How the IBC Handles Insolvency of NBFCs and Financial Firms

Vikrant D. Shetty

14 hours ago

10 min read

How the IBC Handles Insolvency of NBFCs and Financial Firms

Insolvency of a non-banking financial company or other financial service provider in India is not resolved under the ordinary corporate insolvency route; Section 227 of the Insolvency and Bankruptcy Code, 2016 instead empowers the Central Government, in consultation with the sector regulator, to apply a separate, regulator-led process. Only the regulator, not an individual creditor, can trigger this process, which is run by a court-appointed Administrator rather than a resolution professional. The framework exists because a financial firm's failure can threaten depositors and the wider credit market. This article explains who runs the process, how it departs from the standard Code, and what creditors and boards should do.

The starting point is that a financial service provider is generally excluded from the definition of the entities that can be taken through the ordinary corporate insolvency resolution process. In its place stands a special framework built on a specific enabling provision of the Code and a dedicated set of rules, under which the appropriate financial-sector regulator, rather than an individual creditor, controls the gateway to insolvency. What follows explains how that framework is constructed, who runs it, and how it departs from the process most creditors are familiar with.

Why Are Financial Service Providers Excluded From the Ordinary IBC Process?

Section 3(7) of the Code defines a corporate person to include companies and limited liability partnerships but expressly excludes financial service providers from that definition, which is why an NBFC cannot ordinarily be dragged into the standard corporate insolvency resolution process by a financial or operational creditor. The bridge to insolvency for these entities is Section 227, which empowers the Central Government, in consultation with the appropriate financial-sector regulator such as the Reserve Bank of India, to notify categories of financial service providers to which a tailored insolvency and liquidation process will apply. The exclusion is therefore not immunity from insolvency; it is a redirection to a different, regulator-controlled track designed for the systemic sensitivities of financial firms.

The Financial Service Provider Rules and the Administrator

Acting under Section 227, the Central Government notified a dedicated set of rules for the insolvency and liquidation of financial service providers, which supply the procedure for these entities. Under these rules the process is not begun by a creditor at all: the appropriate regulator alone may file the application to initiate insolvency, and it does so only after forming a view that the firm's failure warrants resolution. The regulator also nominates the individual who will run the process, described not as a resolution professional but as an Administrator, who combines in a single office the functions that in an ordinary insolvency are split between the interim resolution professional, the resolution professional, and the liquidator. This concentration of authority in a regulator-nominated Administrator is one of the defining features of the framework.

The Advisory Committee Replaces the Committee of Creditors

In a standard corporate insolvency, the Committee of Creditors is sovereign over the commercial decisions of the process, and the Supreme Court has repeatedly protected its primacy. In Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta [(2020) 8 SCC 531], the Court affirmed that the commercial wisdom of the committee in approving a resolution plan is not to be second-guessed by the adjudicating authority on merits. The financial service provider framework deliberately departs from this model. In place of a creditor-controlled committee it provides for an Advisory Committee of persons experienced in finance, law, and the relevant sector, whose role is to advise the Administrator rather than to command the process. The centre of gravity thus shifts from the creditors to the regulator and its nominee, reflecting the public interest in an orderly resolution of a financial firm.

The Constitutional Object Behind the Special Track

The special treatment of financial service providers is consistent with the purposes the Supreme Court has read into the Code as a whole. In Swiss Ribbons (P) Ltd. v. Union of India [(2019) 4 SCC 17], the Court upheld the constitutional validity of the Code and explained that its object is the revival of the corporate debtor and the maximisation of value for all stakeholders, with liquidation as a last resort. For a financial firm whose collapse threatens depositors and the credit system, a regulator-led resolution that keeps the entity as a going concern where possible serves exactly this object, which is why the framework prioritises continuity and depositor protection over a purely creditor-driven contest. The broader insolvency framework and this special track share the same underlying aim, but the special track pursues it through a differently balanced set of controls.

How Does the Moratorium Protect Depositors and Policyholders?

