' TAHIR MAHMOOD, COMMISSIONER (CLD).---This order shall dispose of show-cause proceedings in the matter of Show Cause No,EMD/233/141/2002/2227-2233 dated August 10, 2010, under section 208 read with 473 and 476 of the Companies Ordinance, 1984 (the 'Ordinance') issued to the directors of J.K Spinning Mill Limited (the "Company").
2. The Annual Audited Accounts of the Company for the year ended June 30, 2009 (the `Accounts') in Note 9 to the Accounts, revealed that the Company has shown an amount of Rs, 24.806 million (2008: 28.943 million) as trade debts receivable from J.K. Sons (Pvt.) Ltd. (the `J.K. Sons'), an associated Company. The Company stated, upon enquiry made by the Commission that it has recovered all the outstanding balances from previous year and the balance outstanding in the current period relate to current year only.
3. However, the current account of the J.K. Sons maintained in the books of the Company reveal the opening balance of Rs, 30.411 million, as on July 1, 2007, due from J.K. Sons, which has only been reduced during the period to Rs, 26.992 million till September 2, 2008 and did not fall below a minimum balance of Rs, 23.572 million during the period ending on June 30, 2009.
4. It has been observed that the Company has been acting as a financer to J.K. Sons and the funds of the public listed company was advanced without the authority of the shareholdeRs, However, the Company has never obtained shareholders approval of the Company for extending advance/loan to its Associate company J.K. Sons under section 208 of the Ordinance.
5. Consequently, a show-cause notice dated August 10, 2010 (SCN) was issued to the Chief Executive and all of the directors (the Respondents'), calling upon them to show-cause as to why penal action may not be taken against them under section 208 read with sections 473 and 476 of the Ordinance for violating the statutory requirements of the Ordinance. Syed Mansoor Naqvi, one of the directors of the Company, on behalf of all of the Respondents, submitted the following arguments vide his letter dated August 18, 2010:--
(a) The Company, while providing Ledger Account of J.K. Sons (Pvt.) Limited, for the period from 1- 7-2007 to 28-2-2008, informed that the said ledger reveal that the Company has recovered all outstanding balance from previous years and outstanding balance amounting to Rs, 1.717 million as on 28-2-2010 relates to current year only.
(b) An amount of Rs, 30.411 Million was recoverable as on 1-7-2007, which was reduced up-to Rs, 24.806 Million as on June 30, 2010. Subsequently huge recoveries were made and outstanding balance was reduced to Nil and may be verified from our Audited Account for the year ended June 30, 2010, after its finalization.
(c) It is further clarified that this is a Trade Debt Account, which does not fall under the provision of section 208 of the Companies Ordinance, 1984, therefore no approval from Shareholders was required as we did not extend any Advance/Loan to our Associated Companies.
(d) The Respondents also requested for personal hearing, if explanations did not meet the standards.
6. The Respondents were provided with hearing opportunities on October 11, 2010 and December 7, 2010. Mr. Syed Hussain Shahid Mansoor Naqvi. a director and one of the respondent, while also representing the remaining Respondents (the "Authorized Representative"), appeared and submitted the following representation:--
(a) These trade debts accumulated of normal sale operations to the associated companies and were remained stuck for a longer period due to the adverse market conditions which were deteriorated at that that time. Hence they could not be conceived as not in the nature of normal traded credit, for which a special resolution under section 208 of the Ordinance could be required.
(b) Furthermore, they were fully adjusted very recently and huge adjustments were made in financial year 2009-2010, through purchases.
7. The authorized representative further submitted his following written arguments vide his letter dated December 7, 2010:--
(a) From a thorough review of the section 208 of the Ordinance, it can be concluded that the "Normal Trade Credit" means a credit generated by any activity conducted in the normal course of an entity as it stipulates no time period for the same whereas for activities other than normal trade like investment, loans and /or advances, the section clearly indicates the terms and conditions for those activates.
(b) The Appellate Bench of the Commission in its order dated September 2, 2005, in the case of Messrs Suhail Jute Mills Limited clarified Normal Trade Credit as a credit given in normal course of business and such credit extended should be a current liability for the receiver.
(c) While interpreting the normal course of business from the definition of "buyer in ordinary course of business" in the "Uniform code by Cornell University Law School its is clearly provided that if the normal activity of an entity is the sale of yarn, then the normal course of business of that entity is the selling of yarn. This explanation read with the clarification provided by the Appellate Bench substantiates that the sales made to J.K. Sons is a normal trade credit.
(d) In view of the above submissions, vacation of above referred case has been requested.
8. The authorized representative solicited another hearing opportunity for presenting additional submissions that was granted on December 22, 2010. The authorized representative appeared on the hearing and submitted additional written submissions vide his letter dated December 21, 2010, that are as follows:--
(a) While referring to issue of open trade credit discussed during the meeting dated December 7, 2010, wordings of order of Appellate Bench of Securities and Exchange Commission of Pakistan in the matter of Suhail Jute Mills Limited were reproduced as under; "Furthermore, Appellate Bench of Securities and Exchange of Securities and Exchange Commission of Pakistan has decided a similar case against Gharibwal Company Limited in 2003. The bench clarified "normal trade credit" as credit given in normal course of business and such credit extended should be a current liability for the receiver. Open ended credit without specific purpose cannot be termed as "normal trade credit".
