Can Abu Dhabi Investment Authority and TN Govt Salvage IL&FS’s Tirupur Project?
The Abu Dhabi Investment Authority and the Tamil Nadu government are doing a due diligence on the controversial Tirupur Water Project set up by the cash-strapped Infrastructure Leasing and Financial Services (IL&FS) more than two decades ago. 
 
Abu Dhabi Investment Authority is the third largest shareholder in IL&FS with 12.56% stake, after Life Insurance Corp of India (LIC) at 25.34% and Orix Corp of Japan with 23.5% stake in the company. 
 
Like the GIFT City project of Gujarat, the Tirupur project, too, led by IL&FS has been mired in litigation for a variety of reasons. 
 
What has angered investors are teh fat project costs extracted by IL&FS as well as frequent changes in its cost structure. 
 
The Tirupur water project, conceived by IL&FS in the mid-1990s was an innovation of privatising water supply. The idea was to provide a steady supply of water to this extremely wealthy hosiery-exporting town in Tamil Nadu. 
 
IL&FS anchored the project and, eventually, ripped off huge project management fees, exactly like in Gift City (READ: Is GIFT City Gujarat’s Gift to IL&FS through One-sided Deals?). After many twists and turns, angry investors who had been promised high return filed litigation in the Madras High Court. 
 
A hard-hitting order by Justice V Ramasubramanian in 2014, is a stunning exposé of IL&FS’s functioning and this strange project. 
 
The Court observed that the Tamil Nadu government, as one of the promoters, was forced into a position where it would be investing more money just for servicing a debt while IL&FS was deducting hefty project management fees and service charges from funds that were yet to be received. 
 
The court order has an excellent narration of what happened. It says… 
 
“In pursuance of the Memorandum of Understanding reached on 25.8.1994, a public limited company, namely New Tirupur Area Development Corp Ltd (NTADCL), was floated and incorporated on 24 February1995 with initial equity participation from Tamil Nadu Corporation for Industrial Infrastructure Development Ltd (TACID), Tirupur Exporters Association and IL&FS.
 
IL&FS floated a competitive bidding process in the United States, for funds from the US Market. It received eight bids, the lowest being from Bear Stearns Co Inc (which actually went belly-up in the 2008 sub-prime mortgage crisis in the US). The lowest bid indicated a tenure of 30 years with a moratorium of 10 years and repayment in 40 equal semi-annual instalments. During the interregnum between the date of the Common Loan Agreement namely 22 March 2002 and the first amendment dated 11 November 2003, IL&FS effected a transfer of Rs93.96 crore being the disbursement of equity debt and USAID loan, after making deductions towards (costs; (ii) project management fee; (iii) upfront fee; and (iv) out of pocket expenses.
 
Though the amount that was actually transferred on 29 May 2002 was Rs93.96 crore, the gross disbursements were taken to be Rs140 crores comprising of Rs35 crore towards equity, Rs15 crore towards subordinate debt and Rs90 crore towards senior debt.
 
Out of the gross disbursement of Rs140 crores, IL&FS deducted a total amount of Rs41.24 crore whose break up was (i) project management fee of Rs9.60 crore; (ii) costs of Rs15.15 crore for USAID loan ; (iii) upfront fee of Rs66.50 lakh; (iv) merchant banking fees of Rs10.04 crore and (v) out of pocket expenses of Rs5.79 crore.
 
(aa) The above deductions made by IL&FS appear to have created ripples in the Board, with the nominee director of AIDQUA Holdings (Mauritius) Inc raising objections. The objection of AIDQUA (appellant herein) was that when the amount of Rs140 crore has not even come to NTADCL, IL&FS were not justified in deducting a huge amount of Rs41.24 crore.
 
(ab) In the meantime, the work on the project of setting up the plant appears to have commenced in November 2002 and eventually, water started flowing (or trickling down) to the common users, both industrial and domestic, in May 2005. What flowed thereafter appears to be only litigation.”
 
Justice V Ramasubramanian observed, “The Government has pumped in money, unfortunately, only to service the debt with a pre-condition that the money will not even be used to improve the infrastructure. Investing more money just for the purpose of servicing a debt, is neither a prudent business decision nor in the interest of the public. 
 
“The result of the approval of the CDR Scheme is that the debt due to the creditors got converted into equity to some extent and that the Government agreed to bring in Rs150 crore, only for the purpose of servicing the debt, without being able to improve either the capacity of the company or to improve the marketability of water through legislation. Therefore, it is clear that the money brought in by the Government is required only to go down the drain, as waste water, if no law is enacted.”
 