On the commencement of proceedings against a financial service provider, a moratorium takes effect that suspends actions against the firm's assets, much as in an ordinary insolvency, but it is calibrated so that the firm's obligations to its own customers, such as depositors and policyholders, are treated with particular care rather than simply frozen against them. The rules prescribe timelines that broadly parallel the ordinary resolution process, with a defined period for the Administrator to invite and finalise a resolution plan, and they contain specific provisions aimed at protecting retail depositors and policyholders whose money or cover is at stake. These protections recognise that the customers of a financial firm are not ordinary trade creditors but members of the public who relied on the firm, and their interests are given a prominence that the standard process does not provide.

How the Framework Has Worked in Practice

The special track is not merely theoretical. It was used to resolve at least one large housing-finance company whose failure had unsettled the credit market, and that experience confirmed both the strengths and the strains of the design. On the positive side, a single Administrator working under the eye of the regulator was able to keep the firm operating as a going concern, run a competitive process for its business, and produce a resolution that returned value to creditors while protecting the position of retail depositors. On the harder side, the process exposed contested questions about the treatment of different classes of creditors, the recovery of tainted transactions, and the interaction between the insolvency process and parallel investigations, all of which had to be worked out because the rules, being newer and thinner than the ordinary Code, left gaps for the adjudicating authority and the courts to fill. The practical lesson is that creditors of a financial firm should not assume the familiar corporate-insolvency answers will apply.

What Should Creditors and Boards Do When an NBFC Nears Default?

For a creditor of an NBFC, the first task on any sign of distress is to establish the firm's regulatory status, because that single fact determines whether the ordinary Code or the special framework governs, and therefore who controls the gateway to insolvency and whether the creditor can file at all. For the board and promoters of a financial firm, the framework changes the calculus of an approaching default, since the regulator, not the company or its creditors, decides when and whether to trigger the process, and cooperation with the regulator becomes central well before any formal step is taken. For all stakeholders, the concentration of power in a regulator-nominated Administrator and the replacement of the creditors' committee with an advisory body mean that influence over the outcome is exercised differently than in an ordinary insolvency, through engagement with the regulator and the Administrator rather than through voting strength in a committee. Recognising these differences early is what allows a party to protect its position in a process that does not follow the ordinary rules.

In short, the insolvency of a financial service provider is a distinct discipline within the Code rather than a variation on the ordinary process. It is initiated by the regulator, run by an Administrator, guided by an advisory body rather than a creditors' committee, and shaped throughout by the public interest in protecting depositors and financial stability. Any creditor, resolution professional, or board dealing with an NBFC in distress should approach it on that footing from the very first step.

Frequently Asked Questions

Can a creditor file an insolvency application directly against an NBFC under the IBC?

No. For financial service providers notified under Section 227 and the dedicated rules, only the appropriate regulator, such as the Reserve Bank of India, can initiate insolvency proceedings. An individual financial or operational creditor cannot file directly, because these entities are excluded from the definition that governs the ordinary corporate insolvency route.

How does the Administrator differ from a Resolution Professional?

The Administrator under the financial service provider framework combines in one office the functions that the ordinary process divides between the interim resolution professional, the resolution professional, and the liquidator. The Administrator is nominated by the appropriate regulator rather than proposed by creditors, which reflects the regulator-led character of the special track.

Does the Committee of Creditors exist in NBFC insolvency proceedings?

No. The framework replaces the creditor-controlled Committee of Creditors with an Advisory Committee of experts in finance, law, and the relevant sector. The Advisory Committee advises the Administrator rather than exercising the commercial control that a Committee of Creditors holds in an ordinary insolvency.

Which financial service providers are covered by the special framework?

The framework applies to categories of financial service providers notified by the Central Government under Section 227, in consultation with the appropriate regulator. It has been applied to systemically important non-banking financial companies above a specified asset threshold, and small entities that have not been notified are treated differently.

What happens to a small NBFC that has not been notified?

A financial service provider that has not been specifically notified under Section 227 does not fall within the special framework, and its treatment turns on whether and how the ordinary provisions can apply. The safest course for creditors dealing with any financial firm is to confirm its regulatory status before assuming which insolvency route is available.

Who has been notified as a financial service provider under Section 227 of the IBC?

