the advantage of a strong parentage. This meant that the depositors could get access to their entire deposits if the amalgamation was successful. As per the reasons recorded by the RBI, DBIL would invest Rs. 2,500 crores upfront to support the credit growth of the company. Since DBIL has a strong financial position with sturdy capital support, even after the amalgamation, the combined banks would be able to sustain, owing to the comfortable level of DBIL’s capital. It is pertinent to note that according to the scheme of amalgamation published by the RBI (“Scheme”), by the exercise of its powers under section 45(4) of the Banking Act, the LVB’s undertaking shall be transferred and vested in DBIL.
The exercise of RBI’s power to compel this amalgamation in these dire straits for LVB is not typically the appearance that an amalgamation takes, as it involves consideration flowing to the shareholders of the transferor company. Moreover, as per the definition of amalgamation under Section 2(1)(b) of the Income Tax Act, 1961, it involves ¾ of the shareholders of the transferor company becoming the shareholders of the transferee company. However, according to Section 45(5)(g) of the Banking Act, the RBI is not obligated to comply with the aforesaid construct because sub-section (5) gives RBI the liberty to include any or all of the items provided under it to be included in a scheme.
3. BATTLEGROUNDS - BOMBAY HC AND MADRAS HC
The Bombay High Court (“Bombay HC”), in its interim order dated November 26, 2020, refused to adversely conclude that the scheme was not in the nature of an amalgamation even though Indiabulls contended that the scheme violated the rights of the Petitioners and 97,000 other shareholders, conferred upon them under Article 300A of the Constitution of India. Instead, the Court affirmed the RBI’s power to reduce the interest and rights of the member as may be necessary in the public interest. The Bombay HC, exercising established judicial restraint in matters of economic action or policy, refused to grant ad-interim relief and stated that any monetary claims of the shareholders may be decided upon at a later stage.
Contrary to the Bombay HC order, the Madras High Court (“Madras HC”) granted limited interim relief to the shareholders of LVB, although it refused to put a stay on the amalgamation. The Madras HC held that, “even if the power of reduction of their share value to a lower figure is given, reducing it to zero or negative, prima facie, cannot be done without very, very compelling reasons”. It further observed that the entire exercise of amalgamation had taken place in a fast-tracked manner, in the space of a week between November 17 and November 25, leaving the LVB shareholders in a blackout. The interim reliefs were as follows:
● No further prejudicial action shall be taken by DBS Bank against the LVB shareholders.
● DBS Bank should furnish an undertaking in the Court stating that if the Court concludes and directs it to provide compensation to LVB, they shall compensate the shareholders of LVB.
● As security, DBS Bank should create a separate reserve fund in its books of account to the extent of the face value of shares of the LVB and maintain the same subject to further orders and directions of the Court.
The Madras HC reiterated that they were not interfering with the operation of the scheme in any manner whatsoever. While the Madras HC and the Bombay HC have diverged in their views with respect to the scheme, they have left the door open for the shareholders to be remedied in the form of compensation, if at all.
4. ANALYSIS OF THE MERGER
The transaction posits an interesting structure where LVB shall be effectively & completely owned by DBIL, which is a subsidiary of a foreign bank, and thus, there shall be no breach of the FDI Policy. Since the Indian entity will not be issuing any shares, the 74% sectoral cap will not apply. Accordingly, the conditions under Annexure 8 of the FDI Policy may not be breached because:
Firstly, a foreign bank may operate in India through only one of the three channels, viz., (i) branches, (ii) a wholly-owned subsidiary, and (iii) a subsidiary with aggregate foreign investment up to a maximum of 74 percent in a private bank. DBIL will continue existing as the subsidiary of the parent foreign bank in consonance with the above condition. Secondly, in the event of the acquisition of shares of an existing private sector bank, at least 26 percent of the paid capital of the private sector bank is to be held by residents. Thirdly, DBIL shall not be in breach of the above conditions as the transaction is in the form of an amalgamation and there is no ‘acquisition’ of shares being undertaken.
The salient features of the Scheme include:
Firstly, the entire amount of the paid-up share capital, reserves, and the surplus of LVB will be written off. This means that the shareholders of LVB will be left with nothing, as the shares will completely lose their value. Subsequently, this will affect both retail and institutional shareholders of the bank. Therefore, LVB shareholders are not in favor of the merger, and have asked the RBI to reconsider the amalgamation scheme. In line with the Madras HC’s ruling, it may eventually transpire that the promoter-held share capital may be cancelled without any corresponding consideration, and the reduction of the shares held by the public, upon paying an exit price to protect the interest of the retail investors.
However, it remains to be seen if such an option remains feasible for DBS, considering that public shareholding constitutes almost 93% of the share capital. Additionally, LVB shall cease to exist when the merger is made effective. As a result, its shares and debentures on any stock exchange will be delisted without any further action.[vii] However, the implementation appears to ignore the repercussion of this provision, considering that the Scheme was published on November 17, 2020, post which, until November 23, the turnover volume on NSE has been almost Rs. 700 lakhs of shares, whose value is quite certainly NIL and have possibly been passed off to unsuspecting customers. This is also indicated by the fact that on November 14, 2020, the traded volume was approx. 57 lakhs, which jumped to 181 lakhs on the date of publication of the Scheme.[viii]
Secondly, the rights of employees have been preserved under the Scheme, as all the employees of LVB shall continue in service at the same remuneration and terms and conditions. Further, staff deposits shall be paid in full or the requisite provision shall be made to ensure the employees do not face losses. Thirdly, all varieties of deposits present with LVB as a part of the savings a/c, current account, or fixed deposits, recurring deposits, etc., shall be credited as a part of a new DBIL a/c.
