Tuesday, January 23, 2007

Key talking points 2

Here comes one more.

On May 2003, Chandu opened a company called 'Bricks real estate' that invests in real estate in India. The idea was to buy and sell land and make money with the difference. The property would be registered in the company's name. He invested 50 lakhs of his own. His uncle who thought the idea was good agreed to lend his company about 50 lakhs for a year at 5% interest (below the market rate). At the end of the first financial year (March 2004), the company had cash reserves of 1 crore and owned property estimated at about 5 crores and the company had earned a reputation in the market for smart investment. Chandu's friend Rakesh said he wanted to pick a 49% stake in the company for 5 crores and Chandu agreed. In May 2004, when they had to return uncle's money, Chandu said that the company shud pay 20% interest rather than the agreed 5% since he had helped him set up and the company had made loads of money. Rakesh disagreed.

1. Is the uncle entitled to more interest than 5%?
2. Does Rakesh have the right to oppose since the loan was taken before he became partner?
3. Can Chandu go ahead and give his uncle 20% even if Rakesh opposes?
4. Do the answers for above questions change if the loan was given at 15% (market rate) instead of 5%

Chandu and Rakesh later decide to go for an IPO in June 2006. After the IPO, Chandu holds 25%, Rakesh holds 24% and the public holds 50% in the company and the company was called Bricks real estate public limited valued at 30 crores. By 2006 december, the real estate market had crashed and the company and was left with only properties worth 2 crore in the market without any cash reserves. The company had a loan of 1.5 crores from ICICI that it repaid by selling all properties. At the same time, two employees sued the company for not giving the incentives promised for that year. The court ruled in their favour and ordered the company to pay 1 crore in incentives to the two employees. With only 50 lakh cash, the company paid half the incentives and closed down. The company also had another HDFC loan of 20 lakhs that it had not repaid

1. Can the employees claim the other 50 lakhs from Chandu and Rakesh. If so in what ratio. Note that Chandu and Rakesh made huge money by selling their stakes in the IPO.
2. Can HDFC get any money from the company
3. Can HDFC claim its money from Chandu and Rakesh. If so in what ratio.
4. Many people who invested in the IPO lost out too. Can they claim their money from Rakesh and Chandu. Again, in what ratio.
5. Wud the answers to above question change if the company did not go public, but went for some more investors and became a private limited company.

Some questions may look heavy, but I am sure it will clear a lot of basics at the end of it. So do answer all the questions without fear of it being wrong. I hope the basics you learn here will be helpful in future GDs.

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Anonymous Anonymous said...

My answers go as follows
1. I dont think, his uncle is entitled to interest more than 5% legally but it will be purely out of goodwill...Just as in case of dividends
2. Rakesh has the right to put forth his views as he has 49% stake but Chandu has the rights to pass his decision (51% stake)
3. Chandu can go ahead with his wish but it wud b better if it was a mutual consent
4. The answers for the above question remains the same but then the goodwill might be lost.

1. I do not think, the employees can claim the same from Chandu and Ramesh as its the company which is entitled to give the money and not the individuals
2. HDFC wud have given loan keeping something as mortgage so if it cannot extract the money it can take that thing.
3. I dont think HDFC can claim money from the individuals
4. NO as they had invested on their own risks. I do have a faint idea of the amount to be returned by the company in case of bankruptcy....that is written in a book before filing the IPO
5. I m not to sure abt the same, but I think it remains the same


1:54 AM, January 24, 2007  
Anonymous Anonymous said...

Hey gyaan-ee
Good to increase some knowledge this way s well


1:55 AM, January 24, 2007  
Anonymous Anonymous said...

For Part-I, My answers would be same as PS' ones.

Regarding part-II, the issue being talked here is about "Limited liability". I don't know much about its intricacies but Rakesh and Chandu can't be forced to pay any percentage of loan amount more than their percentage shareholding in the company. Based on this, my answers are as follows:
1) 25% of 50 lakhs = 12.5 lakhs will be liability of Chandu. 24% of 50 lakhs will be liability of Rakesh. Employees can definitely claim money from Rakesh and Chandu as they were the shareholders of the company and if they were the gainers from rise of the company, they will have to bear the costs of losses too but not beyond their percentage shareholdings.

