This order will dispose of the proceedings initiated against the Chief Executive and Directors of M/s S.G. Power Limited (the "Company") for making unauthorized investments in its associated company in violation of the provisions of Section 208 of the Companies Ordinance, 1984 (the "Ordinance").
2. The brief facts of the case are that while examining the annual audited accounts of the Company for the year ended June 30, 2004, it was observed by the Commission that as per Note 9 and 11 to the said accounts, Company has receivable balances of Rs.194,497,933 and Rs.28,694,388 as "Trade debts" and "Other receivables" respectively from its associated concern i.e. M/s S.G. Fibre Limited. These receivable balances from S.G. Fibre Limited were not falling in the nature of normal trade credit which is in violation of Section 208 of the Ordinance. {{TABLE}} Quote 2004 2003 Rupees Rupees "Note 9 DEBTOR Unsecured - considered good Associated undertaking - S.G. Fibre Limited 194,497,933 198,658,855 Maximum aggregate amount due from associated undertaking (S.G. Fibre Limited) at the end of any month during the year was Rs.231,514,771 (2003: Rs.198,658,855).
2004 2003 Rupees Rupees Note 11 OTHER RECEIVABLES Considered Good Interest on loan to associated undertaking - S.G. Fibre Limited 28,694,388 28,694,388 Maximum aggregate amount due from associated undertaking (S.G. Fibre Limited) at the end of any month during the year was Rs.28,694,388 (2003: Rs.28,694,388)."
Unquote {{TABLE}} The above revealed that the trade debts amounting Rs.194,497,933 far exceeded the annual sales of the Company which amounts Rs.191,862,245 thus resulting in trade debt collection period of 374 days which appears to be an abnormal trade credit period. It appears from the above analysis that there was no movement or any recovery in the year 2004 with respect to the interest on loan which was recoverable from the said associated company. The aforesaid details have been further compared and analysed for the years 2001 to 2005 in Para 7 of this Order.
3. It has been observed that the Chief Executive and Directors of the Company during the year ended June 30, 2004, instead of recovering the trade debts which were not in the nature of normal trade credit, extended further trade credit which is evident from the fact, as disclosed in above quoted Note 9 to the accounts that the maximum aggregate amount due from said associated company at any end of any month during the said year was Rs.231,514,771 as compared to Rs.198,658,855 in the year ended June 30, 2003. Further the said trade debts have risen to Rs.242,515,485 for the year ended June 30, 2005. In this connection, attention is drawn to the decision of this Commission in the Order of the Appellate Bench dated April 12, 2002 of M/s Gharibwal Cement Limited which states: "An open ended credit without specific purpose cannot be termed as normal trade credit.
Therefore, the mere fact that the parties have covered these financial facilities by subsequently entering into a Commercial Trade Agreement would not make the financial facilities extended fall within the ambit of "normal trade credit". In our view the Appellants have failed to prove that the objective was for normal trade practice."
In view of the above, the said ever increasing receivables were open ended credit and cannot be termed as normal trade credit.
4. The Chief Executive and Directors have breached their fiduciary duty by failing to exercise due diligence while providing open ended trade credits to its associated company and not recovering long outstanding interest receivables from the said associated company, without authority of the shareholders which is in violation of the provisions of Section 208 of the Ordinance which requires: "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."
This clearly establishes that the Chief Executive and all the Directors have knowingly and willfully avoided complying with the mandatory provisions of the Ordinance.
5. In this connection, a show cause notice dated March 1, 2005 was issued to the Chief Executive, Chairman and all the other Directors calling upon them to show cause as to why penal action may not be taken against them under Sub-section (3) of Section 208 read with Section 476 of the Ordinance for violating the statutory requirements of the Ordinance. A period of 14 days was given to respond to the aforesaid notice. The aforesaid notice was responded by the Company Secretary of the Company vide letter dated March 12, 2005 seeking extension of ten days for reply. The extension was granted and the Company was advised to submit reply by March 21, 2005. The reply was received on March 19, 2005. The submissions made by the Company in their said reply against the SCN are summarized as under:
(i) The Company stated that it examined the provision of Section 208 of the Ordinance and are of the view that trade debts are normal business trade debts and do not attract the provision of Section 208 of the Ordinance. The outstanding amount against S.G. Fibre Limited is neither loan nor advance, but normal trade receivable on account of electricity sold to S.G. Fibre Limited, a sister concern. Explanation of Section 208 of the Ordinance clearly state " 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. S.G. Fibre Limited, being sole buyer of their electricity, the Company had to extend credit facility with mutual consent, keeping in view their cash flow requirements. The associated company had been regularly paying the bills for electricity purchases.
