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Financial service providers – regulatory framework for insolvency and liquidation proceedings notified

Introduction:

 

The Insolvency and Bankruptcy Code, 2016 (“Code”) as enacted, specifically excludes Financial Service Providers (“FSPs”) from the definition of corporate debtor. Therefore, any proceeding under the Code, ideally, could not be initiated against an FSP.

In light of the current crisis in the Indian financial sector, in particular the Non- Banking Finance Companies and Housing Finance Companies, on 16 August 2019, the Ministry of Corporate Affairs along with the Insolvency and Bankruptcy Board of India (“IBBI”), had formed a sub-committee to set up the regulatory framework for the insolvency and liquidation proceedings with respect to FSPs in furtherance to their being notified under Section 227 of the Code. Pursuant to the deliberations of the sub-committee, on 15 November 2019, the IBBI formulated, notified and made effective the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 (“FSP Rules”). As a first step, on 18 November 2019, NBFC having an asset size of more than INR 500 crore were notified as the first FSPs under the Code.

Who are FSPs?

Financial Service Provider is a person engaged in the business of providing financial services in terms of authorisation issued or registration granted by a financial sector regulator.

Financial Services includes any of the following services, namely:

  1. accepting of deposits;
  2. safeguarding and administering assets consisting of financial products, belonging to another person, or agreeing to do so;
  3. effecting contracts of insurance;
  4. offering, managing or agreeing to manage assets consisting of financial products belonging to another person;
  5. rendering or agreeing, for consideration, to render advice on or soliciting for the purposes of:
    1. buying, selling, or subscribing to, a financial product;
    2. availing a financial service; or
    3. exercising any right associated with financial product or financial service;
  6. establishing or operating an investment scheme;
  7. maintaining or transferring records of ownership of a financial product;
  8. underwriting the issuance or subscription of a financial product; or
  9. selling, providing, or issuing stored value or payment instruments or providing payment services;

Financial Sector Regulator means an authority or body constituted under any law for the time being in force to regulate services or transactions of financial sector and includes the Reserve Bank of India, the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority of India, the Pension Fund Regulatory Authority and such other regulatory authorities as may be notified by the Central Government;

Corporate Insolvency Resolution Process and Liquidation of FSPs

Application of the Code: Provisions of insolvency and liquidation as set out in the Code, apply mutatis mutandis to the corporate insolvency resolution process (“CIRP”) of an FSP, as well as its liquidation, voluntary or otherwise, as notified pursuant to the FSP Rules by the Central Government.

Who can file and when: CIRP can be initiated against an FSP which has committed a default, where the amount of such default exceeds one lakh rupees. Provided that any application for CIRP against an FSP can only be initiated if the application is made by the sectoral regulator and such an application shall be treated as an application by a financial creditor under Section 7 of the Code. Even an application for voluntary liquidation requires the regulator’s prior permission.

Key Features:

