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IBC Amendment,2020: Constitutional Vires Of The Minimum Threshold On The Allottees

Pareekshit Bishnoi
5 May 2020 6:18 AM GMT
IBC Amendment,2020: Constitutional Vires Of The Minimum Threshold On The Allottees
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The Legislature of India enacted the Insolvency and Bankruptcy Code, 2016 ("the Code") for the speedy revival of companies and consolidation of laws relating to liquidation. The Code provided Financial Creditors and Operation Creditors a right to initiate the Corporate Insolvency Resolution Process ("the CIRP") against a Corporate Debtor, before the National Company Law Tribunal ("the Tribunal").

The evolution of the allottee(s) of a real estate project as Financial Creditors under the Code may be exhaustively noted in a previous blog. However, briefly, the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 ("IBC Amendment, 2018") included the allottees of a real estate project as Financial Creditors under section 7 of the Code. Hereafter, the allottees could apply to initiate the CIRP "either by itself or jointly" against a Corporate Debtor ("Real Estate Developer(s)") alike other Financial Creditors i.e. banks & financial institutions. The Supreme Court of India in Pioneer Urban Land and Infrastructure Ltd. & Anr. v. Union of India & Ors. (2019) 8 SCC 416 ("Pioneer") upheld the constitutional vires of the IBC Amendment, 2018 and confirmed the right of the allottees, including individual allottee, to approach the Tribunal and initiate the CIRP (para. 56-57, Pioneer) in the same manner as other Financial Creditors.

However, on 28.12.2019, the President of India promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019 ("the Ordinance"). Pertinently, section 3 of the Ordinance has amended section 7 of the Code by insertion of three provisos. The first proviso has limited the right of the security or deposit holders represented by a trustee/agent to approach the Tribunal. This proviso has mandated them to be 100 or 10% of the total number of such creditors in the same class, whichever is less. The second proviso mandates an identical minimum threshold for allottees of "same real estate project". And, the third proviso mandated that the applications of these Financial Creditors which were pending before the Tribunal but yet has not been admitted, the applicants shall modify the applications in compliance with the amendment within a period of one month. If such applicants fail to comply with the amendment, their applications shall be deemed automatically withdrawn.

Subsequently, the Standing Committee Report on Insolvency and Bankruptcy (Second Amendment) Bill, 2019 was laid before the Lok Sabha and Rajya Sabha on 04.03.2020. On 13.03.2020 the legislature has enacted the Insolvency and Bankruptcy Code (Amendment) Act, 2020 ("IBC Amendment, 2020") which approved the Ordinance with identical provisions.

The constitutional vires of section 3 of the Ordinance (hereafter of the IBC Amendment, 2020) have been challenged in Manish Kumar v. Union of India & Anr. ("Writ Petition") on the contours of Article 14 and 21 of the Constitution of India, 1950. The Court ordered maintenance of status quo on 13.01.2020 as already noted in another previous blog.

The author in the present article attempts to aver that the minimum threshold imposed on the allottees of a real estate project with retrospective effect vide the IBC Amendment, 2020 is intra vires and constitutional. The three primary issues raised by the Petitioners in the aforesaid writ petition may be examined as follows:

I. Whether the second proviso of section 3 of the IBC Amendment, 2020 overrides the decision of the Supreme Court in the Pioneer?

The Supreme Court had in its decision in the Pioneer confirmed the right of individual allottee to approach the Tribunal and apply to initiate the CIRP alike other Financial Creditors. The Court in its decision categorically refused to read down any limitation suggested by the different counsels in terms of numbers or otherwise like the enquiry of whether the majority of allottees want initiation of the CIRP or whether the real estate developer is otherwise well managed and is solvent. The Court held that "the NCLT will not turn a Nelson's eye to legitimate defences by a real estate developer,…..There is, therefore, no necessity to read into or read down any of these provisions" (para. 56-57, Pioneer).

This is one of the primary ground for the challenge of the IBC Amendment, 2020 in above-said writ-petition. The Petitioners contend that the amendment encroaches the judgement of the Court in Pioneer wherein it confirmed the right of individual allottee to apply for initiation of the CIRP. However, the author is of the view that this observation of the Court in Pioneer does not support the cause of the Petitioners for two reasons.

First, the Court in the Pioneer had merely given primacy to the words used by the legislature and legislative intent drawn therefrom. The "legislative primacy" meaning a statute is to be construed according to "the intent of those that make it" is a well-settled principle of the statutory interpretation. [para. 6, RMD Chamarbaugwala v. Union of India]. The Court noted that the legislature had not imposed any limitation on the allottees to apply for initiating the CIRP vis-à-vis other Financial Creditors. The Court held that the doctrine of reading into or reading down is of utility where the language employed by the legislature in a provision is vague and ambiguous. However, the Court found the language of section 7 as clear and unambiguous. The doctrine of reading down could not have been used to make excessive additions and if done, it would be beyond the jurisdiction of the Court. The Court noted that - "it is not permissible either to mend or bend it, even if such recasting is in accord with good reason and conscience" (para. 56, Pioneer).

