How IL&FS Was Enriching Itself at Public Cost

Jolted by the massive systemic risk that the defaults of Infrastructure Leasing & Financial Services (IL&FS) can create, a sleeping government has, finally, sacked a part of the board of directors of IL&FS on 1st October and injected seven new directors. It has also ordered an investigation by the SFIO (serious frauds investigation office). With many insiders starting to allege that top executives of IL&FS were gold-plating projects to create their own pot of gold, an investigation is clearly warranted.

The reconstituted board of IL&FS has to submit a resolution plan to the NCLT (National Company Law Tribunal) by 31st October. How difficult is the new board’s job? Well, it has to first understand the enormity of the problem and the modus operandi of Ravi Parthasarathy who ran the IL&FS show with his cronies for over two decades creating 175 subsidiaries and 66 joint ventures and associates (higher than those mentioned by the finance ministry’s press release ). It holds assets of around Rs1,65,000 crore of which a whopping Rs30,000 crore are at risk , according to data analysed by REDD Intelligence.

Modus Operandi

The IL&FS group switched from arranging and structuring infrastructure finance, to being a partner in projects, around 2005. Typically, it leveraged its big public sector shareholding to find acceptance with state governments. It also offered a 50:50 joint venture, where the state got to appoint a non-executive chairman while IL&FS ran the show with its own managing director (MD) and virtually owned the projects.

Its flamboyant, high-spending ways were used to build deep contacts with bureaucrats in all state governments. It had dozens of IAS officers on its payroll and also doled out favours like houses/apartments for politically connected persons (PCPs), facilitating admission of their children to Ivy League universities abroad and other benefits.

The bureaucracy enjoyed its lavish spending ways; it didn’t matter that the costs were passed on to the project and borne by the public. IL&FS brought project development and fund raising ability to the table, for which it extracted hefty fees, based on the project cost. So, every cost escalation only worked to its benefit.

It also cultivated banks and other lenders assiduously. It lists over 40 domestic and international banks as lenders, apart from selling its financial paper across the spectrum. It has even managed to sell its debt to nationalised banks at a profit!

Key to the gold-plating of projects was its template capital structure that was never questioned by pliant bureaucrats representing state governments, says a former insider who wants to remain anonymous.

Although each project was structured as a 50:50 partnership, the equity capital was tiny (as low as 5%)—keeping risk capital minimal. Another 25%-30% would be brought in as subordinate debt which helped balance the debt-equity ratio. That was also subscribed by IL&FS, to give comfort to the government partner. The rest was raised through senior debt, raised mainly from public sector banks. According to this source, “the bloating debt problem of IL&FS can be understood if the debt profile of SPVs (special purpose vehicles) and the holding companies are analysed.”

Fees, Fees and More Fees

Typically, IL&FS charged multiple fees that allowed it to recover its entire investment even before the project got off the drawing board. IL&FS, as a group, earned project management fees, loan syndication fees, success fees, upfront fees, merchant banking fees, fees/charges for feasibility studies, environmental impact and social impact studies, etc. In fact, any cost or fee that could be pushed past the state government was loaded on to the project.

A good example is the Tirupur water project where an order of the Tamil Nadu High Court notes: “Out of the gross disbursement of Rs140 crore, IL&FS deducted a total amount of Rs41.24 crore whose break-up was (i) project management fee of Rs9.60 crore; (ii) costs of Rs15.15 crore for USAID loan; (iii) upfront fee of Rs66.50 lakh; (iv) merchant banking fees of Rs10.04 crore; and (v) out-of-pocket expenses of Rs5.79 crore.” The deductions were made before transferring the rest of the money to the project.

This win-win structure for IL&FS was supposed to be Ravi Parthasarathy’s genius and, probably, worked in the early days, until the costs had to be passed on to users. Then, like in the Noida Toll Bridge case, public anger erupted and the Supreme Court ordered the bridge to remain toll-free. Almost every major project of IL&FS is mired such controversy and litigation.

Now, let us look at how its dubious activities were already in the public domain, but nobody would act to cut the group to size.