  1. Filing process:The Application is to be filed in Form 1, along with a fee of INR 25,000. A copy of the said application is also be forwarded to the registered office of the FSP.
  2. Supporting Documents: The application is to be accompanied by a written consent and declaration furnished by the proposed Administrator in prescribed Form 2 and all documents referred to in the application and proof of payment of fee.
  3. Interim Moratorium:An interim moratorium prevails from the date of filing of the application till the admission or rejection of the application by the Adjudicating Authority (“AA”). The interim moratorium prohibits institution or continuation of suits or proceedings against the FSP, transfer, encumbrance, alienation or disposal by FSP, enforcement action in respect of the property of FSP. The interim moratorium and moratorium shall not apply to third party assets and properties in custody of the FSP, inclusive of funds, securities and other assets as may be prescribed.
    During the interim moratorium period and during the CIRP period, the license or registration which authorises the FSP to engage in the business of providing financial services will not be suspended or cancelled. During liquidation, such license or registration cannot be cancelled or suspended unless an opportunity of being heard is provided to the liquidator.
  4. Admission of the Application:On admission of the application, the AA appoints an administrator to exercise all the powers and functions of the interim resolution professional, resolution professional or the liquidator in the insolvency or liquidation proceedings. Moratorium as applicable under the Code, commences and continues for 180 days, extendable up to 270 days from the date of admission of the application.
  5. Committee of creditors:Upon admission of an application and assessment of claims received against the FSP, a committee of creditors is constituted, consisting of financial creditors of the FSP. Once the committee is constituted, the FSP is required to take its permission for specified activities, including raising any interim finance, creating security interest over its assets, recording change in ownership, amending constitutional documents, changing its management.
  6. Advisory Committee:The appropriate regulator may, constitute an Advisory Committee comprising of 3 or more members, qualified under the FSP Rules, within 45 days of the insolvency commencement date, to advise the Administrator in the operations of the FSP during the corporate insolvency resolution process. The terms and conditions of the members and the manner of conducting of their meetings and observance of rules of procedure are to be determined by the appropriate regulator. It is pertinent to note that the compensation paid to the members of this committee shall be part of the insolvency resolution process costs.
  7. Resolution Plan:The AA assisted by the Administrator and committee of creditors, arrive at a plan for resolution of insolvency of the FSP. If a resolution plan is not arrived at within the time prescribed in the Code or is rejected by the AA, the AA has the power to direct liquidation of the FSP. The resolution plan which is to be furnished for an FSP shall have to fulfil not only the mandatory contents as prescribed in Section 31 of the Code, but also include a statement explaining how the resolution applicant satisfies or intends to satisfy the requirements of engaging in the business of the FSP, as per extant laws.
  8. Permission of the regulator:Once the committee of creditors approves the resolution plan, the regulator’s no objection is to be obtained. The appropriate regulator would also be required to issue a “no-objection” on the basis of the “fit and proper” criteria applicable to the business of the FSP to the resolution plan. No order of dissolution or liquidation of an FSP can be passed unless the regulator has been given the opportunity of being heard. The Administrator can be appointed or replaced only with an application to be filed before the AA by the regulator.
  9. Withdrawal of Application:Withdrawal of the application may be permitted by the AA before its admission on a request made by the appropriate regulator.
Conclusion

These notifications augment the intent of the Code, that an FSP is a special category of entity and they ought not to be dragged into insolvency without there being a strong reason and involvement of the concerned regulator. With the notification of the FSP Rules, this interpretation is further strengthened and another layer of protection i.e., notification as FSP by Central Government, has been added for the FSP Rules to apply to an entity. Furthermore, the FSP Rules have also taken into consideration the continuation of the license and registration of FSPs in order to enable them to remain going concerns while their CIRP is ongoing. Given that an FSP is likely to have an interface with public, even the resolution applicants are required to be adequately equipped to engage in the business of an FSP, to further enable the “going concern” aspect. In our view, these steps are aimed at implementation of the intent of the Code, and bring clarity to the letter and spirit of the insolvency regime.

Regulatory framework for insolvency and bankruptcy proceedings for personal guarantors

 

Background

Personal guarantors have been in the news ever since the provisions of the Insolvency and Bankruptcy Code, 2016 (“Code”) were notified and the first set of 12 insolvency resolution processes were initiated. The jurisprudence on the subject at that time ranged from according a moratorium on personal guarantors during the corporate insolvency resolution process (“CIRP”) of a corporate debtor (“CD”) to personal guarantors being kept out of the CIRP process.

Creating a framework for insolvency and bankruptcy of personal guarantors, the Central Government, on 15th November, 2019, appointed 1st December, 2019 as the date of implementation of provisions of the Code for the insolvency and bankruptcy relating to personal guarantors. Towards that end, following regulations and rules were also made and notified over the next few days, all with effect from 1st December, 2019:

  1. Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (“Insolvency Rules”).
  2. Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 (“Insolvency Regulations”) (the Insolvency Rules and Insolvency Regulations hereinafter collectively be referred to as “Insolvency Rules and Regulations”).
  3. Insolvency and Bankruptcy (Application to Adjudicating Authority for Bankruptcy Process for Personal Guarantors to Corporate Debtors) Rules, 2019 (“Bankruptcy Rules”).
  4. Insolvency and Bankruptcy (Application to Adjudicating Authority for Bankruptcy Process for Personal Guarantors to Corporate Debtors) Regulations, 2019 (“Bankruptcy Regulations”) (the Bankruptcy Rules and Bankruptcy Regulations hereinafter collectively be referred to as “Bankruptcy Rules and Regulations”).

