Insolvency of Financial Service Providers: Section 227

Financial firms are different from ordinary companies. Their failure can spread to depositors, investors and the wider financial system, and their assets often include money held for others. The Code therefore excludes financial service providers from corporate insolvency, but section 227 allows the government to bring notified categories back in, with special rules that give the regulator a central role. Since 2019, large NBFCs and housing finance companies have been resolved this way. This note explains the framework and the leading cases.

1. The Exclusion and Its Reasons

• Exclusion. A financial service provider is not a corporate person under section 3(7), so it cannot ordinarily be the subject of CIRP (Topic 5)
• Reasons. The failure of a bank, insurer or large lender can trigger a loss of confidence across the system; resolution must be quick, must protect depositors and policyholders, and must be led by the regulator rather than by creditors.
• Banks and insurers. Banks are resolved under the Banking Regulation Act, 1949, through moratorium, reconstruction or amalgamation by the RBI and the Central Government, as with Yes Bank and Lakshmi Vilas Bank in 2020; insurers fall under the Insurance Act and the IRDAI.
• FRDI Bill. The Financial Resolution and Deposit Insurance Bill, 2017, which proposed a separate resolution corporation for financial firms, was withdrawn in 2018 after public concern over its bail-in provisions.

Figure 1: Banks and NBFCs compared

2. Section 227 and the FSP Rules

• Section 227. Notwithstanding anything in the Code or any other law, the Central Government may, for the purpose of insolvency and liquidation proceedings, notify financial service providers or categories of them, in consultation with the appropriate financial sector regulators, to be dealt with under the Code with such modifications as may be prescribed.
• The Rules. The Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019 were notified on 15 November 2019.
• Notified category. By a notification of 18 November 2019, non-banking finance companies, including housing finance companies, with an asset size of 500 crore rupees or more were notified, with the RBI as the appropriate regulator.

3. How the Process Works

Figure 2: Steps in the insolvency of a notified NBFC

• Supersession. The RBI first supersedes the board of the NBFC under section 45-IE of the RBI Act, inserted in 2019, and appoints an administrator to run it.
• Application only by the regulator. Only the RBI may apply to the NCLT to initiate CIRP; creditors cannot, though their claims are dealt with in the process.
• Interim moratorium. A moratorium begins on the filing of the application and lasts until it is admitted or rejected, unlike an ordinary CIRP where there is no moratorium before admission.
• Administrator. On admission, the NCLT appoints the person proposed by the regulator as administrator, with the powers of an interim resolution professional, resolution professional and liquidator; the regulator may constitute an advisory committee to advise the administrator.
• Licence protected. The licence or registration of the provider cannot be suspended or cancelled during the interim moratorium or the CIRP; during liquidation, it can be cancelled only after hearing the administrator.
• Third party assets. The moratorium does not apply to third party assets or funds held by the provider in trust, such as customers' money.
• No objection. After the committee approves a resolution plan, the administrator must obtain the RBI's no objection to the persons who will control or manage the provider, who must be fit and proper, besides being eligible under section 29A.
• Liquidation. The NCLT must hear the regulator before ordering liquidation, and a provider needs the regulator's permission to begin voluntary liquidation.

4. The Leading Cases

Figure 3: Financial service providers resolved under the Code

• Dewan Housing Finance Corporation. The first financial service provider taken into CIRP: the RBI superseded its board in November 2019 and its application was admitted in December 2019; the NCLT approved Piramal Capital and Housing Finance's resolution plan in June 2021, the first completed resolution of a financial firm under the Code.
• SREI group. The RBI superseded the boards of SREI Infrastructure Finance and SREI Equipment Finance in October 2021 and initiated CIRP; a plan by the National Asset Reconstruction Company was approved in 2023.
• Reliance Capital. The RBI superseded the board in November 2021 and the application was admitted in December 2021; the NCLT approved IndusInd International Holdings' resolution plan of about 9,661 crore rupees in February 2024, with implementation requiring regulatory approvals for its insurance subsidiaries.
• Lessons. These cases showed that the Code can resolve large financial firms, but also that regulatory approvals, valuation of loan books and treatment of subsidiaries regulated by other bodies add time and complexity.

5. Frequently Asked Questions

Can a bondholder of a large NBFC file for its insolvency?

No. Under the FSP Rules, 2019, only the appropriate regulator, the RBI, may apply to the NCLT to initiate CIRP of a notified financial service provider. Bondholders participate as financial creditors once the process begins.

Why is there an interim moratorium for financial service providers?

To prevent a run on the provider and the dismemberment of its assets in the period between the RBI's application and admission, which would harm all creditors and the financial system.

Can a failing bank be taken into CIRP?

No. Banks have not been notified under section 227 and are resolved under the Banking Regulation Act, 1949, as Yes Bank and Lakshmi Vilas Bank were in 2020.

6. Related Topics

• Topic 5: Corporate Person and Corporate Debtor. The exclusion of financial service providers.
• Topic 38: Section 29A. Eligibility of resolution applicants.
• Topic 77: Section 238. Overriding effect and sectoral laws.