The presence of insolvency rules for non-financial companies in the form of the Insolvency and Bankruptcy Code, 2016 (IBC), and the lack of similar rules for financial companies led to a peculiar dichotomy. The IBC has been seen in most circles as a progressive move, and despite issues involving implementation is largely considered a success. In contrast, the high-profile collapse of a number of large financial sector entities, and the lack of such rules for financial sector entities has dampened investor and creditor confidence. Recent decisions in various fora have also seen creditors of financial sector entities pulling in different directions, thereby severely affecting potential recovery measures. While the government had introduced the Financial Resolution and Deposit Insurance Bill, 2016, to deal with the winding up of financial sector entities, this was later withdrawn after much controversy.
In exercise of powers under section 227 of the IBC, which enables the government to extend it to insolvency and liquidation proceedings of financial service providers or categories of financial services providers, the Ministry of Corporate Affairs issued the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019, on 15 November. The rules deal with insolvency and liquidation proceedings of financial service providers under the IBC, and extend the application of certain provisions of the IBC, such as on the corporate insolvency resolution process, liquidation process and voluntary liquidation process to financial service providers with some modifications.
The rules prescribe that a corporate insolvency resolution process can be initiated only upon application being made by the appropriate regulator. Such an application will be dealt with in the same manner as an application by a financial creditor. Upon admission, the relevant bench of the National Company Law Tribunal (NCLT) may appoint an administrator based on the recommendation of the appropriate regulator to exercise the powers and functions of an insolvency professional, resolution professional or a liquidator for the purpose of insolvency and liquidation proceedings. The rules also prescribe an interim moratorium from the date of the making of the application until its admission or rejection. This interim moratorium will have the same effect as a moratorium under section 14 of the IBC, including prohibiting the institution or continuation of suits, encumbering any assets, and taking any foreclosure or enforcement action.
The extension of the provisions of the IBC to financial services providers means that where an application is admitted, the NCLT can declare a moratorium under section 14 of the IBC. Once admitted, a committee of creditors has to be constituted, which will, among other things, consider a plan for resolution prepared by a resolution applicant, (i.e., any person who submits a plan for resolution). If a resolution plan is approved, the administrator must seek a “no objection” from the appropriate regulator in relation to the persons who would be in control or management of the financial services provider. Such a no objection shall be issued by the appropriate regulator on the basis of the fit and proper criteria applicable to the financial services provider. A no objection shall be deemed to be granted if the appropriate regulator does not reject the request within 45 days. The rules also prescribe that a financial services provider can only seek voluntary liquidation with the permission of the appropriate regulator.
Importantly, the interim moratorium and the moratorium shall not apply to any third-party assets or properties in the custody or possession of the financial services provider, including funds, securities and other assets held in trust for the benefit of third parties. An administrator can take control and custody of such assets only for the purpose of dealing with them in the manner notified by the government. It is noteworthy that this has been specifically clarified in the rules, as there have been recent decisions that indirectly cast an unfavourable light on securitization transactions, which have provided a continued source of funding.
The government has issued a notification applying these rules to all non-banking financial companies (including housing finance companies) with asset size of at least ₹5 billion (US$70 million). It is expected that there will be further notifications to cover other systemically important financial institutions, including insurance companies. The complete operationalization of these rules for all categories of financial institutions will be a positive step in rebuilding confidence in the financial markets.
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