2) The company has closed down but hasn't been declared bankrupt. So, HDFC can claim money after this.

3) Answer would be similar on lines of my Answer 1.

4) No, they can't. They bought stake in company by their own will. Unless it becomes proved in courts that Chandu and Rakesh cheated, The shareholders can't claim any compensation.

5) Nothing will change with respect to any of the answers as the percentage shareholding still are same in this case.

3:19 AM, January 24, 2007  
Anonymous Anonymous said...

My answers:
Part 1:
1> No uncle is not entitled to more intrest than 5% as there was no legal obligation that if company makes profit the intrest rate should be increased. Conversely, if the venture would have failed he would not have lowered the intrest rate or the principal in total.
2> Since there is no legal obligation Rakesh can oppose it.
3> Since Chandu owns more than 50% stake I think he can give his uncle 20% even if Rakesh opposes.
4> No I think the answers would remain the same.

Part 2:
1> No I don't think they can claim the money as they are also just the stake holder's in the company. It was the company that had employed them and not the two individuals. The company can file in for bankcruptcy.
2> No, for the same reason above.
3> No, again for the same reason.
4> No, people cannot claim money as they would have invested money on their own risk.
5> I think yes, the answers would change as their would be jus a couple of people who would have been the owners. Until the company files in for bankcruptcy the bank and the former employees can claim their money.


5:17 AM, January 24, 2007  
Anonymous Anonymous said...

Great effort Gyan-ee ji,,

its gonna help us big time....


5:19 AM, January 24, 2007  
Anonymous Anonymous said...

My Answers are as follows:


Ans1: Ideally speaking,no.He had willingly lend Chandu's co. 50lakhs below d market rate luking at d future prospects of his co.

Ans 2: No,Rakesh does not have d right 2 oppose 4 2 reasons:

(1)The loan was taken b4 he joined as a partner.

(2)He has 49% stake in d co. as opposed 2 Chandu who has 51%.Chandu's decision will b binding.

Ans3: Yes,he certainly can..as a gesture 4 lending him at d onset of his co. at a lower rate.Rakesh opposition will not matter 4 d reasons above.

Ans4: No,except 4 Q3,where Chandu wud not really want 2 give his uncle 20%..coz he had lend him money like ny other lender at d market rate.


Ans1: Yes d employees can claim d other 50 lakhs in d ratio 25:24(Chandu:Rakesh),since d court has given d ruling in their favour.

Ans2: The co. has closed,since it has no cash reserves left..so HDFC cannot get ny money from d co.

Ans3: No, HDFC cannot claim d moey from Chandu & Rakesh.The liablity is of d co. as a whole and they r not liable 2 pay 4 it personally.

Ans4: Investment comes wid risk as well...nd d investors ought 2 have known this.So they cannot claim nything.

Ans5:Yes, in that case d liability of the co. wud have been in sync with d liability of each of d partner ..they wud have been personally liable 2 pay 2 d employees &HDFC out of their personal gains.


6:20 AM, January 24, 2007  
Anonymous Dilip said...

My answer would be :
1) No , Uncle is not entitled to get more than 5 % interest rate legally. As he agreed on 5 % interest rate. So according terms and conditions he can not get more than 5 % interest rate.
2) Yes , he has the right to oppose . At the time when he became stakeholder of comp he must be knowing about loan at 5 % of interest rate . So legally he can oppose.
3) No , he can not give 20 % interest rate to his uncle . Rakesh can go to court and can file case against chandu. As he is not sticking to his initial terms of 5% interest rate on loan he took from his uncle.
4) No answer will not be changed.

10:27 PM, January 24, 2007  
Anonymous Dilip said...

My answer of part - 2 would be
1) It is not clear whether comp has gone bankrupt or not. If company has gone bankrupt. employee can not claim even though court has favoured in two employees. If comp has not gone bankrupt then employees has legal rights to claim for their money to comp honcho. then 25 % of 50 lakhs= 12.5 and 24 5 of 50 =12 lakhs from chandu and rakesh respectively.
2) I think here same concept applies ..if comp has gone bankrupt then HDFC can not . if not then HDFC can ask for that.
3) No HDFC can not claim money from them . As comp has closed down . HDFC can not ask from individuals.
4) no they can not claim money from chandu and prakash. They invested in IPO and lost out. comp is not responsible for it.
5) No , answers won't change..

