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The news sent shares in United Spirits up as much as 6.4 per cent on Friday morning in Mumbai.
Diageo, which paid roughly £1.8bn for a 55 per cent stake in United Spirits, has been locked in a bitter boardroom stand-off with Mr Mallya, the former controlling shareholder, since April, when he refused a request from United Spirits’ board to resign.
Diageo’s demand that Mr Mallya step down as chairman was prompted by its discovery that funds had been “improperly advanced” from United Spirits to other parts of Mr Mallya’s business empire between 2010 and 2012, as he sought to save his now defunct Kingfisher Airlines from collapsing under debt.
But Mr Mallya described the findings of the Diageo investigation as “half-truths and twisted facts”. He refused to step down and insisted that Diageo honour its “contractual obligations”.
Under the terms of the agreement announced on Thursday, Diageo will pay Mr Mallya $75m over five years, during which he has agreed not to compete against the group. The deal also ends disputes between Mr Mallya and United Spirits and prevents him from buying any more shares in the company his father founded.
Diageo, which will book the payment as an “exceptional item”, defended the hefty payout, saying it would end the uncertainty hovering over United Spirits, and its governance.
Ivan Menezes, Diageo chief executive, said the agreement was “in the best interests” of both companies and would allow United Spirits to “build on its strong platform in one of the biggest spirits markets in the world”.
Diageo has also agreed to pay $15m to extend Smirnoff’s sponsorship of Force India Formula 1 team, which Mr Mallya part-owns.
Mr Mallya is being replaced by Mahendra Kumar Sharma, a non-executive director at United Spirits and former chairman of India’s largest private sector bank, Industrial Credit and Investment Corporation of India Bank.
Amit Tandon, the founder and managing director of Institutional Investor Advisory Services, said Diageo might have felt compelled to act as Mr Mallya had been declared a “wilful defaulter” by Indian banks, which, under central bank rules, could have prevented United Spirits from accessing bank loans as long as he remained the chairman.
But Mr Tandon said the generous pay-off raised questions about Diageo — including about the due diligence it carried out before its acquisition of the Indian group, and its handling of the boardroom crisis.
“I think this is something that will come back and bite Diageo,” said Mr Tandon. “Mallya seems to have short-changed the company, and they’ve said ‘OK, we forgive you for that’.”
Tensions between Diageo and Mr Mallya emerged in 2014, when directors questioned a $225m loan by United Spirits to its parent company, controlled by Mr Mallya. A few months later, the board began its formal inquiry into whether funds had been diverted to another company owned by Mr Mallya before the Diageo takeover, eventually concluding that they had.