Modi Rubber vs.

Financial Institutions
Abstract: The case provides a detailed insight into the events during a decadelong dispute between Modi Rubber (Modi) and its lender/owners financial institutions (FI). It examines the FI's threat to sell their stake in Modi in the open market, which led to a major debate regarding the role of FIs in the companies in which they had an equity stake. Issues: Role of FIs in the management of companies, dual role of F Is as owners and lenders, Corporate Governance How can they not offer us the right of first refusal to the shares? Can anyone question our commitment to the company?" - B K Modi, commenting on the FIs selling their stake in Modi Rubber in the open market, in August 1996. The Power Struggle On June 30, 2001, a statement issued by Panduranga Rao, Chairman of Modi Rubber Ltd. (MRL) came as a big surprise to Indian corporate watchers. The statement revealed that the MRL board had, after a special meeting decided to strip Managing Director B K Modi of his functionary powers. Rao said, "We have been compelled to transfer all areas hitherto looked after by Dr B.K. Modi to the second MD (V K Modi - B K Modi's brother) for he is not giving enough attention to the affairs of the company." The board also suspended three other directors, B K Gupta, R L Ahuja and Atul Prakash - all reported to be close aides of B K Modi. What was more intriguing was the fact that B K Modi was absent from the meeting though a notice had been duly served to him. Rao commented, "The notice was served and the agenda was circulated. He cannot make us wait." Further, the move was reported to have the

backing of V K Modi as well. Though the two brothers were not known to be the best of friends, this move was rather unexpected. The very next day, B K Modi held a press conference where he announced his rejection of the board's decision. He asserted that he was still the MD of the company and that the board was not empowered to remove him from the post. He claimed that the constitution of the board itself was doubtful since the previous chairman Bodhishwar Rai (an independent director) was 'unceremoniously' thrown out and replaced by a UTI nominee. This was against the guidelines of the capital markets regulator Securities and Exchange Board of India (SEBI), according to which the chairman should be an independent director and not a nominee director. He also said that there were no disputes between him and V K Modi. Analysts however took this with a pinch of salt as V K Modi was absent from the press conference. On July 5, B K Modi sent a notice to V K Modi, charging him of breach of a shareholder's agreement between them. (The agreement mentioned that while he would look after the production side of MRL, V K Modi would look after sales and marketing. Moreover, it had been agreed that any change in this arrangement would require the mutual consent of the two brothers.) MRL's move against B K Modi eventually came to be seen as a major victory for financial institutions (FIs) in the decade long MRL/FI battle for control of the company... Background Note MRL, established in 1971, was a part of the Modi Group of companies. While B K and V K Modi held 23.87% of MRL's equity, the FIs held 44.5% and the public held 31.63%.2 A major part of the FI stake in MRL was with Life Insurance Corporation (LIC) and UTI. The other FIs involved were the Industrial Finance Corporation of India (IFCI) and the Industrial Credit and Investment Corporation of India (ICICI). The FIs had acquired their stake in MRL over the years, both through conversion of unpaid loans into equity and market purchases. The company's business comprised the manufacturing and marketing of automobile tyres/tubes/flaps and retreading materials. A small portion of the revenue came from trading in tyres, tubes, flaps, garments and other articles. The company had a technical

collaboration with Continental AG of Germany for manufacturing tyres. MRL's major customers included Telco, Ashok Leyland, Maruti Udyog, Punjab Tractors and Escorts... Excerpts The Modi Rubber Story Since the early days of MRL, B K Modi and V K Modi were reported to have 'rarely seen eye to eye.' Even after they signed a shareholder's agreement, their relationship never really improved. One of the main reasons for their differences was B K Modi's desire to get a higher share in MRL. The Modis had been defaulting on FI loans since the 1980s. After a formal split in the family in 1989, the Modis refused to repay the money they owed the FIs on the grounds that the crossholdings of the various family factions in Modi companies were so complex that the liability of each of the brothers could not be fixed till the division of property was effected. Since the Modi brothers could not arrive at an equitable division of assets, the Government appointed an arbitrator from IFCI. The arbitrator came up with a solution, which was summarily rejected by the Modis... The Open Offer In March, 1998, the Modis agreed to repay the entire outstanding FI loans if the FIs sold their stake to MRL for a price higher than the ruling market price of Rs 26.90 a share. This development was attributed to an agreement between the Modi brothers to put an end to their quarrels. The Modis offered to buy back UTI's holding in MRL at Rs 58 a share. However, UTI was asking for Rs 70 per share. The FIs had formed a committee to negotiate the price at which their holdings were to be sold. However, the negotiations reached a deadlock since the FIs were not willing to bring down the sale price from Rs 123 per share. Meanwhile, MRL's sales declined to Rs 1.96 billion in the first quarter of 1998 from Rs 2.16 billion in the same period in the previous year. This was largely due to the shutting down of one of the company's units. In November, 1999, the Modis appointed Hong Kong & Shanghai Banking Corporation (HSBC) to provide a blueprint for increasing their stake in the company to 51%...

Companies & FIs - The Issue Of Corporate Governance The Modis' predicament was not difficult to understand. The brothers claimed that on the one hand, the FIs refused to sell their stake; on the other, they were not allowing MRL to borrow from anyone else. The Modis also claimed that the interest rates being charged by the FIs (nearly 19%) were very high. After repaying these loans, they wanted to look for cheaper loans elsewhere. B K Modi said, "We want to return the entire loan taken from them, and look for cheaper loans from other banks. Why should we service such a high cost debt? And if we return their loan, we would also get them out of our board. For a long time, they sat on our board and did not allow us to borrow from other banks. With them out of our board, we would be able to run the company in a productive manner." The MRL issue came to be seen as an example of the controversial role of FI lenders in Indian companies... What Lies Ahead? In mid-2001, MRL was reported to have begun work on a comprehensive turnaround strategy. It infused Rs 500 million to modernize its operations and implemented stringent cost-cutting measures. The Modis also began negotiations for selling the non-tyre assets of the company to raise the money for augmenting the working capital base. This was deemed necessary to make the company profitable once again. The Modis had begun negotiations to get the FI loan freeze removed. The total capacity utilization of MRL's facilities was under 60-65%, which was proposed to be raised after the restructuring. Substantial salary cuts for senior executives of the company and the formation of a management team with well-defined work targets and instructions to report to the Modis were also on the anvil...