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Leela-Brookfield Deal To Leave Behind Shell Company With Only Liabilities, ITC Says

If Hotel Leelaventure Ltd. is allowed to sell its properties and operations to Brookfield Asset Management Inc. in a Rs 3,950 crore deal, it will end up becoming a shell company with only liabilities. Two minority shareholders—ITC Ltd. and its wholly-owned subsidiary Russell Credit Ltd.—of Hotel Leela Venture have approached the National Company Law Tribunal with this argument, alleging oppression and mismanagement.

ITC is not the only one to have beef with the Leela-Brookfield deal. As per Hotel Leelaventure’s stock exchange notification, Securities and Exchange Board of India in its letter dated April 23, has also noted the red flags raised by ITC and Life Insurance Corporation of India regarding related party transaction violations. SEBI is examining these representations and has directed Hotel Leelaventure to put the deal on hold.

The Brookfield-Leela Deal

The Leela-Brookfield deal entails:

  • Sale of hotels, including property and operations, situated in Delhi, Bengaluru, Udaipur and Chennai.
  • Transfer of 100 percent shares of the company which owns the property and holds license for development of a hotel in Agra.
  • Transfer of intellectual property owned by promoters and their affiliates to Brookfield for Rs 150 crore.
  • Additional payment of Rs 150 crore to promoters Vivek Nair and Dinesh Nair by Brookfield for providing certain business expansion services.
  • A potential joint venture agreement between the promoters and Brookfield for certain development activities, which have not been elaborated.
  • A license agreement and centralised services agreement between Brookfield and Hotel Leelaventure for the hotel in Mumbai, pursuant to which Brookfield will be in charge of its operations.
  • Execution of a fresh lease agreement for the Bengaluru hotel and termination of the old one.

Each of these transactions is considered vital for the entire proposal and failure of even one of them would ensure that the entire transaction falls through, ITC has emphasised.

Hotel Leelaventure has stated that the deal amount of Rs 3,950 crore will be used to repay debts to existing lenders, including JM Financial Asset Reconstruction Company (JM ARC) which is both a creditor and shareholder in the company.

Oppression and Mismanagement Allegations

ITC has stated that the transaction is prejudicial to the interest of the shareholders because:

  • It involves disposing virtually the whole of company’s assets and undertakings, leaving it a shell company with only liabilities.
  • The proposed non-compete covenant on Hotel Leelaventure, some of its promoters and directors will restrict the company’s ability to conduct business. Through this, the income stream of the company is sought to be depleted artificially and wrongfully for the benefit of the promoters, who will still benefit as a result of side deals worth Rs 300 crore.
  • Neither the board nor audit committee sought a valuation report while evaluating and approving the transaction. This is prejudicial to the interest of the company and its shareholders and the committee members are in breach of their fiduciary and statutory duties.
  • The board and audit committee neither recorded nor treated the transaction as a related party transaction. If the transaction is deemed to be a related party transaction, the promoters of the company along with JM ARC, would not be able to vote on it.

The Related Party Angle

Given that the deal is a composite of several transactions, and some of those transactions involve related parties, the entire deal should be should be treated as a related party transaction, argues ITC.

  • Integral aspects of the transaction—potential joint venture, business expansion services—is directly linked to the promoters.
  • JM ARC—which is both a shareholder and creditor—will receive full payment of its dues pursuant to the transaction. In addition, JM Financial, parent of JM ARC, is the exclusive advisor to the company for the transaction and will receive payment for its services as investment banker on completion of the transaction.

Back in 2012, JM ARC had acquired 95 percent of the total debt, worth Rs 4,150 crore, of Hotel Leelaventure when its corporate debt restructuring process failed. Subsequently, JM ARC converted a part of its debt into equity and acquired 26 percent stake in the company. The promoters and JM ARC’s collective shareholding is 73.27 percent.

Accordingly to ITC, the transaction is a scheme of arrangement under the Companies Act which can only be implemented after due regulatory scrutiny of the stock exchanges, SEBI, and NCLT.

The transaction is nothing but a thinly guised device to evade such approvals and scrutiny and defeat the provisions of law.
ITC’s Petition

ITCs allegation is that the promoters and JM entities will benefit from the transaction, which will in turn deny the minority shareholders of value and benefits from the transaction. Even if true, it would amount to a transaction that benefits the promoters but it does not fall within the definition of related party transaction under the Companies Act, Murtaza Somjee, partner at law firm Jerome Merchant + Partners told BloombergQuint.

What may become a challenge for the promoters and JM entities are the SEBI regulations which define ‘related party transactions’ more widely. However, in my opinion to prove that a transfer of resources is occurring between Leela and its promoters it will need to be shown that the side arrangements aren’t genuine and are merely diversion of funds, which may be an uphill legal challenge.
Murtaza Somjee, Partner, Jerome Merchant + Partners told Bloomberg Quint.

Relief Sought By Hotel Leelaventures

Hotel Leelaventures’ minority shareholders have asked for the following reliefs:

  • Issue of 26 percent shares to JM ARC be declared void and illegal.
  • The meeting of audit committee and board of directors which approved the Brookfield deal on behalf of the company be declared vitiated and of no legal effect.
  • The promoters—Vivek Nair, Dinesh Nair, Leela Lace Holding Pvt Ltd. along with JM ARC—as shareholder not be entitled to vote on the resolutions pertaining to the transaction.
  • Promoters Vivek Nair and Dinesh Nair step down as directors and chairman/co-chairman along with four other members of the board and audit committee.

The petitioners have also sought mandatory injunction against the implementation of the transaction.

ITC’s Asks: Hurdles

Before ITC can even get to arguing the merits of its case, it will need a waiver from the NCLT. An oppression and mismanagement case can be brought by shareholders that collectively hold 10 percent or more of the issued shares. In this case the aggregate shareholding of ITC and its subsidiary is 8.72 percent.

ITC will need to cross this major hurdle of shareholding threshold and this is definitely a challenge that may not be easily surpassed, Somjee said. But there is enough for the court to look into as ITC has strong grounds to make a case of promoters and JM entities benefiting at the expense of the company, he said.

There is no straightforward formula-based test to grant waiver. One of the factors that tribunals have considered in the past is the value of the investment of shareholders raising an oppression or mismanagement claim. If ITC’s investment in Leelaventures by value is considered significant by the tribunal, it could certainly be a ground to allow the waiver.
Murtaza Somjee, Partner, Jerome Merchant + Partners

Sandip Bhagat, partner at S&R Associated, pointed to the NCLAT judgement in Photon Infotech Pvt. Ltd., where it was held that the 10 percent threshold requirement can be waived in the interest of ‘substantial justice’ in case of exceptional circumstances. In that case, a substantial portion of the company’s business was transferred to another by way of slump sale and it was held to be an exceptional case just to hear the minority, he said.

The tribunal has in the past given waiver to other shareholders with less than the stipulated 10 percent shareholding, in the Tata Mistry case for instance. The NCLT will have to consider the specific set of facts that apply here before determining if there are grounds for waiver.
Sandip Bhagat, Partner, S&R Associates

Whether the court actually finds oppression or mismanagement is a different matter, he said.