(b) Since our trade credit is based on specific purpose (i.e. Sales of our own Manufactured Yarn), therefore, it is a "Normal Trade Credit" and this cannot be viewed as breach of section 208 of the Ordinance". Hence, it is humbly requested that the above referred show cause may please be vacated.
9. I have gone through the facts of the case, record of the Company, relevant provisions of the Ordinance and written submissions made by the Respondents. My observations on the issue are as follows:-
(a) In the context of arguments put forth, the first and the foremost question to be addressed, among others, is whether the funds advanced to J.K. Sons from July 2007, which remained outstanding in the following years are in the nature of the normal trade credit or not. Although the words 'trade credit' could be of widest scope in general legal usage, I am of the view that the context in which these words have been used in the aforesaid provisions of law has limited meaning. In my opinion, 'Normal Trade Credit' has been used with reference 'to investing company and refers to the credit allowed by the investing company to its customers in the ordinary course of business, which should not be an open ended credit without specific purpose, as also referred by the Appellate Bench of the Securities and Exchange Commission of Pakistan, in the matter of Gharibwal Cement Company Limited in 2003 (The Respondents wrongly referred to the Enforcement Order in the matter of Messrs Suhail Jute dated September 2, 2005 as that of Appellate Bench Order.). The following discussion would sufficiently deliberate upon the tenor of loan far beyond a normal trade debt and was not a normal trade credit in the light of aforesaid discussion and the industry norms and the comparative credit terms afforded by the Company to other debtoRs,
(b) The current account of the J.K Sons, when called from July 1, 2007 revealed that there was an opening balance of Rs, 30.411'as on July 1, 2007 due from J.K Sons, and this outstanding amount, remained outstanding with minimal adjustments for two consecutive years i.e. Till June 30, 2009 (Rs, 24.807 million). The following table clearly shows that the overall balance remained on a higher side and did not fall below a dead/floor level of Rs, 23.572 Million (that only because of a large recovery of Rs, 2 Million) during the period from July 1, 2007 till June 30, 2009, which is the amount of funds made available by the Company to its associate without being charged with any interest which caused the Company with the opportunity cost of interest on the said outstanding amount.
Ledgar Account of J.K. Sons Summary of Major Credits after from July 1, 2007 to June 30, 2009 date Debit Credit Entries Running balance 1-7-2007 30,411473 18-10-2007 819,000 31,230,473 22-10-2007 819,000 32,049,473 25-10-2007 650,000 31,399,473 13-11-2007 871,000 32,270,473 15-11-2007 871,000 31,399,473 23-1-2008 819,000 30,399,473 26-1-2008 133,000 30,713,473 14-5-2008 3,721,150 26,992,323 9-2008 1,370,000 25,622,323 19-9-2008 50,000 25,572,323 31-12-2008 370,000 25,942,323 15-1-2009 170,000 25,772,323 15-1-2009 200,000 25,572,323 20-5-2009 24,940,323 31-5-2009 632,000 20,000,000 25,572,323 20-6-2009 23,572,323 30-6-2009 455,000 24,027,323 30-6-2009 259,500 24,286,823 30-6-2009 400,000 24,686,823 30-6-2009 120,000 24,806,823
(c) As for as the adjustment of the aforesaid balances due from the J.K. Sons by the Company is concerned, the following extract of major credit entries in the Ledger Account of J.K. Sons indicates declining balances mainly between the period starting from July 1, 2009 to February 2010, owing to the major credits summarized below, which however is a post event adjustment. The post facto adjustment/compliance does not discharge the respondents of their responsibility. The adjustments were made subsequently and almost after a period of two years where funds amounting to Rs, 23.572 million approximately were remained due from their associates for this period.
Ledgar Account of J.K. Sons Summary of Major Credits after from July 1, 2007 to June 30, 2009 date Mods of receipt Credit Entries Runnning blance 31 July, 09 Purchase-JV 2,781,354 22,367,369 31 July, 09 Purchase-JV 2,861,631 19,505,738 31 August, 09 Purchase-JV 2,934,240 16,424,398 31 August, 09 Purchase-JV 3,176,842 13,247,556 31 August, 09 Purchase-JV 3,046,803 10,200,753 1 Dec, 09 Purchase-JV 2,949,500 9,509,253 31 Jan, 10 Purchase-JV 2,678,802 4,441,951 31 Jan, 10 Purchase-JV 2,936,401 1,505,550
(d) In addition to the above, the following debtor turnover ratios and the average collection period for related party sale and others calculated from the information submitted by the Company, vide their reply dated April 26, 2010, indicate that J.K Sons has been favored vis-a-vis other debtors, proving the outstanding balances to be in the nature of abnormal trade credit. Preferential treatment was given to the associate when it was allowed an abnormally extended credit period when compared to other debtors of the Company.
