Corporate Governance and Rule of Law: the Case of Enron

 sickle_s.gif (30476 bytes) People’s Democracy

(Weekly Organ of the Communist Party of
India (Marxist)


No. 44

November 04,2001

The Twisted Tale
of Enron’s Equity

Prabir Purkayastha

ENRON, without
any intimation or notice to the government of India or Maharashtra, has obtained an ex
injunction from the High Court of Justice in London on 10th October 2001. This
injunction prohibits the state of Maharashtra, its servants, agents or otherwise, from
commencing or participating in proceedings in any Court or Tribunal in India (or in any
other jurisdiction) with respect to any disputes involving the Dabhol Power Company.

The London High
Court must still be believing that the British Raj continues in India, and its writ must
run in India. Enron’s attempt is to force the Maharashtra government and MSEB to
appear in London in the Arbitration Proceedings as the only platform with respect to
the Dabhol dispute,
and blackmail the Indian and Maharashtra governments into paying
the $1 billion it claims it brought in as equity. While the legal implications of such an
injunction will be carefully studied before charting out the response and course of
action, we would here like to restrict ourselves to what is the real major issue here – how
much actual capital did Enron bring into the Dabhol project.


There are two
points involved here. The first is on the question of compensation. Enron’s friends
and champions are campaigning on the ground that the $ 1 billion that Enron brought in as
its equity, must be returned to it, i.e., Enron should be “adequately”
compensated, even if it is recognised that the Enron project is a disaster.

When a contract
goes against the interests of the people, then a host of people start discussing the
‘sanctity’ of contracts. When other contracts are found not to be generating the
anticipated profits, we are told of the need for bailing out a “vital sector of the
economy”. If the Telecom companies had to be saved from their contracts earlier, how
come the people of Maharashtra do not need the same attention today?

Even if we
assume that Enron needs to be compensated, the question still remains what should be the quantum
of this compensation. When a company takes a commercial risk and brings in capital, it
is not automatic that the compensation should be equal to what it brought in originally,
rather compensation is calculated on the basis of what the capital is currently worth.
That is the principle on which all buying and selling of equity operates. And the Godbole
committee, going by this principle, has clearly indicated that the net worth of
Enron’s equity today is only 25% of its face value.

The second point
that the friends of Enron are not willing to discuss is, what happens if a contract is
reached through fraud? Again, it is a well-settled principle in law that if a contract has
been reached through corrupt practices or through fraud, the contract has no validity.

The Godbole
Committee’s report has given computations showing how, (i) in the Power Purchase
Agreement, the MSEB agreed to excessive payments to Enron to the tune of Rs.930 crore per

(ii) it has
given detailed examples, showing how every “error” made in the agreement
favoured Enron;

(iii) it has
substantiated the point raised by a petition filed in the Courts by the CITU (with Abhay
Mehta), that the Central Electricity Authority failed to fulfil its statutory
responsibility of carrying out a techno-economic evaluation of the project.

(iv) it has
chronicled how the protracted “negotiations” carried out by MSEB from August ’92
to December ’93, led to an increase in the rate of power from 6.91 cents to 7.5 cents,
despite the drop in fuel prices in this period.


What are the
excess payments that the Godbole Committee has pointed out?

  • A major portion of them pertains
    to Enron’s attempt to pass on the entire cost of re-gasification of LNG to the
    MSEB, although the power plant would use only about 40 per cent of the total
    re-gasification capacity while Enron was offering the remaining 60 per cent to others.
  • Double-charging MSEB for
    facilities such as harbour charges – once as a part of the capital recovery charges of the
    project, and again as harbour charges.
  • Built-in inflated operations and
    maintenance costs, and a higher fuel consumption rate for the plant, leading to a higher
    charge for fuel than the actual consumption.

All this, in
normal legal terms, is fraud.

That the
government acquiesced in this fraud in no way exonerates Enron from reaching a contract
through illegal means, and thus renders such a contract null and void.

The problem with
the Maharashtra government is that it is unwilling to state the obvious – that this
contract was reached through corrupt means and in collusion with the leaders of the
governments theninvolved. It was a Congress government, led by Sharad Pawar, that signed
the initial Enron deal, followed up by an even worse deal perpetrated by its successor
BJP-Shiv Sena government. And to seal this whole scandalous process, the counter guarantee
vital for the deal was given by the 13-day Vajpayee government a scant two hours
before it fell.

It is clear that
the reasons for the watering down of the fraud charges against Enron lie in this Congress
legacy, the pressure of the Sharad Pawar-led NCP, and the BJP-led central government, to
protect the complicity of these earlier governments. But the legal situation today is such
that unless the issue of fraud is taken up strongly, the Maharashtra government’s
present legal battle against Enron will stand considerably weakened.


