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Banking Law

Winding Up of Banking Companies under Section 38, Banking Regulation Act

Winding up is the end of the line. It is reached when a bank cannot be rescued by a scheme, cannot be sold, and cannot be allowed to continue. Because the creditors of a bank are ordinary depositors, numbered in the hundreds of thousands and unable to look after themselves in a liquidation, the Banking Regulation Act departs from company law at almost every point: who may apply, who is liquidator, what must be proved, and how fast it must be done.

1. Suspension of Business

  • The provision (Section 37): where a banking company is temporarily unable to meet its obligations, the High Court may, on the application of the company, and on such terms and conditions as it thinks fit, stay the commencement or continuance of all actions and proceedings against the company for a fixed period, and may extend the stay from time to time.
  • The limit: the stay may be extended, but the total period of moratorium may not exceed six months.
  • Reserve Bank report (Section 37(2)): the application must ordinarily be accompanied by a report of the Reserve Bank that the company will be able to pay its debts if relief is granted. The court may for sufficient reason grant relief without it, but must then call for the report and may rescind or modify its order.
  • Special officer (Section 37(3)): the High Court may appoint a special officer to take custody of the company's assets, books and actionable claims in the interests of the depositors.
  • Winding up instead (Section 37(4)): where the Reserve Bank is satisfied that the affairs of a company under a stay are being conducted in a manner detrimental to the interests of the depositors, it may apply for winding up, and the High Court may then not extend the stay.
  • Distinguish Section 45: a stay under Section 37 is granted by the High Court on the company's own application. A moratorium under Section 45 is ordered by the Central Government on the Reserve Bank's application. The first is a debtor's breathing space; the second is a step in a resolution.

2. Winding Up by the High Court

The route to a winding up order

Figure 1: The route to a winding up order

  • The obligation (Section 38(1)): notwithstanding anything in the company law, and without prejudice to its own powers under Section 37(1), the High Court shall order the winding up of a banking company if the company is unable to pay its debts, or if an application for its winding up has been made by the Reserve Bank under Section 37 or Section 38.
  • When the Bank must apply (Section 38(2)): the Reserve Bank shall make an application for winding up if it is directed so to do by the Central Government under Section 35(4)(b).
  • When the Bank may apply (Section 38(3)): the Reserve Bank may apply where the company has failed to comply with the requirements of Section 11 as to minimum capital; has by reason of Section 22 become disentitled to carry on banking business in India; has been prohibited from receiving fresh deposits under Section 35(4)(a) of the Act or Section 42(3A)(b) of the RBI Act, 1934; or has failed to comply with any other requirement of the Act and has continued the failure beyond the period allowed after written notice. It may also apply where, in its opinion, a compromise or arrangement sanctioned by the court cannot be worked satisfactorily, the returns or information furnished show that the company is unable to pay its debts, or the continuance of the company is prejudicial to the interests of its depositors.
  • Deemed inability (Section 38(4)): a banking company is deemed unable to pay its debts if it has refused to meet any lawful demand at any of its offices or branches within two working days where the demand is made at a place where there is an office, branch or agency of the Reserve Bank, and within five working days at any other place, and the Reserve Bank certifies in writing that the company is unable to pay its debts.
  • Court liquidator (Section 38A): a court liquidator is attached to every High Court for the purpose of conducting the winding up of banking companies.

The grounds on which the Reserve Bank may apply

Figure 2: The grounds on which the Reserve Bank may apply

📖 Joseph Kuruvilla Vellukunnel v. Reserve Bank of India, AIR 1962 SC 1371

Facts: A banking company was ordered to be wound up on the Reserve Bank's petition under Section 38(3)(b)(iii), founded on the opinion of the Reserve Bank that the continuance of the company was prejudicial to the interests of its depositors, and Section 38(1) required the court to order winding up on that application. A director challenged the provision under Articles 14 and 19(1)(g) as conferring an unguided power and depriving banking companies of the protections other companies enjoy.

Held: The provision was upheld. Banking companies constitute a reasonable class because they hold the money of the public and their failure affects the financial system rather than only their own members. The Reserve Bank is an expert body whose satisfaction rests on periodical inspection and statutory duty, not on caprice, and the Act makes it the authority to sanction, permit, certify and inspect. The restriction on the right to carry on business was therefore a reasonable restriction in the interest of the general public.

Ratio: Where a statute entrusts a technical financial judgment to a specialised regulator, a court will not substitute its own assessment, and the stricter treatment of banking companies is not discriminatory. The decision remains the foundation of judicial deference to the Reserve Bank.