The Central Government, in consultation with the Reserve Bank of India, has notified non-banking financial companies, including housing finance companies, with an asset size of five hundred crore rupees or more as financial service providers to which the special insolvency and liquidation rules apply. Smaller NBFCs below this threshold, and categories the government has not separately notified, remain outside the special framework, though the government retains power to extend notification to further categories as it considers necessary.

Can a financial service provider be wound up under the Companies Act instead?

No. Once an entity falls within a notified category of financial service provider, the special framework under Section 227 of the Insolvency and Bankruptcy Code, 2016 and its rules is the applicable route, and the entity is not wound up through the ordinary company-law liquidation process or through creditor-initiated corporate insolvency. This exclusivity is deliberate, so that the regulator retains control over the timing and manner of resolving a systemically sensitive financial firm rather than leaving it to a creditor's individual application.

What happens to the board of directors once the Administrator is appointed?

The powers of the board of directors are suspended once the Administrator is appointed and takes charge of the financial service provider's affairs, in a manner broadly similar to how a resolution professional displaces the board in an ordinary corporate insolvency. The Administrator manages the entity, runs the resolution process, and reports to the Tribunal, while the erstwhile board and its officers are expected to cooperate and hand over records, though they may still be examined regarding the affairs of the firm.

Can creditors challenge the Administrator's decisions before the NCLT?

Yes. Although the Administrator, guided by the Advisory Committee, runs the day-to-day resolution process, the National Company Law Tribunal retains supervisory jurisdiction over the proceeding, and an aggrieved creditor can approach the Tribunal where the Administrator's conduct is alleged to be improper, in breach of the applicable rules, or contrary to the interests of the class of creditors or depositors concerned. The Tribunal's oversight is the principal check on a process that otherwise concentrates significant authority in the Administrator.

How is a resolution plan for a financial service provider approved?

A resolution plan is examined by the Advisory Committee, which provides its views to the Administrator, and the Administrator then places a plan before the Tribunal for approval, in a sequence that parallels the ordinary Code's process of committee evaluation followed by Tribunal sanction. Because there is no creditors' committee wielding a voting threshold in the way an ordinary corporate insolvency process requires, the safeguards instead rest on the Advisory Committee's scrutiny and the Tribunal's own assessment of whether the plan is fair and complies with the applicable rules.

Do employees of a distressed NBFC have any special protection under the framework?

Employees are not given a bespoke protection distinct from the general principle that an insolvency process should not be used to strip a workforce of its dues, and their claims are considered as part of the overall resolution or, if it comes to that, the distribution of the entity's assets. Because financial service provider insolvencies are relatively new and the rules are thinner than the ordinary Code, the precise treatment of employee claims has in practice been worked out case by case as proceedings have unfolded.

What role does the RBI play once an NBFC is referred for insolvency?

The Reserve Bank of India, as the sector regulator, is the body that decides whether and when to trigger the special insolvency framework, typically after first exercising its own regulatory powers, such as superseding the board of a failing NBFC, before filing the application that commences proceedings under Section 227 of the Insolvency and Bankruptcy Code, 2016. In the resolution of Dewan Housing Finance Corporation Ltd, the first financial service provider taken through this framework, the RBI superseded the board and its nominated Administrator then filed the insolvency application before the Mumbai bench of the National Company Law Tribunal.

Can a financial service provider's insolvency proceeding be converted into liquidation?

Yes. Where a viable resolution plan cannot be found within the process, or the Tribunal is satisfied that resolution is not achievable, the proceeding can move to liquidation of the financial service provider under the applicable rules, broadly mirroring the fallback to liquidation available in an ordinary corporate insolvency where no resolution plan is approved. Given the systemic sensitivities involved, liquidation of a financial firm is generally treated as a last resort pursued only once resolution options have been genuinely exhausted.

Is there a minimum default threshold for triggering NBFC insolvency under Section 227?

There is no fixed monetary default threshold analogous to the one crore rupee minimum that applies to ordinary corporate insolvency applications, because the process is not triggered by a creditor's default-based application at all. Instead, the regulator decides to initiate the process based on its own assessment of the entity's financial health and the risk its failure poses, which means the trigger is regulatory judgment rather than a specific quantified default.