Debtor Turnover Ratios/Average Collection Period (Rs, in million) Related Party Others Year Sale/ Trade Debts Turnover Ratio/ Average Collection PeriodSale/ Trade DebtsDebtor Turnover Ratio/Average Collection Period 2007 105.098/31.31 3.36/ 108 Days 805.724/94.725 8.51/ 43 Days 2008 34.035/30.142 1.13/ 323 Days 931.961/66.63 13.99/ 26 Days 2009 52.610/25.651 2.05/ 178 Days 791.711/124.754 6.35/ 58 Days
(e) The principal activity of the Company is manufacturing and sale of yarn and that of J.K. Sons is stitching and export of fabric and made ups. However, the Respondents claim that the amounts become due from J.K Sons were a result of sale of yarn, and that later on they were settled mainly on account of purchase of finished fabric from J.K Sons, which was exported to international market by the Company. The above explanation and the sequence of advancing of funds by the Company to its associate and its subsequent recovery through purchases demonstrate that the said funds were made available to its associate from July 2007 till the close of year 2009, without any specific purpose. Secondly, the Company first acted as supplier of yarn and later become the buyer of finished fabric, which is not its principle line of business. Infact, merely a quick look on the abnormally stretched credit period for which these funds remained outstanding and then their recovery in the form of purchase of finished fabric which is not covered by their main line of business, sufficiently demonstrate that there did not exist a normal trade relationship between the Company and its associate.
(1) This practice, evidently cannot be covered by the term `Normal Trade Credit' in accordance with requirements of section 208 especially in view of the fact that the expression "investment" has particularly been defined which provides that "The expression 'investment' shall include loans, advances, equity, by whatever name called, or any amount which is not in the nature of normal trade credit".
(g) In view of the foregoing discussion and the account analysis shows that the outstanding amount due from J.K. Sons by the Company is not in the nature of normal trade credit as explained in the particular context of the expression "investment" which has been defined in "Explanation" to subsection (1) of section 208 of the Ordinance. Rather in fact this is financing arrangement to support the cash flow requirements of the J.K. Sons.
8. The Directors utilized funds of the listed company to support the operation of their owned undertaking without approval of the shareholdeRs, It is a mandatory requirement of section 208 of the Ordinance that the funds can only be invested in the associated/ subsidiary company under the authorization of the shareholdeRs, It has been established that the Respondents have has violated the mandatory requirements of section 208 of the Ordinance. The management of the Company has deprived the shareholders to exercise their legitimate right to make a decision to invest in its associate.
9. The directors owe fiduciary duties to the Company they serve and its shareholdeRs, They must discharge their statutory obligations in good faith with fairness and honesty. In fact the Company has been acting as a financier by providing funds to the associated concerns to fulfil their financial requirements at the cost of the Company. They have breached their fiduciary' duty by providing unnecessary benefits to its associated undertakings where they are major shareholders and thereby acting against the interest of its shareholdeRs, The directors have failed to exercise reasonable care to see that mandatory provisions of law were being violated and have not respected the mandate of the shareholdeRs, This clearly establishes that the Chief Executive and all the Directors have purposefully and deliberately avoided complying with the mandatory provisions of the Ordinance knowing well that they were duty bound to do so. The default, therefore, is considered deliberate and wilful. The Chief Executive and the Directors have, therefore, made themselves liable for fine as provided under subsection (3) of section 208 of the Ordinance.
10. For the foregoing reasons, it is established that the provisions of section 208 of the Ordinance have been violated and funds have been advanced in total disregard to the shareholders approval. After analyzing the facts of the case and arguments put forward, I am of the considered view that these do not carry rationale and are not acceptable. However, considering the representations of the Respondents that the remaining debt balance due from J.K. Sons, standing in the books of the Company, has been adjusted by way of subsequent purchases from J.K. Sons, I, instead of imposing maximum penalty of Rs, 10,000,000 (Ten million rupees) on each of the respondent as prescribed by subsection (3) of section 208 of the Ordinance, impose an aggregate fine of Rs, 700,000 (Rupees Seven hundred thousand only) on all of the Respondents, in the following manner:-- S. No. Name of the Respondent Penalty
1. Mr. Jawed Anwar, Chief ExecutiveRs, 100,000
2. Mr. Faiq Jawed, Director Rs, 100,000
3. Mr. Shaiq Jawed, Director Rs, 100.000
4. Syed Hussain Shahid Mansoor Naqvi, Director/Company SecretaryRs, 100.000
5. MRs, Farhat Jehan, DirectorRs, 100.000
6. MRs, Samina Abid, DirectorRs, 100.000
7. MRs, Nageen Faiq, DirectorRs, 100.000 11, The Chief Executive of the Company and aforesaid Respondents are hereby directed to deposit the aforesaid fine of Rs, 700,000 (Rupees Seven hundred thousand only) in the designated bank account maintained in the name of Securities and Exchange Commission of Pakistan with MCB Bank Limited within thirty days from the receipt of this Order and furnish receipted vouchers to the Commission, failing which proceedings under the Land Revenue Act, 1967 will be initiated which may result in the attachment and sale of movable and immovable property. It may also be noted that the said penalty is imposed on the Chief Executive and other respondents in their personal capacity and they are required to pay the said amount from their personal resources.