LEGAL UPDATE | NBFCs AND OTHER FINANCIAL SERVICE PROVIDERS NOW UNDER IBC

Introduction

Under the Insolvency and Bankruptcy Code, 2016 (IBC), the corporate insolvency resolution process contained in Part II applies to corporate debtors. A corporate debtor is defined as a “corporate person who owes a debt to any person.” Corporate person is defined to exclude financial service providers. A financial service provider is a person engaged in the business of providing financial services in terms of an authorisation granted by, or registration with, a financial sector regulator who is an entity constituted under any law in force to regulate services or transactions in the financial sector.

Under Section 227 of the IBC, the Central Government is empowered in consultation with the financial service regulator to make the provisions of the IBC applicable to financial service providers or certain categories of financial service providers. The financial crises involving IL&FS and Dewan Housing Finance Limited (DHFL) prompted demands to include certain financial service providers (like housing finance companies and other specified non-banking financial companies) under the IBC. This led the Central Government to issue a notification dated 15 November 2019 notifying the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 (Rules). This update summarises the salient features of the Rules.


Salient Features of the Rules

• The Rules apply to financial service providers or categories of financial service providers, as may be notified by the Central Government under Section 227 of the IBC, from time to time.

• The corporate insolvency resolution process (CIRP) has been made applicable to notified financial service providers. For CIRP to commence, an application must be made by the relevant financial sector regulator to the National Company Law Tribunal (NCLT).

• The aforesaid application must also propose the name of an “Administrator” who substitutes an insolvency professional, interim resolution professional, resolution professional or liquidator, on admission of the application, for the purpose of insolvency and liquidation proceedings of a financial service provider.

• The Rules also contemplate an Advisory Committee appointed by the financial service regulator to assist the Administrator during the insolvency process.

• A moratorium commences from the date of filing the application till its admission or rejection by NCLT. The license or registration granted to the financial service provider continues in force throughout the CIRP.

• The resolution plan must contain a statement of how the resolution applicant satisfies the sectoral requirements of the financial service provider as laid down by the financial service regulator.

• Upon approval of the resolution plan by the committee of creditors, a no objection from the financial service regulator must be obtained on the persons who would take over the control and management of the financial service provider. The no objection (without prejudice to the disqualifications under Section 29-A of the IBC) must be issued by the financial service regulator based on ‘fit and proper criteria’ applicable to the business of the financial service provider. If the financial service regulator does not respond within 45 (forty five) days of the no objection request, the no objection is deemed to have been given.

• The provisions on liquidation including voluntary liquidation under the IBC apply mutatis mutandis to financial service providers.

• The moratorium does not apply to third party assets or properties in the custody or possession of the financial service provider including any funds, securities and other assets required to be held in trust for the benefit of third parties. The Administrator must take control of these assets and deal with them in the manner notified by the Central Government.

• The Rules also prescribe Form 1 for applying under the Rules to commence CIRP against the financial service provider by the financial sector regulator.

On 18 November 2019, the Central Government notified the applicability of the Rules to non-banking finance companies (which include housing finance companies) with asset size of Rs. 500 crore or more as per the last audited balance sheet. A separate notification will be issued on dealing with third-party assets of such companies.

DHFL UPDATE

On 21 November 2019, the Reserve Bank of India (RBI) has, under the provisions of the Reserve Bank of India Act, 1934, superseded the Board of Directors of DHFL owing to governance concerns and defaults by DHFL in meeting various payment obligations and appointed Mr. R. Subramaniakumar, ex-MD and CEO of Indian Overseas Bank as the Administrator. The RBI also intends to commence CIRP against DHFL shortly under the Rules with the Administrator appointed as the resolution professional.

MHCO COMMENT

The Rules are a positive step and will help creditors of financial service providers who are in distress recover a portion of their debt if a suitable resolution plan is in place. This remedy is far more suitable than the process under the relevant laws applicable to a financial service provider since the regulatory bodies have rarely taken steps to resolve the distress of financial service providers who are in default. The IBC is a pro-active legislation and with the finality granted by the Supreme Court in the Essar Steel case, should help reduce the problems faced by creditors in recovering debt from asset-rich corporate debtors / financial service providers in distress.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.comfor any assistance.

