Insolvency for financial services providers in India

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Kumar Saurabh Singh
Khaitan & Co, Mumbai
mumbai@khaitanco.com

Aditi Bagri
Khaitan & Co, Mumbai
mumbai@khaitanco.com

India’s Insolvency laws have been evolving at a steady pace since the inception of the Insolvency and Bankruptcy Code (Code) in 2016. Recent developments under the Code include the extension of its applicability to a segment of financial services providers (FSP). The liquidity crisis which began in India’s financial services sector in 2018 increased stress faced by FSPs due to rising non-performing assets in the portfolios of various lenders. This also resulted in significant stress on the finance of various lenders. While discussion on financial services providers’ debt resolution has been underway for some time, the extension of applicability of the Code has been carried out based on challenges posed in finding a resolution acceptable to various FSP stakeholders.

Challenges in FSPs restructuring/resolution

By their structure as a group, FSPs have certain unique features and challenges which only they would have to deal with in case of a restructuring/insolvency. The debt and equity capital of FSPs is complex – and restructuring/reorganising these requires significant regulatory intervention and approvals.

A FSP raises funds by issuing various types of bonds and loans. These could be external commercial borrowing, domestic lending, Tier-1 bonds, Tier-2 bonds or perpetual bonds, amongst others. FSPs also raise a significant amount of money from the public markets, which consequently makes any restructuring/reorganisation/resolution a more challenging process. In addition to the challenges in the restructuring of an FSP’s liabilities, the mechanism of asset distribution pursuant to the restructuring – including overcoming challenges from due diligence of assets – create a rather peculiar situation for restructuring/reorganisation/resolution, especially in cases where the assets and their valuation themselves become questionable.

As is the principle for any restructuring/reorganisation/resolution, the greater the number of stakeholders, the more complex the resolution process. This has weighty importance for FSPs with the interests of the public involved in more ways than one such as deposits, bonds, equity holders, customers. Other FSPs are also vital stakeholders in the process being involved in not just liabilities, but often through securitisation transactions as well. The varied liabilities availed by FSPs make the FSP restructuring/reorganisation/resolution process a fairly unique process.

Extension of the Code to FSPs as a solution

The extension of the Code to FSPs appeared to be natural progression for the restructuring/reorganisation/resolution which were being evaluated at the time of notification of such extension. Under a notification dated 18 November 2019, the Ministry of Corporate Affairs (MCA) extended the applicability of the Code to include housing finance companies (HFCs) having an asset size of more than INR5bn (approx US$66m) as per their last audited balance sheet, with the appropriate regulator being the Reserve Bank of India. The Code’s rules governing the corporate insolvency resolution process for FSPs were issued by the MCA on 15 November 2019 (FSP Rules) and the rules pertaining to dealing with an FSP’s third-party assets issued by the MCA on 30 January 2020.

Key deviations from general FSP insolvency laws

Some of the key changes in the initiation of insolvency proceedings against FSPs, compared to those for non-FSPs are:

Initiation of insolvency proceedings only by the appropriate regulator

Typically, insolvency proceedings under the Code could have been initiated by a financial creditor, operational creditor or the corporate debtor itself. Given the importance of FSPs in the stability of India’s financial markets, it was only prudent to ensure that a step such as initiation of insolvency proceedings is only undertaken with adequate representations and by the relevant FSP regulator. An application made by the appropriate regulator will be considered as an application made by a financial creditor and thus treated accordingly.

Appointment of administrator

Instead of an interim resolution professional/resolution professional, an ‘administrator’ is appointed to undertake all actions which would otherwise be required to be undertaken by the IRP/RP under the Code. The administrator is appointed by the appropriate regulator.

Constitution of an advisory committee

In addition to the administrator and the committee of creditors as and when constituted, an ‘advisory committee’ is also to be constituted to assist and advise the administrator on the resolution process. This advisory committee must be constituted within 45 days of the insolvency commencement date.

Moratorium

As opposed to general insolvency proceedings under the Code, an interim moratorium in terms of section 14(1) of the Code,[1] commences immediately on filing the insolvency application against the FSP, and a moratorium commences on admission of the insolvency application. This is different from the general process, as there is no interim moratorium for non-FSPs. It is only on admission of the insolvency application under the Code, that a moratorium is imposed under section 14(1).

Dealing with third-party assets

For non-FSPs, third-party assets are clearly carved out from the assets taken over by the resolution professional during the corporate insolvency resolution process. However, for FSPs, this may not be as clear-cut, since various securitisation transactions/debt assignment transactions may have been undertaken by the FSP. To address this aspect and bearing in mind the ‘true sale’ nature of these transactions, a mechanism for dealing with third-party assets has been provided by the MCA to ensure that the rights of all third parties are protected.

The IL&FS aberration

The case of Infrastructure Leasing and Financial Services Ltd (IL&FS) is indeed an absolute aberration to the restructurings/resolutions in the finance and legal community in India. The IL&FS group had approximately 347 companies – with the main holding company and a couple of other key companies being FSPs, a majority of the companies, being non-FSPs. At the time of initiation of proceedings by the Government of India against the IL&FS group, under sections 241 and 242 of the Companies Act 2013 neither insolvency for FSPs nor group insolvency norms were notified in India. A group level resolution of this nature, involving FSPs was unheard of.

Unlike any other FSP in India and the general norm for stress resolution for financial services entities, IL&FS and the other FSPs within the IL&FS group have not been resolved/are not being resolved by the relevant regulators. In addition, the group has several non-FSP entities: solvent and insolvent, which have also not been taken to insolvency. This is a significant departure from the general structure of resolution for FSPs. Although no insolvency proceedings have been initiated, the selective application of insolvency principles to the resolution makes this case exclusive.

Conclusion

The many questions associated with the IL&FS resolution process being undertaken outside the Code, provided enough thought for undertaking steps to extend the Code to FSPs. In addition, the regulatory approvals/process for resolution of FSPs to date, have not evolved to the extent required to ensure such a resolution for FSPs can take place outside of the Code and/or without judicial approval which equally binds all stakeholders. For a case such as Dewan Housing Finance Corporation Ltd which is the sole FSP referred under the Code so far, a resolution outside the Code, appeared challenging due to the absence of a single binder for all stakeholders. The extension of the Code to FSPs has levelled the playing field so far as the various types of creditors are concerned, ensuring that at least one large issue has been appropriately dealt with.