(ii) The Company stated that it was formed in 1994 with the objective of generation and sale of electricity to its sister concern and also to other industry in the vicinity. However, the concerned authorities did not allow sale of electricity to other industries which were mentioned in annual report of 1997, 1998 and 1999. The Company had no choice but to supply electricity only to its associated undertaking S.G. Fibre Limited.
(iii) Buyer of the Company's electricity is only the said associated concern and Company's survival is totally dependant on S.G. Fibre Limited. The Company submitted that without compromising its own cash flow, the receivable had to be staggered keeping in view the cash flow of the sister concern. The Company's cash flows were in stable condition and it had not borrowed any amount from banks for its working capital need.
(iv) Filament industry is in deep problems due to the following factors:
(a) High price of polyester chip in international market where current import price of chips is US$1,250 per metric tonne.
(b) Dumping of yarn in local market from far eastern countries. Declared value of yarn from China is US$1,000 per metric tonne which is US$250 less than imported price of chips (raw materials of the Company's sister concern).
(c) Under invoicing of imported yarn.
(d) Disparity in custom duty on chips, PTA, MEG and polyester filament yarn.
(e) Smuggling of polyester fabrics.
Domestic filament yarn industry consists of 21 units of which 11 units have been closed down owing to the factors mentioned above and the rest are at the verge of their extinction and struggling for their survival. The Company also mentioned that to improve liquidity position of S.G. Fibre Limited, its Directors had given loan of over Rs.100 million which was interest free.
In light of the above, the Board of Directors agreed and passed a resolution for soft payment terms of 12 months credit to the associated undertaking.
(v) The Company contended that in order to maintain a good liquidity, the Directors of S.G. Fibre Limited have forgone their dividend of Rs.15,595,701 in the year 2003. This is duly reflected in the Statement of Changes in Equity of that year.
(vi) The Company had assured that the amount of trade debts of the sister concern would not be allowed to exceed 12 months.
6. The aforesaid submissions of the Company have been analysed as follows:
(i) The average trade debt collection period based on annual audited accounts of S.G. Power Limited and the listed captive power producer companies are found to be as under: {{TABLE}} Particulars Average for three years ended June 30, 2004 Average for Year ended June 30, 2004 S.G. Power Limited 306 days 374 days Sector (inclusive of S.G. Power) 191 days 240 days Sector (exclusive of S.G. Power) 132 days 158 days {{TABLE}} The average collection period for the three years from June 30, 2002 to June 30, 2004 of the Company is 306 days and in the current said year 2004, it is 374 days both of which are far greater than the sector averages. Moreover, the Company has informed in its reply that: "The Board of Directors agreed and has passed a Resolution for soft payment terms of 12 months credit to associated undertaking."
In view of the above, it is clear that the trade credit is for 12 months; hence, it cannot be termed as normal trade credit.
(ii) The following analysis shows that the trade debts receivable from S.G. Fibre Limited rose by 341 % from 2001 to 2005 with a corresponding increase of only 46% in sales. In this connection, the intention of the Company to provide interest free financing to its associated company is very clear whereas it was considered by the Company as a normal trade credit. Further, the long term advances against which the said interest is receivable declined from Rs.86,200,000 in 2001 to nil amount in 2003. However, the interest accumulated thereon at the rate of 14 % per annum amounts Rs.28,694,388 as on June 30, 2003 has not been recovered or compounded until the year ended June 30, 2005. The non recovery of the said No: SGP/MD/05/08/1532 dated August 06, 2005. No loan was given after that date. All the loans were repaid and out of the total outstanding mark-up amount of Rs.28,694,388, an amount of Rs.5,600,000 has since been repaid. A statement showing the sale of electricity to the sister concern from 1996 to 2005 and the payments received during the years is enclosed."
Enclosure to the aforesaid reply is as under: {{TABLE}} Quote SALE AND RECOVERY POSITION FROM 1996 to 2005 YEAR OP. BALANCE SALE TOTAL RECOVERY BALANCE 1996 112,500,726 112,500,726 80,354,110 32,146,616 1997 32,146,616 146,272,964 178,419,580 106,228,720 72,190,860 1998 72,190,860 154,229,557 226,420,417 164,261,550 62,158,867 1999 62,158,867 165,227,084 227,385,951 143,849,226 83,536,725 2000 83,536,725 130,254,750 213,791,475 96,220,239 117,571,236 2001 117,571,236 126,635,250 244,206,486 189,191,665 55,014,821 2002 55,014,821 163,576,738 218,591,559 85,018,378 133,573,181 2003 133,573,181 181,242,704 314,815,885 116,157,030 198,658,855 2004 198,658,855 191,862,245 390,521,100 196,023,167 194,497,933 2005 194,497,933 184,925,568 379,423,501 136,908,016 242,515,485 Unquote {{TABLE}} It is evident from the above, that in years 2003, 2004 and 2005 the receivable balance exceeded the annual sales figure and the gap kept on increasing and reached its maximum in 2005. This clearly shows that the credit allowed to S.G Fibre Limited was not a normal trade credit.
