{"id":28546,"date":"2020-01-31T17:00:10","date_gmt":"2020-01-31T11:30:10","guid":{"rendered":"https:\/\/enterslice.com\/learning\/?p=28546"},"modified":"2021-01-04T16:23:12","modified_gmt":"2021-01-04T10:53:12","slug":"insolvency-and-bankruptcy-code-now-covers-nbfcs-and-other-fsps","status":"publish","type":"post","link":"https:\/\/enterslice.com\/learning\/insolvency-and-bankruptcy-code-now-covers-nbfcs-and-other-fsps\/","title":{"rendered":"Insolvency and Bankruptcy Code now covers NBFCs and other FSPs"},"content":{"rendered":"

Before the Insolvency and Bankruptcy Code, 2016 (IBC)<\/strong>[1]<\/strong><\/a><\/sup> came into effect; there was no special law to regulate Insolvency and Bankruptcy in India. There were several laws which cumulatively enforced and helped to regulate Insolvency and Bankruptcy system in India<\/a><\/strong>. IBC served as a consolidated enactment providing single window related to time-bound insolvency of “corporate persons” which includes<\/p>\n\n\n\n

\"corporate<\/figure>\n\n\n\n

The definition of “corporate person” as provided under Section 3(7) of <\/strong>the Code explicitly excludes financial service\nproviders (FSPs).<\/strong><\/strong><\/p>\n\n\n\n

Why are NBFCs excluded from IBC?<\/h2>\n\n\n\n

Financial\nService Providers (FSPs) include various participants, which play a crucial role\nand facilitate the smooth functioning of the economy. <\/p>\n\n\n\n

The definition of “financial service provider<\/strong>” as provided under Section 3(17) <\/strong>of the Code is<\/p>\n\n\n\n

a person engaged in the business of providing financial services in terms of authorization issued or registration granted by a financial sector regulator;<\/div>\n\n\n\n

The\nregulators are respective regulators of that sector, such as RBI, SEBI and\nIRDAI etc. The rationale behind excluding Non-Banking Financial Companies (NBFCs)\nis that they are not <\/strong>“systematically critical<\/strong>” financial\ninstitutions and in case of financial crisis, they would not lead to a domino\neffect in the economy. The financial institutions with that clout are\ncolloquially referred to as “too\nbig to fail”<\/strong>. Mostly they consist of banks and mutual funds. However\nit is interesting to note that NBFC<\/a> has not been defined in the code explicitly\nand as such it is to be evaluated if the concerned NBFC falls under the\ndefinition of Financial Service Providers on case to case basis<\/a> depending on\nthe business in which the entity is engaged in.<\/p>\n\n\n\n

Also, Read:<\/b> Audit Report Format for NBFC<\/a><\/mark>.<\/p><\/div>\n\n\n\n

What triggered the inclusion of NBFC under\nIBC?<\/h2>\n\n\n\n

The failure of Infrastructure Leasing & Financial Services (IL&FS)<\/strong> and the\nsubsequent financial crisis involving Dewan\nHousing Finance Limited (DHFL)<\/strong> acted just as a trigger to set off a\nliquidity crisis, at a time when the NBFC sector was already reeling under\ntoxic levels of stress. This raised the demand to include certain financial\nservice providers (FSPs) – such as housing finance companies and other\nspecified NBFCs under the purview of IBC to save investors interest.<\/p>\n\n\n\n

What is the legal position on NBFCs as\nFinancial Service Providers (FSPs)?<\/h2>\n\n\n\n

Financial institutions that offer various banking services without holding a license of a bank are called Non-banking financial companies (NBFCs<\/a><\/strong>). Since these institutions, neither take deposits from the public and nor are the part of payment systems hence they can be kept outside the scope of traditional oversight and compliance requirements concerning banking regulations.<\/p>\n\n\n\n

