It's advantage clients in fight over derivatives losses

 
Source :BS :Ranju Sarkar / New Delhi May 20, 2010, 0:32 IST

Court interventions turn the tables on forex derivative losses, as banks push for out-of-court settlements.

The scales are slowly tilting in favour of exporters in their fight with banks on foreign exchange derivatives losses, which triggered a number of court cases in 2008.


If banks had an upper hand initially and forced many exporters to bear the losses, today many of them were willing to bear a bulk of the losses, said sources in the exporter community.

Axis Bank, for instance, recently settled a contract with Nahar Industrial Enterprises at 30 per cent, meaning the bank agreed to bear 70 per cent of the losses.
 
In 2009, YES Bank settled a contract with Sundaram Brake Linings in which it agreed to absorb 60 per cent of the losses.

Axis Bank did not respond to an email from Business Standard. Nahar officials confirmed the settlement, without disclosing details. YES Bank said the figures were incorrect but did not deny the settlement. Sundaram Brake Linings, in its results for the year ended March 2009, said it had settled the contracts with all banks. In two years, it paid Rs 9.48 crore to settle the total loss of Rs 109.48 crore it ran up on these contracts. If one goes by these figures, it seems the company had to bear only a tenth of the losses.

This is a big change from 2008, when a few judgements went in favour of banks and companies like Sundaram Multi-Pap or Nitin Spinners had to bear all the losses. So, what has changed?

Orissa HC stepped in

For one, there was an Orissa High Court order on December 24, 2009, wherein it directed a Central Bureau of Investigation (CBI) probe on a public interest suit blaming banks for these losses. More than this order, there was a sequel — the two reports sought by the court from the Reserve Bank of India (RBI) and CBI which confirmed many of the violations the exporters were claiming. ‘‘With this, the civil cases have become stronger. We don’t have to argue the extremely complex cases afresh before district courts to convince the judiciary about violations. Wwe can furnish the two reports, which confirm our allegations,’’ said S Dhananjayan of Tirupur’s Forex Derivatives Consumer Forum.


The HC had asked CBI to probe alleged mis-selling of these products, violation of foreign currency laws and any ‘‘offences of cheating, criminal conspiracy and fraud’’.

‘‘If the allegations are found to be true, CBI would be busting a large financial scam affecting the economy of the country,’’ the court had observed. But, on February 19, banks got an interim stay from the Supreme Court on the HC order.
Earlier, in a report to the high court,  
CBI gathered data from RBI that 11 banks
had unrealised dues from customers
to the tune of Rs 755.45 crore between April 2007 and December 2008, 
while the gross mark to market losses 
(by writing down the value of assets to their current value)
for customers of 22 banks were Rs 31,719 crore 
between 2006 and 2008.


Banks had sold exotic derivatives to exporters,
who suffered huge losses when their calls on currencies
went wrong. In 2007, such bets had backfired when the
swiss franc and the yen rose dramatically against the dollar.

After Orissa, more settlements are happening.
‘‘We would keep crying foul about banks and
few would take note. But, when everything
we have been saying is confirmed by RBI and CBI,
we stand vindicated,’’ said Dhananjayan,
a chartered accountant whose business is at stake,
as many Tirupur’s exporters facing closure are his clients.

Bankers’ imperative

On the other side, banks are also under pressure to clean up their balance sheets and provide for the losses on forex derivatives. ‘‘Besides, they realise there’s little chance of them winning the civil cases,’’ said Dhananjayan.

No wonder, banks are increasingly pushing for out-of court settlements (see table). They have already settled many high-profile cases.

Some exporters in Tirupur, who paid a substantial amount to settle the contracts, sense an opportunity. ‘‘They realise that it was not worth paying and are trying to recover their money by filing recovery suits,’’ said an exporter.

Besides the Orissa HC ordering a CBI probe, another milestone in exporters’ battle was the Supreme Court judgement on June 29, 2009, in the case titled Nahar Industrial Enterprises vs HSBC Bank.

The court said the challenges go into the very legality of the contract, and hence, these cases have to be tried in the civil courts, and not in debt recovery tribunals (DRTs).

What this means is that all forex derivative cases will have to be tried in civil courts and not DRTs. ‘‘These tribunals (DRTs) are mainly recovery agents of banks; there’s very little scope of getting a fair trial,’’ said an exporter.

In fact, cases (on forex derivatives) in various courts have never been argued, except in Rajshree Sugars. In every case, banks take up the jurisdiction point.

They have been arguing that every dispute should go to the Mumbai DRT, given the Isda Agreement and the terms of the contract. Isda, the International Swaps Dealer Association, represents participants in the derivatives industry.