LEGAL UPDATE | LANDMARK JUDGMENT OF THE SUPREME COURT IN ESSAR STEEL

Factual Background

The Corporate Insolvency Resolution Process (CIRP) was commenced against Essar Steel Limited (Essar Steel) under the Insolvency and Bankruptcy Code, 2016 (IBC). Arcelor Mittal was the successful resolution applicant in this process. The resolution plan proposed by Arcelor Mittal involved a payment of approximately Rs. 42,000 crores (Resolution Amount) to the creditors of Essar Steel. The decision on how this amount would be divided between the various financial creditors of Essar Steel was left to be determined by the Committee of Creditors (COC) of Essar Steel. The COC decided that approximately 92% of the loan outstandings of the secured financial creditors would be met out of the Resolution Amount. The operational creditors would, therefore, receive nothing more than the liquidation value of Essar Steel, which was negligible. The National Company Law Tribunal (NCLT) approved the resolution plan with some modifications. This decision was challenged by Standard Chartered Bank and the operational creditors before the National Company Law Appellate Tribunal (NCLAT). NCLAT rejected the claims of the financial creditors and held that both operational and financial creditors must be treated equitably. As a result, from the Resolution Amount, 60.7% of the outstanding dues was payable to each of the creditors, whether financial or operational. The NCLAT also held that the COC cannot determine the distribution of payments pursuant to a resolution plan which must be decided by the resolution applicant. This decision caused considerable heartache to the financial creditors as a class and to the Government who sees the IBC as a major economic reform. To mitigate the impact of the NCLAT order the Government amended the IBC in 2019 to provide that the COC could decide the distribution of amounts pursuant to a resolution plan under the IBC. We have prepared updates on both the NCLAT decision and the IBC Amendment. These can be obtained here and here.

Decision of the Supreme Court

On appeal to the Supreme Court, the Supreme Court overturned most of the decisions of NCLAT in the Essar Steel case. The resolution plan of Arcelor Mittal was approved and the distribution of the Resolution Amount as determined by the COC was upheld. In doing so, the Supreme Court gave finality to a number of issues that had arisen on the interpretation of the IBC. Briefly, the Supreme Court held:

• Corporate resolution under the IBC is ultimately in the hands of the COC. Under the applicable regulations (Regulations), it is clear that it is the commercial wisdom of the COC which operates to approve what is deemed by a majority of such creditors to be the best resolution plan, which is finally accepted after negotiation of its terms by the such COC with prospective resolution applicants.
  
  
• If the COC has approved a resolution plan, the resolution professional must submit such plan to the NCLT for approval. On receipt, NCLT is required to satisfy itself that the resolution plan as approved by the COC meets the requirements of Section 30(2) of the IBC. This includes whether the resolution plan provides for costs of insolvency, payments to operational creditors, management of the corporate debtor and does not contravene any provision of law. This is clearly spelt out in Section 31 of the IBC which provides that the scope of judicial review of the NCLT is limited to determining that such requirements are met. NCLT cannot substitute its opinion on the resolution plan for that of the COC since the commercial wisdom of the COC is the driver for approval of resolution plans. Similarly, the scope of judicial review of NCLAT is limited to the factors mentioned in Section 61(3) of the IBC. These include (i) the resolution plan contravenes law; (ii) there has been material irregularity in the exercise of powers by the resolution professional; (iii) the debts owed to operational creditors have not been provided in the plan in the manner determined by the Insolvency and Bankruptcy Board of India (Board); (iv) the costs of insolvency have not been provided for; and (v) any other requirement laid down by the Board has not been met. Thus, while the relevant adjudicating authority cannot interfere on merits with the commercial decision taken by the COC, the limited judicial review available is to see that the COC has taken into account the fact that the corporate debtor needs to keep going as a going concern during the insolvency resolution process; that it needs to maximise the value of its assets; and that the interests of all stakeholders including the operational creditor have been taken care of. If the adjudicating authority finds, on a given set of facts, that these parameters have not been kept in mind, it may send a resolution plan back to the COC to re-submit such plan after satisfying these parameters.
  