“…the Government of Tamil Nadu shall not make any further investment, towards the implementation of the corporate debt structure (CDR) Scheme, till a decision on the question of enacting a law is taken. Till then, the status-quo as on date shall be continued subject to the other conditions imposed by the Company Law Board, for retention of the affirmative voting rights and the preservation of the Articles of Association,” the HC said, while hearing a petition filed by AIDQUA Holdings, a special purpose vehicle floated by Singapore-based AIDEC Management Co Pte Ltd, an investor in the Tirupur water project. AIDQUA Holdings was lured by IL&FS to invest Rs90 crore in the project, the High Court observed. But more about the court case later.  
 
In the same year, IDBI sanctioned rupee term loan to NTADCL (New Tirupur Area Development Corporation Limited), promoted by IL&FS, to set up Tirupur Water project involving drawal, treatment, and distribution of 185 million litres of water per day (MLD) of water from River Cauvery to industrial and household consumers in Tirupur Municipality, Tirupur Local Planning Area, and wayside villages. 
 
The project also involved waste water treatment. IDBI accepted the estimated project cost of Rs1,163 crore with this break-up..
 
 
The project was based on a 30-year build-own-operate-transfer (BOOT) structure with project IRR (internal rate of return) `of 20%. If case of IRR shortfall, the project could be extended by another 20 years in terms of the Concession Agreement between the company and government of Tamil Nadu.
 
When IL&FS approached IDBI for the debt, the project development was largely over with most of the project documents executed. That was quite impressive. 
 
Assuming that the subordinated debt would be genuinely and fully subordinated, the DER of 1.5:1 for the project (see the table below) looked appropriate calculated on base-case projections that seemed feasible.
 
Means of Financing
 
 
However, the proposed shareholding pattern (given below) was absolutely jarring.
 
 
According to Rajendra M Ganatra, an insolvency resolution professional and restructuring consultant, it was inconceivable that IL&FS, the main promoter who claimed 20% project IRR, would keep just 9% in the game and give away 91% equity to others. 
 
"The lines of credit, which IL&FS was deploying were available for limited time and hence Tirupur project seemed to be the only option. If we recall Australia Japan Cable project of Telstra, it had shared equity with high-class partners such as AT&T, NTT DoCoMo, at par, but that was for specific risk mitigation by them and resultant huge value addition," he says.
 
IL&FS’s largesse had no such lofty ideals behind it. This made the IDBI project appraisal team sceptical about the credibility of projected project returns and the promoter’s ability to execute the project. 
 
The appraisal team had other issues too relating to the organisation. There was no one who had the credentials for constructing and operating such project, successfully. Hence, IDBI sanctioned the debt with several caveats.
 
Over a year after the sanction, IL&FS went back to IDBI with a reduced project cost of Rs1,050 crore for the same configuration. 
 
It turned out that the World Bank, consistent with its procurement guidelines, had insisted on international competitive bidding for the project contracts. 
 
Biddings under the aegis of multi-lateral-agencies cannot be doctored. Afraid that they might lose the contracts, the same project contractors bid lower values and won the bids. This meant that the earlier project cost had been padded by IL&FS. However, given the importance of the project, IDBI went ahead with the final debt sanction.
 
In project financing, Mr Ganatra says, lenders look at the promoter’s credentials in executing similar projects successfully or ability to forge strong teams to ensure successful construction and operation. 
 
This vital element was absent in the Tirupur water project, and it became evident when the project was handed over to a chief executive (CEO), who had been a bureaucrat without any experience in project execution. The project continued to lag and is a failure. Today, even after almost two decades, the project debt stands at around Rs700 crore.
 
Coming back to the Madras High Court judgement, there were several cases filed by the promoters and partners of the Tirupur water project. 
 
In one such case, the Company Law Board (now it is National Company Law Tribunal-NCLT), dismissed the petition filed by AIDQUA Holdings, which resulted in the writ petition before the HC. 
 
