HOW TO FIND RISK FACTORS AND OUTSTANDING LITIGATIONS BY READING THE DRHP (DRAFT RED HERRING PROSPECTUS) FILED WITH SEBI IN AN IPO?

 

HOW TO FIND RISK FACTORS AND OUTSTANDING LITIGATIONS BY READING  THE DRHP (DRAFT RED HERRING PROSPECTUS) FILED WITH SEBI IN AN IPO?

WHAT IS DRHP (DRAFT RED HERRING PROSPECTUS)?

DRHP MEANING:

A Draft Red Herring Prospectus (DRHP) is the initial document filed with SEBI by companies planning an Initial Public Offering (IPO) to raise capital.

CONTENTS:

It includes details on company financials, promoters, and business operations, but typically excludes the exact price band and number of shares.

PROCESS:

After SEBI reviews the DRHP, the company files a Red Herring Prospectus (RHP) with the Registrar of Companies (ROC) before the final, full prospectus.

HOW TO FIND THESE DISCLOSURES?

·    If you are looking at a specific IPO, search the PDF of the DRHP for these keywords:

·    "Internal Risk Factors" (usually the first 20–50 pages).

·    "Outstanding Litigation" (near the end of the document).

·    "Objects of the Issue" (to see if the money is actually staying in the company).

RED FLAGS IN DRHP

DISCLOSURE AREA	WHAT TO LOOK FOR
PROMOTERS	Criminal cases, PMLA investigations, or SEBI debarment.
Financials	Sustained losses, negative cash flow, or auditor "Qualifications."
Use of Funds	Paying off old debt or buying assets from "unknown" vendors
Litigation	Tax , criminal cases or contingent liabilities that demands that exceed the total IPO size

STARTLING RISK FACTORS

Companies often list "boilerplate" risks, but some are specific and "horrible":

CUSTOMER CONCENTRATION:

Disclosing that 80–90% of revenue comes from just one client. If that client leaves, the company collapses.

RELATED PARTY TRANSACTIONS:

Disclosing that the company rents its offices from the promoter’s wife or buys raw materials from the promoter’s own side-business at non-market rates.

CRIMINAL PROCEEDINGS & PROMOTER LITIGATION

WEWORK INDIA (2025/2026)

In this case, petitioners challenged the DRHP for allegedly downplaying serious criminal charges under the PMLA and IPC (Sections 409 and 477A) against promoters.

BANNING FROM MARKETS:

If any promoter or group company was previously banned by SEBI from the capital markets (e.g., the historic DLF case where subsidiary transactions were concealed.

TRAFIKSOL ITS TECHNOLOGIES (2025)

SHAM VENDORS:

In the case of Trafiksol ITS Technologies (2025), SEBI found the company intended to use IPO proceeds to buy software from a third-party vendor that turned out to be a shell entity with no technical expertise.

BRIDGE LOAN SECRETS:

Some companies fail to disclose that they took high-interest "bridge loans" just weeks before the IPO, intended to be paid off immediately with investor money.

FINANCIAL RED FLAGS & "GOING CONCERN" RISKS

NEGATIVE NET WORTH:

Disclosure that the company has lost more money than its total capital.

NEGATIVE CASH FLOWS:

Admitting that the business "burns" cash and has never actually made a profit from operations (common in tech startups like Paytm or Zomato at the time of their IPOs).

AUDITOR QUALIFICATIONS:

If an auditor adds a "Going Concern" note, it means they doubt the company will survive the next 12 months without the IPO funds.

RED FLAGS IN CURRENT 2026 DRHP FILINGS WITH SEBI

COMPANY	RISK FACTORS
Shadowfax Technologies	High "Offer for Sale" (OFS) component vs. Fresh Issue; high operational burn.
KRM Ayurveda	Look for regulatory approvals for Ayurveda formulations and any pending consumer court cases.
Rodec Pharma	Look for pending USFDA observations or drug quality litigation (common in the pharma sector).

KEY TAKEOVERS

It requires a deep dive into the specific sections of their DRHP before investing your hard earned money  in IPOs.

LITIGATION INVOLVING THE PROMOTERS:

This is where you find criminal cases, tax evasion charges, or money laundering (PMLA) investigations against the founders.

LITIGATION INVOLVING THE COMPANY:

Look for "Environmental violations," "Intellectual Property (IP) disputes," or "Material Tax demands" that could exceed the company's net worth.