National Company Law Appellate Tribunal (NCLAT) in a recent case of HDFC Bank Ltd. vs RHC Holding Pvt. Ltd.<\/strong>, while dismissing the application for insolvency of RHC Holding filed by HDFC, held that NBFCs are Financial Service Providers (FSP) and hence beyond the jurisdiction of the Code. This decision reiterates the decision by the principal bench of NCLT in Randhir Thakur vs Jindal Saxena & Mayfair Capital<\/strong>, wherein also an application for the initiation of “Corporate Insolvency” was dismissed. The main rationale behind these being that the Respondents in these cases were Non-Deposit taking NBFCs whose main object was merely lending and in no way involved public money or any such activity which might be crucial for the smooth functioning of the economy.<\/p>\n\n\n\n

However, there is an alternate view that those services which\nare enlisted under section 3(16) of IBC as “financial services” are the ones which\nare intricately linked to the money market<\/a> or capital market and failure of\nthem might trigger systemic risk in the economy. Hence the corporations engaged\nin inter-corporate deposits (or any other activity not falling under the\numbrella of financial services) shall not be construed as Financial\nService Providers (FSPs) hence excluding them from the vigour of the Insolvency\nand Bankruptcy Code, 2016.<\/p>\n\n\n\n

Can the Central Government include FSPs under\nthe Insolvency & Bankruptcy Code (IBS)?<\/h2>\n\n\n\n

After huge\nNBFCs, such as Dewan Housing Finance Corporation (DHFC), went stressed\nGovernment decided to open window under existing laws on insolvency to bring\ncertain categories of financial institutions, especially those having\nsufficient public money involved, under the preview of IBC. <\/p>\n\n\n\n

Section 227\nof IBC, being enabling provision, allows the Central Government to include\nNBFCs (as FSP) or categories of FSPs under the IBC for insolvency and\nliquidation proceedings. This is done only after consultation with the\nfinancial sector regulators and by passing a notification in this regard. The\nprovision being overriding in its nature, gives extensive power to Central\nGovernment in order to allow insolvency of FSPs for limited purpose.<\/p>\n\n\n\n

However the\nchallenge is that certain class of financial institutions such as HFCs,\nbrokerages, non-systemic important NBFCs can only be included under the code\nand not ‘systematically critical’ institutions such as banks and mutual funds\nas it might trigger negative sentiments in the market.<\/p>\n\n\n\n

Regulators’ concern on NBFCs falling under\nInsolvency and Bankruptcy Code <\/h2>\n\n\n\n

Initiation of insolvency proceeding against strong NBFCs may\nhave a spiraling effect in the sector causing panic consecutively putting huge\nor even serious risk on depositors and investors money parked in these NBFCs.\nThis is the exact issue which emerged in case of DHFL and IL&FS where\ndefaults created a fear in the entire sector creating liquidity crisis since\nDHFL was one of the largest housing finance corporation in India that went into\ntrouble. <\/p>\n\n\n\n

What are the fresh rules under IBC for NBFCs?<\/h2>\n\n\n\n

Government of India recently issued fresh rules under the Insolvency and Bankruptcy Code, 2016 (IBC) that are likely to help out distressed shadow banks and housing financiers, which have been battling a liquidity crunch for a year. The ministry of corporate affairs, after addressing the central banks (regulator) concern, issued a notification on 18th<\/sup> November, 2019<\/strong> specifying the categories of financial service providers (FSPs) against whom corporate insolvency can be filed for under the Insolvency and Bankruptcy Code. It also clarified that NBFCs, or classes of such entities, will be covered by a special window under the bankruptcy code, which will be notified from time to time.<\/p>\n\n\n\n

The Insolvency and Bankruptcy (Insolvency\nand Liquidation Proceedings of Financial Service Providers and Application to\nAdjudicating Authority) Rules, 2019<\/strong> was notified to\nresolve severe liquidity crisis of NBFCs and to create overall stability in the\nfinancial sector.<\/p>\n\n\n\n

Salient features of new rules<\/h3>\n\n\n\n