Advent of Financial Service Providers under IBC, 2016 Radar
Section 227 of the Insolvency and Bankruptcy Code,2016 (“Code”) deals with the “Power of Central Government to notify Financial Service Providers etc.” which states that:
“Notwithstanding anything to the contrary contained in this Code or any other law for the time being in force, the Central Government may, if it considers necessary, in consultation with the appropriate financial sector regulators, notify financial service providers or categories of financial service providers for the purpose of their insolvency and liquidation proceedings, which may be conducted under this Code, in such manner as may be prescribed.”
Explanation: For the removal of doubts, it is hereby clarified that the insolvency and liquidation proceedings for financial service providers or categories of financial service providers may be conducted with such modifications and in such manner as may be prescribed.”
The Ministry of Corporate Affairs vide its notification dated 15th November 2019, exercised its power as granted under Section 227 read with Section 239(2)(zk) of the Code, notified the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 (“FSP Rules”) to provide a framework for insolvency and liquidation proceedings of systemically important FSPs other than banks. Further vide notification dated 18th November 2019, the Ministry of Corporate Affairs in consultation with Reserve Bank of India (“RBI”) notified that insolvency and liquidation proceedings of Non-Banking Finance Companies (which include Housing Finance Companies) with asset size of Rs. 500 Crores or more (as per last audited balance sheet) shall be undertaken in accordance with the Code, FSP Rules and applicable regulations.
With the NPA crisis plaguing the Indian banking sector, outright frauds and scams in the banking sector has overshadowed this sector, thereby a framework regulating the insolvency of NBFCs was the need of the hour.
II. Background : Connecting NBFCs with FSPs
The Part II of the Code specifically applies to the corporate debtors, who were defined as corporate person who owed debt to any person under Section 3(8) of the Code. Further under Section 3(7) of the Code, corporate person was defined to exclude financial service provider(“FSP”).The Code did not define the term ‘non-banking financial company’ instead FSP was defined under Section 3(17) of the Code, as (i) person engaged in providing financial services and (ii) authorization issued or registration granted by a financial sector regulator. Since entities providing financial services come under definition of FSPs, the scope of financial services has been defined under Section 3(16) of the Code, which provided following categories of services:
- accepting of deposits;
- safeguarding and administering assets consisting of financial products, belonging to another person, or agreeing to do so;
- effecting contracts of insurance;
- offering, managing or agreeing to manage assets consisting of financial products belonging to another person;
- rendering or agreeing, for consideration, to render advice on or soliciting for the purposes of–– (i) buying, selling, or subscribing to, a financial product; (ii) availing a financial service; or (iii) exercising any right associated with financial product or financial service;
- establishing or operating an investment scheme;
- maintaining or transferring records of ownership of a financial product;
- underwriting the issuance or subscription of a financial product; or
- selling, providing, or issuing stored value or payment instruments or providing payment services.
From the perusal of above activities, it can be inferred that NBFCs can be considered as FSP on case to case basis as the definition of financial services is inclusive in nature. The intent of the legislation from Section 3(17) of the Code is to cover activities which are substantive and crucial to the economy, including those of capital market intermediaries. These entities entail public trust which are directly linked to money market and capital market functioning and thus their health is important to ensure the stability and resilience of the financial systems. Therefore, these entities were excluded from the Code, as the insolvency of such entities could lead to disruption and distrust in the market thereby triggering financial instability in the economy as a whole.
III. FSP Rules: New Framework under the Code
The FSP Rules shall apply to such FSPs or categories of FSPs, as may be notified by the Central Government under Section 227 of the Code from time to time for the purpose of their insolvency and liquidation proceedings under these rules and for the purpose of these rules in all the provisions relating to insolvency and liquidation proceedings under the Code:
- for the expression “Corporate Debtor” wherever they occur, shall mean “FSP”; and
- for the expressions “Insolvency Professional”, “Interim Resolution Professional”, “Resolution Professional” Or “Liquidator”, wherever they occur, shall mean “Administrator”.