REGULATORY ACTIONS:

 Any past penalties imposed by SEBI, RBI, or the Enforcement Directorate (ED) on the company has to searched for.

 

R V SECKAR, FCS, LLB ,79047 19295

WHETHER RANSOM PAID TO A CRIMINAL GANG TO RESCUE A KIDNAPPED DIRECTOR BE ALLOWED AS BUSINESS EXPENDITURE?

 WHETHER RANSOM PAID TO A  CRIMINAL GANG TO RESCUE A KIDNAPPED DIRECTOR BE ALLOWED AS BUSINESS EXPENDITURE?

Madhya Pradesh HC held ransom paid to save a director’s life be allowed as business expenditure.

CIT vs Khemchand Motilal Jain, Tobacco Products (P) Ltd.

FACTS OF THE CASE

The assessee-company was engaged in manufacturing and sale of bidis. ‘A’ was a whole-time director of the assessee-company and was looking after the purchase, sales and manufacturing of bidis. During his business tour to Sagar for purchase of tendu leaves, ‘A’ was kidnapped by a dacoit for ransom.

The assessee lodged complaint with the police and awaited the action of the police, but the police was unsuccessful to recover ‘A’ from the clutches of dacoit.

Ultimately after 20 days, the assessee paid Rs 50 lacs by way of ransom for release of ‘A’ and got him released. The assessee claimed deduction of that amount as business expenditure.

The Assessing Officer disallowed the claim of the assessee on the ground that the ransom money paid to the kidnappers was not an expenditure incidental to business.

However, the CIT(A) and the Tribunal allowed the assessee’s claim for deduction.

APPEAL

On appeal by the Revenue, the Revenue contended that the amount of ransom could not have been claimed by way of expenditure as the Explanation to s.s(1) of section 37 prohibits such expenditure.

YES BY MADHYA PRADESH HIGH COURT

However, the Madhya Pradesh High Court upheld the decision of the Tribunal.

HIGH COURT OBSERVED THE FOLLOWING

COMMERCIAL EXPEDIENCY

The director was on a business tour for the purpose of purchasing raw materials. Paying for his safety was seen as necessary to preserve the "business asset" (the director's expertise and life) and ensure the continuity of business operations.

SECTION 37 OF THE INDIAN INCOME TAX ACT

Section 37 of the Indian Income Tax Act allows deductions for legitimate business expenses but prohibits deductions for expenses that are personal, capital in nature, or incurred for illegal purposes, fines, bribes, protection money.

NOT AN OFFENCE

While kidnapping is a crime under the Indian Penal Code (Section 364A), the High Court observed that paying ransom to save a life is not prohibited by any law, nor is it defined as an offence.

LAST RESORT:

In the Khemchand case, the Court noted that the company first approached the police and only paid the ransom after official efforts failed.

KEY TAKEAWAY

The court's logic was that "wholly and exclusively for the purpose of business" includes expenses incurred out of commercial expediency. If a director is kidnapped while performing business duties, the company's decision to pay for their release is a business decision to protect its human capital.

R V SECKAR , FCS, LLB 79047 19295

HOW NEW LABOUR CODE 2025 IMPACTS ON LISTED COMPANY FINANCIALS?

 HOW NEW LABOUR CODE 2025 IMPACTS ON LISTED COMPANY FINANCIALS?

WAGE DEFINITION CHANGES

·    A minimum of 50% of CTC must be classified as basic salary and dearness allowance, compared to lower previous thresholds.

STATUTORY BENEFITS EXPANSION

·    Provident Fund (PF), gratuity, leave encashment, and other employee benefits now calculated on the expanded wage base.

·    Increased coverage, including fixed-term and gig workers in social security frameworks. (benefits / compliance.

LEAVE & EMPLOYMENT NORMS

Changes to leave eligibility (e.g., decreased threshold for paid leave).

HOW IT IMPACTS ON FINANCIALS OF INDIAN COMPANIES

·    Many listed companies reported significant one-off expenses for compliance with statutory benefit changes under the new codes.

·    Profit margins in certain sectors have been materially affected in the first implemented quarter.

·    Increases in recurring cost is anticipated due to broader wage definitions and social security coverage.

ONE-TIME EXCEPTIONAL CHARGES

Many publicly listed companies—especially in the IT and engineering sectors—have taken one-off provisions in Q3FY26 financials to account for revised gratuity and leave encashment liabilities:

HOW TCS,INFOSYS,HCLTECH,WIPRO AND TECH MAHINDRA FINANCIALS IMPACTED?