How much capital
did Enron actually bring in to the Dabhol project? The Godbole Committee did not examine
the capital costs of the Dabhol project, but the stark point is that Enron did not in fact
bring any equity into the project. It first of all inflated the capital costs of the
project, borrowed the funds from financial institutions, including Indian ones, recycled
these funds through the EPC contractor and other equipment suppliers into its account, and
then showed these funds as its project equity. In other words their equity is nothing but
the recycled funds of the project based on fictitious project costs.

Thus, in its
first phase, Dabhol was shown as having a capital cost of Rs 5.2 crore/mw. In the same
period, NTPC built the Kayamkulam project in Kerala with the same fuel and virtually with
the same equipment, at a cost of Rs 3.5 crore/mw. In this period also, a number of
projects were undertaken internationally using the same combined cycle plant route. The
costs of such projects varied from $600/kw for North America, to 1,000 dollars for India
and Africa, i.e., the international costs of similar projects around the globe varied from
Rs 2.5 crore to Rs 4.0 crore per mw, depending on the location. Therefore, if we take
NTPC’s cost of Rs 3.5 crore/mw, already on the high end of the spectrum, the Enron
plant cost at least Rs 1.7 crore per mw more than the prevailing international price

Totally for the
first stage, with a capacity of 695 mw, the Enron plant cost was about Rs 1,300 crore more
than what it should have been. For the second stage, of another 1400 mw, the situation is
even worse. If we take the re-gas facilities into account, the cost per kw comes to about
$1400, Rs 6.6 crore per mw at the current price of the dollar. The overpricing here is of
the order of 600 dollars per kw and works out to more than 1.2 billion dollars or more
than Rs 5,000 crore.

Without access
to its accounts. it is difficult to establish how Enron accomplished all this. However, a
recent case, in which two promoters have fallen out, brings out the modus operandi
of IPP promoters. In the Godavari Spectrum project, the two promoters Mohan Rao and
Krishan Rao, fell out amongst themselves. The documentary evidence filed against each
other shows how both of them had stolen project funds and brought them in as
equity. The EPC contractor, Rolls Royce, paid 19.3 million dollars and 1.5 million pounds
sterling, as commissions, into a Virgin Island account of the promoters. Further, through
other methods, another Rs 70 crore were siphoned off into Krishan Rao’s account.
Project loans were taken by the two promoters from various Indian financial institutions,
and as documented, it now turns out that the entire equity of the promoters was nothing
but these loans recycled. Interestingly, after these manipulations, the cost per mw for
the Godavari Spectrum is also similar to that of Enron.


This brings us
to our last point. How much have the Indian financial institutions paid for Enron? In
terms of loans, 1.3 billion dollars; another 600 million dollars have been guaranteed to
foreign lenders. Thus their total exposure on Dabhol is to the tune of 1.9 billion
dollars. No wonder the finance ministry, after having forced Enron on the country as a
“reasonable” project, and having pressurised IDBI and others to extend loans to
Enron, is now pushing that Dabhol should somehow be rescued from sinking. If not, all
these loans would turn into Non-Performing Assets, sinking some of these financial
institutions. Incidentally, with this same 1.9 billion dollars, a 2000 mw plant could have
easily been built without any other investment.

What then is a
reasonable compensation that should be paid to Enron? Clearly, the Indian people should
not be asked to pay for the spurious equity that Enron has brought in. In fact there is a
splendid criterion already being enforced in America itself. And that is the logic that
Californians are urging on their government.

They have argued
that the eminent domain of the state should be used to take over generating companies that
have overcharged the California consumers, paying the former a “reasonable
cost.” The reasonableness of this cost must be established by opening their
books and checking for the fraud they have committed on Californian consumers.

We should demand
the same logic be applied here. Enron’s ‘equity’ can be taken over by paying them a
“reasonable compensation.” But Enron will have to establish why they paid so
much more than the market price for plant and equipment for the Dabhol project. We can
check their accounts to trace where this so-called equity came from. In other words, if
they want their one billion, it is they who have to show that they have not overcharged
the project. The evidence otherwise is overwhelmingly of Enron having cooked their books.

The friends of
Enron are of course not interested in any of the above issues. All they want is that Enron
be given a golden handshake of $1 billion. It does not matter that Enron brought in very
little to the project. The Independent Power Producers Association of India (IPPAI), in
its latest issue, has even quoted from Ramayana “jaan jaye par bachan na jaye“.
( The pledge must be honoured even at the cost of life) But the question is whose bachan
(pledge), and whose jaan (life)? Or is it that those who gave the bachan
to Enron are worried that they may not receive their cut, and for that they are prepared
to sacrifice the jaan of the people of Maharashtra?

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