Treatment of Financial Service Provider under IBC

India’s economic landscape needed robust economic legislation to strengthen the country’s investment climate, enhance creditor rights, and facilitate the ease of doing business. Before the enactment of the  Insolvency and Bankruptcy Code, 2016 (for brevity referred as “IBC/Code”) the prevailing legislations were fragmented, outdated and more often burdened with litigations.  Hence, to keep abreast with the current global economic trends and the necessity for a swifter and creditor-driven framework, the enactment of IBC took place. The IBC was modeled on prevalent best international practices with the aim to boost the domestic credit market and to resolve maximum debt ridden entities within a compact timeframe. IBC as amended to date deals with insolvency and bankruptcy of companies, partnership firms, LLPs, guarantors, individuals, and financial service providers.

However, Financial Service Providers under IBC have been provided with a differential treatment under IBC. Financial Service Providers are defined under Section 2(17) of IBC as an entity engaged in the business of providing financial services in terms of authorisation issued or registration granted by a financial sector regulator. Whereas, the definition of Financial Services is provided under Section 2(17) which includes services like accepting deposits, administering assets consisting of financial products, insurance contracts, etc.

These entities encompass a wide array of entities, including banks, insurance companies, and non-banking financial companies (NBFCs). The failure of a Financial Service Provider can have far-reaching consequences, impacting the stability of the financial sector and the economy as a whole. In short, the economic scale of failure behind these FSPs are much higher than any other corporate.

Differential Treatment of Financial Service Providers

The idea of “Too Big To Fail” ensured that a differential treatment of Financial Service Providers under IBC was required and unlike the insolvency resolution process of corporates, they cannot be brought under insolvency proceedings by a mere filing of insolvency application by any creditor.

One of the key reasons behind a separate framework is that the FSPs are directly engaged with consumers’ deposit and monies at large and the disruption of such entities can cause severe financial distress.

Therefore, the Central Government has retained the power with themselves to notify any entity as FSP whose insolvency and liquidation proceedings will be governed under IBC.

The main enabling provision under IBC  for Financial Service Providers is provided under Section 227 through which the Central Government reserved such power with themselves. Further, the Central Government is required to consult with the appropriate regulator of the concerned Financial Service Provider before notifying such FSP for its resolution under IBC. 

Financial Service Provider under IBC

Before the 2019 notification of the Ministry of Corporate Affairs which notified the IBBI (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudication Authority) Rules, 2019 (“Rules”) to enable the framework for Financial Service Provider under Insolvency Code, the Courts were not inclined to initiate insolvency process against the Financial Service Provider under IBC primarily on the ground that the definition of ‘corporate person’ under IBC does not include the ‘Financial Service Provider’ and hence, the CIRP of such entities cannot be initiated.

Some of the glaring examples are of Randhiraj Thakur vs Jindal Saxena Financial Services (P.) Ltd and Saumil A. Bhavnagrin vs Nimit Builders & Anr. [CA (AT) (Ins.) No.710 of 2019] wherein the NCLAT held that the company in question is a financial service provider and dismissed the application for initiation of its CIRP as it involved an NBFC.

However, the position changed with the enactment of Rules for Financial Service Provider under Insolvency Code. Although, these Rules shall only be applicable when a Central Government notifies any FSP under Section 227 to be governed under IBC framework.

Although the Rules state that provisions of IBC related to the Corporate Insolvency Resolution Process (“CIRP”) of any entity shall apply on the insolvency and liquidation proceedings of the FSPs there were certain exceptions made to this general applicability of CIRP procedure.

Firstly, the initiation of CIRP against FSP can only be initiated on the application filed by the appropriate regulator of such FSP (for example in case of Banks, financial institutions, NBFCs – RBI shall be an appropriate regulator).

Role of the Regulator

Under the framework for Financial Service Provider under IBC, the role of the respective regulator of FSPs is crucial. Since the FSPs have a direct bearing on the economic scale due to the large and direct consumer interaction, therefore, the best judge to bring any Financial Service Provider under IBC are their respective regulators.

For instance for the insolvency and liquidation proceedings for an FSP like Dewan Housing Financing Limited, the RBI being an appropriate regulator filed the application for initiation of insolvency process. Such provision also ensures that the regulator being the recommending authority over the insolvency process of an FSPs commands the direct control over the insolvency process of these FSPs and dictates terms keeping in mind the larger interest of the public.

Another important facet through which FSPs exercises control the FSP process under IBC is by recommending the appointment of an administrator to the NCLT who handles the entire insolvency and liquidation process, as the case may be, of an Financial Service Provider.