·    TCS reported the largest charge; Infosys, HCLTech, Wipro, and Tech Mahindra also recognized substantial provisions totalling nearly ₹5,000 crore.

·    Tata Technologies’ profit plunged 96% in Q3 due almost entirely to labour code related provisions.

·    Tata Elxsi saw 45% profit drop with an exceptional charge tied to the codes.

·    Similar impacts were reported by Wipro and L&T Technology in their quarterly releases.

FINANCIAL STATEMENT IMPACTS

 

PROFIT & LOSS:

·    Sharp falls in net profit due to exceptional and current period charges.

BALANCE SHEET:

·    Increased provisions for employee benefit liabilities (gratuity, leave encashment).

MARGINS:

·    Reported margin compression due to sudden cost recognition.

HIGHER STATUTORY CONTRIBUTIONS RESULTED IN LESSOR MARGINS

FACTORS	IMPACT
Higher Provident Fund (PF) Contribution	This may lead to a reduced take-home salary for employees unless the CTC is increased
Gratuity	Higher eligibility for fixed-term employees reduced from five years to one year of service.
Leave encashment and bonus calculations.	Higher contribution leads to higher employee costs
Operational Shifts:	Annual health check-ups, crèche facilities), social security contributions for gig and platform workers, and a "Worker Re-Skilling Fund" contribution for laid-off staff.
Long-Term Benefits:	In the long run, the codes are expected to improve compliance, formalize the workforce, and offer greater operational flexibility (e.g., raising the threshold for government approval for layoffs to 300 workers).

 

SECTOR-SPECIFIC FINANCIAL IMPACTS

IT AND TECHNOLOGY SECTOR

·    IT firms reported significant upfront costs that materially reduced quarterly profits and operating margins (by 260–320 bps in Q3).

·    Analysts warn the impact may not be fully one-off and could sustain cost pressures in FY27 and beyond.

FINANCIAL IMPACT OF NEW LABOUR CODE 2025 ON INDIAN COMPANIES
₹ in Crore
Company	Q3 2025
TCS	2,128
Infosys	1,289
HDFC	1,037

BANKING AND FINANCIAL SERVICES

·    Private banks and insurance companies have reported incremental employee cost hits in Q3FY26 filings:

·    HDFC Bank: ₹800 crore.

·    ICICI Bank: ₹145 crore.

·    HDFC Life / ICICI Prudential / ICICI Lombard also disclosed incremental impacts.

CASE STUDY – ANALYSIS OF TATA CONSULTANCY SERVICES LIMITED FINANCIALS WITH Q3 -2025 & Q3-2024

	Q3 -2025--₹ in Crores	Q3-2024--₹ in Crores
Statutory impact of new Labour Codes 2025	₹2128	0
Provision regarding Legal claim	₹ 1010	0
Profit before tax	₹12912	₹ 15509
Current Tax	₹2903	₹3638

 

·    There is a decline in profit before tax of ₹2597 Crores in Q3 -2025 as increased overheads due to new Labour Codes 2025 is ₹3138.

·    However , TCS saved tax in Q3 -2025  ₹ 735 crores as compared to Q3 -2024 taxes as increased overheads due to new Labour Code 2025 has lessened its tax burden.

KEY TAKEAWAY

·    Increased labour costs due to Labour Code 2025   distorts YoY margin comparisons

·    It compresses Q3/Q4 profitability optics

·    It disproportionately hurts services, IT, BFSI, manpower-heavy models

·    It is not operational underperformance

·    Higher operating expenses, lower margins

·    Profit volatility and margin compression could weigh on earnings forecasts and investor sentiment, especially in sectors with large headcounts.

·    India's five largest IT companies alone reported a combined upfront cost of approximately ₹4,645 crore ($500 million), which reduced their profitability in the quarter 3-2025.

·    HDFC Bank reported an incremental impact of ₹800 crores on its operating expenses.

R V SECKAR, FCS, LLB 79047 19295

“AN EMPLOYEE CAN NEVER FUNCTION AS AN INDEPENDENT DIRECTOR BECAUSE ECONOMIC DEPENDENCE INEVITABLY DESTROYS INDEPENDENCE.”---WITH REAL CASE STUDIES

 “AN EMPLOYEE CAN NEVER FUNCTION AS AN INDEPENDENT DIRECTOR BECAUSE ECONOMIC DEPENDENCE INEVITABLY DESTROYS INDEPENDENCE.”---WITH REAL CASE STUDIES

REGULATORY OBJECTIVE

The Companies Act, 2013 and SEBI LODR Regulations lay down objective rules for independence and duties as safeguards to protect stakeholders.