11. The Representative agreed in the hearing to submit a recovery plan for the said receivables in the next final hearing. The said hearing was held thereafter on March 07, 2006, in which the Representative submitted a schedule of recovery of outstanding mark-up and the outstanding receivable from the associated company and further agreed to extend the credit facility period of 120 days for future sale of electricity.
12. After having considered the admitted default of the Chief Executive and Directors of the Company and the perusal of the documents and information placed on record, it is evident that the said credit facility extended to the associated company, cannot be termed as a normal trade credit and therefore falls under the ambit of Section 208 of the Ordinance and was extended without seeking prior approval of the shareholders through a special resolution, in violation of the requirements of Section 208 of the Ordinance and without charging any return on such credit given. Had there been any return on such credit it would have been higher than the borrowing cost under the Law. It is important to mention that the Company's paid up capital is just Rs.178.332 million for both of the years 2004 and 2005 whereas the closing balance of trade debts due from the associated company during the year ended June 30, 2004 and 2005 was Rs.194.498 million and Rs.242.515 million respectively. The said trade debts for both said years are far exceeding the paid up capital of the Company.
13. For the foregoing reasons, it is established that the Chief Executive and the Directors have violated the provisions of Section 208 of the Ordinance and have not exercised due care while extending the said credit to the associated concern. I have, however, noted that the Directors of the Company have admitted the default and are in a process of rectifying the default by recovering the balance of trade debts due from its associated company along with outstanding interest and reduce the credit extension period to 120 days in order to bring it close to the three years' sectoral average being practiced as normal trade credit period. The Representative of the Company has also assured that Company would ensure strict compliance of the provisions of the Ordinance in future.
14. In view of the above, I, instead of imposing maximum penalty as prescribed by Sub-section (3) of Section 208 of the Ordinance, take a lenient view of the default and impose a fine of Rs.100,000 (Rupees one hundred thousand) on each of the directors namely, Mr. S.M.Ahmed, Mr. Asim Ahmed, Mst. Zubaida Khatoon. Mr. Sohail Ahmed, Mrs. Saba Sohail, Mr. M. Rafiq Dawood and Mr. Rafiq Ahmed. The afore-named directors are directed to deposit the aforesaid fine in the designated bank account maintained in the name of Securities & Exchange Commission of Pakistan in the Habib Bank Limited within 30 days of the date of this order and furnish a receipted challan to the Commission in this regard.
Direction under Section 473 of the Ordinance
15. Before parting with this Order, it is necessary for me to issue directions regarding the aforesaid outstanding receivables from the said associated company. I deem it appropriate in the said circumstances, to invoke powers contained in Section 473 of the Ordinance and direct the Company to:
(i) Recover the balance receivable as outstanding interest of Rs.28,694,388 from its associated company in quarterly installment of Rs.5 million each commencing from the quarter April - June 2006. The payment is required to be made in the first month of each said quarter. Upon full recovery of the aforesaid interest, the Company shall submit an auditors' certificate certifying the full recovery.
(ii) Recover the outstanding amount of electricity sales from the associated company and settle in quarterly installment of Rs.10 million each beginning from April - June 2006 quarter. The payment is required to be made during the months of each quarter. In this connection, the Company shall reduce the said credit period in order to bring it in close proximity to the sectoral normal trade credit collection period, with a limit of maximum 120 days, which had already been assured by the Company. The Company shall enter into a written agreement with the said associated company and specify the said collection period therein. The said agreement shall be submitted to the Commission thereafter.
(iii) The Company shall calculate and thereafter, recover the interest as return on its previous years' credits which were not in the nature of normal trade credit. The return to be calculated on such credits shall not be less than the borrowing cost of the Company. In this connection, the chief executive and directors of the Company are called upon to submit a certificate from statutory auditors of the Company within 30 days indicating that interest is calculated in accordance with the provisions of proviso (b) of Sub-section (1) of Section 208 of the Ordinance. The Chief Executive and Directors are further called upon to recover the interest from the said associated company within a reasonable period.
(iv) The minutes with regard to Board of Directors decision on the below mentioned matters shall be submitted to the Commission: a. Recovery of electricity bills from associated company in future shall be made within a period not exceeding 120 days. b. The said associated company shall pay off its bills on the said due date in future as per agreement to be signed between the associated companies.
(v) Auditors' certificate on full compliance of the above directions shall be submitted by the Company to the Commission.