UNDER PROVISIONS OF SECTION 208 READ WITH SECTION 476 OF THE COMPANIES ORDINANCE, 1984 This order will dispose of the proceedings pertaining to making unauthorized investments in an associated company in contravention of the provisions of Section 208 of the Companies Ordinance, 1984 ("the Ordinance"), which have arisen out of the show cause notice EMD/233/645/2002 dated February 15, 2006 served on all the directors including the Chief Executive of Ittehad Chemicals Limited ("the Company").
2. The Company is a public company limited by shares incorporated on September 28, 1991 and got listed on Karachi Stock Exchange on April 14, 2003. Company has authorized capital of Rs.750 million and paid up capital of Rs.300 million as per its audited financial statements for the year ended June 30, 2005. The Board of Directors of the Company during 2005 comprises of the following: i). Mr. Muhammad Siddique Khatri, Chairman & Chief Executive ii). Mr. Abdul Ghafoor Khatri, Director iii). Mr. Abdul Sattar Khatri, Director iv). Mr. Abdul Aziz Khatri, Director v). Mr. Mansoor Ahmed Khatri, Director vi). Ms. Farhana Sattar, Director vii). Mr. Fawad Yousuf, Director
3. The facts leading to this case are that on examination of annual audited accounts ("the accounts") of the Company for the year ended June 30, 2005, it was revealed that Company has shown an amount of Rs. 41.058 million as trade debts receivable from an associate M/s Chemi Visco Fibres Limited (hereinafter referred to as "CVFL"). Note 9.1.1 to the accounts further mentioned that: QUOTE "The amount under this head includes a balance of Rs. 40.026 million receivable from CVFL, an associated company. This balance is net of payment made as per the settlement agreement dated June 29, 2005 as approved by Board of Directors of the Company in their meeting dated June 29, 2005. The balance is receivable in equal quarterly installments latest by June 30, 2006 ..."
UNQU OTE The above statement raised doubt that the said receivable may not be in the nature of normal trade credit as provided in Section 208 of the Ordinance. The Enforcement Department ("the Department") vide letters dated December 01, 2005; January 06, 2006 and January 24, 2006 sought details of the aforesaid transaction from the Company. The Company provided the relevant information vide its letters dated December 14, 2005; January 20, 2006 and Janaury 31, 2006 along with copies of the following documents: i). Copy of settlement agreement between Company and CVFL dated June 25, 2005; ii). Annual accounts of CVFL for the year ended June 30, 2004; iii). Copies of current accounts of associated undertakings; and iv). Extracts from the minutes of the relevant board meetings.
4. The information, particularly copies of current accounts, provided by the Company raised further doubts that transaction with CVFL were in the nature of 'investment' as provided in Section 208 of the Ordinance. Consequently a show cause notice dated February 15, 2006 under the provisions of Section 208 of the Ordinance was issued to all the directors including the Chief Executive of the Company, requiring them to show cause within 14 days of the date of the notice as why penal action may not be taken against them under Sub-section (3) of Section 208 of the Ordinance.
Briefly, following were the grounds of the show cause notice: i). Copies of the current account of associates revealed that the Company is selling goods to its associated companies on regular basis whereas the amount outstanding against such sales is not recovered on a periodical basis. As a result, outstanding balance from associated undertakings has been increasing from year to year. ii). Company kept on selling goods to CVFL without following any systematic recovery procedure.
As on June 25, 2005 the outstanding balance with CVFL reached to Rs. 80.526 million. On the same date Company entered into a settlement agreement with the associate to recover the outstanding balance in installments. iii). Company has paid expenses on behalf of CVFL.
5. The reply of show cause notice was jointly submitted by the Chief Executive Mr. Muhammad Siddique Khatri and other six directors vide their letter dated March 09, 2006. Following submissions were made in the letter: i). Section 208 applies to cases where investment is made in the associated companies and by no stretch of imagination the transactions entered between the Company and CVFL can fall within the definition of "investment". CVFL is in fact a consumer/purchaser of chemicals manufactured by the Company. The sale of products to CVFL on normal financial and credit terms cannot be construed as investment requiring a special resolution under the provisions of Section 208 of the Ordinance. ii). No preferential treatment has been given to CVFL. The Company has in fact, saved money by selling the caustic soda to CVFL rather than in the market as the particular concentration of soda being sold to CVFL has lesser market demand. iii). The Commission is being influenced by the subsequent events which resulted in CVFL's project being delayed and subsequently suspended and repayment of normal trade credit faced some delays. However, the Company was able to make recovery arrangements with CVFL and a sum of Rs. 63.249 million has been received from it since June 30, 2005 to date and the Company has also recovered late payment charges from CVFL. iv). The Commission may appreciate that any requirement of passing a special resolution under Section 208 would have arisen if the Company would have made investment either by way of granting of a loan or credit facility to CVFL in a nature other than as a normal trade transaction.
