National Herald : sordid case of self-dealing will test the entire fiduciary model
“You will not believe what the Congress party has gone and done ” – this is the reaction of many who first read about the National Herald Scam that is currently rocking the country. To assuage this initial shock , the Congress Party is tweeting frenetically various defences of real and imaginary charges that will in due course be heard in the court.
The transactions are extraordinary and unprecedented – as the Delhi High court judgment says. What makes the National Herald case hard to comment on is not that the transactions are one of a kind, but that the counter arguments put forth by the Congress Party challenge you to step down and question long settled assumptions. It is quite natural for most of us to exit at this point. Let me explain this further because this will be the target of this article. We just know by intuition that self-dealing is wrong. We just assume that it is so based on our own moral and ethical codes passed on by our cultures. Say you donate to Help Age India you assume that even though the money has left your hands the trustees wont simply take all the money for their private use – even if the private use is virtuous. We sort of just get it that ‘you cant splitz the stuffs and run yaar‘ without having any statute dictate that to us. This is what is known fancifully as the Non Distribution Constraint. Law meets morality and they agree. Now let us drop that assumption : What is wrong if trustees are given total freedom to self deal. The range of self dealing transactions consists of outright larceny which is taking actual money and putting it in your wallet to spinning off rival trusts and the ability to rearrange the concentration of interests at will. Why not let the fiduciary persons instead prove their business acumen and efficiency ? This is where the Congress Party has taken the debate. They deny outright larceny but that is not even the issue.
A 2 Min Recap of the Triple Play : Hop-Skip-Jump
There are three transactions in question. Lets call them Hop-Skip-Jump.
Hop : Associated Journals (AJL) is a dormant Public Limited Company with large real estate assets it appears that it is a mixture of freehold and leasehold. If leasehold the property value is pro-rata adjusted for the remainder of the lease. The National Herald Building in the heart of New Delhi appears to be the most valuable property and hence the scam is named after it. There are thousand plus shareholders and a board of directors whose chairman is Mr Motilal Vora. To wind up operations AJL needs to settle employee dues and that needed 90-odd crores and the Congress whose treasurer is also Mr Vora gives that money.
Skip : Now instead of owing 90Cr back to the Congress Party, a new company ( a Section 25 Private Limited Liability) called Young Indian is created. Starring in this new company are Sonia Gandhi, Rahul Gandhi, and Motilal Vora ! The Congress Party writes off the 90Cr loan without making any attempts to recover it and transfers this to this new company for a meager 50Lakhs.
Jump : The new company Young Indian strikes a deal with AJL where lakhs of new shares are issued to Young Indian essentially washing out the existing shareholders into minuscule minority (1%) . This is conducted by the Chairman of the Board who is also Motilal Vora !! But the beneficiaries are Mrs Sonia Gandhi and Mr Rahul Gandhi with 76%.
Post this 3 step deal here are the positions of the parties :
- Congress – poorer by 90Cr.
- AJL shareholders – washout.
- Young Indian – poorer by 5 Lakhs paid up capital but new trustee of AJLs estimated USD $1Billion property base
The self dealing transactions which the Congress does not deny and their defences in detail for each of them are the following.
- Hop : Mr Motilal Vora is Treasurer of the All India Congress , the name itself implies someone who guards the ‘treasure’. This person is in a clear position of a fiduciary. In this case the fiduciary lends 90Cr to a Public Limited Company where he is the Chairman and MD of the board. It seems it was argued by Congress lawyers that BJP invests in Canbank Mutual Funds too !! What is missing is that mere disinterested investment is something a treasurer ought to do to maximize the beneficiary interest. So they ask what if there is self dealing as long as it is beneficial in some abstract sense.
- Skip : Write off loan. This is Vora again who loaned himself – the CMD behind the veil of AJL – writing off the loan. This loan is due to the Congress Party coffers filled by thousands of members as a result of active solicitation. Here is a news story where Motilal Vora demands party members pay up. ( “Vora feels the pinch as Congress Partymen dont pay up” / “Rajasthan legislators default Vora demands payment” ) The Congress response to this is two fold : 1) Use the word “entrusted” in a clever way. This money apparently wasnt ‘entrusted’ to Congress to mean that Congress Treasurer does not have a Trustee, i.e. Fiduciary responsibility. 2) Question standing of outsiders. “You are an intolerant Sanghi hence who are you to ask, our tolerant Congress members dont care if their money is siphoned as you are incorrectly claiming.”
- Jump : The most audacious – the loan that was written off is assigned to a special purpose vehicle called Young India , a Private Limited Liability company with Section 25 (non profit/ charity) status. Once again Vora is a director with 12% where the 1-plus-3/4th majority (76%) is held by the Gandhis. Vora then using his position as Chairman of AJL turns over 99% of the company to this new company. I call Young Indian a special purpose vehicle because there is no evidence that it engaged in any other activity before or after the deal. To support the ‘jump’ transaction the Congress claims that not a single penny has been taken out and since this is non-profit company the Gandhis cannot financially benefit.
