Understanding India’s New Regime for Insolvency of Financial Service Providers

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Introduction:

On 15th November’19, the Ministry of Corporate Affairs notified the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 (hereinafter the Rules). Section 3 (17) of the Insolvency and Bankruptcy Code (the Code) defines FSP as, “person engaged in the business of providing financial services in terms of authorization issued or registration granted by a financial sector regulator”.[1] FSPs may be involved in providing a gamut of financial services including but not limited to banking, investment or asset management, stock broking, underwriting etc.

Until now, Financial Service Providers (hereinafter FSPs) lay outside the purview of insolvency because as per Section 3 (7) of the Code the definition of the term, “corporate persons” excludes FSPs. This was due to the recommendations of the Financial Sector Legislative Reforms Commission which cautioned against casting of a wide network of regulations for financial entities since the same had the potential to hamper market stability. Nonetheless, the Committee did in fact acknowledge the fact that mere reliance on self-regulation was inefficient and insufficient for the regulation of such entities. In furtherance of the same, the Committee has suggested the constitution of a “resolution corporation” that would be responsible for insolvency and related aspects for “systemically important” financial entities. More often than not, consumers and clients often trust these entities with their money and other financial assets. It was in this respect that the Bankruptcy Law reforms Committee (BLRC) might have thought it essential that a provision for such rules to be made in future must be incorporated in the Code.

However, the haven manifested by the exclusion of FSPs from the scope of the Code could only be availed of by the FSP in so far as it concerned its financial services. For example, in Apeejay Trust v. Aviva Life Insurance Company India Limited,[2] the NCLT held that since the claim of the creditor involved dues pertaining to service tax and license fees, Aviva cannot be permitted to claim the defence that it being an insurance company, it was an FSP and was hence outside the purview of the Code.

It’s probably on account of IL&FS’s default on its loans that the MCA must have thought it expedient to frame the Rules. Moreover, in light of the recent failure by DHFL [a Non-Banking Financial Company (NBFC)], to repay its loans, it is only salutary that these rules have been enacted. However, the Rules do not yet apply to all kinds of FSPs since they provide that they shall apply to only those FSPs which have been notified by the Central government from time to time. As of 30th November’19, the Central government has only notified NBFCs whose asset size exceeds 500 crore that have been brought within the purview of application of the rules.

The Rules provide that the provisions of the Code, both with respect to insolvency as well as liquidation shall apply mutatis mutandis to FSPs to the extent they are not modified by the Rules.

10 Ways in which the Insolvency and Liquidation Procedure for FSPs Differs from that of other Corporate Debtors:

  1. In place of the insolvency professional, interim resolution professional and resolution professional, there shall be an “Administrator” who shall be appointed by the adjudicating authority that is the National Company Law tribunal (NCLT) on the recommendation of the regulatory authority responsible for governing the sector in which the said FSP operates.
  2. Instead of the creditors, it is only the concerned regulator who can apply to the adjudicating authority for initiation of the process of insolvency for FSPs under the Rules.
  3. Unlike the moratorium for corporate debtors, which remain in place till the end of the entire Corporate Insolvency Resolution Process (CIRP), the moratorium for FSPs applies only till the application of the regulator is either admitted or rejected. This moratorium, however, shall not apply to the property or assets of third parties which are in custody or possession of the FSP. But the Rules do authorize the Administrator to take charge of such assets and property for the benefit of such third parties.
  4. Whereas there is no provision under the Code to assist a Resolution Professional in the management of the affairs of the corporate debtor, the Rules do provide that the regulator may appoint an Advisory Committee consisting of 3 members who are experts in the field to assist the administrator in managing the FSP.
  5. The Rules also provide that the license or registration of the FSP shall not be either suspended or cancelled till the end of the entire CIRP.
  6. The Resolution Plan, apart from requiring the assent of the Committee of Creditors, shall also additionally require the approval of the regulator in the form of a No-Objection Certificate (NoC). The Rules provides that if the concerned regulator does not expressly dismiss the application for NoC within 45 working days of its receipt, it shall be deemed to have been granted by the regulator.
  7. The Resolution Plan must contain a declaration to the effect that the resolution applicant is capable of and shall indeed comply with the rules and regulations which need to be adhered to under the law governing the functioning of that FSP and its like entities.  
  8. Under the Rules, unlike the provisions for Insolvency of FSPs, in case of FSPs undergoing liquidation, their license or registration may be cancelled during the liquidation process, the only rider being that the regulator must be afforded an opportunity of being heard.
  9. Before finalizing either the liquidation or dissolution of the FSP, it is obligatory upon the adjudicatory authority to provide a hearing opportunity to the regulator.
  10. The FSP shall take prior consent of the regulator prior to applying for voluntary liquidation and shall state the factum of such approval in his application to the adjudicating authority. It shall also be the duty of the adjudicating authority to take into consideration, the concerns of the regulator before allowing such liquidation.

Future Course of Action:

Some scholars have also opined that the Rules are good only insofar as they were needed to immediately deal with the NBFC crisis that the economy is now facing and that they shall not be adequate for the long run. Therefore, they suggest that the Legislature must consider enacting a full-fledged law to deal specifically with insolvency of FSP, taking into consideration the special needs of that particular industry/sector.

Secondly, as of now, banks have been expressly excluded from all kinds of insolvency proceedings, both under the Code as well as under the Rules. However, several other common law jurisdictions, including the U.K, U.S.A and Australia already have special procedures in place for insolvency resolution of banks for at least a decade now. Even the International Monetary Fund, in an article in 2005 emphasized on the need for countries to adopt a special regime for insolvent banks.[3] Though this suggestion might seem a little too far-fetched for the Indian economy at this juncture, but it is necessary that the same be given serious consideration in the near future.

Conclusion:

After having notified the NBFCs [which also include Housing Finance Corporations (HFCs)] on 15th November’19, the Reserve Bank of India (RBI) at once took over the board of Dewan Housing Finance Limited (DHFL) and has also moved the NCLT in order to initiate insolvency proceedings against it. In light of the Press Release issued by RBI dated 9th August’19, HFCs are also to be considered a category of NFCS are hence to be governed by RBI. Thus RBI is the rightful regulator in the instant case.

If admitted, this shall be the first FSP to undergo the insolvency procedure under the Rules. As the adjudicating authority, the burden on NCLT is severe considering that this case shall set the precedent for insolvency against other FSPs in future, just like Innoventive Industries v. ICICI[4]is for insolvency of corporate debtors.

Lastly, though it is appreciable that NBFCs (including HFCs have already been notified and brought within the ambit of the Rules, the Government must also consider notifying other FSPs also as soon as possible.

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[1] Section 3(17), Insolvency and Bankruptcy Code, 2016.

[2] Apeejay Trust v. Aviva Life Insurance Company India Limited, MANU/NC/8525/2019.

[3] Hupkes, Insolvency:Why a Special Regime for Banks?, IMF, 2005, last accessed on 27/11/2019 at 10:45 p.m. at https://www.elibrary.imf.org/view/IMF072/01499-9781589063341/01499-9781589063341/ch25.xml?redirect=true.

[4] Innoventive Industries v. ICICI, AIR 2017 SC 4084.

This article is written by Nidhisha Garg of National Law Institute University, Bhopal.

Disclaimer:  This article is an original submission of the Author. Lex Insight does not hold any liability arising out of this article. Kindly refer to our Terms of use or write to us in case of any concerns. You may also refer to our Copyright regulations.

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