This legal update aims to provide a quick overview of the notified provisions of the Code and the rules and regulations made in connection thereto. These apply to personal guarantors for a corporate entity whose personal guarantee has been invoked and remains unpaid.

Insolvency Resolution of Personal Guarantor

 

Key Features

Who can file and where: Application for the insolvency resolution of a personal guarantor can be filed by (i) the guarantor, either personally or through a Resolution Professional (“RP”), in Form A; or (ii) by a creditor of such a personal guarantor, either personally or through a RP in Form C. The Adjudicating Authority for insolvency of a personal guarantor is the Debt Recovery Tribunal (“DRT”).

However, if the CIRP of a CD is already pending with the National Company Law Tribunal (“NCLT”), then the insolvency petition for the personal guarantor ought to be filed before the same NCLT. If the petition of insolvency resolution of the personal guarantor predates the CIRP of the CD, then such an application will be transferred to the NCLT.

Demand Notice: Creditor to send a demand notice to the personal guarantor in Form B, demanding payment in 14 days of service of notice.

Withdrawal of Application: The DRT may permit withdrawal of the application either (i) before its admission, on a request made by the applicant or (ii) after its admission, on the request made by the applicant, if 90% of the creditors agree to such withdrawal.

Interim Moratorium: Upon filing of the application, a moratorium commences i.e., during such time any action or proceeding pending in respect of the debt is stayed and no proceedings can be initiated by a creditor against the personal guarantor, for any debt. Interim moratorium ceases upon admission / rejection of the application.

Resolution Professional: If the application lists an RP, then the DRT would either confirm the appointment or reject and nominate a replacement within 14 days of filing the application. If the application does not list an RP, then within 7 days of filing of the application, an RP is nominated to the DRT by the Insolvency and Bankruptcy Board (“Board”), who is then appointed as the RP vide an order of the DRT subject to the eligibility criteria being met.

Admission or Rejection: The appointed RP reviews the application and sends his comments to DRT within 10 days of his appointment recommending rejection or admission of the application. Based on the RP’s report, DRT can either admit or reject the application within 14 days of the RP’s report. If the application is admitted, the DRT can instruct negotiation between the guarantor and the creditor for arriving at the repayment plan. If the application is rejected due to the RP’s recommendation or that the application is to defraud the creditors, DRT would record that the creditor is entitled to file for a bankruptcy of the guarantor.

Moratorium: Once the application is admitted, a moratorium is applicable for 180 days. During this period, all pending legal proceedings for any debt of the personal guarantor are stayed, creditors cannot initiate legal proceedings for any debt and the guarantor cannot transfer, alienate, encumber or dispose of any of the assets or his legal right or beneficial interest.

Publication and Claims: The DRT will issue a public notice of the order of admission and call for submission of claims from the creditors within 21 days of the issuance.

Committee of Creditors: The RP to verify and collate all the claims received and prepare a list of creditors within 30 days of the public notice and establish a committee of creditors (“CoC”).

Repayment: The guarantor along with the RP will prepare a repayment plan with a proposal for restructuring of debts. The proposal should contain a justification and reason why creditors would agree to the proposed plan and also provide for payment of fee to the RP. While Insolvency Rules require the RP to submit the plan and his report within 21 days from the last submitted claim, the Insolvency Regulations require this to be done before completion of 120 days from the resolution process commencement date.

Meeting of the CoC: The plan would either propose a meeting of the creditor or mention that a meeting is not required. A meeting of the creditors, if required, will be held between 14 and 28 days of the RP submitting his report to the DRT, with at least 14 days’ notice. The notice ought to be accompanied by the repayment plan, report of the RP, forms for proxy voting and state of affairs of the guarantor.

The CoC may approve, modify or reject the repayment plan or decide to alter it, with the consent of the guarantor. The approval of the repayment plan requires a majority of more than 3/4 in value of the creditors present in person or by proxy and voting on the resolution in a meeting of the creditors. The voting right of each creditor is in proportion to the debt they are owed.

Report on the meeting by the RP: The RP submits a report on the meeting of creditor, which includes whether the plan was approved or rejected, any modifications that were proposed, the resolutions proposed and decided, creditors who were present or represented at the meeting, and the voting records of each creditor for all meetings of the creditors; and their voting. A copy of the report is to be provided to the guarantor, creditors and the DRT.

