| Contingent liabilities and legal proceedings | 13. Contingent liabilities and legal proceedings
(a) Guarantees and related matters
As of 31 December 2018, the group has no material unprovided
guarantees or indemnities in respect of liabilities of third
parties.
(b) Acquisition of USL shares from UBHL, winding-up
On 4 July 2013, Diageo completed its acquisition, under a
share purchase agreement with United Breweries (Holdings) Limited
(UBHL) and various other sellers (the SPA), of 21,767,749 shares
(14.98%) in United Spirits Limited (USL) for a total consideration
of INR 31.3 billion (£349 million), including 10,141,437
shares (6.98%) from UBHL. The SPA was signed on 9 November
2012 and was part of the transaction announced by Diageo in
relation to USL on that day (the Original USL Transaction). Through
a series of further transactions, as of 2 July 2014, Diageo
had a 54.78% investment in USL (excluding 2.38% owned by the USL
Benefit Trust).
Prior to the acquisition from UBHL on 4 July 2013, the High
Court of Karnataka (High Court) had granted leave to UBHL under
sections 536 and 537 of the Indian Companies Act 1956 (the Leave
Order) to enable the sale by UBHL to Diageo to take place (the UBHL
Share Sale) notwithstanding the continued existence of five
winding-up winding-up
Following closing of the UBHL Share Sale, appeals were filed by
various petitioners in respect of the Leave Order. On
20 December 2013, the division bench of the High Court set
aside the Leave Order (the December 2013 Order). Following the
December 2013 Order, Diageo filed special leave petitions (SLPs) in
the Supreme Court of India against the December 2013 Order.
On 10 February 2014, the Supreme Court of India issued an
order giving notice in respect of the SLPs and ordering that the
status quo be maintained with regard to the UBHL Share Sale pending
a hearing on the matter in the Supreme Court. Following a number of
adjournments, the next date for a substantive hearing of the SLPs
(in respect of which leave has since been granted and which have
been converted to civil appeals) is yet to be fixed.
In separate proceedings, the High Court passed a winding-up
Diageo continues to believe that the acquisition price of INR 1,440
per share paid to UBHL for the USL shares is fair and reasonable as
regards UBHL, UBHL’s shareholders and UBHL’s secured
and unsecured creditors. However, adverse results for Diageo in the
proceedings referred to above could, absent leave or relief in
other proceedings, ultimately result in Diageo losing title to the
10,141,437 USL shares acquired from UBHL. Diageo believes it would
remain in control of USL and be able to consolidate USL as a
subsidiary regardless of the outcome of this litigation. There can
be no certainty as to the outcome of the existing or any further
related legal proceedings or the timeframe within which they would
be concluded.
Diageo also has the benefit of certain contractual undertakings and
commitments from the relevant sellers in relation to potential
challenges to its unencumbered title to the USL shares acquired on
4 July 2013, including relating to the winding-up
(c) Continuing matters relating to the resignation of Dr Vijay
Mallya from USL and USL internal inquiries
On 25 February 2016, Diageo and USL each announced that they
had entered into arrangements with Dr Mallya under which he had
agreed to resign from his position as a director and as chairman of
USL and from his positions in USL’s subsidiaries. As
specified by Diageo in its announcement at that time, these
arrangements ended its prior agreement with Dr Mallya regarding his
position at USL, therefore bringing to an end the uncertainty
relating to the governance of USL, and put in place a five-year
global non-compete non-interference, non-solicitation
for the year ended 31 March 2014 (the Initial Inquiry) which
had revealed, among other things, certain diversions of USL funds.
Dr Mallya also agreed not to pursue any claims against Diageo, USL
and their affiliates (including under the prior agreement with
Diageo). In evaluating entering into such arrangements, Diageo
considered the impact of the arrangements on USL and all of
USL’s shareholders, and came to the view that the
arrangements were in the best interests of USL and its
shareholders.