A. Initiation of Corporate Insolvency Resolution Process (CIRP)
Conventional Procedure under the Code
- The conventional procedure under the Code is that in case of CIRP, the operational creditor or financial creditor or corporate debtor itself could initiate CIRP on minimum default of One Lakh Rupees. In such a case, an application before Adjudicating Authority i.e. National Company Law Tribunal (“NCLT”), with proof and name of proposed resolution professional shall be furnished by the creditors or corporate debtor. On admission of application, the Adjudicating Authority appoints the proposed resolution professional.
Procedure under the FSP Rules
- Rule 5 of FSP Rules state that the CIRP, it is only the appropriate regulator i.e. RBI for NBFCs that can file an application as petitioner against a FSP. Such application by the appropriate regulator is deemed to be application filed by financial creditor against corporate debtor under Section 7of the Code.
- On the admission of application, the Adjudicating Authority shall appoint such Administrator as proposed by appropriate regulator, who shall act and have same duties, functions, obligations, responsibilities, rights and powers of an insolvency professional, interim resolution professional, resolution professional or liquidator as under Rule 9 of FSP Rules.
- Rule 6 of FSP Rules provide that the application by appropriate regulator under Rule 5 shall be made in Form 1 accompanied by a fee of Rs. 25,000; a written consent and declaration in accordance with Form 2 from proposed Administrator and other documents and records as specified in Form 1 of FSP Rules.
B. Advisory Committee
An Advisory Committee under Rule 5(c) of FSP Rules prescribes for three or more members to aid and advice the administrator shall be constituted by the appropriate regulator within 45 days of the commencement of the insolvency commencement date. The terms and conditions of the members of the Advisory Committee and the manner of conducting meetings and observance of rules of procedure shall be determined by the appropriate regulator. Administrator is authorized to chair the meetings of the Advisory Committee.
Conventional Procedure under the Code
- On the admission of application under Section 7, 9 or 10 of the Code, the Adjudicating Authority shall by its order declare a moratorium under Section 14 of the Code, which comes into effect from the date of the admission of the application for initiation of CIRP. Once a moratorium is declared, no proceedings can be initiated or continued against a corporate debtor.
Procedure under FSP Rules
- In case of FSPs, an additional interim moratorium shall commence on and from the date of filing of application for initiation of CIRP. The interim moratorium shall be in effect till the application is admitted or rejected. After the Adjudicating Authority admits the initiation of CIRP application, the moratorium under Section 14 of the Code shall apply.
- Rule 5(b)(ii) of FSP Rules further bars the suspension or cancellation of license or registration which authorises the FSP to engage in the business of providing financial services during the interim-moratorium, CIRP and liquidation proceedings (unless an opportunity of being heard has been provided to the liquidator).
D. Assets of Third Parties
- With the ultimate objective of removing the ambiguous region, the FSP Rules elucidates that moratorium will not be applied on such assets in the custody or possession of the FSP including any funds, securities and other assets required to be held in trust for the benefit of third parties.
- It also entails that an Administrator is duty-bound to take control and custody of third-party assets or properties in custody or possession of the FSP, only for the purpose of dealing with them in the manner as may be notified by the Central Government under Section 227 of the Code.
- This is done in order to provide unfeigned recognition to the third-party purchasers of assets from Financial Service Providers along with other akin contractual agreements.
E. Resolution Plan
Conventional Procedure under the Code
- In normal insolvency cases, the standard procedure mandates that after the collation of all claims accrued against the corporate debtor and ascertainment of its financial position, the Interim Resolution Professional constitutes Committee of Creditors and the Committee of Creditors consists of all financial creditors of the Corporate Debtor. The resolution plan thereafter submitted by the resolution applicant to resolution professional would be required to be approved by Committee of Creditors under Section 30 of the Code and thereafter by the Adjudicating Authority under Section 31 of the Code .
Procedure under FSP Rules
- Besides acting in accordance with all the provisions pertaining to resolution plans incorporated under Code, the FSP Rules entail that a resolution plan must distinctively include a statement illustrating as to how the resolution applicant satisfies or intends to satisfy the requirements of engaging in the business of the financial service provider, in consonance with the laws applicable at that time.