  
• A bankruptcy code should not be read so as to imbue creditors with greater rights in a bankruptcy proceeding than they would enjoy under general law, unless it is to serve some bankruptcy purpose. If an “equality for all” approach recognising the rights of different classes of creditors as part of the insolvency resolution process is adopted, secured financial creditors will, in many cases, be incentivised to vote for liquidation rather than resolution, as they would have better rights if the corporate debtor was to be liquidated rather than a resolution plan being approved. This would defeat the entire purpose of the IBC. Equitable treatment is only of similarly situated creditors. Financial and operational creditors cannot be paid the same amounts in any resolution plan before it passes muster. It is the commercial wisdom of the COC that determines the payments to be made to the various creditors in terms of the IBC and this may involve differential payments to financial creditors and operational creditors set out in the resolution plan. Equitable treatment is to be accorded to each creditor depending upon the class to which it belongs: secured or unsecured, financial or operational.
  
  
• Delegation of authority to a sub-committee to negotiate with the resolution applicant is within the power of the COC since the subject matter of delegation is not a core function of the COC.
  
  
• The moratorium under the IBC would not apply to claims under a personal guarantee pursuant to Section 31 of the IBC and the decision of the Supreme Court in State Bank of India v. V. Ramakrishnan (2019). Further, all claims under the IBC are deemed to be settled so that the successful resolution applicant can make a fresh start on a clean slate.
  
  
• The relevant changes brought about by the Amendment Act of 2019 were constitutionally valid.
  
  

MHCO Comment: The judgment of the Supreme Court delivered by Justice Rohinton Nariman has certainly clarified a number of issues that plagued the effective implementation of the IBC. However, at its core the judgment suffers from an infirmity in so much as operational creditors will now be left with little or no money from a distribution of proceeds pursuant to an approved resolution plan that does not cater to this class of creditors. The liquidation value of debt-intensive companies is likely to be negligible or even negative which leaves operational creditors in the lurch. This appears unfair given that the day-to-day functioning of a company depends on providers of goods and services. If such providers face the risk of non-recovery of dues they are likely to suspend the provision of goods and / or services to the company, which would affect its ability to continue as a going concern.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.comfor any assistance.
 

LEGAL UPDATE |INSOLVENCY PROCEEDINGS COMMENCED UNDER THE IBC AGAINST A FINANCIAL SERVICE PROVIDER

The National Company Law Tribunal, New Delhi Bench (NCLT) recently clarified the law on maintainability of an insolvency petition filed against a prominent insurance company on the ground of non-payment of license fee and service tax to the licensor in the case of Apeejay Trust v. Aviva Life Insurance Company India Ltd.

NCLT held that even though the insurance company is running its business as a financial service provider, it cannot be said to be providing financial services to its lessee in terms of paying license fees and admitted the insolvency petition to commence the Corporate Insolvency Resolution Process (CIRP) against the insurance company. NCLT also appointed an Interim Resolution Professional (IRP) for the insurance company. This update briefly summarises the decision of NCLT.

Facts of the Case:

The operational creditor, Apeejay Trust (Apeejay), entered into a leave and license agreement with the corporate debtor, Aviva Life Insurance Company India Limited (Aviva) for its office premises located at Mumbai. Aviva had failed to pay license fees, car parking, maintenance/ service charge and service tax, despite repeated requests from Apeejay, who was the licensor of the premises. The total default amount was Rs 27,67,203/-(Rupees Twenty Seven Lakhs Sixty Seven Thousand Two Hundred and Three only). Apeejay filed a petition before NCLT under Section 9 of the Insolvency and Bankruptcy Code, 2016 (IBC) to commence CIRP against Aviva.

Issue:

Aviva raised a preliminary issue of maintainability of the petition, since Aviva is a financial service provider and there is a bar on initiating proceedings against a financial service provider under the IBC for financial services rendered by it.

