Chapter B2
Rule 2: The Governing Environment
Deciding to fight is not that different from running the Paris to Dakar rally. First things first, you need a driver with the skill and strength to navigate the grueling ten-thousand-kilometer journey. He has to have the personal power to be able to do it. We have looked at that piece of it in the previous chapter. But is it enough to have a driver who can do it? Wouldn’t you need to understand road conditions so that you can pick the right car for the race? Perhaps even the car is not enough. It’s a desert out there in the wilderness. You need to equip yourself for the desert. You need appropriate food, water, supplies, spare parts, fuel, and so forth. You need to think about the high temperatures and the low humidity and how it may impact both car and driver. Each of these factors combine to create the Governing Environment impacting the outcome of your war.
The Governing Environment consists of factors that come not from the contenders in the legal dog fight: they come from the general environment around the warring parties. These are the larger forces impacting the theatre of war. This is the key thing about the Governing Environment: it’s the same for everyone, but it impacts different people in different ways. The sun in Jaisalmer in summer is the same for everyone but the Indian and the Eskimo don’t react to it in the same way. In a conventional military battle, heavy rain is good for a defender and bad for an attacker. In a liberal modern democracy, marriage and divorce laws naturally favors woman over men. In any traditional society, regardless of what the law says, the enforcers of the law are biased towards men. In any third world democracy, voters favor large public subsidies and low or no tolls for publicly supplied service. This is the bias of the environment and it’s a harsh fact of life in every environment. The misbalanced impact of the environment makes the fight harder, or easier, depending on which side of the impact you stand. Only a fool operates in ignorance of it.
Just so we don’t get bogged down with faddist subjects, let’s consider this rule in an industrial context. Think about labor in a shareholders’ battle for control of a company. Because labor doesn’t have long term financial staying power, its focus on short term survival and solvency is pretty obsessive. It frequently doesn’t have the will to see the “big picture”, big in the context being long term. If labor is a factor in a corporate dog fight – and it often is – the contender who shakes the money bags will tilt the balance in his favor. Even if there is no immediate cash payout, the contender with the deeper pocket will be able to persuade the union bosses that he will raise wages very high very soon. He can then leverage the trade union to create a favorable political climate. He can get the local petty politician to whip up opinion in his favor. He can get lawyers representing trade unions to intervene in a court case between shareholders and support him in the proceedings.
Here’s another example. Notwithstanding all the global gobbledygook you hear in urban Indian print media, rural India is still pretty insular and there is a visible distrust of outsiders. While everyone wants to make a fast buck out of the incoming foreigner, a bias for the local person is still pretty common. When you walk into a small town as an outsider, you have to fight a mindset. Getting favorable court orders in this kind of environment is just that little bit harder. It’s the same when you deal with regional, ethnic, class, caste and creed perceptions in the environment in which you choose to fight your wars.
There are of course many kinds of Governing Environments. Here are a couple of examples:
- First, to go back to bare bone basics, fighting on home soil is always a huge advantage over fighting on foreign soil. This isn’t necessarily about nationality. It could be about culture and language, but it could as easily be about networking relationships. A north Indian is as foreign in Tripura as a Brazilian is in Delhi. It’s a long way away and a challenge to manage the case, an unknown place to manage it in and a strange language to communicate in. Here, simple geography and logistics are dominant elements of the Governing Environment. If you want to fight a legal case on truly foreign soil, you have to develop strategies to neutralize the home advantage.
- The party with relevant resources in the Governing Environment will generally win. What do I mean by relevant resources? Most small towns generally have one great lawyer and a whole lot of wonnabes who were very likely his juniors not so long ago. If you have easy access to this hot local lawyer and hire him first, you have a huge head start. Likewise, if you have World Bank and non-profit institutional support on an infrastructure project, you will find it a lot easier to combat green peace activists. In a society that is generally religious, you will find it just a little bit easier to resist efforts by the municipal corporation to demolish the illegal temple you built at the gate of your factory on that encroached bit of forest land!
