The Insolvency and Bankruptcy Code, 2016 (“Code”) does not, in general, deal with insolvency of financial service providers (“FSPs”), as FSPs are seen to be systemic and complex structures with unique transactions in their kitty. However, the Dewan Housing Finance Corporation Limited (DHFL) collapse led to notification of the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 (“Rules”) under Section 227 of the Code. The Rules applied the law to FSPs, with certain modifications. The Rules, inter alia, with respect to third party assets, stipulates that the moratorium provisions will not apply to such assets or properties in custody or possession of the FSP, including any funds, securities and other assets required to be held in trust for the benefit of third parties. The Rules further state that the Administrator shall take control and custody of such third-party assets or receivables, but only for the limited purpose of dealing with them in the manner as may be notified by the Central Government.
Pending notification of clear rules with regard to third party assets with the FSPs, there were ambiguities, which demanded judicial intervention (see below). However, now, the Central Government has, vide notification dated 30.01.2020 (“Notification”), notified the manner in which third party assets in custody or possession of financial service providers (against whom insolvency proceedings have been initiated) has to be dealt with.
THE DHFL ISSUE:
On 30.09.2019, the Hon’ble Bombay High Court passed an ad-interim order, on an application filed by deposit-holders, and injuncted DHFL from making any payments and/or disbursements to any of its unsecured creditors and secured creditors, except in cases where payments made on pro-rata basis to all secured creditors, without the sanction of the Court. Aggrieved by the said order, various banks, including State Bank of India, Bank of Baroda, Union Bank of India, Indian Overseas Bank, Canara Bank, Bank of India, Standard Chartered Bank, filed intervening applications before the High Court seeking modification of the above order to the extent that DHFL is allowed to make payment of amounts due to banks pursuant to securitization and assignment agreements.
Finally, vide order dated 13.11.2019, the Bombay High Court allowed DHFL to make payments to banks and NBFCs that have securitisation arrangements with the stressed mortgage financier.
Pursuant to notification dated 18.11.2019, DHFL became the first FSP against which the insolvency proceedings were initiated on 02.12.2019,
As the Notification was not issued, the following issues arose in the DHFL case:
- While DHFL continued to be the servicer of the pool underlying the securitisation transaction, it held that transferring of collections from securitised assets and liquidation of cash collateral by the trustee would be in violation of the NCLT order declaring moratorium, and therefore, refrained from depositing the collections from securitised assets into the respective collection and payout accounts.
- The accessibility of cash collateral to trustee was, thus, restricted as DHFL informed the trustees that until the Central Government notification related to “dealing with third party assets” is issued, transfer/ appropriation/ enforcement of security or collateral will be in contravention of the Code.
To secure the rights of banks under securitisation agreements for cases, and put an end to the unwarranted circumstances in future as in case of DHFL, the Central Government issued the Notification, which casts the following obligations on the administrator of the FSP:
Dealing with third party receivables:
- Where a FSP is contractually obliged, as on the insolvency commencement date, to act as a servicing or collection agent on behalf of third parties, the administrator is required to prepare a statement of such transactions and respective agency contract.
- The administrator is required to continue to discharge the obligations of the FSP as a servicing or collection agent.
- The administrator is required to ensure that the receivables collected in respect of securitisation transactions are deposited and maintained in a separate account and are not merged with the funds or other assets of FSP.
Dealing with Third Party Assets:
- Where the FSP has, as on the insolvency commencement date, in its custody or possession assets owned by third parties, and is under an obligation to return or transfer such assets in accordance with the terms and conditions of the contract, the administrator is required to prepare a statement of such assets and the respective contracts.
- Further, the administrator is required to ensure that third party assets are maintained in a separate and distinct manner, capable of identifying them contract-wise, and are not merged with those of FSP.
- The administrator is required to return or transfer such assets to the person entitled to receive it in accordance with the terms and conditions of the contract, however, when due to breach of the terms of the contract, the FSP becomes entitled to retain certain assets or dispose of the same, the administrator shall not be required to return such assets.
1. Appointment of alternate servicer or collection agent:
In securitisation transactions, while the originator of the loan (assignor) is appointed as the servicer or collection agent on behalf of the assignees, the assignees are provided with the sole and unquestionable right to replace the servicer with an alternate servicer, particularly in the case of event of default (insolvency is an event of default in all the cases). In our view, the obligation cast upon the administrator to continue acting as collection agent does not take away/ restrict such right of the assignee in any manner. If the assignees do not avail the option of appointing alternate servicer and is desirous to continue with the services of the FSP, only in such cases, the administrator will act for the FSP. Also, immediately, on termination of the services of the servicer, the servicer is required to transfer to the alternate/ successor servicer, the custody of all loan agreements, underlying documents, electronic payment instruments, cheques including post-dated cheques, drafts, instruments (if any), demand promissory notes, correspondence, records, information and monies held by the servicer with respect to the assets
2. Operation of collection accounts:
Generally, it is seen that the receivables are first collected and deposited by the servicer in one common account, and thereafter disbursed to the beneficiaries as per the waterfall provided in the assignment agreement. The Notification provides that the administrator will be required to maintain separate collection accounts for each securitisation transaction. The requirement to maintain separate accounts means the administrator, on appointment, will be required to open separate bank accounts for collection of funds received from each assignment, which might result in administrative difficulties.
3. Commingling of pool of loans:
The Notification provides that the administrator shall prepare a statement of assets and the respective “contracts” and further stipulates that the administrator shall ensure that such assets are maintained in a separate and distinct manner, capable of identifying them “contract-wise”. In securitisation transactions, a pool of loans are transferred to the assignee vide an assignment agreement, the language of the Notification may give rise to a confusion as to whether the term “contract” is used for loan agreement or assignment agreement. In our view, the intent was to distinguish between each securitisation transaction and not individual loans.
4. Security interest enforced by the administrator on behalf of the assignee:
While the Notification provides that the assets which continue to be in the custody or possession of the FSP as on the insolvency commencement date shall be dealt with in the manner provided in the contract, there may be certain assets which might subsequently come in possession of the FSP/ administrator, the Notification is not clear about the treatment of such assets. We believe that the assets which subsequently come in possession or control of the FSP will also be dealt with in the same manner, i.e. in accordance with the terms and conditions of the respective assignment agreements.
While there seems to be some relief to the financial sector, since the Notification delinks the insolvency of one FSP from affecting the other financial entities, there still exists ambiguity so far as the scope of the term “third party” is concerned. Also, there is a need to clarify the manner in which third party assets is to be treated in resolution plans or in case of liquidation.
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