3. The Reserve Bank as Official Liquidator

  • Appointment (Section 39): where the High Court orders the winding up of a banking company, it shall appoint the Reserve Bank, the State Bank of India or any other bank notified by the Central Government, or an individual as the Reserve Bank may direct, as the official liquidator, if the Reserve Bank applies in that behalf.
  • Why a regulator as liquidator: the Reserve Bank already has the bank's books, knows its borrowers, can realise advances without disturbing the system and can act far faster than an outside liquidator starting from nothing.
  • Application of company law (Section 39A): the provisions of the company law relating to winding up apply to the winding up of a banking company subject to the provisions of the Banking Regulation Act, which prevail.
  • Preliminary report (Section 41): the official liquidator must submit a preliminary report to the High Court within two months of the winding up order, giving the amount of assets in cash, the amount likely to be realised, and whether further inquiry is needed into any matter.
  • Notice to claimants (Section 41A): the liquidator must give notice calling upon preferential claimants and secured and unsecured creditors to send in their claims within a stated time.
  • Dispensing with meetings (Section 42): the High Court may dispense with meetings of creditors and contributories where, having regard to the assets and liabilities, no useful purpose would be served.
  • Booked credits deemed proved (Section 43): every depositor of a banking company in liquidation is deemed to have filed his claim for the amount shown to his credit in the books of the company, and it is deemed to be proved unless the liquidator shows otherwise. A depositor therefore does not have to prove his deposit.

⚠ Note

Section 43 is the single most practical protection in the whole winding up chapter. In an ordinary liquidation every creditor must lodge and prove a claim, and many never do. A bank in liquidation may have millions of small depositors, most of whom would never file anything. By treating the entry in the bank's own books as the claim, the Act ensures that a depositor is paid whether or not he knows the bank has failed.

4. Voluntary Winding Up and Speedy Disposal

  • Voluntary winding up (Section 44): notwithstanding anything in the company law, a banking company may be voluntarily wound up only if the Reserve Bank certifies in writing that the company is able to pay in full all its debts to its creditors as they accrue. A solvent bank may therefore close itself down; an insolvent one may not.
  • Court's powers in a voluntary winding up: the High Court may, on the Reserve Bank's application, order that the voluntary winding up shall continue subject to the supervision of the court, or that the company be wound up by the court, where the Bank considers that the voluntary winding up cannot be concluded without detriment to the depositors.
  • Part IIIA (Sections 45A to 45X): a complete code of special provisions for speedy disposal of winding up proceedings, which overrides other law and the company law to the extent of inconsistency.
  • Settlement of the list of debtors: the High Court sits to settle the list of debtors of the banking company on the liquidator's application, and may pass orders for payment against them, so that recovery proceeds in the winding up itself rather than by separate suits.
  • Special procedure: the court may dispense with ordinary rules of evidence in favour of the books of the banking company, which are prima facie evidence of the matters recorded, may proceed summarily, and may transfer pending suits to itself.
  • Why it exists: winding up a bank under ordinary company procedure took decades, during which depositors recovered nothing. Part IIIA was inserted to compress the process, and its premise is that speed is itself a protection for depositors.

5. Where Winding Up Now Fits

Winding up has become the least used of the resolution tools. A bank that fails today is far more likely to be reconstructed or amalgamated under Section 45, because that preserves the franchise, keeps the depositors whole and avoids the delay of a liquidation. The Insolvency and Bankruptcy Code, 2016 does not apply to banks as corporate debtors, so the Banking Regulation Act remains the only route. The gap in Indian law is that there is no comprehensive resolution statute for financial firms of the kind other jurisdictions have adopted, a gap the withdrawn Financial Resolution and Deposit Insurance Bill, 2017 was intended to fill.

6. Questions Arising

Can a bank be taken to the National Company Law Tribunal under the insolvency code?

Not as an ordinary corporate debtor. Financial service providers are excluded from the definition of a corporate person for the purposes of the Insolvency and Bankruptcy Code, 2016, and may be brought within it only through rules notified by the Central Government in consultation with the appropriate regulator. Those rules have so far been used for non-banking financial companies, not for a bank. A bank is therefore wound up under Sections 38 to 44 of the Banking Regulation Act, on the application of the Reserve Bank.

Who is paid first when a bank is wound up?