- The party fighting on an issue that has popular sympathy will generally have a huge advantage. For example, in the 1990s, labor was a holy cow, no less, and the pinko-socialist tenor of the times meant that they could do no wrong to the money-grubbing mean-minded industrialists they worked for. Today, unionized labor is seen as either slothful problem children, or worse political pawns in an extortion racket being run by a class of politicians who need to be ruthlessly suppressed. Trade union strikes in Haryana for instance are routinely dealt with through coercive police action. Similarly, up until the mid 1980s, press, public and judiciary were generally sympathetic to the tenant, as opposed to the landlord. The opposite is now true. Again, in the 1990s, journalists were deeply respected, indeed revered in many cases, their word was definitive. The journalists are the same today but they are now projected as tradable commodities, paid to run to agendas or worse, despicable propogandists. In some notable cases, individuals we know well have transformed from sages to demagogues in the space of a few years!
Simply put, the Governing Environment is often about the ‘popular cause’. If you are fighting a popular cause, you have everyone’s ears and everyone’s heart, even the judiciary. The spirit of the land, and the spirit of the times, will determine what happens to your case.
This brings up the real question: how do you know whether the Governing Environment is on your side? The trick is to figure out what factors of the Governing Environment are relevant to your case. Ask yourself this question: apart from the hard-core law, what other factors will come into play if you choose to make a fight of it? If you know what these factors are, you know how they will impact you, and you know how they will impact your enemy. In a jiffy, you will know whether you are going to win or find yourself in a spin dryer with no exit and no kill switch.
I can add that this is not a static, passive, evaluation of fixed realities. Just because the Governing Environment is not in your favor doesn’t mean that you have to give up. The exercise is pro-active in nature: if you decide that (say) three of five factors shall hurt your case, you can find a way to either neutralize these factors or bring them to act in your favor. How would you do such a thing? Well, it depends on the factor, and it depends on you. Half the time, it’s about…well, lobbying. You can take out press advertisements; publicly contribute funds to popular causes; purchase…dare I say it…news items, hire a lobbyist, donate to local charities, fund NGO’s, open schools, kiss babies, influence the influential, whatever… it depends on what looms before you that has the power to hurt your interests. It’s only if you decide that you absolutely cannot do anything about the Governing Environment that you roll up your bags and admit defeat.
Let us look at a case where in the face of otherwise overwhelming odds, a single individual was able to prevail over a mega corporation only because he was a master of the Governing Environment.
The Hargear case
In 1993, an Indian engineering company called Hargear entered into a technology and equity partnership with Lerion, an Italian company. Lerion had been wooing Hargear for years before the marriage. They placed lucrative export orders, year on year, in ever expanding volumes, and talked about taking their mutual cooperation to the next level. Hargear got the impression that Lerion was a major European distributor of engineering products. Those were the days before the Internet, when information was scanty and the culture of investigation had few takers. At some point, Lerion told Hargear that they would like to move all their manufacturing to India if Hargear would take them as equity partners.
Hargear was at this time a one-man show, run by a technocrat named Hooda. Many of his shareholders were friends and family. As business grew, Hooda became increasingly autonomous in his ways, consulting his shareholders little and listening less even though he directly controlled only about 37% of the equity of his company. A lot of his friends thought he had become very haughty and unapproachable.
As the deal developed, Lerion signed an amateurish Shareholders Agreement and picked up 26% of Hargear equity. They also took the option of buying 23% more shares within two years. They agreed that the price of this second share purchase would be based on Hargear’s financial performance in these two years. In short, the better the company did, the more Lerion paid. You can say that Lerion had no incentive to improve Hargear’s business for at least two years!
Curiously, Lerion also sweet talked Hooda into ceding board control. Lerion insisted they wanted a technical director on the board, and they wanted a very small Board of Directors. Hooda agreed to 2 directors each, which meant that both partners had to agree to pass any resolution by majority. Hooda soon found he had to persuade Lerion, a mere 26% shareholder, on every decision he wanted to take. This gave Lerion a lot of power and even more capacity for mischief. What would happen if Lerion took its equity up to 49% and added some voting power by joining hands with some disgruntled minor shareholders?