Coming down heavily on the CLB, Justice Ramasubramanian said, “Under the guise of passing an order either under Section 402 or under Section 403, the CLB is not competent to re-write a contract. The appellant was lured to invest a sum of Rs90 crore in the company, at the instigation of IL&FS and a shareholders' agreement dated 12 April 2001 was entered into. The shareholders' agreement conferred certain special rights upon the appellant. The CLB, by the impugned order, has obliterated those special rights, by reducing the shareholding of the appellant from 27.89% to 14.35%. This has the effect of re-writing the shareholders' agreement itself…”
 
“The CLB ought to have seen that the Government of Tamil Nadu failed to enact a law regulating the abstraction and use of ground water for non-domestic purposes in the service area of the company. Therefore, the CDR cannot really take off,” the HC noted.
 
Tirupur water project’s failure is typical of IL&FS’s consistent failures in all the projects that it has undertaken as developer so far. It adopted form over substance in the matter or risk management and fleeced the banks as long as it could thinking that if it turned too big to fail, it will continue to get restructurings ad-infinitum. Alas for IL&FS, the profligacy has its limits.
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    COMMENTS

    Dayananda Kamath

    11 months ago

    It is one more case of Modi Govt not initiating action when due. Which may lead to its waterloo.

    Shankar Pachari

    11 months ago

    This is a good article. A complex issue explained in simple terms.

    IL&FS appoints SB Mathur as its new Chairman
    Infrastructure Leasing & Financial Services (IL&FS), the debt-ridden conglomerate, has appointed Sunil Behari (SB) Mathur as its new chairman. Mr Mathur replaced Hemang Bhargava. Following step down by its founder Ravi Parthsarathy on 20 July 2018, IL&FS had appointed Mr Bhagava as non-executive chairman.
     
    Mr Mathur is former chairman of Life Insurance Corp of India (LIC). He was also former Administrator of Specified Undertakings of Unit Trust of India (SUUTI). He has been on the Board of IL&FS since January 2005 and is an independent director. Mr Bhargava, who is stepping down as non-executive chairman of IL&FS is managing director of LIC. 
     
    As reported by Moneylife, IL&FS, the massive conglomerate of over 174 direct and indirect subsidiaries, is unravelling fast. Like the cops in Bollywood movies, the regulators and rating agencies have woken up to the implications of IL&FS’s imploding only after it began to default on its obligations. The Reserve Bank of India (RBI), which classifies IL&FS as a systemically-important non-banking finance company, has ordered a special audit, only after it began to default.
     
    At IL&FS, things started unravelling rapidly after Moneylife first reported its Rs1 000-crore default to SIDBI (Small Industries Development Bank of India) on 4th September.
     
    This was followed by other defaults and a series of credit downgrades by rating agencies. The group debt is currently estimated at Rs1.2 lakh crore and what we have seen so far are tiny ineffectual steps by the board. It is nowhere up to the task of resolving a giant problem that is, once again, likely to need a bailout by the public through the exchequer.
     
    During August 2018, rating agencies downgraded credit rating of IL&FS Holding Co to AA+ by all three agencies (placed on credit watch with negative implications by two and rating watch with developing implications by one) from AAA (stable) due deterioration of credit profile of some of its key subsidiaries and continued leverage at an elevated level with depletion of liquidity buffer.
     
    Deterioration in the credit profile of IL&FS Transportation Networks Ltd (ITNL) consequent to escalated leverage at Standalone as well as Consolidated level together with decision to terminate few projects led to downgrade of its credit rating from A to BB. ITNL intends to terminate some of its projects affected by breach of key obligations of the project authority such as handover of land and full ROW. It has withheld further support to these SPVs which have subsequently reported irregularity in debt servicing. ITNL is pursuing early realisation of substantial project related claims, has taken up a strategic divestment programme and is recapitalising with a Rights Issue of Rs3,000 crore. However, the foregoing have resulted in delays in servicing its liabilities in few instances. 
     
    The rating of IL&FS Financial Services Ltd (IFIN), wholly owned subsidiary of IL&FS was downgraded from AAA to AA (with negative implications) on account of increased exposure to group companies, moderate profitability on account of higher credit costs and reduced level of importance to its parent company in view of the reorganisation of business at IL&FS level. 
     
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    Why Does IL&FS Ratings Downgrade Matter to You
    In the previous week, rating agencies ICRA, CARE and India Ratings downgraded the bonds, long-term loans and short-term commercial papers of Infrastructure Leasing & Financial Services (IL&FS) and its subsidiaries. It is interesting to note that IL&FS did not seek ratings from CRISIL.
     
    The credit ratings of IL&FS’ bond papers went down by nine notches to ‘BB’ grade, which is...
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