Diageo's United Spirits embarrassment: Shareholder pact with Mallya is the villain

A few months ago Diageo made no secret of its displeasure with Vijay Mallya for his less than honest dealings with it in the run up to the acquisition of United Spirits Ltd.

There were many debtors who did not pay up on the ground that their debts to United Spirits qualified for set off against outstandings in their favour in the books of several Mallya companies.

Diageo obviously felt peeved but somehow did not blame the audit firm that did the due diligence – de rigueur before one sinks his money in – for its loss.

It had paid the kind of price for about 54% which in retrospect it should not have, given the murky state of the United Spirit’s finances. Winner’s curse in M&A is common but the reason often is over enthusiasm in forking out more than necessary in a bid to oust competition. But Diageo’s nemesis was not over enthusiasm but just plain stupidity in not going over the figures and details with a fine toothcomb.

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Diageo must be ruing its shareholders’ agreement with Mallya in terms of which he is one of the non-executive directors on the board with the edifying Chairman’s status. The shareholders’ agreement is a secretive document not open to public scrutiny.

In India its validity is doubtful, with the Supreme Court in V.B. Rangaraj v. V.B. Gopalakrishnan (AIR 1992 SC 453) frowning upon it. The apex court in that case said articles of association cannot be overridden by shareholders’ agreement.

In effect, what the highest court in India has said is such bilateral agreements cannot be enforced unless its terms are incorporated in the articles themselves. Now this is too much to expect of the two dominant groups of shareholders because as pointed out earlier it is a secretive document and often goes beyond the letter and spirit of the company law.

It is often replete with undemocratic clauses such as drag?along rights, tag?along rights, right of first refusal (ROFR), composition of board of directors, specific provision as to quorum requirement for board and general meetings, veto or super majority rights available to certain shareholders at board or shareholder level.

To wit, it is de rigueur for foreign collaboration agreements between a dominant foreign partner and his Indian partner to guard their turfs through shareholders’ agreements that can shock the conscience of the champions of corporate democracy.

The foreign collaborator often has veto power and also says a board meeting cannot take place without his nominee’s presence who obviously is going to exercise the veto power.

It is obviously in pursuance of the shareholders’ agreement that Mallya is still in the saddle and calling the shots in United Spirits. All the nine resolutions rejected by the minority shareholders of United Spirits on 28th November 2014 were designed to benefit Malaya companies.

Diageo obviously felt constrained to suffer him despite his less than honest dealing with it. It couldn’t break free of the shareholders’ agreement with him. What a pity! The lesson for foreign collaborators is while the Indian promoter often does indulge the foreign partner with obnoxiously invidious rights such as veto power etc, he also writes in clauses for his own self-perpetuation.

Malaya did precisely that. Chickens came home to roost much to the chagrin of Diageo but hats off to the Indian minority shareholders led apparently by institutional holders who rose to the occasion and defeated Mallya’s designs.

But for the Indian law makers and regulator’s avant-garde initiative in keeping promoters out of bounds insofar as related party transactions are concerned when it comes to voting, Mallya perhaps would have had his way with Diageo just twiddling its thumb in helplessness, perhaps held back by some secretive clauses in the shareholders’ agreement between the two and for the fear of testing their rights in Indian courts.