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Inter-corporate financing a boon or a bane

June 17, 2012

IT was as far back as in 1984 that Irtiza Hussain, the first chief of Corporate Law Authority (now SECP), cracked down on a textile company that attempted to commit fraud on the small shareholders.

Believing that no one was watching the CEO of the company, who also was the head of the powerful textile lobby—All Pakistan Textile Mills Association, doled out immense sum of money to a private subsidiary at a high interest rate.

But a year later, the textile tycoon quietly wrote off the interest , which he told the shareholders the new subsidiary was unable to pay. At the next shareholders’ meeting, the sponsors lamented that the subsidiary was unable to pay the principal sum too, which they proposed to write off.

However, Irtiza got the principal and interest reimbursed to the publicly listed company.

Over the years, inter-corporate financing has taken many hues and is sometimes difficult to trace. Besides siphoning off funds from public limited company into subsidiaries—which are generally wholly owned by the sponsors and directors, there have been countless other ways to rip off small shareholders of their fair share in listed companies.

Some recent examples include unauthorised donations to the associated companies, renting out company-owned premises to associated companies without recovering full and timely rentals and misstatements in published annual accounts.

Yet, many corporate executives argue that inter-corporate financing is not altogether a dirty business. “What is required is to create a balance between the rights of shareholders and the need to facilitate access to finance associated undertakings ,” says Muhammad Ali Tabba, CEO at Lucky Cement, the largest cement producer in the country. Mr Tabba also heads a segment of Yunus Brothers group of companies that holds diversified interests in textile, cement and power generation. He asserted that so long as the financing to subsidiaries and associated undertakings is at “arms length” and the funds are lent on a return of market or bank rate, there should be no grievance.

The former Chairman of National Investment Trust Tariq Iqbal Khan says that it is not always with an eye to milk the listed public company that sponsors tap funds from such companies to finance smaller associated companies or subsidiaries: “It is much easier source of acquiring finance than to go through all the procedural hassles in securing loans from banks,” he observes.

And anecdotal evidence suggests that even many of the big conglomerates, whom the banks are always pleased to extend credit, are, loathe to turn to them, due to the persistent volatility in the money market; instead, they prefer inter-corporate borrowings.

The two most common forms of regulatory misconduct that the majority shareholders are guilty off in inter-corporate lending include the failure to disclose to the shareholders, the fact that company has disbursed funds to the subsidiaries and eventually to keep all of the profit that the subsidiary earns for self, instead of sharing it with minority shareholders.

The regulator(SECP) has continued to advocate that the ‘‘Companies (Investment in Associated Companies or Associated Undertakings) Regulations, 2011, have tried to provide guidelines for streamlining investments made by listed companies in associated firms and its proper disclosure.

Also to ensure disclosures and strictly monitor directors from making investments in their own companies, the name, amount of loans, their purpose and the expected benefits to the investing company has to be clearly spelt out in the company reports.

Many market experts also suspect that the statutory auditors have in several cases fallen short of fulfilling their responsibility of pointing out unlawful inter-corporate financing and giving out an independent and objective opinion on financial statements of the companies.

Section 208 of the SECP Ordinance, which pertains to the inter-corporate financing, provides that a company should obtain approval of shareholders through a special resolution for financing subsidiaries and associated concerns.

As the largest mutual fund in Pakistan, the NIT holds big stakes in scores of listed companies and the Funds’ representatives often sit on the company boards. With this exposure, Tariq Iqbal Khan points out three things that ought to be looked into the fairness or otherwise of inter-corporate lending.

One that it should be approved by 45 per cent of the shareholders present at the extraordinary meeting at which such resolution is to be moved; second, there ought to be no cost mis-match, and third , the financing should not exceed 20 per cent of the sponsors’ equity.

But for all that, Tariq Iqbal Khan argued and many other market participants concurred that if the inter-corporate financing is on the rightful terms, the minority shareholders should not have right to intervene and block such lending.

“Such an act will put corporate democracy in peril and give the minority shareholders undue rights,” they say, adding that all of that could result in small shareholders rowdiness at the annual general meetings, who are seldom interested in the company beyond gifts and lunch. To an honest set of minority shareholders, the law provides the right to restrain majority from exercising their decision on corporate financing, if those small shareholders could gather 55 per cent of the votes of members present at the company meeting against such a resolution.