- Shoring up the significance of Committee of Creditors, their approval of the resolution plan is called-for. In furtherance of which the Administrator is required to seek ‘No Objection Certificate’ from the appropriate regulator, who on the basis of ‘Fit and Proper’ criteria will issue the certificate without prejudice to the provisions contained in Section 29A of the Code. Where an appropriate regulator does not refuse ‘no objection’ on an application made within forty-five working days of receipt of such application it is deemed that ‘no objection’ has been granted.
F. Liquidation Process
- According to Rule 7 of FSP Rules, provisions laid out under Code related to liquidation are to be applied in totality while dealing with FSPs. However, few modifications have been brought into existence.
- License or registration that authorizes FSP to engage in the business of providing financial services is not to be suspended or cancelled during the liquidation process and the Adjudicating Authority is under an obligation to provide the appropriate regulator an opportunity of being heard before passing an order for liquidation & dissolution of the FSP.
G. Voluntary Liquidation Process For FSP
- Rule 8 of FSP Rules provides that the provisions relating to the voluntary liquidation process of the corporate debtor shall apply mutatis mutandis to the voluntary liquidation process of a FSP with following modifications:
- In pursuance of initiating the voluntary liquidation process, FSP is under an obligation to acquire prior permission of the Appropriate Regulator under Section 59 of the Code.
- Affidavit referred to in clause (a) of sub-section (3) of Section 59 of the Code shall include a declaration that the permission under clause (a) has been obtained.
- Adjudicating Authority has the duty to grant an opportunity of being heard to the appropriate regulator before passing an order for dissolution for FSP.
IV. Current India’s Scenario Under Moratorium
A. Yes Bank Under Moratorium
On 5th March 2020, the Central Government after considering application by RBI made under Section 45(1) of Banking Regulation Act, 1949 , declared moratorium in respect of Yes Bank Limited (“Yes Bank”)under Section 45(2) of Banking Regulation Act, 1949, for period effective from 5th March, 2020 to 3rd April 2020, taking in consideration the rapidly deteriorating financial position of Yes Bank in relation to liquidity, capital and other critical parameters, and the absence of any credible plan for infusion of capital necessitated RBI to take immediate action in public interest and particularly in the interest of the depositors.
Pursuant to the moratorium order, RBI in consultation with the Government, superseded the board of directors of Yes Bank for a period of thirty days and appointed Mr. Prashant Kumar, ex-DMD and CFO of State Bank of India (“SBI”) as Administrator and further restricted Yes Bank from making any payment to any depositor beyond Rs. 50,000 during the period of moratorium. Any amount above Rs. 50,000 can be allowed only for the following purpose with special permission from RBI such as medical emergency, payment for foreign education and marriage in the family provided that the amount so allowed to be paid out of the balance lying to the credit of the depositor shall not exceed the sum of 5,00,000/- (Rupees Five Lakhs only) or the actual balance lying in the account of the depositor, whichever is less.RBI has assured the depositors of the bank that their interest will be fully protected.
The Government of India in its notification dated 13th March 2020,notified ‘Yes Bank Ltd. Reconstruction Scheme, 2020 (“Scheme of Reconstruction”), with the effect from this notification, the declared moratorium shall cease to have effect from 18th March, 2020.
Meanwhile, Mr. Rana Kapoor, Founder of Yes Bank has been arrested by Enforcement Directorate under the provisions of the Prevention of Money Laundering Act, 2002. Further in context to the money laundering charges, certain report has also surfaced in regards to suspicious loans extended by Yes Bank to 44 (forty-four) companies accounted to Rs. 34,000 Crores of Non-Performing Assets of Yes Bank.
B. DHFL Insolvency Proceedings
The FSP Circular provides for RBI as the appropriate regulator to initiate CIRP against NBFCs with an asset size of Rs. 500 Crores or more. Following the FSP Circular, RBI on 20th November, 2019 exercised its powers under Section 45 IE 5(a) of the RBI Act, 1934 owing to governance concerns and defaults by DHFL in meeting various payment obligations led to decision of superseding the board of directors of DHFL and appointing Mr. R. Subramaniakumar, ex-MD and CEO of Indian Overseas Bank as the Administrator.
