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A $400 Billion Legal Interpretation

September 13, 2019

A single sentence definition has pulled a large segment of the Indian legal fraternity in a debate. The debate is worth approximately $400 billion dollars. The sentence of contention is buried within a 109 page document and reads,

 

‘a person engaged in the business of providing financial services in terms of authorisation issued or registration granted by a financial sector regulator.’

 

Let’s get some context. The 109 page document where this sentence figures is called the Insolvency and Bankruptcy Code, 2016 (aka, IBC or the Code). IBC is the Grundnorm or guiding force for consolidation and amendment of the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms, LLPs and individuals in a time bound manner. In simple words, it tells us what to do with companies that have run out of money and owe a lot of debt to various kinds of people. Now, companies are of various types. One of them is a ‘Non-banking Financial Company’ (aka, NBFC). NBFCs are just like banks as they give loans, but they cannot take deposits under Indian law. The IBC identifies a NBFC as a financial creditor under Section 7 of Part II of IBC [2] as,

 

“a person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to.”[3]

 

However, it has been a long-standing debate if the same would be considered under the ambit of IBC as a Corporate Person [4] and excluded from financial service providers. The financial service providers[5], which are regulated by separate financial regulators, have been specifically excluded from the purview of IBC.

 

With respect to IL&FS, a leading NBFC being in news for serious debt defaults, the lack of certainty concerning the applicability of IBC has added to anxiousness among stakeholders. To lay this issue to rest once and for all, it is imperative that the code be interpreted in a manner consistent with its complexities.

 

To put it simply, ‘Financial service providers’ under the Code are specifically excluded from the definition of ‘Corporate Person’[6], which implies that an entity engaged in providing ‘financial services’ cannot be made to undergo corporate insolvency resolution process under the provisions of the Code. It is pertinent to note that the expression ‘non-banking financial company(ies)’ has not been expressly mentioned in the Code. Hence, the issue arises in the event of identifying whether a NBFC can fall within the purview under the definition of ‘financial service provider’.

 

Entities at Stalemate? – NCLAT sets the record straight

In the recent case of Housing Development Finance Corporation (HDFC) v. RHC Holding Private Ltd.[7], the National Company Law Appellate Tribunal (“NCLAT/Appellate Tribunal”) held the NBFC to be a financial service provider and thus exempted from being a Corporate Debtor [8] under the Code.

 

The Appellate Tribunal took note of the fact that the Registration of Certificate issued to the alleged NBFC by the Reserve Bank of India (“RBI”) envisages that it has granted a certificate to commence/carry on business of "non-banking financial services". This implies that the company had been registered as a NBFC but was not allowed to accept deposits from the public. Additionally, the tribunal also perused Section 45-I (f) of the RBI Act, 1934[9] to confirm that the respondent company falls within the definition of a “financial institution”[10].

 

The Appellate Tribunal was of the view that if the terms and conditions imposed by the RBI have been violated, one may bring the same to the notice of the RBI and not before the tribunal. This effectively means that NBFCs do not fall under the purview of the Code. It was further noted that according to provisions of Section 45-I (f) of the RBI Act, NBFCs carrying on the business of a financial institution were to be classified as financial service providers, and therefore outside the definition of Corporate Person/Corporate Debtor.

 

NBFCs and Financial Service Providers – A Case of Mistaken Identity

But here’s when we return to our starting point, a ‘financial service provider’ under IBC is,

 

‘a person engaged in the business of providing financial services in terms of authorization issued or registration granted by a financial sector regulator.’

 

The above definition therefore, has two essential ingredients –

  1. the entity should be providing ‘financial services’; AND,

  2. the entity must be authorized to do so by a ‘financial sector regulator’ (like RBI).

Therefore, an entity may not be a ‘financial service provider’, when the RBI certificate only allows it to carry on an activity which does not qualify to be a financial service. Thus, the term ‘Financial Service Provider’ needs to be individually applied in order to ascertain whether an entity qualifies for the same or not.

 

Every financial institution, therefore, may not necessarily be a ‘financial service provider’. A NBFC can thus be classified as Financial Service Provider ONLY IF it carries on a business classifiable in any of the clauses between (a) to (i) of section 3(16) of the Code.