The Congress defence basically then consists of a) disowning fiduciary duty of the Congress Treasurer (no entrustment argument) b) questioning standing ( if Congress members dont care who are you to ask) c) since a non-profit company is now the owner of the properties there no wrongful gain (not a penny taken out)
The Fiduciary Test
By now it must be clear that the Congress is essentially not denying that the hop,skip, and jump transactions were instances of self dealing. What they are saying is that the deals are fair and that they wont take a penny. This should alarm everyone who deals with Trust issues because it breaks the entire model. In my view, this is the essence of this case so lets see what this is about.
Who is a Fiduciary ?
“A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence”
A fiduciary “must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal. This is not intended to be an exhaustive list, but it is sufficient to indicate the nature of fiduciary obligations.”
Even though this is from the UK, this makes sense even in Indian context we have for long known the role of the Dharma Kartha – the temple manager who was entrusted with accounting expenses. The common law rules in this domain are not far off from the Indian traditions.
Now the central question is : If a fiduciary self deals can we allow that and then test it ex post facto on the basis of a fair deal test ? If a treasurer acting as a fiduciary advances a loan to himself but paid 1% over market rate. Should that be allowed? Here is where things get interesting.
Most countries especially those derived from common law tradition disallow any self dealing NO MATTER HOW beneficial it is to the trust. To understand why they do this – think about what will happen if they did the opposite. Any trustee acting as the legal owner of funds could self deal in any manner – then it is the beneficiaries and donors to hit up the court seeking to void this or that transaction. The burden on the court is to examine EVERY such transaction to check if a fair deal was obtained. This is totally outside the domain of the courts expertise. So they just ban self dealing at the front end to prevent such painful ex post facto assessment. The rule is called the “No Further Inquiry Test” – here is Lexis Nexis explaining the rule.
Self-dealing is simply not tolerated in the relationship between a fiduciary and those whose interests he or she is to protect. In attempting to address the problem of self-dealing, a bright-line prohibition has evolved in trust law so that where self-dealing is found, the Court will make “no further inquiry.” It is immaterial whether the transaction was fair, or even if it garnered favorable results.
Source : Lexis on the self dealing fiduciary
With corporates we generally have mechanisms to check self dealing by requiring executives to get permission from the board for certain types of transactions, various disclosure requirements for family member of directors, and finally the business judgment rule to test if senior executives did pursue meaningfully the best considered option. But the standard is much higher for those holding trust property such as the Congress Party. Now you understand why they are seeking to present that ‘funds are not entrusted rather just donated” ? A piddly wordplay is not an innocent sentence but a giant leap.. To suggest that people just throw money at the party and do not expect the treasurer to act in fiduciary capacity. For a minute stop here and see how low the party of Nehru , Gandhi , and Patel has sunk to make these kinds of arguments that appeals to ethics of very few.
Non profit – cant take a penny
The argument goes : Even though the Young Indian company now owns the properties including National Herald House it is not a big deal because it is a Section 25 (Non Profit/ Charity) company so no profits/dividends/remuneration can be taken out. I dont think anyone really believes this argument. First of all , the non-profit constraint does not preclude using the real estate assets for commercial use. So AJL which is now 99% owned by YI can rent out those properties but the money can be used by YI only to further its charity objectives. The stated objectives are to ‘inculcate secularism in youth’. What they have really done is to create a massive endowment which can then pay for various activities like funding think tanks, lucrative op-ed consulting contracts, partronizing various kinds of people as awards, not to mention building a large team of salaried staff. Therefore an entire ecosystem can be built without the directors Mrs Gandhi and Mr Gandhi and others taking ‘a penny out’.
In my view the real interesting thing that arises out of this case is the future of Indian Trust Law. If we do not adopt the “No further inquiry rule” in Indian courts then we will open up a Pandoras box that can go on to destroy the entire fiduciary-beneficiary relationship.
One interesting angle in this is the “Idea of India”. If you think there should be extraordinary processes – then it is perfectly understandable why the Gandhis are putting up such an unsightly fight. It is important that they demonstrate to the regional satraps like Laloo that they have an inside track in the law. That in itself is a major attraction for these groups who hold key to political power. If you also concede that fiduciary self dealing be allowed if it is a fair-deal then you need to combine the two. I would then argue that is absolutely a great deal that properties vest with the people who have immunities from pesky laws that affect the others.
S. Gurmurthy’s article explaining the transaction details http://www.newindianexpress.com/columns/s_gurumurthy/National-Herald-affair-It%E2%80%99s-fraud-all-the-way/2012/11/08/article1332271.ece
In Tito v Waddell (No 2)  3 All ER 129, 241 Megarry V-C said: “The self dealing rule is (to put it very shortly) that if a trustee sells the trust property to himself the sale is voidable by any beneficiary ex debito justitiae, however fair the transaction.”
A really good Self Dealing guide prepared by Price Waterhouse funded by Ford Foundation (for US viewers). Explains prohibited transactions and disqualified persons and IRS (US Tax guy) strict rules for 501(c)(3) – their version of Section 25 – http://www.wvgrantmakers.org/data/sites/1/banners/pdfs/news/self.dealing.guide.pdf