On 22ndNovember 2019, RBI has announced a three-member Advisory Committee to assist the Administrator of Dewan Housing Finance Corporation Limited (“DHFL”) in discharge of his duties. The members are Dr. Rajiv Lall, Non-Executive Chairman, IDFC First Bank Ltd, Shri N S Kannan, Managing Director and CEO, ICICI Prudential Life Insurance Co. Ltd, Shri NS Venkatesh, Chief Executive, Association of Mutual Funds in India. It is important to note that with this representation, RBI has included representation from banks, insurance companies and mutual funds.
Further RBI on 29th November, 2019 exercised its powers under FSP Rules and filed application before NCLT, Mumbai for initiation of CIRP against DHFL under Section 227 read with Section 239(2)(zk) of Code read with Rule 5 and Rule 6 of FSP Rules. Interim Moratorium began as soon as the application to initiate CIRP was filed against DHFL. Thus, DHFL became the first FSP against which CIRP was initiated. Details of Default of DHFL as provided in case of Reserve Bank of India v. Dewan Housing Finance Corporation Limited, NCLT, Mumbai Order dated 3rd December, 2019 (“Order”) is as follows:
Type of Borrowing
External Commercial Borrowings
SBI on 27.07.2018 granted loans in two tranches. The default occurred on 07.11.2019
Rs. 3,920,074 (in lakhs)
DHFL had sanctioned secured loans from 25 banks aggregating to Rs. 6,144,344.48 (in lakhs), out of which the outstanding amount is provided as on 31.03.2018
Rs. 1,888,199 (in lakhs)
DHFL had sanctioned unsecured loans from several banks aggregating Rs. 1,888,199 (in lakhs) which has been outstanding as on 31.03.2018
The said Order admitted the application of RBI and imposed moratorium under Section 14 of the Code with effect from 29th November, 2019. On 4th December, 2019, the Administrator called for submission of claims from creditors of Corporate Debtor, DHFL and included public depositors as class of creditors under Section 21(6A)(b) of Code. The list of claims as published on website of corporate debtor provides for claims(as of 28.01.2020) of over Rs. 1,032,328 Crores of claims were submitted by the creditors/ claimants. Further on 30th December, 2019the Committee of Creditors allowed DHFL to commence with the disbursement of loans to the tune of Rs. 500 Crores per month.
C. PMC Bank Crisis
Punjab and Maharashtra Cooperative Bank Limited (PMC Bank) has been facing regulatory actions and investigation over alleged irregularities in certain loan accounts. Loans given to financially stressed real estate player Housing Development & Infrastructure (HDIL) are at the centre of the investigation. The crisis at PMC Bank first came to light on 24 September 2019 when RBI announced moratorium on the activities of the PMC Bank for initial six months and also limited the amount a customer could withdraw from their account from Rs. 40,000 to Rs 50,000.Enforcement Directorate has filed a money laundering case in the PMC Bank scam and have also taken the founders of the PMC Bank under its custody.
V. International Perspective in Relation to FSPs
A. Framework in United States of America
- In USA, the resolution framework for systematically determined firms is Dodd-Frank Act of 2010 while the bankruptcy in USA is governed under US Bankruptcy Code. The Dodd- Frank Act applies to financial firms which are governed under Dodd- Frank Act such as banks, insured deposit-taking institutions, Brokers, Dealers, investment firms and insurance Companies.
- The Title II of Dodd-Frank Act provides for establishment of Orderly Liquidation Authority (“OLA”) which applies to bank holding companies and certain other financial companies “failure and resolution under otherwise applicable Federal or State law would have serious adverse effects on financial stability in the United States”. OLA has powers to liquidate financial companies in such a manner that tax-payers money is not used to bailing out such financial firms which could have adverse effect on US Economy.
- While under the US Bankruptcy Code the entities may file a petition for relief under a number of different chapters of the Code, depending upon the circumstances. The prominent chapters being Chapter 7 for liquidation of the entity and Chapter 11 for reorganization of the entity.