WHAT COMPANIES ACT 2013 MEANS BY “INDEPENDENT”

·    Under Section 149(6) of the Companies Act, 2013, an Independent Director must not:

·    Be or have been an employee of the company, its holding, subsidiary or associate within the three financial years before the proposed appointment.

·    Have any pecuniary relationship (other than sitting fees)

·    Have any material business, professional or financial connection with promoters or management

·    Be a person of integrity with relevant expertise and experience.

·    Not be a promoter or related to directors/promoters.

·    Have no material pecuniary relationship with the company, its promoters, or management.

·    Not hold significant shares (threshold defined by regulation).

These thresholds are designed to create structural independence in judgment.

PERMISSIBLE REMUNERATION UNDER THE ACT FOR INDEPENDENT DIRECTORS

The remuneration of an Independent Director (ID) is primarily governed by Section 197 and Section 149(9) of the Companies Act, 2013, along with the SEBI (LODR) Regulations for listed companies.

1. SITTING FEES

Sitting fees are paid for attending meetings of the Board or its Committees (e.g., Audit Committee, NRC).

·    Maximum Limit: Restricted to ₹1 Lakh per meeting.

FLEXIBILITY:

The Board has the discretion to decide the actual amount (e.g., ₹50,000 for a Board meeting and ₹20,000 for a Committee meeting), as long as it doesn't exceed the cap.

PARITY:

The fee for Independent Directors or Women Directors cannot be lower than the fee paid to other directors.

EXCLUSION:

Sitting fees are excluded when calculating the overall ceiling on managerial remuneration (the 1% or 11% limits).

2. COMMISSION (PROFIT-LINKED)

Profit-linked commission is a variable component based on the company's financial performance.

SCENARIO	MAXIMUM COMMISSION LIMIT
If the company has a Managing Director (MD) or Whole-Time Director (WTD)	1% of net profits (for all non-executive directors combined).
If the company has NO MD or WTD	3% of net profits (for all non-executive directors combined).

 

REAL CASE STUDIES ILLUSTRATING INDEPENDENCE ISSUES

CASE  STUDY  —1

SATYAM COMPUTERS SCANDAL (2009)

T.R. Prasad, an ID at Satyam, ultimately resigned amid intense pressure after attempting to stabilize the company in the immediate aftermath, which illustrates the operational and reputational constraints faced by IDs when confronted with major governance crises.

CASE STUDY —2

GENSOL ENGINEERING LTD RESIGNATIONS (2024–25)

In the Gensol (now associated with BluSmart Mobility) governance issues investigated by SEBI revealed share price manipulation and irregular loans.

INDEPENDENT DIRECTOR BEHAVIOUR

Multiple independent directors resigned once regulatory scrutiny intensified, citing concerns about financial sustainability and inability to add shareholder value.

One director cited commitment issues; others exited rather than confront structural governance and promoter control issues.

CASE STUDY- 3

BOARD APPOINTMENT CONTROVERSY (ONGC/POLITICAL APPOINTMENT)

Sambit Patra’s appointment as an independent/non-official director of ONGC was legally challenged on the basis of potential political connection compromising independence.

OUTCOME

The Delhi High Court dismissed the petition, saying mere political association is not sufficient to disqualify an ID.

CASE STUDY -4

THE DR. VIPIN KUMAR CASE (SAHARA GROUP)

Dr. Vipin Kumar was shown as an Independent Director on boards of Sahara Group companies, including Sahara Housing and Sahara India Real Estate.

THE HIDDEN REALITY

SEBI’s investigation revealed that:

·    He was a full-time salaried employee of the Sahara Group

·    He worked as a senior executive

·    He was receiving remuneration, perks and benefits from the promoter-controlled Sahara ecosystem

·    Yet in statutory filings, he was projected as an “Independent Director.”

WHAT SEBI FOUND?

SEBI rejected the legal fiction created by Sahara.

It held:

“A person who is in an employment relationship with the promoter group cannot be considered independent, regardless of the designation given to him.”

SEBI imposed penalties and held that:

·    Dr. Vipin Kumar was not independent in substance

·    Sahara had made false disclosures to investors

·    The so-called independent directors had enabled a ₹24,000 crore illegal fund-raising

·    This was upheld by SAT and later by the Supreme Court while confirming Sahara’s liability.