Diageo’s agreement with Dr Mallya (the February 2016
Agreement) provided for a payment of $75 million (£53
million) to Dr Mallya over a five year period in consideration for
the five-year global non-compete, non-interference, non-solicitation USL-related
As previously announced by USL, the Initial Inquiry identified
certain additional parties and matters indicating the possible
existence of other improper transactions. These transactions could
not be fully analysed during the Initial Inquiry and, accordingly,
USL, as previously announced, mandated that its Managing Director
and Chief Executive Officer conduct a further inquiry into the
transactions involving the additional parties and the additional
matters to determine whether they also suffered from improprieties
(the Additional Inquiry). USL announced the results of the
Additional Inquiry in a notice to the Indian Stock Exchange dated
9 July 2016. The mutual release in relation to the Initial
Inquiry agreed by Diageo and USL with Dr Mallya announced on
25 February 2016 does not extend to matters arising out of the
Additional Inquiry.
As stated in USL’s previous announcement, the Additional
Inquiry revealed further instances of actual or potential fund
diversions from USL and its Indian and overseas subsidiaries to, in
most cases, Indian and overseas entities in which Dr Mallya appears
to have a material direct or indirect interest, as well as other
potentially improper transactions involving USL and its Indian and
overseas subsidiaries.
In connection with the matters identified by the Additional
Inquiry, USL has, pursuant to a detailed review of each case of
such fund diversion and after obtaining expert legal advice, where
appropriate, filed civil suits for recovery of funds from certain
parties, including Dr Mallya, before the relevant courts in
India.
The amounts identified in the Additional Inquiry have been
previously provided for or expensed in the financial statements of
USL or its subsidiaries for prior periods. Further, at this stage,
it is not possible for the management of USL to estimate the
financial impact on USL, if any, arising out of potential
non-compliance
(d) Other continuing matters relating to Dr Mallya and
affiliates
DHN issued a conditional backstop guarantee on 2 August 2013
to Standard Chartered Bank (Standard Chartered) pursuant to a
guarantee commitment agreement (the Guarantee Agreement). The
guarantee was in respect of the liabilities of Watson, a company
affiliated with Dr Mallya, under a $135 million (£92
million) facility from Standard Chartered (the Facility Agreement).
The Guarantee Agreement was entered into as part of the
arrangements put in place and announced at the closing of the USL
transaction on 4 July 2013.
DHN’s provision of the Guarantee Agreement enabled the
refinancing of certain existing borrowings of Watson from a third
party bank and facilitated the release by that bank of rights over
certain USL shares that were to be acquired by Diageo as part of
the USL transaction. The facility matured and entered into default
in May 2015. In aggregate DHN paid Standard Chartered
$141 million (£96 million) under this guarantee, i.e.
including payments of default interest and various fees and
expenses.
Watson remains liable for all amounts paid by DHN under the
guarantee. Under the guarantee documentation with Standard
Chartered, DHN is entitled to the benefit of the underlying
security package for the loan, including: (a) certain shares
in United Breweries Limited (UBL) held solely by Dr Mallya and
certain other shares in UBL held by Dr Mallya jointly with his son
Sidhartha Mallya, and (b) the shareholding in Watson.
Aspects of the security package are the subject of various
proceedings in India in which third parties are alleging and
asserting prior rights to certain assets comprised in the security
package or otherwise seeking to restrain enforcement against
certain assets by Standard Chartered and/or DHN. These proceedings
are ongoing and DHN will continue to vigorously pursue these
matters as part of its efforts for enforcement of the underlying
security and recovery of outstanding amounts. Diageo believes that
the existence of any prior rights or dispute in relation to the
security would be in breach of representations and warranties given
by Dr Mallya to Standard Chartered at the time the security was
granted and further believes that certain actions taken by Dr
Mallya in relation to the proceedings described above also breached
his obligations to Standard Chartered. In addition to these third
party proceedings, Dr Mallya is also subject to proceedings in
India under the Prevention of Money Laundering Act and the Fugitive
Economic Offenders Act in which the relevant Indian authority, the
Directorate of Enforcement, is seeking confiscation of the UBL
shares which were provided as security for Watson’s
liabilities. DHN is participating in these proceedings in order to
protect its security interest in respect of the UBL shares.
Under the terms of the guarantee and as a matter of law, there are
arrangements to pass on to DHN the benefit of the security package
upon payment under the guarantee of all amounts owed to Standard
Chartered. Payment under the guarantee has now occurred as
described above. To the extent possible in the context of the
proceedings described above, Standard Chartered has taken certain
recovery steps and is working with DHN in relation to these
proceedings. DHN is actively monitoring the security package and is
discussing with Standard Chartered steps to continue enforcement
against the background of the proceedings described above, as well
as enforcement steps in relation to elements of the security
package that are unaffected by those proceedings. DHN’s
ability to assume or enforce security over some elements of the
security package is also subject to regulatory consent. It is not
at this stage possible to determine whether such consent would be
forthcoming. In addition to the Indian proceedings just described,
certain of the assets comprised in the security package may also be
affected by a worldwide freezing order of the English High Court
granted on 24 November 2017 and continued on 8 December
2017 and 8 May 2018 in respect of the assets of Dr Mallya.