Contention of Aviva:

Aviva contended that by reason of being an insurance company, it would be considered a “financial service provider” (as defined under Section 3(17) of IBC). Thus, its business was to be controlled by the “financial sector regulator” (as defined under Section 3(18) of IBC) and therefore, there was an absolute bar on initiation of proceeding against it, under IBC. An analogy of banks was given. It was argued that as much as no proceedings under IBC can be filed against the banks, no proceedings can be initiated against the insurance company which is a financial service provider. Therefore, the petition is not maintainable.

Response of Apeejay:

Apeejay responded stating that the contention of Aviva is fallacious because Sections 3(17) and 3(18) of IBC must be construed in light of Section 3(16) which defines “financial services”. Even if Aviva is running a business in financial services, as regards Apeejay, it was only a licensee. It was argued that Aviva had not provided any insurance cover or financial assistance to Apeejay. Therefore, qua Apeejay, Aviva could not be considered as a financial service provider. Therefore, the petition was maintainable.

Held:

NCLT accepted the argument of Apeejay and held that “the definition of financial service under Section 3(16) of the 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 service tax amounts. Hence the corporate debtor cannot use the provisions of Section 3 of IBC as a blanket cover to claim exclusion from IBC proceedings on the ground that it is a financial service provider”. Therefore the petition was admitted and CIRP commenced with the appointment of the IRP by the NCLT.

MHCO COMMENT:

Aviva is a prominent company in the business of life insurance. Initiation of CIRP and appointment of IRP is expected to have serious ramifications on Aviva since its board of directors will now be superseded. The reasoning of NCLT seems sound with a significant impact on defaulting financial service providers where the default does not relate to the service that they provide. As the default amount is not significant, Aviva may settle the dues or challenge the order before NCLAT. If it is appealed by Aviva, it remains to be seen whether NCLAT (and may be the Supreme Court) concurs with this decision.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.com for any assistance.

 

LEGAL UPDATE | GOVERNMENT PRESCRIBES FURTHER REQUIREMENTS FOR INDEPENDENT DIRECTORS

Introduction

Section 150 of the Companies Act, 2013 (CA) provides the manner of selection of independent directors and the maintenance of databank of independent directors. On 22 October 2019, the Central government in three separate notifications provided further requirements in relation to the (a) appointment; (b) qualifications and (c) maintenance of a databank of independent directors. This update briefly summarises these notifications.

Companies (Creation and Maintenance of Databank of Independent Directors) Rules, 2019 

These rules provide for the creation of a databank of independent directors, duties of the Indian Institute of Corporate Affairs (Institute) notified under Section 150(1) of the CA and appointment of a panel to approve certain actions of the Institute.

Databank

The Institute is required to create and maintain a databank of persons willing and eligible to be appointed as independent directors under the CA. This databank is required to be available online on the website of the Institute. The databank must contain 16 particulars of the individuals who seek to be or are independent directors including DIN, Income Tax PAN, name and surname in full, educational and professional qualifications, details of criminal proceedings, if any, list of limited liability partnerships where the individual is a designated partner and the list of companies where the individual is a director. These details will only be provided to companies required to appoint independent directors on payment of a requisite fee.

Duties of the Institute

The Institute is required to (i) conduct an online proficiency self-assessment test (Test) covering company law, securities law, basic accountancy and such other areas relevant to the functioning of an individual acting as an independent director; (ii) prepare basic study material, online lessons, including audio-visuals for individuals taking the Test; (iii) provide an option to individuals to take advanced tests on the areas mentioned above in (i) and provide study material in this regard; (iv) inform the Central Government on a daily basis of the cumulative list of individuals (a) whose names are included in the databank along with the date of inclusion and Income Tax PAN for Indian individuals and Passport number for foreign directors (not required to have an Indian PAN); (b) whose applications for inclusion have been rejected along with the grounds and dates of rejection; (c) whose names have been removed from the databank along with grounds and date of removal.