 

 

Intent behind excluding financial service providers

The Bankruptcy Law Reforms Committee had the mandate of suggesting comprehensive reforms in the areas of bankruptcy of individuals and non-financial entities. The exclusion of ‘financial firms’ was in view of the work of the Financial Sector Legislative Reforms Commission (‘FSLRC’)[11] which made recommendations for the failure of financial firms in the previously proposed Indian Financial Code, 2013.

 

The Commission was of the view that failure of financial firms has the potential of being highly disruptive for the consumers, the market, as well as the economy as a whole. Therefore, the FSLRC recommended a specialized resolution mechanism and establishment of a ‘resolution corporation’. The idea was that the mechanism would,

 

“…concern itself with all financial firms that make highly intense promises to consumers, such as banks, insurance companies, defined benefit pension funds, and payment systems. The corporation will also take responsibility for the graceful resolution of systemically important financial firms, even if they have no direct link to consumers.”

 

Furthermore, Section 227 of the Code empowers the Central Government to notify Financial Service Providers or categories of Financial Service Providers for the purpose of insolvency and liquidation proceedings, which may be conducted under this Code. However, this can only be exercised in respect of entities, which are ‘Financial Service Providers’.

 

Conclusion

As seen above, there is no generic exemption for NBFCs from being a ‘corporate debtor’ under the Code and the applicability or non-applicability of the same needs to be decided by applying the test of being a financial service provider.

 

While the debate on the NBFCs being treated as a Corporate person or Financial Service Provider continues, the clarity with respect to the provisions becomes more necessary as time progresses. This is an interpretation on which the future of an approximately $400 billion dollar industry depends, with ripple effects on the whole economy.

 

References

[1]The Insolvency and Bankruptcy Code, 2016 [Act no. 31 of 2016, dated 28.5.2016] as amended by Insolvency and Bankruptcy Code (Amendment0 Act, 2018, (Act No. 8 of 2018) dated 18.1.2018 w.r.e.f 23.11.2017.

[2]http://www.mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndia.pdf

[3]Mr. Kapil Goyal, CA, Commercial’s Guide to the Insolvency and Bankruptcy Code, 2016 [Edition 2018]

[4]Section 3(7) of the Insolvency and Bankruptcy Code, 2016 - "corporate person" means a company as defined in clause (20) of section 2 of the Companies Act, 2013, a limited liability partnership, as defined in clause (n) of sub- section (1) of section 2 of the Limited Liability Partnership Act, 2008, or any other person incorporated with limited liability under any law for the time being in force but shall not include any financial service provider;”

[5]Section 3(17) of the Insolvency and Bankruptcy Code, 2016 - "financial service provider" means a person engaged in the business of providing financial services in terms of authorisation issued or registration granted by a financial sector regulator;”

[6]Section 3(7) of the Insolvency and Bankruptcy Code, 2016. (Ibid.)

[7] https://nclat.nic.in/Useradmin/upload/11493138195d25d9f0d704d.pdf

[8]Section 3(8) of the Insolvency and Bankruptcy Code, 2016 - “corporate debtor” means a corporate person who owes a debt to any person”

[9]Reserve Bank of India Act, 1934, available at https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/RBIAM_230609.pdf (last seen on 3/8/2019).

[10]Section 45-I (f) of the Reserve Bank of India Act, 1934 - ‘‘non-banking financial company’’ means– (i) a financial institution which is a company; (ii) a non-banking institution which is a company and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner; (iii) such other non-banking institution or class of such institutions, as the Bank may, with the previous approval of the Central Government and by notification in the Official Gazette, specify;]

[11] https://dea.gov.in/sites/default/files/fslrc_report_vol1_1.pdf

 

Views expressed are solely those of the author.

 

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About the Author

Shivani Malik is a fifth year law student who will often be found with her head buried in her phone reading e-books. She is currently pursuing law from Vivekananda Institute of Professional Studies (affiliated to Guru Gobind Singh Indraprastha University) and has assisted in many cases involving trademark and infringements as a Paralegal in a reputed law firm. She spends her free time petting and feeding her neighborhood dogs and aspires to improve animal rights in India.

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