Financial Service Provider under the clutch of IBC? Nature of the “debt” vs. Nature of the “debtor”

-Megha Mittal

(resolution@vinodkothari.com)

In a first of its kind, the Hon’ble National Company Law Tribunal, Principal Bench at New Delhi (“NCLT”) vide its order dated 04.11.2019[1] in the matter of Apeejay Trust v. Aviva Life Insurance Co. India Ltd., has initiated corporate insolvency resolution process against the Corporate Debtor, despite it being a financial service provider under the Insolvency and Bankruptcy Code, 2016 (“Code”).

In the above pretext, one may recall the order of the Hon’ble National Company Law Appellate Tribunal in the matter of Randhiraj Thakur v. Jindal Saxena Financial Services[2], wherein the Hon’ble Appellate Tribunal upheld that financial service providers shall not fall within the ambit of the Code. The order of the Hon’ble NCLAT in the said matter has been discussed in our articles “NBFCs and IBC- the Lost Connection”[3] and “State of Perplexity- Applicability of IBC on NBFCs”[4].

In this article, the author has made a humble attempt to analyse the order of the Hon’ble NCLT based on its facts, observations and the extant law.

Facts of the case

In the instant case, the Apeejay Trust filed an application under section 9 of the Code, against Aviva Life Insurance Co. India Limited, an insurance company, towards service tax and license fee, car parking/ maintenance charges, allegedly not paid by the latter, accruing pursuant to a leave and license agreement entered into between the parties.

The preliminary contention put forward by the counsel for the Corporate Debtor was that financial service providers are explicitly excluded from the scope of the Code, and as such, the Corporate Debtor being an insurance company strictly under the ambit of financial sector regulators like the Insurance Regulatory and Development Authority (IRDA), the provisions of the Code shall not be applicable in this case. However, the counsel for Applicant contended that in the instant case application was filed towards operational expenses and does not relate to the insurance business of the Corporate Debtor; hence, provisions of the Code must be applied.

The Hon’ble NCLT, on similar lines as contended by the Applicant, was of the view that the since the claim against the Corporate Debtor was operational in nature, irrespective of the nature of the business of the Corporate Debtor, it shall fall within the purview of the Code; and accordingly passed an order for initiation of corporate insolvency resolution process against the corporate debtor.

Analysis

Enacted with the objective to act as a single-stop solution consolidating various laws relating to reorganization and insolvency of corporate persons, partnership firms, limited liability partnerships and individuals, the Code, vide section 3 (7) explicitly provides for exclusion of financial services providers from its ambit. Section 3 (7) of the Code ad-verbatim provides that

“a company as defined in clause (20) of section 2 of the Companies Act, 2013 (18 of 2013), a limited liability partnership, as defined in clause (n) of subsection (1) of section 2 of the Limited Liability Partnership Act, 2008 (6 of 2009), 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”

(emphasis supplied)

Further, a combined reading of section 3 (16) and 3 (17) indicates that a financial service provider is one that provides financial services as defined in the Code and is also regulated by or registered with a financial sector regulator; financial services meaning inter-alia accepting of deposits, effecting contracts of insurance, assisting of financial products.

Hence, it is evident from the very text of the Code that an company engaged in the business of effecting contracts of insurance, being subject to financial regulators is a financial service provider as per the Code and as such, is ought to be excluded from its gamut.

The Bankruptcy Law Reforms Committee (“BLRC”) in its Report[5] also observed that the Code was being introduced with an objective to create a uniform framework that would cover matters of insolvency and bankruptcy of all legal entities and individuals, save those entities with a dominantly financial function. (Emphasis supplied). The Report further explicitly states that

“5.1. The Code will not cover entities that have a dominantly financial function, whose resolution is covered by the Resolution Corporation in the draft Indian Financial Code, proposed by the Financial Sector Legislative Reforms Commission. In order to ensure legal clarity, the Committee recommends that provisions in existing law that deals with insolvency of all registered entities be replaced by this Code (companies and limited liability partnerships to begin with). Then, all questions related to insolvency of any legal entity in India will find an answer in a single Code.”