Some Examples of the Plunder

1. Noida Toll Bridge Company Ltd: This controversial company had given itself an assured return of over 20% (higher than its borrowing cost) which soared to 40% when its high-cost loans were renegotiated to 10% and the concession period dramatically extended from 30 years to 100 years. It was also given 30 acres of government land as a sweetener which it sold at a profit. No cost reduction was passed on to the toll-paying public. Instead, it was structured to ensure that the initial shortfall in toll collection was added to the project cost. This led to a 12 times cost escalation -- from Rs408 crore in early 2000 to over Rs5,000 crore when it was eventually scrapped by the courts.

2. Tamil Nadu Road Development Company (TNRDC): This SPV was a 50:50 joint venture between IL&FS and the Tamil Nadu government (TNGov). It implemented the Rs205 crore IT corridor road project and east coast road-widening project.

While both were equal equity partners, the subordinate loan of Rs41 crore from IL&FS earned a 15% return while the state provided an interest-free grant of Rs34 crore. This became the subject of a book—Evolution of IT Corridor by K Malmarugan and Sabina Narayan which exposes how IL&FS structures its deals.

In that project, says the book, TNGov got back Rs2 lakh on its Rs44 crore investment in the first seven years, while IL&FS got back Rs91.3 crore on its investment of Rs69.6 crore. It also sold its senior debt at a profit to Punjab National Bank and earned a 4% management fee.

Further, TNRDC was assigned a 4.9-acre plot at Rs1 crore which now has a market value of Rs50 crore, say sources. In this case, TNGov realised how it was being duped and ousted Ravi Parthasarathy as chairman of TNRDC. It also bought out IL&FS’s stake and converted it into a 100% government company.

3. Tirupur Water Project: The Tirupur water project, to privatise water supply and make it available to the wealthy, hosiery-exporting town, was conceived by IL&FS in the The Tirupur water project, to privatise water supply and make it available to the wealthy, hosiery-exporting town, was conceived by IL&FS in the mid-1990s and remains mired in litigation . The allegations, again, are fat fees charged by IL&FS and false promises to investors.

Just one sentence from a hard-hitting, 2014 order by Justice V Ramasubramanian (also quoted above) encapsulates all that is wrong with this project: “The Government has pumped in money, unfortunately, only to service the debt with a pre-condition that the money will not even be used to improve the infrastructure. Investing more money just for the purpose of servicing a debt, is neither a prudent business decision nor in the interest of the public.”

A top source in TNGov says there is an unwritten understanding in the state not to do business with IL&FS anymore. Did this never reach the ears of the former finance minister, who was from Tamil Nadu? You can draw your own conclusions.

GIFT City Gujarat: The Gujarat International Finance Tec-City, again structured as a 50:50 joint venture with the Gujarat government, was extraordinary in that the head of its audit committee filed a litigation against the The Gujarat International Finance Tec-City, again structured as a 50:50 joint venture with the Gujarat government, was extraordinary in that the head of its audit committee filed a litigation against the project in 2016 . The petition, by Dr DC Anjaria, alleged that this massive, Rs70,000-crore project had been virtually gifted away to IL&FS, leading to massive losses to the state government and the people.

Here, too, IL&FS has extorted high fees. It got the land valued at Rs2/acre at a nominal price translating to a giveaway of Rs440 crore to IL&FS, says Dr Anjaria. This also has an expensive, ongoing arbitration with the original contractor consortium headed by Fairwood, with large claims and counter-claims on both sides.

Gift City has been a favourite project of prime minister Narendra Modi; but not a word about it was in the public domain until I wrote about in August this year , just before IL&FS began to default on payments.

There are similar issues with IL&FS’s ventures with the Rajasthan government, with the power project at Cuddalore and many others. But the most chilling one I have heard so far is a joint venture with RAHI Aviation to build airports at Gulbarga and Shimoga.

When things turned sour, IL&FS accused the promoter of RAHI Aviation of forgery, and worse, and got him arrested. It ensured that he remained in Arthur Road jail (Mumbai) for six months by piling on more charges. As a direct result of that fight, the project has been taken over by the Karnataka government, which also invoked bank guarantees of Rs20+ crore.

The details of what happened are the subject of a separate article; but IL&FS, which has now caused a systemic issue, lost the project and an investment of over Rs40 crore without anyone being held responsible.

Well, it is time we woke up and started asking questions and ensure that this deliberately created mess is not foisted on public sector institutions and, eventually, on the people of India.