THE “MASK OF INDEPENDENCE” PROBLEM IN INDIA TODAY

Dr. Vipin Kumar was not an aberration. He was a template.

TECHNIQUE	HOW INDEPENDENCE IS FAKED
Ex-employee	Promoter’s CFO becomes “independent” after resignation
Consultant	Paid via professional contract
Group payroll	Salary paid by a subsidiary
Retainer	Monthly retainership fee
Family firm	Fees routed through relatives’ firms

CASE STUDY -5

 YES BANK — “INDEPENDENT” DIRECTORS WHO APPROVED A ONE-MAN CREDIT EMPIRE

YES Bank collapsed because CEO Rana Kapoor ran a related-party lending machine through shell companies linked to his family.

Large loans were sanctioned to:

·    DHFL

·    Essel Group

·    Reliance ADAG

·    Cox & Kings

·    Indiabulls

All of these later defaulted.

WHERE WERE THE INDEPENDENT DIRECTORS?

YES Bank had 9 Independent Directors.

They:

·    Approved massive loan concentrations

·    Approved repeated restructuring of bad loans

·    Ignored RBI warnings

SEBI’S FINDING (2023)

SEBI held that the Independent Directors:

“Failed to exercise due skill, care and diligence and acted in a manner that facilitated concealment of the true financial position of the bank.”

Several Independent directors were banned and fined.

CASE STUDY -6

 IL&FS — INDIA’S BIGGEST BOARD-LEVEL GOVERNANCE FRAUD

IL&FS had 6 Independent Directors, including:

Former Cabinet Secretary

Former SEBI Chairman

Former SBI Chairman

Yet IL&FS hid ₹91,000 crore of debt through:

·    300+ subsidiaries

·    Evergreen loans

·    Fake asset values

SFIO AND NCLAT FINDINGS

The Government’s investigation concluded:

“The Independent Directors completely abdicated their fiduciary responsibilities and functioned as a rubber stamp for management.”

HOW “INDEPENDENCE” WAS NEUTRALIZED

These directors:

·    Sat on 10–20 IL&FS group boards

·    Earned large sitting fees

·    Were dependent on management for information

·    They had no operational control, only ceremonial authority.

·    This is exactly the Sahara–Vipin Kumar pattern:

CASE STUDY -7

-DHFL — THE BOARD THAT APPROVED ₹34,000 CRORE OF FAKE LOANS

DHFL’s promoters (Wadhawans) created:

·    Shell borrowers

·    Fake project loans

·    Circular money flows

The board approved all of it.

DHFL had:

6 Independent Directors

Big names: ex-bankers, lawyers, regulators

SFIO AND CBI FINDINGS

The board:

·    Approved loans to non-existent entities

·    Approved related-party transactions

·    Approved misleading financial statements

·    SEBI and MCA disqualified several Independent Directors.

Why this is a Dr Vipin Kumar situation?

These directors:

·    Received fees from DHFL

·    Sat on multiple Wadhawan-controlled entities

·    Depended on promoter goodwill for re-appointment

 

·    They were not employees, but they were economically captured.

Law treats that as functional employment.

CASE STUDY 8

ANIL AMBANI GROUP — “INDEPENDENT” DIRECTORS WHO APPROVED VALUE DESTRUCTION

Reliance ADAG companies collapsed after:

·    Money was diverted to promoter-controlled entities

·    Debt was rolled over using fake profits

·    Listed companies were stripped of assets

SEBI’S 2024 ORDER

SEBI held that:

“The Independent Directors failed to protect the interests of public shareholders and permitted diversion of funds.”

Several ID’s were banned and fined.

HOW INDEPENDENCE WAS FAKED

They:

·    Sat across multiple Anil Ambani group boards

·    Earned large retainers fees

·    Approved every related-party transaction

This is the corporate equivalent of being on the promoter’s payroll.

KEY TAKEAWAYS

Mask of independence is now legally pierceable — exactly as it was torn off in the Dr. Vipin Kumar – Sahara case.

·    Legally, independent directors must be free from material relationships that affect judgment.

·    Indian case experiences (e.g., Satyam, ONGC appointment challenges) reveal that formal independence criteria do not always ensure effective or perceived independence.

·    Regulatory and judicial frameworks continue to evolve to strengthen both the structure and the function of independent directorship in corporate governance.

 

R V SECKAR , FCS, LLB 79047 19295