Almost immediately after joining hands with Hooda, Lerion orders from Italy started dropping, as you would expect. Hargear’s financials plummeted and with it dropped the price at which Lerion would buy the remaining shares, when they chose to buy them. Simultaneously, Lerion started to cozy up to some of Hooda’s small shareholders. Within a year, Hooda faced a stonewalled Board of Directors, hostile small shareholders and declining business. At the same time, Lerion became increasingly belligerent. Hooda was in trouble.
Hooda went to see a law firm. They gave him no joy. His partner had 26% equity and could pick up another 23% cheaply. In comparison, Hooda had 37% and didn’t have the money to pick up more. Lerion didn’t have to buy more equity to beat Hooda: they just needed to convince a few small shareholders to vote with them. As it was, the small shareholder knives were out seeking Hooda’s back. Lerion had the technology, they controlled the sales and marketing and now, they practically controlled the Company. Any which way you looked at it, Lerion had the balance of personal power. But did they have the Governing Environment?
Lerion was still new to India. They were barely at grips with the company’s shop floor. They did not understand the bureaucratic environment. They struggled to deal with the procession of predatory babus, inspectors, enforcement official, preventive staff and meter readers who came sniffing in search of snacks every other day. They did not know their raw material suppliers. Perhaps, Lerion had moved too early.
In any case, Hooda decided that he was done with Lerion. He wanted his company back and would kill or die for it. It helped that the Governing Environment was with him, more or less. And then again, the environment is what you make of it. Hooda was a first-generation entrepreneur and he could deal with conflict. If he could create an even more adverse environment for the Italians, he surely would. He started with the suppliers. He had excellent relations with all local vendors. The vendors were already upset that Hargear orders had declined as orders from Italy had declined. He made sure that Hargear suddenly developed vendor supply problems.
Hargear had long had its shares of tax problems. Now that Lerion nominees were on the board, they carried the can for its tax problems too. Hooda started dragging his feet on his tax compliance. The revenue departments reacted by increasing the pressure on Board members. It did not help that both Italian directors had executive powers. The Italian directors started to flinch.
Hooda was also pretty good with customs. All of a sudden, exports became a nightmare. The consignments to Italy would not clear. Hargear faced supply defaults with foreign customers. It all started to look very edgy and out of control. Hooda made a real mess of the Governing Environment for Lerion. What had seemed like a cakewalk was now beginning to look dodgy.
Lerion needed to do something. They decided that they had to get Hooda out completely.
The war started with Lerion exercising their call option on the additional 23% equity. Hooda stonewalled, demanding that Lerion get their Indian law approvals first. In those days, a foreigner could not invest in India without approval from something called the Foreign Investment Promotion Board. This being India, in the best Orwellian tradition of those days, FIPB spend more time blocking investment proposals than promoting foreign investment. Lerion wilted and approached FIPB. In the meantime, Hooda made the necessary moves and stonewalled the application before FIPB, entrapping Lerion in a web of procedures and clarifications.
Not much later, the Excise Tax department raided Hargear. They followed up this traumatic visit by issuing summons asking 8 different officers of the company, big and small, including both Italian directors, to visit the enforcement directorate and record their statements. Lerion came to believe that its directors face eminent threat of arrest: a fear that Hooda did everything to fan.
Not long after, Hooda quietly encouraged the Government to investigate the declared value of some equipment Lerion had supplied to the Company. Authorities investigated the foreign exchange impact of over-invoiced capital imports. A different authority also investigated the customs duty impact of under-invoiced imports! Lerion could not believe they were damned if they did one or the other and had no idea how to prove that the declared value of these machines was exactly right down to the last paisa. It all seemed like a nightmare.
What broke the camel’s back though was Hooda’s confidential disclosure to Lerion’s Technical Director that he had not obtained employment approvals for him from Indian authorities. It appeared that they were working illegally in India. If there is such a thing as perfect chaos, this was it!
Meanwhile, the supply chain started to come apart. Suppliers became tardy in accepting orders and delayed executing them. Hooda blamed Lerion for the deteriorating vendor management situation.
In all this mess, Hooda upped the ante and sued Lerion before the Company Law Board for oppression and mismanagement even though he was the largest single shareholder. He asked for all kinds of absurd interim orders which of course he did not get. He made the wildest personal allegations against the Italian directors knowing them to be wild. Lerion found itself running a contracting business and an expanding litigation. Lerion directors lost their nerve, fearing they would carry personal potential liability. Their enthusiasm began to flag and they started to signal headquarters that compromise may be the more commercial way to go.