As per the Rules for Financial Service Provider under Insolvency Code the Administrator is vested with the same duties, functions, obligations, responsibilities, rights, and powers of a resolution professional. Further, the Rules also requires  approval of the appropriate regulator for the persons, who would be in control or management of the FSP after approval of the resolution plan and the no-objection statement is also required from the regulator before the resolution plan of any entity is approved.

DHFL – First Financial Service Provider under IBC

Dewan Housing Finance Limited (“DHFL”) which was a prominent NBFC engaged in core financial services like housing finance, insurance products, asset management and fixed deposit services having more than 77000  deposit holders to its credit with a stable credit rating and positive outlook.  DHFL became one of India’s top three mortgage lenders and had thousands of crores worth of investment in its portfolio.

The Fallout of DHFL

The ‘good story’ of DHFL soon came to end sending shockwaves across the debt market and its stakeholders. The downhill started in the year 2019 when the company started defaulting on the repayment of loans and multiple instances were reported for financial irregularities including fund diversion, round tipping and siphoning of funds. Soon one of the major housing finance companies   in the country started facing severe financial stress and the stocks of the company started tanking as well.

Although certain market factors including the IL&FS crisis, Yes Bank debacle added to the misery of the company but the company itself became a classic case of shoddy mismanagement, poor corporate governance, alleged financial irregularities, bogus related party transactions and inefficient due diligence for such a mammoth financial company. It was estimated that DHFL owed more than INR One lakh Crores to its creditors at the initiation of insolvency proceedings. Ultimately, RBI after enough contemplation decided to intervene in the DHFL mess and take matters into their own hands.

RBI led insolvency proceedings

Since an expeditious resolution of such entity was of  paramount importance to ensure there is a minimum financial fallout, the RBI, who is an appropriate regulator for NBFC, moved an application before the NCLT to initiate an insolvency proceedings against DHFL which was admitted by NCLT vide order dated 03 December 2019 and appointed RBI recommended Administrator in accordance with FSP Rules. However, before the initiation of insolvency process against DHFL, the RBI released a press statement informing about the suspension of the board and appointed an Administrator.

Number game in DHFL insolvency:

It’s a no brainer that the numbers involved with one of the biggest  housing finance companies will be overwhelming. For instance the creditors of the DHFL filed claims to the tune of INR 1,00,001 Crores before the Administrator, whereas, the claims of the creditors admitted by the Administrator were upwards of INR 87000 Crores. To put this into perspective, the GDP of more than 30 countries is less than the claims of the creditors, hence, the magnitude of economic scale involved was massive.

Further, there were multiple giants who have shown their interest in filing the resolution to acquire the management and control of DHFL on the back of the diverse and large customer base business of DHFL, however, the resolution plan of Piramal Capital & Housing Finance was put to vote before the Committee of Creditors for a total financial consideration of INR 33,250 Crores.

One of the major bones of contention was the treatment of recovery of the retail fixed deposit holders of the DHFL under the resolution plan as these are hard earned money of the individual deposit holders who were facing a steep loss. As per the contours of resolution plan the FD holders received around Rs 1241 Crores against their admitted claim of Rs 5400 Crores.

Another interesting point about the resolution plan is the assignment of INR 1 only to the avoidance transaction recovery which was approved by the CoC and later on by the NCLT. Hence, as per the financial proposal of the plan there is a haircut of almost INR 65000 Crores taken by the creditor of the DHFL or around 65% of their original contested value.

Litigation ridden process

The whole insolvency process of DHFL saw challenges and litigations filed by the creditors, promoters, deposit holders, debenture holders, prospective resolution applicants which significantly delayed the process. For instance the litigation revolving around the assignment of Rs 1 for the avoidance transaction was fiercely contested by one of the creditors wherein on an appeal the NCLAT directed the CoC to reconsider this aspect of the resolution plan.

However, the Supreme Court on an appeal of the CoC stayed the NCLAT’s Order. Although the plan has been approved by the NCLT and the management was taken over by the Piramal Capital, still there were multiple challenges post resolution which hampered the proper implementation of the resolution plan and take over of the company.

Conclusion

IBC’s specialized framework for Financial Service Providers under IBC is a critical step in ensuring the resilience and stability of India’s financial sector. By tailoring the resolution process to the unique characteristics of FSPs and emphasizing regulatory oversight, the IBC seeks to strike a balance between protecting stakeholders and preserving the integrity of the financial system.

Continued refinements and collaboration between regulators and resolution professionals will be essential to navigate the intricacies of FSP insolvency effectively. Further, the resolution of bigshot NBFCs like DHFL are adding to the jurisprudence and streamlining the framework of Financial Service Provider under Insolvency Code.

Thoughts of this article is composed and compiled by –