Final Order: DRT can either approve or reject the repayment plan on the basis of the report of the RP and provide a decree for implementation. Where a meeting of creditors is not convened, the DRT can direct for it to be convened. If a modification is directed, the DRT can re-convene a meeting of the CoC for reconsidering the modifications in the repayment plan.

Once approved, repayment plan takes effects and binds the guarantor and the creditors. If the plan is rejected, the guarantor and the creditors are entitled to file an application for bankruptcy.

Implementation of the Plan: The implementation of the plan is supervised by the RP. Once implemented, the RP to send the notice of implementation to the creditors, debtors and DRT, report summarising the receipts and payments made pursuant to the repayment plan and the extent of implementing. If the timeline mentioned in the plan passes without the plan being implemented completely, the plan is deemed to have ended prematurely. In such a case, the RP submits a report to DRT and details of receipts and payments under the plan, reasons for the premature end, details of the creditors, not fully satisfied. The premature end is recorded by the order of the DRT and unsatisfied creditors can file for bankruptcy of the guarantor. Basis the plan, a discharge order can be procured recording a discharge either subject to implementation or upon implementation of the plan.

Bankruptcy Process for Personal Guarantors

Key Features:

Who can file and when: The application for initiating bankruptcy can be filed to the DRT by (i) the guarantor himself, in Form A; or (ii) by a creditor either personally or through a RP in Form B where an order has been passed by the DRT due to:

  1. rejection of application for insolvency; or
  2. rejection of repayment plan due to insolvency; or
  3. order that the repayment plan is not completely implemented or has ended prematurely.

In its application, the creditor must either confirm giving up of security for the benefit of all creditors of the personal guarantor once the order of bankruptcy is passed or that the application is only in respect of the unsecured debt.

The Adjudicating Authority for bankruptcy of a personal guarantor is also DRT. However, if the liquidation of a CD is pending with the NCLT, then the bankruptcy petition for the personal guarantor ought to be filed before the same NCLT and if the bankruptcy petition of the personal guarantor is filed and then the liquidation of the CD is ordered, then the bankruptcy petition will be transferred to the relevant NCLT.

Withdrawal: An application, once submitted, can only be withdrawn with the leave of the DRT.

Interim Moratorium: Upon filing of an application for initiating the bankruptcy process, a moratorium commences against the properties of the personal guarantor in respect of this debt. This moratorium ceases upon admission or rejection of the bankruptcy application.

Bankruptcy Trustee: If the application proposes the name of the bankruptcy trustee, then the DRT, would either confirm the appointment or reject the appointment after checking the disciplinary status with the Board. If the application does not propose a bankruptcy trustee, then within 7 days of filing of the application, a bankruptcy trustee is nominated to the DRT by the Board, who is then appointed as the bankruptcy trustee by DRT subject to the eligibility criteria being met.

The bankruptcy order does not affect the right of any secured creditor to realize or otherwise deal with his security interest, subject to the declaration given by the creditor in his application for bankruptcy. Any action for realisation of the security ought to be taken within 30 days of the bankruptcy order.

Effect of the Bankruptcy Order: On and from the date of the bankruptcy order the bankrupt is:

  1. disqualified from acting as a trustee, a public servant, being elected to any public office or as a member of any local authority;
  2. prior to entering into any financial or commercial transaction for INR 1,00,000/- and above, inform the other parties that he is undergoing bankruptcy;
  3. not to act as a director of any company, or take part in the promotion, formation or management of a company, prohibited from creating any charge on his estate or taking any further debt, incompetent to maintain any legal action or proceedings in relation to the bankruptcy debts and not be permitted to travel overseas without the permission of the DRT.

Public Notice: The DRT issues a public notice inviting claims from all creditors of the bankrupt, in Form C within 10 days of the bankruptcy commencement date. A creditor should submit a claim with proof to the bankruptcy trustee within 7 days of the publication of the notice, in Form F.

Committee of creditors: The bankruptcy trustee, within 14 days from the bankruptcy commencement date, prepares a list of creditors of the bankrupt and establish a CoC. Constitution of the CoC is to be informed to the DRT within 3 days from the meeting of creditors.