- Some of the commonly practiced resolution tools are as follows:
- Purchase and Assumption Transactions: The most common resolution method for failing banks is the Purchase and Assumption Transaction whereby a closed institution transaction in which a healthy institution (generally referred to as either the acquirer) purchases some or all of the assets of a failed bank or thrift and assumes some or all of the liabilities, including all insured deposits. Occasionally, an acquirer may receive assistance from the Federal Deposit Insurance Corporation (“FDIC”) as insurer to complete the transaction. As a part of the P&A transaction, the acquirer usually pays a premium to the FDIC for the assumed deposits, which decreases the total resolution cost.
- Single Point Entry: Under Single Point Entry System, the FDIC will be appointed as receiver of the ultimate parent holding company of the financial group following the company’s failure and the completion of the appointment process set forth in Title II of the Dodd-Frank Act. When the parent holding company is placed into receivership, a bridge financial company will be formed into which the assets of the failed financial company, including its investments in and loans to subsidiaries, will be transferred. This newly-formed bridge financial company will allow the enterprise to continue to perform the systemically important functions of the failed financial company, thereby minimizing disruptions to the financial system and minimizing the risk of spill over effects to counterparties.
B. Framework in United Kingdom
- The Banking Act 2009 came into force in February 2009 post repealing of Banking (Special Provisions) Act 2008. It provides for administration process of banks, building societies and investment banks in United Kingdom. The Special Resolution Regime( “SRR”) under Banking Act 2009 provides for Bank Administration and Bank Insolvency in order to provide ease to Bank of England (Financial Services Authority) and Treasury in resolving insolvency issues pertaining to the banks and other financial institutions.
- The triggers for initiation of the key powers available in the SRR are set out in Section 7 of the Banking Act. They are twofold and both conditions must be satisfied. First, the bank must be failing, or likely to fail, to satisfy its ‘threshold conditions’. Second, it must not be reasonably likely that action will be taken by or in respect of the bank (other than potentially through the SRR) that would enable it once again to satisfy the threshold conditions.
- SRR contains three pre-insolvency stabilisation tools pursuant to which following first two options can be exercised by Bank of England and last option can be exercised by Treasury with regard to the bank undergoing financial stress.
- Transfer of all or part of the bank to a Private Sector Purchaser (PSP).
- Transfer of all or part of the bank to a bridge bank via business sale. (Bridge Bank is a company owned and operated by Bank of England).
- Transfer of shares of the bank to a nominee of the Treasury or to a company wholly owned by the Treasury.
- The UK SRR empowers the authorities to split up a bank and effect a Partial Property Transfer (PPT) as means to resolution of the insolvent Bank. The PPT powers are closely modelled on the US approach in particular. When the FDIC exercises its power to transfer part of the assets and liabilities (including financial contracts and derivatives) of a failed bank (either to a PSP or a bridge bank), it simultaneously establishes a ‘receivership’, into which the remaining assets and liabilities are placed.
- The receivership is very similar to the bank administration procedure that comes into effect in a PPT under the UK SRR. In both cases, essential facilities or services that has not been possible to transfer may be used to support the PSP or bridge bank as necessary, while assets can be moved between the two entities in order to maximise the chances of effecting a going concern sale at a premium of as many as possible of the failed bank’s assets.
C. Framework in Japan
- In Japan, Financial Services Agency (“FSA”) is a financial sector regulator responsible for supervising banking, securities and exchange and insurance sectors in order to ensure the stability of the financial system of Japan. The agency operates with a Commissioner and reports to the Minister of State for Financial Services. It oversees the Securities and Exchange Surveillance Commission and the Certified Public Accountants and Auditing Oversight Board.
- The Deposit Insurance Act (Act No. 34 of 1971) provides for the mechanism to deal with financial crisis in Japan. Article 59,102 and 126 provides for handling financial distress crisis of financial institutions10. In Japan financial institutions are divided into three categories: Locally Systemic Institutions, National Institutions and Globally Systemic Institutions.
- In case of smaller banks primarily there are early action mechanisms by way of supervision pursuant to a system known as Prompt Corrective Action. In case of non-working of preventive measures, then small banks resort to general insolvency proceedings on standalone basis. However larger banks undergoing financial crisis are required to work out a viability plan, which should provide for improving the capital structure and management system and restructuring of its business.
- General insolvency proceedings provide for three possible measures: Civil Rehabilitation, Corporate Reorganization and Bankruptcy (liquidation).
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