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Institutional EYE

Commentary on Corporate Governance Issues

What next for IL&FS

The government has superseded the board of Infrastructure Leasing and Finance Company Limited (IL&FS). What should the board now do, to help put the company back on track.

Given the size of the of the problem, IL&FS is the largest bankruptcy facing the Indian financial system. For the government to stand aside and let events take their own course was never going to be an option. Their intervention is welcome, in large part for the signal this sends. Appointing a new board is the easy first step. Now the heavy lifting needs to begin.

First the board needs to appoint a chief executive officer (CEO) and a new management team. These are the people who will separate the wheat from the chaff.

They will first need to unpack IL&FS. IL&FS has 169 group companies with 24 direct subsidiaries, 135 indirect subsidiaries, six joint ventures and four associate companies2. Subsidiaries have subsidiaries. IL&FS Transportation Network Limited for instance has 72 subsidiaries, with the offshore subsidiaries having even more subsidiaries. This is the starting point of any analysis.

They will then need to look at each entity and each project housed within it, with the linkages and money flows. Also look at related party transactions undertaken, not just between parents and subsidiaries, but also between ‘fellow subsidiaries.’ These should be revisited primarily to look at their legitimacy and establish whether profits of any entity were being artificially inflated as a consequence. 169 group entities warrant this exercise. Once the viability of each project is established, the board will be able to decide which project can be sold, and those that require a work-out to make these projects attractive to potential buyers.

Integral to this exercise is the financing structure for each of the projects and their cash flows. This will help determine the funding gaps both at the project and consolidated level, and importantly will bring focus on how these are to be met, factoring in the optimum leverage profile for the business as a whole. Putting large parts of it under a scalpel for the much need simplification, negotiated sales, work-outs and renegotiating agreements will keep the management busy for the foreseeable future.

This brings me to the decision of the government to supersede the board and replace it with one of its own choosing. In one step the board regains credibility. Shareholders and lenders will be comforted by the board with Uday Kotak, the tallest banker, Vineet Nayyar, who dealt with the Satyam fiasco first-hand and emerged victorious, GN Bajpai, with his deep linkages to LIC and SEBI and serving (Malini Shankar) and retired (GC Chaturvedi, Nand Kishore) civil servants. Having trustworthy persons on the board – or certainly those who enjoy the governments confidence, together with shareholders nominees, helps in many ways.

First in calming markets – certainly at the time of writing, it has.

Two the fear building was that decisions will just not get taken and that even if there is a realistic bid on the table neither will the government owned shareholders nor will the state-owned banks be able to decide. This risked even serious players from bidding for the assets, substantially lowering the expected recovery rates. This new board signals that the government is backing it, providing the needed comfort to shareholders and to the various lenders – particularly those government owned. This will empower them to take bold decisions within a reasonable time frame. For example, shareholders should now be more sanguine in subscribing to the rights issue as a few adults have been brought into the room to monitor it. The same applies to asset sales.

Three, this is a board the government can now work with. If there are payments due from the government entities, the issues can be resolved on a priority basis. If the projects are stuck because of land acquisition, the board can have these expedited. If the viability of projects is questionable, the board can lean on the government to modify the concession terms, so that these become whole again.

Even as this work is underway to realize value from the business, it is the time for market participants to introspect. For rating agencies to ask themselves what is it that they missed that lead IL&FS to ‘jump to default.’ For lenders to ask why themselves they continued to lend when leverage was way beyond what may be considered prudent. For mutual funds to ask themselves why they blindly accept what the rating agencies said and did not do their own homework. For the regulators to ask themselves about their actions when they first spotted signs of risk building up. For directors to ask themselves, why were they not more questioning of management and let themselves be blindly led. And for shareholders to ask themselves why they ignored the auditors warning regarding the “ability of the company’s ability to continue as a going concern” or the “managements plan to raise funds” and waited for the company to default.

A modified version of this blog appeared in Business Standard on 4 October 2018. This version updates for developments upto EOD 4 October 2018, as footnotes. You can read the article by clicking on this link or typing the following url: https://www.businessstandard. com/article/opinion/what-next-for-il-fs-118100400065_1.html


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