On November 25, 2020, the cabinet approved this merger where DBS would invest Rs. 2500 Cr in the equity of the bank that will help the merged entity have an enjoyable position.[ix]
This move by the RBI is not unprecedented where it has saved a local bank from sinking. A similar instance was seen when the Global Trust Bank was merged with the Oriental Bank of Commerce in 2004, and Yes Bank was rescued by a consortium led by the State Bank of India in 2020.[x] However, what is interesting to note here is that LVB had been incurring losses for the past 3 years and the RBI only intervened once it began drowning irreversibly. The RBI was compelled towards the end when various capital raising or proposed mergers did not crystallize, and it exercised its wide plenary powers to secure public deposits, and depositor confidence. However, the RBI had to decide to guillotine the share capital of LVB, seemingly in line with the principle that while equity has unlimited upside potential in its investment, it conversely carries the burden of the entire risk as well. This relief comes as good news for the depositors.
The banking sector merger with a falling bank appeared to be a good commercial proposition for the foreign private player, suggesting that there is continuing trust in the Indian financial sector as an asset class, which has suffered from a few ‘Code Blue’ scares recently. It would be interesting to see if the shareholders take this amalgamation to the Supreme Court due to the unfortunate fact that their shares have been written off, as well as the differing views of the High Courts, and where the amalgamation undergoes a complete overhaul, in light of their protestations. It is also a matter of commercial practicality as it is unclear whether DBS will have contemplated having to make payments to shareholders, considering that RBI’s stand, inferred from the Scheme, would have been that DBS would not have to make payments to shareholders, and if monetary compensation was ordered, whether the transaction would continue to remain an attractive value of the proposition. As the case may be, DBS will have to live with this ‘onerous gift’, as unwinding an amalgamation is not as straightforward as a share exit and DBS will have to carry the burden of the liabilities that come with LVB.
[i] What went wrong with Lakshmi Vilas Bank? Here is all you need to know - ET BFSI, ECONOMIC TIMES, (October 01, 2020, 19:56 IST), https://bfsi.economictimes.indiatimes.com/news/banking/here-is-all-you-need-to-know-about-what-went-wrong-with-lakshmi-vilas-bank/78404094.
[ii] Religare case: Embezzlement of Rs 729 crore by 2 Lakshmi Vilas Bank employees- ET BFSI, ECONOMIC TIMES (September 28, 2020, 15:20 IST),
[iii] Surabhi, What the merger with Indiabulls Housing Finance would have meant for Lakshmi Vilas Bank, HINDU BUSINESS LINE,(10 October 2019), https://www.thehindubusinessline.com/money-and-banking/what-the-merger-with-indiabulls-housing-finance-would-have-meant-for-lakshmi-vilas-bank/article29633421.ece.
[iv] RBI rejects proposed merger of Indiabulls Housing with Lakshmi Vilas Bank, INDIA INFOLINE, (October 10, 2019 9:45 IST), https://www.indiainfoline.com/article/news-top-story/rbi-rejects-proposed-merger-of-indiabulls-housing-with-lakshmi-vilas-bank-119101000288_1.html.
[vi] Clix Group submits offer for up to 90% stake in Lakshmi Vilas Bank, BUSINESS STANDARD, (October 8, 2020 23:32), https://www.business-standard.com/article/companies/clix-group-submits-offer-for-up-to-90-stake-in-lakshmi-vilas-bank-120100801721_1.html.
[vii] Azman Usmani, Lakshmi Vilas Bank’s Shareholders To Get Nothing In Proposed Merger With DBS Bank, BLOOMBERG QUINT,(November 17 2020, 10:54 PM), https://www.bloombergquint.com/business/shareholders-to-get-nothing-as-rbi-proposes-lakshmi-vilas-banks-merger-with-dbs-india.
[viii] Lakshmi Vilas Bank, NSE INDIA, https://www1.nseindia.com/live_market/dynaContent/live_watch/get_quote/GetQuote.jsp?symbol=LAKSHVILAS#.
[ix] Anulekha Ray, Cabinet approves RBI's proposal to merge Lakshmi Vilas Bank with DBS Bank, LIVEMINT, (25 Nov 2020, 03:10 PM IST), https://www.livemint.com/industry/banking/cabinet-approves-rbi-s-proposal-to-merge-lakshmi-vilas-bank-with-dbs-bank-11606294724242.html.
[x] TT Ram Mohan, The Lakshmi Vilas Bank Rescue Does Not Mark A Trend, BLOOMBERG QUINT, (November 20 2020, 7:58 AM), https://www.bloombergquint.com/opinion/lvb-dbs-the-lakshmi-vilas-bank-rescue-does-not-mark-a-trend.