Insolvent financial service providers a class apart

By Abhirup Dasgupta and Bhawana Sharma, HSA Advocates
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When the Insolvency and Bankruptcy Code (IBC) was introduced in 2016, an exception was made under section 3(17) for financial service providers (FSP) to prevent them from being dragged into insolvency. The legislature has since seen fit to remove this blanket protection. Under the powers conferred by sections 227 and 239(22)(zk) of the IBC, the Ministry of Corporate Affairs issued a press release in 2019, introducing the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 (rules). These rules provide a framework for the systematic insolvency and liquidation of FSPs.

Abhirup Dasgupta, HSA Advocates, Insolvent financial service providers a class apart
Abhirup Dasgupta
Partner
HSA Advocates

The rules have made the provisions under the IBC relating to the corporate insolvency resolution process (CIRP) and the liquidation process apply to the resolution process for an FSP in the same way they apply to any other corporate debtor, subject to certain sector-specific differences. For starters, the insolvency of an FSP can only be initiated by the regulator, that is the Reserve Bank of India (RBI). Before starting the process, the RBI rather than an interim resolution professional (IRP) must nominate an administrator, who has the same rights and obligations as the IRP, resolution professional or the liquidator, as the case may be. An interim moratorium under rule 5(b) of the FSP Rules, which has the same effect as a moratorium under section 14 of the IBC, comes into force immediately on the filing of the petition, rather than on admission of the petition. Within 45 days of the admission of the petition, the RBI is required to form an advisory committee of at least three experts to assist and aid the administrator.

As regards the continuation of the business, rule 5(b)(ii) stipulates that the license or registration under which the FSP is engaged in providing financial services will not be suspended or terminated during the interim moratorium and the resolution process of the FSP, meaning that even if an FSP is admitted to insolvency, it must continue its business of providing financial services. While the interim moratorium protects the assets of the FSP, it does not apply to the assets of a third party in the custody of the FSP prior to the commencement of the insolvency process. Rule 10 of the FSP Rules gives the administrator of the FSP, the authority to take custody or possession of such third-party assets and liquidate them to recover the outstanding amounts due from the debtors of the FSP.

While the process of inviting resolution plans may be the same, the prospective resolution applicant must satisfy the requirements attendant on engaging in the business of an FSP. In addition to the requirement that the committee of creditors approve the resolution plan, the RBI must confirm that it has no objection to the persons who would be in control or part of the management of the FSP in case the plan is approved. The RBI is required to respond within 45 working days of receiving the application. If the RBI does not object to the resolution plan, it is deemed that there is no objection to such a plan being accepted.

Bhawana Sharma, HSA Advocates, Insolvent financial service providers a class apart
Bhawana Sharma
Associate
HSA Advocates

In the absence of any resolution, the liquidation of the FSP is initiated. In terms of rule 7(b) of the FSP rules, prior to passing an order for the liquidation of the FSP, the RBI is required to be heard. Even when the FSP is undergoing liquidation, the license or registration of the FSP cannot be cancelled without hearing the FSP. It is interesting to note that an FSP may be voluntarily wound up. However, the consent of the RBI is mandatory in such cases. The liquidation proceedings can culminate in an order of dissolution, but such an order can only be made after hearing the RBI. It is clear that the legislature intends that the regulator, that is the RBI, is involved at every critical stage of the insolvency/ liquidation process of an FSP.

The reality is that the insolvency of an FSP can only be resolved by another FSP and that during the insolvency process of such FSP, it must continue its business of providing financial services. This process has recently been invoked in the cases of Dewan Housing Finance, Reliance Capital and the SREI Group of Companies. Considering the current economic circumstances, the insolvency of an FSP should not be viewed with scepticism. It is an opportunity for a financial entity to get back on its feet for the benefit of its customers, depositors, and, indeed, its creditors.

Abhirup Dasgupta is a partner and Bhawana Sharma is an associate at HSA Advocates.

HSA Advocates

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