Companies (Appointment and Qualifications of Directors) Fifth Amendments Rules, 2019

These rules come into force with effect from 1 December 2019. Under these rules every individual (i) who has been appointed as an independent director in a company on the date of commencement of this rules must within a period of three months from such commencement; (ii) who intends to get appointed as an independent director in a company after such commencement must before such appointment, apply online to the Institute for inclusion of his name for a period of one year or five years or for his lifetime (Term) till he continues to hold the office of an independent director in any company. Such individual is also required to file an application for renewal for further periods of one year or five years or for his lifetime within a period of thirty days from the date of expiry of the Term failing which the name of the individual shall stand removed from the databank of the Institute.

Every individual whose name is so included in the databank must pass the Test conducted by the Institute within a period of one year from the date of his inclusion in the databank, failing which his name will be removed from the databank provided that an individual who has served for a period of not less than 10 years as on the date of his inclusion of his name in the databank, as director or a key managerial personnel in a listed public company or in an unlisted public company having a paid up share capital of Rs 10 crores or more is not required to pass the Test. To pass the Test the individual must score not less than 60% in the aggregate.

Companies (Accounts) Amendment Rules, 2019

These rules also come into effect on 1 December 2019. By the amendment the Board of Directors (Board) of a company is required to include a statement in the Board’s report regarding its opinion on the integrity, expertise and experience (including proficiency) of independent directors appointed during the relevant year. Proficiency refers to the performance of the independent director in the Test.

MHCO COMMENT 

In India there is a limited pool of independent directors. While maintaining a databank and prescribing a proficiency requirement may appear to be positive steps, there appears to be excessive interference by the Government in areas which should be left to the discretion of a company’s management and shareholders. The independent director requirement applies to listed companies and unlisted public companies who meet certain turnover thresholds. The CA and requirements of the listing agreement already provide a long list of requirements for independent directors. Their code of conduct and liability are also laid down. In the circumstances, adding a proficiency test could be cumbersome since the companies required to appoint independent directors would in their own interest only appoint persons of standing to be independent directors. It remains to be seen whether the databank would have sufficient people qualified to be independent directors to meet the requirements of companies required to have such directors. 

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.comfor any assistance.

 LEGAL UPDATE | CONSOLIDATED CODE ON WAGES, 2019

Parliament recently promulgated the Code on Wages, 2019 (Code) which received the assent of the President on 8 August 2019. The Code will come into effect on a date notified by the Central Government in the Official Gazette. The objective of the Code is to amend and consolidate the laws related to wages, bonus and matters connected therewith and incidental thereto. This is in keeping with the Indian Government’s endeavour to distil the existing 44 labour laws into 4 codes, dealing with (i) Wages; (ii) Industry Safety and Welfare; (iii) Industrial Relations; and (iv) Social Security.

The Code replaces 4 existing labour laws (i) Payment of Wages Act 1936 (PWA); (ii) Minimum Wages Act, 1948 (MWA); (iii) Payment of Bonus Act, 1965 (PBA); and (iv) Equal Remuneration Act, 1976 (ERA).

Applicability:

Unlike the previous statutes which each apply to a restricted set of establishments, the Code applies to any place where any industry, trade, business, manufacture or occupation is carried on and includes Government establishments (any office or department of the Government or a local authority). This is significant because the Code now encompasses all commercial and governmental establishments.

Employer and Employee:

The Code defines an “employer” inter alia as a person who employs, whether directly or through any person, one or more employees in his establishment and where the establishment is of the Central Government or State Government, the authority specified by the head of the relevant department. The definition includes (i) the occupier or designated manager of a factory; (ii) for any other establishment, the person or authority who has ultimate control of the affairs of the establishment which would be the managing director or manager where control has been delegated; (iii) a contractor; (iv) legal representative of a deceased employer.

“Employee” is defined as any person (other than an apprentice) employed on wages by an establishment to do any skilled, semi-skilled or unskilled, manual, operational, supervisory, managerial, administrative, technical or clerical work for hire or reward, whether the terms of employment be express or implied and includes an employee of the appropriate Government but excludes armed forces personnel.