In six months, Lerion caved in. The technical director was probably the single biggest reason why. Lerion asked for a solution and Hooda gave Lerion two choices: Hooda could buy Lerion out at their acquisition value, or Lerion should give up management participation and become passive shareholders. Lerion chose to exit and the matter was wrapped up without further disruption.
The weirdest thing about this case is that so little happened in court. Lerion issued a single notice under the shareholders contract asking to up its equity holding. Hooda filed a single caseand CLB didn’t actually didn’t do anything. The whole game was played out in smoke, mirrors and perceptions. Hooda created a pressured environment at work and a menacing environment in the legal system. The Italians became fixated about the form of the legal action, rather than the substance. They started to think as many professionals do. At the end of the day, it was only a job. They didn’t need to stick their necks in a noose in a strange land very far away from home. It worked like magic potion.
What do we learn from this story? There is no doubt that Hooda was weak to begin with. His enemy controlled the Board of Directors and would have controlled the shareholding if a meeting had been called. His enemy controlled the technology and his enemy controlled the customer. So how did Hooda get what he wanted? The short answer is that Hooda understood everything everyone ever wants to know about the Governing Environment but never dared ask. He correctly surmised that Lerion was not at grips with the business side of the Governing Environment. He structured a legal strategy that specifically attacked the business side of the business without focusing too much on filing cases. He added to the chaos when he instituted a litigation he did not expect to win, intending only to create a certain impact and as we have seen, he made the correct call. Hargear’s case shows us that if you want to win your legal war, you have to manage your Governing Environment. If you create a hostile Governing Environment for your enemy, it is going to play on his mind. Hooda created a hostile Governing Environment in which Lerion could not operate, and he won his fight for that reason alone.
Every now and then though, you stumble on a situation where the Governing Environment simply cannot be mastered. Very often, these are the cases where the ‘tide of the times’ are against the litigant. Let us look at a telecom case where the plaintiff never had a chance to win.
The Telemobil case
Back when the ‘new telecom policy’ was announced in 1995, a host of Indian and global businessmen swooped in to cash in on the opportunity. Unfortunately, the policy was flawed in two fundamental ways.
First, it was based on the principle that the highest bidder wins. At that time, India was in the middle of a brutal License Permit Quota Raj. Indians were told what to produce and in what quantities, who they could sell it to, and frequently, at what price. It was punishing, but it also offered exceptional arbitrage opportunities. Indians knew, like no one knew, how to corner a license and then flog it for all it was worth without doing an iota of work. Besides, in a business where no one knew the size of the market, and everyone rode on a wing and a prayer, the wildest and most optimistic gambler would always win.
Second, the policy required Indians to have the majority equity in all telecom companies. Where did the Government to find that many Indians with deep pockets? Indians were encouraged to become sleeping partners of underground foreigners, and boy, did they make money out of bedding aliens!
Telemobil, a chop suey of a company, was one of the bidders. It had one major European shareholder, one major South East Asian shareholder and six surrogate Indian shareholders. One of these six was a fixer named Kathuria who held a British passport. He projected himself as Telecom minister Sukh Ram’s gulli-danda buddy. Kathuria claimed he could deliver a license, and asked for equity in return. As the deal developed, the European and Asian companies together took 46% of the equity, Kathuria took 20% and the other Indians took 39%. Its was a strange gaggle of bedfellows, and shareholders meetings were chaotic at best.
This configuration had one potentially messy piece. Kathuria held a British passport, which meant that any equity he owned was not (at the time) “Indian equity”. Kathuria needed his own sleeping desi partner! Soon enough, Kathuria introduced a well-known Indian company as his Indian surrogate: a once eminent but now rapidly declining Indian business house called Lakshmi. Lakshmi agreed to lend its name to Kathuria for an agreed price. The bids went through, Kathuria claimed to wave his magic wand whatever that was, and Telemobil won the telecom tender.
