The offer of Rs 842.52 crore (Rs 8.42 billion), which came with an interest of around Rs 256 crore (Rs 2.56 billion), was based on SBI Caps' valuation of the stake.
However, in April this year, Attorney General Milon K Banerji advised the government that this price was too low as international aluminium prices had shot up since 2004, making Balco's business more valuable now.
The development has eventually seen Sterlite Industries embark on a high stakes game by approaching the Delhi High Court recently for starting of arbitration proceedings against the government in this regard.
Sources associated with the matter said the Shareholders Agreement drawn up between Sterlite and the government in 2001, at the time of divestment of Balco, was designed to be "harsh on the side that failed to honour its commitment."
According to a clause in the agreement, the winner of arbitration proceedings has the right to buy (a call option) the other party's shares for 75 per cent of the valuation at the time of the call option in 2004. Alternatively, the winner can choose to sell (a put option) its shareholding for 125 per cent of the valuation.
The government had divested 51 per cent of its equity in Balco to Sterlite for Rs 551.1 crore (Rs 5.51 billion) in 2001. If the arbitration award goes in favour of Sterlite and the company chooses to exercise the call option, it can buy the remaining shares for Rs 631 crore.
If Sterlite chooses the put option, the government will have to buy back Sterlite's majority stake at 75 per cent of the SBI Caps' valuation. A Sterlite spokesperson declined to comment on the matter, citing it as being sub-judice.
However, Balco's fate may still not be decided by an arbitration award, given that the Delhi High Court acceded to the government's request last Monday, and gave it four weeks to negotiate with Sterlite, and reach a settlement. If the negotiations remain deadlocked by the first week of September, arbitration proceedings would begin in court.
The build-up to the current situation has taken over two years. Sterlite and the government signed an agreement in 2001, which gave Sterlite the option to buy the residual stake in Balco three years later.
In 2004, Sterlite exercised its right, but the valuation was delayed, partly because the government asked for extensions.
After a delay, SBI Caps carried out Balco's valuation using 2004 data, with the valuation report being submitted early this year. Undervaluation was not the only stumbling block. Banerji felt sections of the agreement that bound the government to sell its residual stake in Balco to Sterlite ran counter to the Companies Act, 1956.
