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Saturday, August 13, 2011

Selectively picking court orders to inflate profits-some examples

Indian litigation is final only when it reaches the apex court, and is either turned down or dismissed. But till that stage, people can interpret judgements to their convenience, or the assessment whether it will be upheld or dismissed at further courts. Unless the judgement is perverse(evidently wrong on facts/law), it would be apt to pass accounting entries at status quo. But companies often pass entries as per their favoured outcome, thus boosting profits/non cash assets. Below are some examples.

  1. Music royalties from FM radio stations to composers/lyricists:- Indian Performing Right Society (IPRS)  collected royalties on behalf of music composers and lyricists.  But between June-July 2011, the Delhi & Mumbai High courts held that the collection had no legal basis. Both HCs stayed the judgement till September 30, to permit IPRS to appeal for a stay in the Supreme Court. That means the judgement has no legal effect till that date, and may not continue if the Supreme Court agrees with IPRS and grants a stay. Naturally, FM radio channels who had paid the royalties till date were pleased. One of them, Reliance Broadcast Network promptly obtained a legal opinion and decided not only to avoid paying future dues, but also claim refund of the Rs 8.79 crores paid till date. They credited that amount to the accounts, assuming that they would get back those proceeds.  That is indeed jumping the gun, and premature, because even if IPRS loses in the SC, it would be difficult to recover payments made under a mistake of law. 
  2. State Advisory Prices(SAP) for sugar procurement in UP:- An annual charade is played out where the UP Govt fixes SAP much above the Centrally advised MSP(minimum support price). Sugar mills do not want to pay that SAP, and thus approach the HC for stays, which is granted if the mills pay farmers at the SAP pending resolution of the case. Cash outflows happen at higher level, but sugar mills account it at the lower MSP, assuming they would win the case, which is doubtful.
  3. Stayed cess/state taxes:- States periodically impose water cess, electricity duty etc which the user industries naturally dislike. They then waste 3-4yrs at the HC/SC level and end up paying the cess with interest, but till then avoid booking those expenses in their books. Of late, to sanctify this practice, an industry association is roped in to file the suit, so that companies can claim to be following an industry practice. 
Takeaway:- As an investor, be aware of such legal risk, especially if the amounts at stake are high. An example of RNRL should warn even the casual investor, how legal risk can destroy the economics of a company. Even if orders do not destroy the company, adverse outcomes may still erode the share price, with no advance warning(orders usually are not leaked in India!). 

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