6. A hearing in the matter was fixed for April 20, 2006 and the same was communicated to all the directors of the Company. On the date of hearing Mr. Arshad Tayebaly, advocate appeared on behalf of all directors along with CFO of the Company Mr. Javed Iqbal, before the undersigned. The representatives reiterated all the arguments which were given to the Commission in the earlier reply. The legal representative stressed that the transactions with CVFL were based on normal trade credit terms and Commission issued the show cause notice merely due to delay in some payments by CVFL, which happened due to its bad financial position. Whereas, despite the bad position of the debtor, Company has received Rs. 55 million from it during the financial year ending June 30, 2005 and adequately responded to the delayed payments by entering into an agreement with CVFL on June 25, 2005 whereby most of the outstanding balance has been received until the date of hearing. He furthersubmitted that as the Company has suffered no loss due to the normal trade transactions with CVFL, therefore, the show cause proceedings against the Company should be dropped.
7. I have considered all the relevant facts, position of law and have also analyzed the documents placed before me. Provisions of Sub-section (1) of Section 208 of the Ordinance provide that:'
QUOTE
(1) A company shall not make any investment in any of its associated companies or associated undertakings except under the authority of a special resolution which shall indicate the nature, period and amount of investment and terms and conditions attached thereto.
Provided that the return on investment in the form of loan shall not be less than the borrowing cost of investing company.
Explanation: 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.
UNQU OTE I have analyzed each transaction made by the Company with its associated undertakings in light of the above provision of law and I would like to discuss the issues which remained unsatisfied even after hearing with the representatives of the Company.
(i) Whether transactions with associates are in the nature of 'normal trade credit'?
It has been contended by the Company, in its letter and during the course of hearing that transactions and outstanding balance with the associate CVFL were in the nature of 'normal trade credit.' In order to determine the nature of these transactions, it would be useful to refer to the expression "investment" which has been defined in "Explanation" to Sub-section (1) of Section 208 of the Ordinance, referred above. It is clearly stated in this explanation that the term 'investment' includes all kinds of loans, advances, equity or any other amount excluding normal trade credit.
Since the main issue in this matter is to determine whether the outstanding balance due from CVFL is normal trade credit or not, it is necessary to analyze all the facts available in this regard. I am of the view that the words 'normal trade credit' have been used in the Section to refer to the 'credit' allowed by a company to its customers in the ordinary course of business and according to industry norms and the amount of Rs. 41.058 million receivable from CVFL as on June 30, 2005 was not a normal trade credit due to the following facts: a) Credit period allowed to CVFL was not normal: Preferential treatment was given to CVFL when it was allowed an extended credit period with compared to other debtors of the Company.
Examination of current accounts shows that during the year 2005, Company kept on making regular sales to the associate throughout the year without recovering the amounts on regular basis as appear from following . {{TABLE}} table: TRANSACTIONS WITH CVFL Rupees in millions Sales and other payments Receipts Receivable at year end 2003 1.734 0.529 (Receivable of Rs. 0.915 million transferred to the account of another associate)
0.289 2004 48.733 26.741 22.113 2005 73.479 55.042 41.058 The bulk of transactions appear in year 2005. Although a sum of Rs. 55 million was recovered against the sales during the year, however, Rs. 43 million of these receipts was recovered after June 15, 2005 i.e. during last 15 days of the financial year.
Otherwise balance outstanding on 15-06-2005 was Rs. 80.526 million. The normal credit period allowed to other customers of the Company is 60 days and in case of non-payment within 60 days, late payment charges are applicable to these customers as appear from Clauses 4(a) and 4(b) of settlement agreement with CVFL, dated June 25, 2005; which states that: "4(a). All future deliveries of caustic soda by Ittehad shall be strictly on 30 days credit with a grace period of 30 days as applicable to other customers of Ittehad.
4(b). In the event of failure on part of Chemi to make payment with in 60 days, Ittehad will be entitled to make late payment charges on the amount thereof calculated at weighted average borrowing cost incurred by ICL during the last preceding quarter.