The agreement with Dr Mallya referenced in paragraph (c) above
does not impact the security package. Watson remains liable for all
amounts paid pursuant to the guarantee and DHN has the benefit of a
counter-indemnity from Watson in respect of payments in connection
with the guarantee. The various security providers, including Dr
Mallya and Watson, acknowledged in the February 2016 Agreement
referred to in paragraph (c) above that DHN is entitled to the
benefit of the security package underlying the Standard Chartered
facility and have also undertaken to take all necessary actions in
that regard. Further, Diageo believes that the existence of any
prior rights or disputes in relation to the security package would
be in breach of certain confirmations given to Diageo and DHN
pursuant to that agreement by Dr Mallya, Watson and certain
connected persons.
On 16 November 2017, DHN commenced various claims in the
English High Court for, in aggregate, in excess of
$142 million (£105 million) (plus interest) in relation
to these matters, including the following: (i) a claim against
Watson for $141 million (£96 million) (plus interest)
under Watson’s counter-indemnity to DHN in respect of
payments made by DHN to Standard Chartered under the guarantee
referred to above; (ii) a claim against Dr Mallya and
Sidhartha Mallya under various agreements creating or relating to
the security package referred to above for (a) the costs
incurred to date in the various Indian proceedings referred to
above (plus interest), and (b) damages of $141 million
(£96 million), being DHN’s loss as a result of those
Indian proceedings which currently prevent enforcement of the
security over shares in UBL (plus interest); and (iii) a claim
against CASL, as a co-surety
(e) Other matters in relation to USL
Following USL’s earlier updates concerning the Initial
Inquiry as well as in relation to the arrangements with Dr Mallya
that were the subject of the 25 February 2016 announcement,
USL and Diageo have received various notices from Indian regulatory
authorities, including the Ministry of Corporate Affairs,
Enforcement Directorate and Securities and Exchange Board of India
(SEBI).
Diageo and USL are cooperating fully with the authorities in
relation to these matters. Diageo and USL have also received
notices from SEBI requesting information in relation to, and
explanation of the reasons for, the arrangements with Dr Mallya
that were the subject of the 25 February 2016 announcement as
well as, in the case of USL, in relation to the Initial Inquiry and
the Additional Inquiry, and, in the case of Diageo, whether such
arrangements with Dr Mallya or the Watson backstop guarantee
arrangements referred to in paragraphs (c) and (d) above were
part of agreements previously made with Dr Mallya at the time of
the Original USL Transaction announced on 9 November 2012 and
the open offer made as part of the Original USL Transaction. Diageo
and USL have complied with such information requests and Diageo has
confirmed that, consistent with prior disclosures, the Watson
backstop guarantee arrangements and the matters described in the
25 February 2016 announcement were not the subject of any
earlier agreement with Dr Mallya. In respect of the Watson backstop
guarantee arrangements, SEBI issued a further notice to Diageo on
16 June 2016 that if there is any net liability incurred by
Diageo (after any recovery under relevant security or other
arrangements, which matters remain pending) on account of the
Watson backstop guarantee, such liability, if any, would be
considered to be part of the price paid for the acquisition of USL
shares under the SPA which formed part of the Original USL
Transaction and that, in that case, additional equivalent payments
would be required to be made to those shareholders (representing
0.04% of the shares in USL) who tendered in the open offer made as
part of the Original USL Transaction. Diageo is clear that the
Watson backstop guarantee arrangements were not part of the price
paid or agreed to be paid for any USL shares under the Original USL
Transaction and therefore believes the decision in the SEBI notice
to be misconceived and wrong in law and appealed against it before
the Securities Appellate Tribunal, Mumbai (SAT). On 1 November
2017, SAT issued an order in respect of Diageo’s appeal in
which, amongst other things, it observed
that the relevant officer at SEBI had neither considered
Diageo’s earlier reply nor provided Diageo with an
opportunity to be heard, and accordingly directed SEBI to pass a
fresh order after giving Diageo an opportunity to be heard.