The order follows the general law of winding up as modified by the Act. Secured creditors stand outside to the extent of their security; the costs of the liquidation come next; then preferential payments, including certain dues of employees and of revenue; and then unsecured creditors, among whom depositors rank. In practice the Deposit Insurance and Credit Guarantee Corporation pays insured depositors first and is then subrogated to their claims against the liquidator, so the Corporation rather than the small depositor is the one waiting in the queue.

⚠ Key point

Section 37 lets the High Court stay proceedings against a bank temporarily unable to meet its obligations, ordinarily on a Reserve Bank report, for not more than six months in all. Section 38(1) requires the High Court to order winding up where the company is unable to pay its debts or where the Reserve Bank applies; the Bank must apply when directed under Section 35(4)(b) and may apply on the grounds in Section 38(3), which include failure of Section 11 capital, loss of entitlement under Section 22, a bar on fresh deposits, continuing non compliance, and its own opinion that a compromise cannot work, that returns show inability to pay, or that continuance is prejudicial to depositors. Section 38(4) deems inability where a lawful demand is refused within two working days near a Reserve Bank office or five elsewhere and the Bank certifies it. Section 39 makes the Reserve Bank, the State Bank or a notified bank the official liquidator. Section 41 requires a preliminary report in two months, and Section 43 deems every depositor's booked credit to be proved. Section 44 permits voluntary winding up only on the Reserve Bank's certificate of solvency. Part IIIA supplies special provisions for speedy disposal. Vellukunnel (1962) upheld the regime.

7. Quick Revision

✦ Points worth fixing

Section 37 is the company's stay; Section 45 is the Government's moratorium. Different applicant, different authority.

Six months in all for a stay under Section 37, as for a moratorium under Section 45.

Shall order in 38(1), shall apply in 38(2), may apply in 38(3). The verbs carry the structure.

Two working days near the Bank, five elsewhere. The deemed inability test in Section 38(4).

The Reserve Bank can be the liquidator. Section 39, and almost unique to banking.

Two months for the preliminary report. Section 41.

Section 43 deems the depositor's claim filed and proved. He files nothing.

Voluntary winding up only if the Bank certifies solvency. Section 44.

Part IIIA, Sections 45A to 45X, provides for speedy disposal.

Banks are outside the insolvency code. Financial service providers are excluded.

8. Frequently Asked Questions

Who can apply for the winding up of a banking company?

Principally the Reserve Bank, which must apply when directed by the Central Government under Section 35(4)(b) and may apply on the grounds in Section 38(3). The High Court must also order winding up where the company is unable to pay its debts. A creditor's petition under the general law is correspondingly rare, because the statutory route runs through the regulator.

When is a bank deemed unable to pay its debts?

Under Section 38(4), where it has refused to meet a lawful demand at any office or branch within two working days if the demand is made at a place where the Reserve Bank has an office, or within five working days elsewhere, and the Reserve Bank certifies in writing that the company is unable to pay its debts.

Does a depositor have to file a claim when a bank is wound up?

No. Section 43 provides that every depositor is deemed to have filed his claim for the amount shown to his credit in the books of the banking company, and that claim is deemed to be proved unless the liquidator shows otherwise. The protection exists because most depositors would never lodge a claim at all.

Can a bank wind itself up voluntarily?

Only if it is solvent. Section 44 permits a voluntary winding up only where the Reserve Bank certifies in writing that the company is able to pay in full all its debts to its creditors as they accrue. Even then the High Court may, on the Bank's application, bring the winding up under its supervision or convert it into a winding up by the court.

Does the Insolvency and Bankruptcy Code apply to banks?

No. Financial service providers are excluded from the definition of a corporate person under the Insolvency and Bankruptcy Code, 2016, and may be brought within it only by rules notified in consultation with the regulator. A bank is dealt with under the Banking Regulation Act, by a scheme under Section 45 or by winding up under Sections 38 to 44.

What is the role of Part IIIA of the Banking Regulation Act?

It supplies special provisions for the speedy disposal of winding up proceedings, in Sections 45A to 45X, and overrides other law to the extent of inconsistency. The High Court itself settles the list of debtors and may pass orders for payment against them, so recovery proceeds within the winding up rather than by separate suits. The books of the banking company are prima facie evidence, procedure may be summary, and pending suits may be transferred to the court. The premise is that speed is itself a protection for depositors, because an ordinary liquidation took decades during which they recovered nothing.

9. Related Topics and Provisions

  • Moratorium and reconstruction under Section 45
  • Voluntary amalgamation and acquisition of undertakings
  • Deposit insurance
  • Inspection, directions and penalties
  • Non-performing assets and the recovery statutes