While the intent of the Code has been to exclude Financial Service Providers from the scope of IBC, it is humbly submitted that the Hon’ble NCLT’s take on the same in the instant case seems to be focused on the nature of supplies made by the operational creditor, and not on the business of the corporate debtor, thereby disregarding one of the very important exclusions from the ambit of the Code.

One may argue that the Code provides for filing of application against two categories of claim, viz. financial and operational, and as such it is rightful on the part of the Applicant to file the instant application on grounds of operational dues. However, it must be noted that the said category of claim must essentially be due from an entity recognized under the Code. For the purpose of identification of a ‘corporate debtor’ against which an application for corporate insolvency resolution process is maintainable, the Code emphasizes on the nature of business of the corporate debtor, rather than the nature of debt for which the application is to be filed. Nature of debt is rather relevant and important for identification of the status of the ‘creditor’ and not the ‘debtor’. Financial service providers, for that matter, are not regarded as being under the ambit of the Code. Hence, the author humbly deviates from the observations of the Hon’ble Bench in the instant order.

The past experiences in the economy also vouch for bailing out of insurance companies from the clutches of insolvency, so as to avert at all costs, the contagion impact that may follow- the infamous Global Financial Crisis of 2008 being one example that stands out. While the primary repercussions of the Global Financial Crisis were faced by the banking industry, the solvency of insurance sector was also jeopardized[6].

The experiences during the Global Financial Crisis led to the new framework for insolvency of insurance companies in Europe called “Solvency II”, with a view to implement a holistic approach in regulation and supervision of insurance companies operations.

Hence, it can be said that owing to the massive public interface that insurance companies, as well as other financial service providers have, it shall be most prudential to have a separate code/ law for dealing with insolvency of such financial service providers, instead of clubbing the same with the general law of insolvency. While the essence in both cases may remain the same, the technicalities may be modified as best suited.

Conclusion

The fabric of the Code was not made for financial service providers, that is, persons providing certain specific category of services which might have a domino effect on the economy and its capital and money markets.

On one hand, in some cases, we have generically put all NBFCs in the same shoe and made them immune to IBC (see Randhiraj Thakur v. Jindal Saxena Financial Services, supra); and on the other hand, we have initiated insolvency proceedings against an insurance company on the grounds that it is the nature of the ‘debt’ which matters, and not the nature of the ‘debtor’. Humbly, this neither goes with the letter not the spirit of the law.

It must be noted that the very reason for exclusion of FSPs from the purview of the Code was to avoid failure of the economy which seems very probable if there is an increase in the number of failing FSPs. Hence, to avoid a systemic failure that may follow, the Legislature was of the view that these entities shall be made subject to a separate customised insolvency law; and now with the government preparing to notify certain financial service providers under section 227 of the Code, clarity in all these aspects is expected.

[1] https://nclt.gov.in/sites/default/files/Interim-Order-pdf/Aviva%20Life%20Insurance%20co.%20india%20Ltd..pdf

[2] https://nclat.nic.in/Useradmin/upload/18747772645ba1eb1cd5d90.pdf

[3] http://vinodkothari.com/2018/12/nbfc-and-ibc-the-lost-connection/

[4] http://vinodkothari.com/wp-content/uploads/2019/01/Article-FSPs-and-NBFCs.pdf

[5] http://ibbi.gov.in/BLRCReportVol1_04112015.pdf

[6] Insurance is one of the key mechanisms of risk management (D&O Market”, Special Report, Advisen Ltd, New York); and in a scenario where these risk managers are exposed to risk, it may lead to a systemic failure- and the most obvious example of this failure that came to light during the global financial crisis is that of the American International Group (“AIG”). It was4 in this case, when the US Government, in order to protect public confidence and avoid potential increase the then existing systemic financial risk, intervened for the first time, and by providing credit line of $85 billion in return for 79.9% share in AIG, factually nationalising the company, and later by providing additional $37.8 billion. (The Implications of the Financial Crisis to the Insurance Industry – Global and Regional Perspective)