However, the Nahar judgement ensured banks could no longer seek to transfer suits to the Mumbai DRT; this was quashed by the SC judgement. ‘‘The DRT mechanism is very simple. Banks would take a recovery certificate from the tribunal and recover the money/assets, just like they would recover other loans,’’ said an exporter. It also meant this fast-track mechanism was closed for banks and they had go through a real probe in civil courts.


Exporters grab advantage

And so, banks have been pushing for out-of-court settlements,
while exporters have been keen to pursue cases in civil courts.
This could simply be a pressure tactic to force banks
to settle the contracts on favourable terms to exporters.

For now, the strategy seems to be working.

But, exporters are equally to blame.
They all made money on these contracts the year before losses
threatened to edge them out of business.

They don’t deny this. 

What they contend is that the losses were highly disproportionate to the profits they made.
For instance, as cited in the Orissa HC judgement, a company which made
a profit of Rs 4 lakh on a contract the previous year made a loss of Rs 2.39 crore
on the same contract in 2008.

‘‘These were highly one-sided contracts.
Banks have speculated on behalf of exporters.
When losses came, they were booked on exporters,’’ said Dhananjayan.

.............................................................................................

FOREX DERIVATIVES: A CHRONOLOGY
 
I  .   MARCH-JUNE 2008

* Banks, exporters discover they are sitting on huge mark-to-market (MTM) losses on forex derivatives contracts due to adverse currency movements

* Many companies had bet on currency markets to make a quick buck. In 2007, such bets had backfired when the swiss franc and the yen rose dramatically against the dollar

* Many companies like Ranbaxy, Amtek start booking MTM losses. It became clear that forex losses would drag down corporate performance for subsequent quarters

* It became apparent that these were not just currency swaps but banks had sold more exotic and complex structures to companies, few of whom understood these trades

* In some cases, the MTM losses on forex derivatives were higher than a company's net profit in the previous year or their net worth, which threatened their existence

* Many smaller companies took banks to court, alleging they mis-sold these exotic products and sought refuge in litigation. Banks also sued many exporters

* Interestingly, many companies made profits on these derivatives the year before bets went wrong. Companies argued losses are several times higher than profits

II .  SEPTEMBER-DECEMBER 2008

* On Sep 15, the Bombay High Court asked Sundaram Multi-Pap to pay ICICI Bank Rs 2.94 crore as dues on derivatives contracts with the bank that it had failed to honour

* On Oct 15, the Madras High Court ruled in favour of Axis Bank, terming its contract with Rajshree Sugars legal. Review petition is pending before the division bench

* The disputes have not been argued, except in Rajshree Sugars' case. Banks harped on jurisdiction and sought to transfer the civil suits to Mumbai DRT
 
III  .  MAY-DECEMBER 2009

* On May 19, 2009, Cuttack-based lawyer Pravanjan Patra files a public interest suit in the Orissa High Court, seeking a CBI probe into forex derivatives losses

* In a significant judgement on June 29, 2009, in a case between Nahar Industrial and HSBC, the SC said derivatives cases have to be tried in civil courts, not in a DRT

* Orissa HC seeks a report from CBI, which finds that 11 banks had unrealised dues to the tune of Rs 755.45 crore between April 2007 and December 2008

* Of this, Rs 329.53 crore is under litigation; banks have written off Rs 203.79 crore. Gross MTM losses on these contracts between 2006 and 2008 were Rs 31,719 crore

* The SC judgement in the Nahar Case and reports by CBI, RBI in the Orissa HC, confirm malpractices and violations in forex derivatives; puts banks on the defensive

* Banks push for out-of-court settlements and are today willing to absorb a majority of the losses, unlike 2008, when they were forcing exporters to bear the bulk of the losses
..................................................................................................

WHAT COURTS RULED
Company	Bank	Court	Verdict
Sundaram Multi Pap Ltd	ICICI Bank	Bombay High Court	Co. lost case on a winding up petition, had to
Rajshree Sugars and Chemicals	Axis Bank	Madras High Court	Lost a case in front of a single judge. Its review petition pending in front of the division bench
Sundaram Brake Linings	Kotak Mahindra Bank	Madras High Court	Out of court settlement
Sabare International	ICICI Bank	Karur District Court	Cases still pending
Precot Meridian	Kotak Mahindra	Coimbatore District Court	Out of court settlement
Garg Acrylite	ICICI Bank	Haryana District Court	Cases still pending
Nahar Industrial Enterprises	HSBC Bank	Supreme Court	The SC disallowed the DRT to hear or pass any rulings on the forex derviative related cases
Sundaram Brake Linings	Yes Bank	Madras High Court	Out of court settlement
NCS Sugars Ltd	ICICI Bank	Hyderabad High Court	Out of court settlement
Nuzhiveedu Seeds	ICICI Bank	Bombay High Court	Out of court settlement
This is not an exhaustive list. Several cases were filed across district courts in the country.