Then corporate greed took over. After Telemobil received its license, Lakshmi declared that it had no intention of accepting the agreed fees and going away. It wanted triple the money for lending a name to Kathuria. Kathuria was incensed. Kathuria stalled while he looked at his legal options. Legally, Kathuria was on slippery ground. Lakshmi had signed the Joint Venture Agreement. Lakshmi was the declared partner in the Bid papers. The license specified Lakshmi as a party. Kathuria was a British national, not an Indian. For the partners to admit in public that Kathuria was the actual owner was to publicly admit that a fraud had been perpetrated. What were the partners to do?
Eventually everyone agreed that it was Kathuria’s equity and Kathuria’s problem. Kathuria liked that because it meant he could fix Lakshmi without trouble from his partners. He persuaded UT, one of the five Indian shareholders of Telemobil, to hold Kathuria’s equity in Telemobil. Kathuria then made sure that Telemobil allotted Kathuria’s equity to UT and Kathuria funded this acquisition by giving the money to UT. Lakshmi had been hung out to dry.
Lakshmi sued Telemobil, and demanded its equity. Lakshmi’s case was simple. It was a joint venture partner who had successfully bid for a license and now it had been double crossed. How could it lose? Conversely, Telemobil’s case hid behind technicalities. It argued that the company was not concerned with deals between shareholders and could allot equity as it wished. This was legally correct of course but that was hardly the point. Telemobil had told the government who its shareholders were and it had won the license on that basis. It had to have the same shareholders when it rolled out the network. To do it different was to breach the license. Clearly Lakshmi had the legal case.
Surprising, the court did not help Lakshmi. The Governing Environment was the reason. Here is the substance of it.
(a) Quite apart from Kathuria’s supposed leverage with the Indian telecom minister, 1995-6 had been a time of great churn in the political and business environment. The Department of Telecommunications (or ‘DOT’) knew that all kinds of wheels were turning within other wheels. Then as now, many political figures had surrogate equity in companies riding on Government approvals. No one quite knew who Kathuria fronted for. In this opaque environment, DOT wasn’t going to stick its neck out and upset this politician or that. Let’s just say that the Governing Environment was one of ‘don’t show don’t tell;B just get on with it’. If DOT had no objections to whatever was going on in Telemobile, the court was not going to go there. DOT’s lawyer did not open his mouth in court, and Lakshmi could not progress its case.
(b) Lakshmi’s reputation wasn’t that hot. Its finances were precarious and it was heading for bankruptcy. It had a lot of disgruntled public shareholders braying for its blood. The court did not want to support a company with a long track record of financial perversity. The court did not want to help a company which had participated in the scheme and was now blackmailing the real owner.
(c) Indian telecom reforms made a hesitant, confused start and soon ran into serious trouble in the face of an uncertain political climate. The bidding had been astonishingly aggressive and the bankers were very skeptical about funding those levels of license fees. High fees meant high airtime rates and customer off-take in those years was pretty poor. The judge understood the commercial reality. The Governing Environment was to not sweat the small stuff and get on with it. The court was not about to destroy the Telemobil project in order to support an Indian participant who clearly didn’t have the money to participate in the project.
This first suit was not the end of the matter. Lakshmi filed four successive cases but neither DOT nor the courts were inclined to help Lakshmi. Lakshmi eventually abandoned the litigation.
The Telemobil case teaches us that legal issues can never to be seen in isolation. All life is lived in its context, even the legal life. Every legal case is understood by the judiciary only in relation to the environment in which it is agitated. In the old world, through to the end of the 1990s, the law was always on the side of the poor, the workman, the small contractor, the David of the piece seeking to battle the Goliath. It was not a good time for the big boys to be seen to be crushing the little boys. This has now changed and the pendulum has swung the other way. The Governing Environment now is about naked money power, unhampered by elevated sentiment.
We can part with Rule 2 on this note. Before you set out to start a war, ask yourself this question: can you battle the Governing Environment facing you? If you can’t battle this environment, you have to ask yourself if you can influence the environment and change it enough so that it doesn’t hurt you? If you can change the Governing Environment, that is your pathfinder to victory. On the other hand, if you can’t change the Governing Environment, you’d better find something else to brawl about.