Vijay Mallya is back where he belongs: in the eye of a storm. The Board of Directors of United Spirits (USLL), once owned and controlled by Mallya, declared on April 25 that it had lost confidence in him as Chairman. The reason: a forensic audit commissioned by the company under its new owner, Diageo plc, revealed that as much as Rs 2,000 crore was diverted from the company to UB Holdings by Mallya between 2010 and 2013.
While Diageo wants him to resign from the Board of USL for allegedly indulging in ‘White Mischief’, Mallya has thrown a ‘Royal ‘Challenge at the company daring it to remove him if it can.
Before we look at how things are likely to pan out, here’s the background to the story. Diageo, the Scottish distiller that brews famous whisky brands such as Chivas Regal and Glenfiddich, bought 25 per cent of United Spirits’ equity from Mallya back in 2012 after doing its due diligence. Subsequently, the company increased its stake in USL to 54.8 per cent through two tender offers to common shareholders and a preferential offer by USL. In all, Diageo spent Rs. 18,023 crore ($2.8 billion) for the acquisition. The deal was completed and Diageo acquired control of the company in July 2013.
While finalising the annual financial statements for 2013-14, Diageo noticed discrepancies in loans extended by USL to UB Holdings before it had acquired equity interest in the former. It decided to do a forensic audit of the financial statements beginning 2010 and appointed audit firm PricewaterhouseCoopers for the purpose. The firm’s report tabled at the board meeting on April 25 showed that loans given by USL to UB Holdings were understated. In other words, funds had been diverted from USLto UB Holdings and other group companies when Mallya was their common owner.
The plot thickens
This is the background for the demand by the Diageo-controlled United Spirits for Mallya’s resignation as Chairman. But how is Mallya still the chairman with just about 3 per cent equity ownership in the company? That takes us to the Shareholders Agreement signed between UB Holdings and Diageo which allows the former to nominate a director on the USL board as long as it holds 1.3 million shares of the company. .
Mallya is now taking refuge under this agreement in the confrontation with Diageo and says that he cannot be removed. Ordinarily, removal of a director is a simple affair — the company has to call an extraordinary general meeting of shareholders and the resolution needs a simple majority to be passed. United Spirits can do the same.
Mallya, however, says that the Shareholders Agreement is supreme. The question is: how can two sets of shareholders sign a confidential agreement keeping out the third set, which is the public? Between Diageo and Mallya, they own approximately 59 per cent of USL; public shareholders own the balance 41 per cent. How can the latter be ignored? This is something that public shareholders can go to Court over.
Mallya has the best of both worlds now. He has raised money selling off his stake in USL but is still on its Board as Chairman, which is akin to exercising de facto control over the company.
Skeletons in the closet
Diageo seems to have painted itself into a corner having given the privilege to Mallya in their agreement. Worse, it is surprising how the company failed to discover the suspicious transactions when it did its due diligence. This is what Mallya is arguing too, in his favour. Diageo has said that it did notice transactions without documentation between USL and UB Holdings during the due diligence. These were consolidated and the amount due to USL was found to be Rs.1,375 crore. The skeletons, however, started falling out of the cupboard only when the financial statements for 2013-14 were finalised after Diageo acquired full control of USL. That is when the loans were found to be under-stated.
With the stock exchanges, SEBI and even The Institute of Chartered Accountants of India (ICAI) entering the scene, the controversy has become very interesting indeed. Mallya may be walking on thin ground if SEBI decides to take the KPMG forensic audit report seriously. Watch this space.
Sidelight: PriceWaterhouse was the auditor of USL until 2010-11, which falls under the period when funds were alleged to have been diverted. Its international affiliate, PricewaterhouseCoopers, UK, was the firm that did the forensic audit now. Isn’t it strange to see an affiliate go into the work of its own group firm?