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  • Sumit Kumar Gupta

Entities Too Big to Fail: Tweaking the Trigger to Get Financial Service Provider into the Game

[Sumit Kumar Gupta is a student at West Bengal National University of Juridical Sciences, Kolkata.]

In what appears to be a routine judgment, the National Company Law Tribunal (NCLT) may have triggered a chain reaction engulfing the entire industry of financial service providers (FSPs) under the ambit of Insolvency and Bankruptcy Code 2016 (IBC). The judgment being referred to is Apeejay Trust v. Aviva Life Insurance Company India Limited, where the NCLT took an erroneous view by initiating the process of corporate insolvency against the corporate debtor, despite it being a financial service provider under the IBC.

The provisions of the IBC are not in consonance with the judgment, highlighting a gap between the legislative provisions and the judicial view of the same. Thus, it becomes imperative to discuss the contentious provisions related to the judgment. Section 3(7) of the IBC categorically excludes FSPs from its purview. FSPs are regarded as ‘entities too big to fail’. They have the power to crumble the economy of the country and have a domino effect. Therefore, it is evident that the legislative intent behind the exclusion is to safeguard public money and consequently, to prevent the failure of the economy. Further, the legislature intended that these entities shall be made subject to a separate customized insolvency law rather than entwining different entities under the same umbrella. In this regard, the IBC entrusts an exclusive responsibility to the ‘financial sector regulator’ so as to adjudicate any dispute regarding FSPs under Section 3(18) thereof.

In the present case, Aviva Life Insurance Company (Aviva) had entered into an agreement with Apeejay Trust (Operational Creditor) for the lease of office premises. On the breach of this agreement, the Operational Creditor initiated insolvency proceedings on account of non-payment of dues towards both service tax and license fees amounting to INR 27 lakhs. Aviva took the preliminary defense that it was outside the purview of the IBC under Section 3(7) by virtue of being an insurance company. It argued that the petition should, therefore, be dismissed. The NCLT, on the other hand, subscribed to a contrary view and looked into the ‘operational nature’ of the transactions. NCLT observed that "the definition of financial service under Section 3(16) of the IB Code clearly includes the transactions effecting contract of insurance. However, the Operational Creditor does not have any claim in respect of contract of insurance. The claim is with respect to the outstanding license fees and the service tax amounts. Hence, the Corporate Debtor cannot use the provisions of Section 3 of the IB Code as a blanket cover to claim exclusion from IB Code proceedings on the ground that it is a financial service provider." The tribunal, then, initiated a corporate insolvency resolution process against the Corporate Debtor.

This decision is marred by several legal fallacies and logical inconsistencies. It is interesting to note that the NCLT did not provide any legal basis for the judgment. Rather, observations were made merely on the set of presented facts. Given the exclusion of FSPs from the purview of the IBC, the decision has raised some unsettling questions which ought to be answered soon by the higher judiciary. The questions are:

- Should the judicial discretion of the adjudicating authority be widened so as to consider other factors before admitting a case under insolvency?

- Is there any limitation provided in the IBC regarding the exclusionary clause of FSPs which can be changed by judicial interpretation?

Section 3(7) of the IBC explicitly provides for exclusion of FSPs from its ambit. A conjoint reading of Sections 3(16) and 3(17) reveals that FSPs are exclusively registered with and are regulated by the financial sector regulator. It is evident from the text of the IBC that a company engaged in the business of providing financial services is subject to the rules of financial regulators and is explicitly outside the ambit of the IBC. This exclusion was also manifested in the report of the Bankruptcy Law Reforms Committee. The committee recommended that the IBC should provide a one-stop solution to all legal entities for all matters relating to insolvency and bankruptcy except those entities with predominant financial service functions. The intention of the legislature of excluding FSPs got reinforced through this report. In the case at hand, the NCLT has focused solely on the nature of the transaction instead of the nature of the operational debtor as an entity carrying out financial services. Therefore, the position taken by the NCLT clearly goes against the exclusion provided in the text of the code.

Further, this decision witnessed a clear departure from the well-established precedent for FSPs in the country. In Randhiraj Thakur v. Jindal Saxena Financial Services (Company Appeal (AT) (Insolvency) Numbers 32 and 50 of 2018), the National Company Law Appellate Tribunal (NCLAT), while discussing the scope of financial service, held that FSPs have been carved out as an exception from the regulation of the IBC and thus, dismissed the application for initiation of its corporate insolvency resolution process (CIRP) on grounds of maintainability. This approach was also adopted in the case of HDFC v. RHC Holdings Private Ltd (Company Appeal (AT)(Insolvency) Number 26 of 2019). These aforementioned decisions have recognized the absolute bar given on the adjudication of FSPs. Therefore, Aviva’s decision has wider ramifications as it makes sweeping changes in the precedents set by the tribunals and is per incuriam.

The judgment sets the first precedent wherein the NCLT looked beyond the wordings of the code to hold FSPs liable based on the nature of the 'debt' rather than the nature of the 'debtor'. The nature and functions of FSPs are very wide. FSPs encompass a broad range of businesses activities starting from insurance, accountancy, brokerages, investment funds, collective investment scheme, consumer-finance, credit cards companies, government sponsored enterprises, et al., as has been enshrined in Section 3(16) of the IBC. Similarly, the purpose of the debt taken by FSPs can have extremely wide dimensions. Their operational and financial appropriation of debts can vary from renting a premise to the transactions of an insurance company, such as in the present case. In this scenario, the decision has the potential to open a floodgate of petitions relating to the objective for which debt was taken by several FSPs from the operational creditors. Consequently, this can bring operational creditors at loggerheads with FSPs so as to start insolvency proceedings based on the purposive nature of debt. This exclusion of debts and subsequent proceedings can, in fact, start a chain reaction, thus bringing FSPs to a standstill.

Moreover, widening the scope of IBC can prove fatal to the effectiveness of the code as the main thrust of the exclusion was to avoid the crumbling of the economy. The failing of FSPs supplemented by the burgeoning litigation against it may lead to a systematic failure. To avoid such failures, the legislature kept the room open for a customized insolvency law under Section 227 of the IBC. This provision allows the government to notify a roadmap for the purpose of conducting the insolvency and liquidation proceedings of such FSPs as has been given in the Code.

In the present case, the position taken by the NCLT lead to two incongruous frameworks i.e. financial and operational. While the code did not provide any distinction between the two and explicitly excluded FSPs from the purview of the IBC, this was the first time when the tribunal lifted the functional aspect to deliberate upon the ‘operational nature’ of the entity. It is in these aspects that it becomes interesting to keep an eye on future judgments by tribunals, especially in cases where the defaults made by FSPs do not relate to services that they provide.


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