10:39 PM, January 24, 2007  
Blogger Gyan-ee said...

Except for some confusions, I think people have been fairly on the mark.

1. Most are correct. He is not 'entitled' to more than 5% inspite of the fact that he gave it in goodwill at a lower than market price and Chandu profited from it

2. Rakesh has the right to oppose since he would have considered all factors in balance sheet while paying a certain amount of money for his stake

3. Even though it is 51-49 ratio, it does not mean that Chandu can take any decision. He cannot give his uncle 20%.
Simple example to elucidate - Chandu cannot double his salary without Rakesh permitting just because he has 51%. Nor can he employ his uncle for one day and give him 1 lakh :)

4. The answers wont change :) that was an easy one

For Set Two
Good attempt here too by all. One thing to understand is the funda of company being a legal entity. For the acts of company, only company can be sued. Neither employees, nor shareholders.

1. No, they cannot claim. It is a limited liability firm and the court has ruled against the company and not Chandu/Rakesh. The very idea of a limited firm is that the liabilities are limited to the investment and thats it!
Example to elucidate: If Infosys had closed before they paid out the dues to Rekha (Phanish Murthy case), she could not have come knocking at my door just because I owner Infy shares

2. The company has declared to close down and has no money to give. HDFC can claim but there is nothing for it to get

3. As for the same reason as answer 1, HDFC cannot claim it from Chandu and Rakesh (or from any of the investors)

4. No they cannot claim. They themselves are owners too

5. The answers will not change since it is still a limited company. Public or private does not matter.

In all these note that the company itself is a legal entity and it can be sued similar to individuals. But employees or investors cannot be sued for company decisions

5:12 AM, January 25, 2007  
Anonymous b2b said...

I agree with set 1.

However in set 2, I think Chandu and Rakesh would be liable. This is because once their assets crashed down to 2 crores and their liability was 2.7 crores( 1.5 + 1 + 0.2), they can not liquidate their assets. Simply because being a company shields them from personal liability also means that being a company its their duty as management to inform all the debtors of the liquidity position. They would have to inform them about their assets situation and then negotiate the settlement of dues with all the members. Since two of the parties are creditors to the company (ICICI and HDFC) and one is court nominated recipient (empolyees), they can only settle legally and can not repay loan of ICICI and not chose to pay others or pay them partially.

If they do so, then being part of management, they would be liable to prosecution and biased in paying the money back would make them liable to employees and HDFC, who can I believe go for their personal assets.

6:51 AM, January 26, 2007  
Blogger Gyan-ee said...

Good point B2B. And agreed with your view too.
So the conclusion is "Chandu and rakesh cannot be liable as 'shareholders' but may be liable as management for wrong decisions".

Again note that it becomes a legally complicated issue as the reason behind the payment of the first loan may not have been personally biased. And as long as they have followed the law, even if their decision is not correct, they will not be liable

10:03 PM, January 28, 2007  
Anonymous SUJAY said...

1) Uncle is NOT ENTITLED to more than 5% interest on loan.However nothing stops the company from paying him more than his due .

2)Rakesh has taken 49% stake in a pvt.ltd company.Thus he has assumed ownership of all assets and liabilities of the company irrespective of when they were contracted. rakesh will have a right to oppose but chandu will win since he has larger stake.

3)He can go ahead and do it.However the company will be responsible to account for the extra payment made and there could be an appeal made to Comapany Law Board by say Rakesh(Not sure on the company law board aspect).The auditors may aslo ask reasons of ectra payment and mention in their report.

4)No.The terms of the loan can be altered if the loan agreemnet specified a provision for increasing or decreasing the interest rate.

1)Employees cannot make a claim agaimnst chandu and rakesh
2)HDFC can get money from company's assets only not from Chandu or rakesh.
However if they are Guarantors of the loan they will be required to pay up.

3)No claim from chandu and rakesh unless they are guarantors of the loan.

4)No they cannot claim from rakesh and chandu



11:44 PM, May 14, 2007  

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