Salient features of the Code:

• The Code prohibits discrimination in any establishment or any unit thereof among employees on the ground of gender in matters relating to wages by the same employer in respect of the same work or work of a similar nature done by the employee. Further, an employer is prohibited from discriminating on the basis of sex while recruiting any employee.
  
  
  • Under the Code, no employer shall pay to any employee wages less than the minimum rate of wages notified by the appropriate Government. Under the Code, the appropriate Government is the Central Government for certain establishments and the State Government for all other establishments. Wages is defined to mean “all remuneration whether by way of salaries, allowances or otherwise, expressed in terms of money or capable of being so expressed which would, if the terms of employment, express or implied, were fulfilled, be payable to a person employed in respect of his employment or of work done in such employment”, including (i) basic pay; (ii) dearness allowance; and (iii) retaining allowance, if any. Components like employer’s contribution towards pension or provident fund, house rent allowance, overtime allowance, conveyance allowance, etc. are not considered as “wages”, unless payments made under these components exceed 50% of all remuneration payable as “wages” under the Code.
  • The appropriate Government is required to fix the minimum wage taking into account the skill levels of workers or geographical area of work or both, provided the number of minimum rates of wages may as far as possible be kept at a minimum by the appropriate Government. In this regard, the Central Government is required to fix a floor wage, taking into account the minimum living standards of a worker, in such manner as may be prescribed. The minimum rates of wages fixed by the appropriate Government cannot be less than the floor wages and if the earlier rate of minimum wages fixed by the appropriate Government is more than the floor wages, then such minimum rate cannot be reduced.
• Under the Code, the employer is required to fix the wage period for employees, either as daily, weekly, fortnightly, or monthly, provided that no wage period in respect of any employee shall be more than a month. For employees engaged on a daily basis, wages must be paid at the end of the shift. For those engaged on a weekly basis, wages must be paid on the last day of the week before the weekly holiday. For those on a fortnightly basis, wages must be paid before the end of the second day after the end of the fortnight. And for those on a monthly basis, wages must be paid before the expiry of 7th day of the succeeding month.
  
  
• Under the Code, every employee drawing wages not exceeding such amount per mensem as determined by notification by the appropriate Government who has put in at least 30 days work in an accounting year must be paid an annual minimum bonus of 8 and 1/3rd % of the wages earned by the employee or Rs 100, whichever is higher, whether or not any employer has any allocable surplus in the previous accounting year. Allocable surplus is to be calculated based on a specified percentage of the available surplus which is computed based on the adjusted gross profits of the establishment.
  
  Where in respect of any accounting year, the allocable surplus exceeds the amount of minimum bonus payable to the employees, the employer shall, in lieu of such minimum bonus, be bound to pay to every employee in respect of that accounting year, bonus which shall be an amount in proportion to the wages earned by the employee, during the accounting year subject to the maximum of 20% of such wages.
  
  
• The Code provides for a single authority, viz. the Inspector–cum–Facilitator, who is responsible for inspection of establishments assigned to him / her with respect to all compliances under the Code.
  
  
• Claims under the Code are adjudicated and determined by an authority appointed by the appropriate Government. An application for adjudication of a claim arising under this Code can be filed before the relevant authority within a period of three years from the date on which the claim arises. Under the Previous Statutes, this time limit varied from few months to a year.
  
  
• Stringent penalties are imposed by the Code for non-compliance with its provisions including fines and imprisonment for continuing or multiple offences.

MHCO Comment: Streamlining Indian labour laws has been an oft-quoted demand of investors and other stakeholders since the liberalisation of the Indian economy in 1991. The myriad and often confusing existing labour laws in India has also been a factor in India’s low position on the “Ease of Doing Business” matrix developed by the World Bank. The Code is a step in the right direction and shows the Government’s commitment to a new labour law regime in India which should bolster foreign investment while ensuring that the labour force in India is duly protected. However, the implementation of the Code is dependant on the rules and circulars issued by the appropriate Government on matters requiring prescription under the Code. Considering the political implications of balancing the interests of employers and employees in India, it remains to be seen whether the steps taken by the Government will fructify into a comprehensive law which achieves such balance.

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.comfor any assistance.