Current accounts show that credit period of several months was allowed to CVFL and Company booked late payment charges only once on 25-06-2005. b) Company paid expenses on behalf of CVFL: Examination of current accounts of CVFL shows that, contrary to the submissions of the Company, there are transactions other than mere sales of caustic soda to CVFL. During 2003 Company paid various expenses on behalf of CVFL including utility bills, salaries, store sales etc. During 2004 and 2005 regular store payments appear in the current accounts. Some further information received from Company vide letter dated April 28, 2005 shows that these store sales comprise of either sulphur, which is a major raw material of both companies and purchased in bulk by the Company, or imported store items. c) Company kept on making sales to CVFL despite its bad financial position: Company has been entering into sales and other transactions with the CVFL without recovering the amount in a regular fashion. These figures in the above table show that receivable from CVFL kept on increasing from year to year because Company kept on making sales/other expenses to associate despite its bad financial position and apparently being a non-viable project, which again shows preferential treatment given to CVFL. The bad financial position of CVFL is apparent from following statements of Company: " The management has made a full provision against the carrying value of the investment in CVFL, an associated company. The provision has been made as a matter of prudence since the project of investee company is not operating and there is some uncertainty regarding future earning and related cash flows."
(Note 5.2 to the annual accounts dated June 30, 2005)
" .....Since the project (CVFL) did not revive during the year 2004 and consequently the net realizable value of investment in the investee company based on the discounted value of projected cash flow was substantially lower than the previous one, directors of the Company thought it prudent to make a full provision ...... "
(Letter to Commission dated December 14, 2005) d) Transactions with other associates: Company has not commented on transactions with other associates. Current accounts show that Company has been paying expenses on behalf of Ittehad Energy Limited other than CVFL. Payment of expenses on behalf of associates can by no stretch of imagination be termed as "trade credit"
(ii) Whether Ittehad Chemical has suffered any loss due to violation of Section 208?
Having established the fact that outstanding balance from CVFL is not in the nature of normal trade credit, and is a violation of Section 208 of the Ordinance, it is to be determined whether the Company has suffered loss due to the action of directors.
Obviously Company has not charged any return on the advances given to CVFL as it has continued to treat the balance as normal trade credit. This undue advantage given to associated undertaking resulted into loss to the Company and its shareholders and is an unwarranted benefit to the shareholders of associated undertakings. For the forgoing, I am left with no doubt in holding that Ittehad Chemical has suffered losses as a consequence of its investment in CVFL, which were made without shareholders approval.
8. From the above discussion, I am of the view that the provisions of Section 208 of the Ordinance have been violated and directors are liable for penalties as defined in Sub-section (3) of the aforesaid provisions of the Ordinance. Sub-section (3) of Section 208 of the Ordinance provides that if default is made in complying with the requirements of this section, every director of the company who is knowingly and willfully in default shall be liable to fine which may extend to one million rupees and in addition the directors shall jointly and severally reimburse to the company any loss sustained by it in this respect.
However, giving the benefit of the fact that Company has recovered major amounts from CVFL subsequent to agreement dated June 25, 2005 and the balance receivable from CVFL as on April 21, 2006 is reduced to Rs. 15.408 million, I am taking a lenient view and instead of imposing a maximum penalty of Rs. 1,000,000/- on each director, impose a total fine of Rs.175,000/= as under: {{TABLE}} S # Name of Directors Amount of Penalty 1 Mr. Muhammad Siddique Khatri, 25,000 2 Mr. Abdul Ghafoor Khatri 25,000 3 Mr. Abdul Sattar Khatri 25,000 4 Mr. Abdul Aziz Khatri 25,000 5 Mr. Mansoor Ahmed Khatri 25,000 6 Ms. Farhana Sattar 25,000 7 Mr. Fawad Yousuf 25,000 Total 175,000
9. The Chief Executive and directors of the Company are hereby directed to deposit the aforesaid fine in the designated bank account maintained in the name of Securities and Exchange Commission of Pakistan with Habib Bank Limited or pay through a demand draft in the name of Securities and Exchange Commission of Pakistan within thirty days from the receipt of this order and furnish receipted bank vouchers to the Commission, failing which proceedings for recovery of the fines as an arrear of land revenue will be initiated. It may also be noted that the said penalties are imposed on the directors in their personal capacity; therefore, they is required to pay the said amount from their personal resources.
10. The directors are further directed to abide by the provisions of law in future and to obtain the approval of shareholders, as provided under Section 208 of the Ordinance, for future transactions with the associates, which are not in the nature of normal trade credit.