Following SAT’s order, Diageo has made its further
submissions in the matter, including at a personal hearing before a
Deputy General Manager of SEBI.
Diageo is unable to assess if the notices or enquiries referred to
above will result in enforcement action or, if this were to
transpire, to quantify meaningfully the possible loss or range of
loss, if any, to which any such action might give rise if
determined against Diageo or USL.
In relation to the matters described in the 25 February 2016
announcement, Diageo had also responded to a show cause notice
dated 12 May 2017 from SEBI arising out of the previous
correspondence in this regard and made its further submissions in
the matter, including at a personal hearing before a Whole Time
Member of SEBI. On 6 September 2018, SEBI issued an order
holding that Diageo had acquired sole control of USL following its
earlier open offers, and that no fresh open offer was triggered by
Diageo.
(f) USL inventory review
As announced in USL’s results for the quarter ended 31
December 2018, USL recently learned of potential differences in
inventory of certain categories of work in progress and related
processes in certain plants in India. USL are undertaking a review
and will take appropriate steps to understand and address any
issues. At this stage, USL is unable to determine the related
financial impact, if any, arising from such potential
differences.
(g) SEC Inquiry
Diageo has received requests for information from the US Securities
and Exchange Commission (SEC) regarding its distribution in and
public disclosures regarding the United States and its distribution
in certain other Diageo markets as well as additional context about
the Diageo group globally. Diageo is currently responding to the
SEC’s requests for information in this matter. Diageo is
unable to assess if the inquiry will evolve into further
information requests or an enforcement action or, if this were to
transpire, to quantify meaningfully the possible loss or range of
loss, if any, to which any such action might give rise.
(h) Tax
The international tax environment has seen increased scrutiny and
rapid change over recent years bringing with it greater uncertainty
for multinationals. Against this backdrop, Diageo has been
monitoring developments and continues to engage transparently with
the tax authorities in the countries where Diageo operates to
ensure that the group manages its arrangements on a sustainable
basis.
In October 2017, the European Commission opened a state aid
investigation into the Group Financing Exemption in the UK
controlled foreign company rules. The Group Financing Exemption was
introduced in legislation by the UK government in 2013. In common
with other UK-based
Diageo has also been in discussions with the French Tax Authorities
over the deductibility of certain interest costs. As previously
reported, the French Tax Authorities have issued assessments
denying tax relief for interest costs incurred in the periods ended
30 June 2011 to 30 June 2017. Diageo believes that the interest
costs are deductible and accordingly is challenging the assessments
from the French Tax Authorities. Including interest and penalties,
the exposure for the periods ended 30 June 2011 to 31 December 2018
is approximately €241 million (£214 million). Based on
its current assessment, Diageo believes that no provision is
required in respect of this issue.
The group operates in a large number of markets with complex tax
and legislative regimes that are open to subjective interpretation.
As assessing an accurate value of contingent liabilities in these
markets requires a high level of judgment, contingent liabilities
are disclosed on the basis of the current known possible exposure
from tax assessment values.
Diageo has reviewed its disclosures in relation to Brazil and
India, where Diageo has a large number of ongoing tax cases. While
these cases are not individually significant, the current
assessment of the aggregate possible exposures is up to
approximately £260 million for Brazil and up to approximately
£130 million for India. The group believes that the likelihood
that the tax authorities will ultimately prevail is lower than
probable but higher than remote. Due to the fiscal environment in
Brazil and in India the possibility of further tax assessments
related to the same matters cannot be ruled out. Based on its
current assessment, Diageo believes that no provision is required
in respect of these issues.
(i) Other
The group has extensive international operations and is a defendant
in a number of legal, customs and tax proceedings incidental to
these operations, the outcome of which cannot at present be
foreseen. In particular, the group is currently a defendant in
various customs proceedings that challenge the declared customs
value of products imported by certain Diageo companies. Diageo
continues to defend its position vigorously in these
proceedings.
Save as disclosed above, neither Diageo, nor any member of the
Diageo group, is or has been engaged in, nor (so far as Diageo is
aware) is there pending or threatened by or against it, any legal
or arbitration proceedings which may have a significant effect on
the financial position of the Diageo group. |