Meeting of the CoC: Within 21 days from the bankruptcy commencement date, the trustee issues a notice for calling a meeting of the creditors, to every creditor of the bankrupt as mentioned in the list. In the meeting, the voting share of each creditor to be in proportion to the debt owed to such creditor. The creditors/participants of the meeting are entitled to receive minutes of the meeting within 48 hours of the conclusion of the meeting. Any decision of the CoC will require the approval of more than 50% of voting share of the creditors who voted.

Realisation of Security Interest: A secured creditor who seeks to realise his security is required to inform the bankruptcy trustee of the price at which he proposes to realise the secured assets. A creditor cannot obtain interest in the assets of the bankrupt.

Administration and Distribution of Assets: The estate of the bankrupt excluding the excluded assets[ Excluded Assets means a) unencumbered tools, books, vehicles and other equipment as are necessary to the debtor or bankrupt for his personal use or for the purpose of his employment, business or vocation, (b) unencumbered furniture, household equipment and provisions as are necessary for satisfying the basic domestic needs of the bankrupt and his immediate family; (c) any unencumbered personal ornaments of the debtor or his immediate family which cannot be parted with, in accordance with religious usage shall not exceed INR 1,00,000; (d) any unencumbered life insurance policy or pension plan taken in the name of debtor or his immediate family; and (e) an unencumbered single dwelling unit owned by the debtor (i) in the case of dwelling unit in an urban area shall not exceed, INR 20,00,000 and (ii) in the case of dwelling unit in rural area shall not exceed, INR 10,00,000. ] vests in the bankruptcy trustee immediately from the date of his appointment and will take possession and control of all property, books, papers and other records relating to the estate of the bankrupt. The bankruptcy trustee may, with the approval of the CoC, divide amongst the creditors, properties which from its peculiar nature or other special circumstances cannot be readily or advantageously sold. Where the bankruptcy trustee has realised the entire estate of the bankrupt he will give notice of his intention to declare a final dividend or that no dividend or further dividend to be declared.

A meeting of the creditor is convened on completion of distribution of assets and the bankruptcy trustee provides a report on administration of the estate for the approval of the CoC which is to be approved within 7 days of receipt. Once approved, the bankruptcy trustee is released.

Discharge order: An order of discharge can be applied for 1)on the completion of 1 year from the bankruptcy commencement date; or 2) within 7 days of the CoC approving the report on administration of estate, whichever is earlier. A discharge order releases the personal guarantor from all bankruptcy debt, except for the breach of contract or fraud or excluded debt2.

KLA Analysis and Conclusion

The notification of the relevant provisions, rules and regulations is a major step towards creating the regulatory regime for insolvency and bankruptcy of personal guarantors. This is likely to be most beneficial for banks and financial institutions as it will be a time bound process and can take all promoters (who have given personal guarantees) into consideration. Now that the Supreme Court in the matter of Essar Steel has upheld the right of lenders to enforce personal guarantee outside a resolution plan, the timing of these notifications is very interesting. These provisions, rules and regulations formulate the pathway for implementation of the directives of the Supreme Court vis-à-vis actions against the personal guarantors.

Footnotes

1Excluded Assets means a) unencumbered tools, books, vehicles and other equipment as are necessary to the debtor or bankrupt for his personal use or for the purpose of his employment, business or vocation, (b) unencumbered furniture, household equipment and provisions as are necessary for satisfying the basic domestic needs of the bankrupt and his immediate family; (c) any unencumbered personal ornaments of the debtor or his immediate family which cannot be parted with, in accordance with religious usage shall not exceed INR 1,00,000; (d) any unencumbered life insurance policy or pension plan taken in the name of debtor or his immediate family; and (e) an unencumbered single dwelling unit owned by the debtor (i) in the case of dwelling unit in an urban area shall not exceed, INR 20,00,000 and (ii) in the case of dwelling unit in rural area shall not exceed, INR 10,00,000.
2Excluded debt means (a) liability to pay fine imposed by a court or tribunal; (b)liability to pay damages for negligence, nuisance or breach of a statutory, contractual or other legal obligation; (c) liability to pay maintenance to any person under any law for the time being in force; (d) liability in relation to a student loan; (e) any other debt as may be prescribed. A discharge order removes the disqualifications of bankruptcy.

Sakate Khaitan

Senior Partner

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