Financial institutions

Impact of the NCLAT ruling on development finance institutions

Jhe judiciary has played a vital role in dealing with issues arising from the Insolvency and Bankruptcy Code, 2016 (code). Recently, in Union Bank of India on behalf of the creditors’ committee of Dewan Housing Finance Corporation Limited v National Housing Bank & Anrthe National Company Law Appellate Tribunal (NCLAT) considered whether a trust, imposed by a special statute on a financial services provider (FSP) over certain assets, would lead to these assets being considered as assets of third parties, i.e. say assets of a development financial institution.

Accordingly, clause (b) of Rule 5 of the Insolvency and Bankruptcy Rules (Insolvency and Winding-Up Proceedings of Financial Service Providers and Application to Contracting Authority) 2019 (FSP Rules), read with article 14 of the code, i.e. the moratorium in the company insolvency resolution process (CIRP), would not apply to these assets either.

Treatment of Third-Party Assets

Soummo Biswas
Shardul Amarcand Mangaldas & Co

Rule 10(1) of the FSP Rules provides that the provision of Clause (b) of Rule 5 and Article 14 of the Code does not apply to third party assets in the custody or possession of the FSP, including including assets to be held in trust for the benefit of third parties. The notification of the Ministry of Social Affairs of January 30 mentions that the administrator will ensure that the assets of third parties held by the PSF on the date of the opening of the insolvency are maintained separately and distinctly, and are not confused with the assets of the PSF.

Dewan Housing Finance Corporation Limited (DHFL) has entered into a Memorandum of Understanding to receive financial assistance from the National Housing Bank (NHB) under its refinance scheme. When DHFL was declared insolvent, while NHB filed a “Form C” for presenting claims as a financial creditor with the administrator of DHFL, it also sought clarification of its statutory rights under Section 16B of the National Housing Bank Act 1987 (NHB Act) before the Mumbai Bench of the National Company Law Tribunal (NCLT). NHB argued that certain loan receivables that NHB refinanced were held in trust by DHFL under Section 16B of the NHB Act.

The NCLT considered that all monies received by DHFL in repayment or realization of loans refinanced by BNH and remaining (marked) assets shall be deemed in trust for and on behalf of BNH, and such marked assets were not the assets of DHLL. These tagged assets should be handled outside the jurisdiction of DHFL’s CIRP. Therefore, the moratorium provisions of the code would not apply. The NCLT also observed that, according to the doctrine of harmonious construction, there was no conflict between section 16B of the NHA Act and section 14 read with section 238 of the code.

The NCLAT observed that the financial assistance that DHFL receives under the NHB Act cannot be considered purely commercial because the NHB is a development finance institution. Therefore, NHB’s status under the CIRP cannot be equated with that of DHFL’s financial creditors.

The NCLAT referred to the Supreme Court ruling in Greater Mumbai Municipal Corporation v Abhilash Lal, where it was held that section 238 may matter where property and assets belong to the debtor and not where they belong to a third party. The NCLAT also focused on Rule 10 of the FSP Rules and concluded that there was no inconsistency with the provisions of the code and the special rights under the NHB Act, as the assets of third parties must be distinct and separate from the assets of the PSP. The Union Bank of India has appealed against this judgment of the NCLAT, and the matter has yet to be decided by the Supreme Court.

Impact of the NCLAT judgment

Shivani Sinha
Shardul Amarcand Mangaldas & Co

Article 18 of the code also excluding property held by a third party in the possession of the debtor legal person held in trust, it remains to be seen whether the principles which will be laid down by this judgment will have an impact on the treatment of claims held under the trust created in terms of trust account and retention (TRA) arrangement. Contrary to the case of Article 16B of the BNH Law, the trustee is not the borrower or the debtor company, and the receivables are not received by the borrower in trust for the lenders. The trust is created in favor of the bank account, which is assigned a cascade to join. Therefore, the NCLAT decision should not affect the debtor companies’ ERT agreements.

The NCLAT judgment also clarifies and strengthens the position of development finance institutions in protecting their loan claims from the impact of insolvency. If corporate debtors are exposed to development finance institutions, which have similar provisions in their constitutional bylaws, all stakeholders should consider such treatment when considering the valuation and liquidation or resolution process.

SOUMMO BISWAS is a Partner and SHIVANI SINHA is an Attorney at Shardul Amarchand Mangaldas & Co. Partner VEENA SIVARAMAKRISHNAN also contributed to this article

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