Thus, in the Pioneer the Court had merely given primacy to the legislative text and the intent which could be drawn therefrom i.e. no limitation. The allottees could apply "either by itself or jointly" like other Financial Creditors under section 7 of the Code. The Court did not hold that the legislature cannot impose any such limitations or imposition of any such condition on individual allottee in the future by the legislature will be invalid or unconstitutional or contrary to the object behind the inclusion of allottees under the Code. Such a direction may be noted by the Supreme Court in BCCI v. Kochi Cricket Ltd. (para. 57) wherein the Court had categorically directed the legislature to not to insert section 87 in the Arbitration Act, 1996 as it would be contrary to the object of the amendments in the years 2015. The legislature can always amend a statute to cure a defect which has arisen in due course of time. The imposition of limitation by the Legislature with retrospective effect was within its realm.

Second, it is must also be noted that the Legislature always has the power to amend and remove the defect pointed out by a Court vide an amendment with retrospective effect. To pertinently note, the Supreme Court in its recent decision in the case of Hindustan Construction Company Limited & Ors. v. Union of India ("HCCL Case") held that though insertion of section 87 in the Arbitration and Conciliation Act, 1996 vide the Arbitration and Conciliation (Amendment) Act, 2019 by the legislature does retrospectively take away one of the "fundamental prop" of the this Court's decision in the case of BCCI v. Kochi Cricket Ltd. (supra). However, the legislature has the power to do so, particularly when "the Court's judgement is purely declaratory in nature". It is always open to the legislature to remove a defect "vide an amendment or validating act, if deemed fit, with retrospective effect removing the basis of the decision of the Court…..Though the consequence may appear to be an exercise to overcome the judicial pronouncement it is so only at first blush; a closer scrutiny would confer legitimacy on such an exercise as the same is a normal adjunct of the legislative power" (para. 43-45, HCCL Case).

Thus, in view of the author, first, the Court in Pioneer merely gave primacy to the legislative intent and second, the decision of the Court in Pioneer was merely declaratory in nature. The legislature is always competent to amend a law and cure any lacuna vide insertion of a limitation if required. Such an act of the legislature cannot be pleaded as an encroachment over the realm of judiciary or any of its decision.

II. Whether the second proviso of section 3 of the IBC Amendment, 2020 lacks reasonable differentia and creates a "class within a class"?

The Petitioners have pleaded that the provision discriminates allottees vis-a-vis other Financial Creditors like bank and financial institutions and Operational Creditors without any reasonable differentia. They have averred that the Financial Creditors already form a class and the allottees were included under the same umbrella at par with other Financial Creditors. The different treatment of allottees vide the amendment creates "a class within a class" and thus, is contrary to Article 14 of the Constitution of India, 1950. However, the author is of the view that the amendment meets the requisite contours of Article 14 for the reasons discussed below.

Article 14 only forbids arbitrary classification for the legislation. However, it does not "forbid reasonable classification". For class legislation to be intra vires the Supreme Court has appositely noted in Shri Ram Krishna Dalmia v. Shri Justice S. R. Tendolkar that the classification must be (1) a reasonable classification/differentia and have an object to be achieved, and (2) there must exist a reasonable nexus between the basis of the classification made and the object sought to be achieved by the amendment (para. 11).

Thus, first, the legislature is always competent to make class legislation, provided the classification has been made on basis of a reasonable differentia and has an object to be achieved. The Supreme Court in State of Gujarat and Anr. v. Shri Ambika Mills Ltd., Ahmedabad held that "a reasonable classification is one which includes all persons who are similarly situated with respect to the purpose of the law. The purpose of a law may be either the elimination of a public mischief or the achievement of some positive public good" (para. 54). The author is of the view that the requisite condition of reasonable classification has been duly met by the legislature.

Foremost, the Code already includes several classes or types of creditors under the umbrella of Financial Creditor depending on the nature of transaction or contract with the Corporate Debtor [See Section 5(8), the Code]. For example, banks and the financial institutions have a relationship with the Corporate Debtor which is purely a financial contract, such as a loan or debt security. Similarly, the amount raised from the allottees of a real estate project was deemed to have a commercial effect of the borrowing like loan etc.

Thus, the allottees already form a distinct class based on the nature of the contract which is not purely of financial nature. The Code only created legal fiction for the allottees under the Code. Their instalments were given a deemed effect of commercial borrowing. Moreover, subsequent addition vide the IBC Amendment, 2018 further clears allottees are separate and distinct class vis-a-vis banks and financial institutions. Thus, they already form a "class within a class" though treated equally.

Alternatively, the legislature always has the power to reasonably classify a group of persons and make a special provision for them. In the present case, the legislature can be deemed to have reasonably classified the allottees considering the existence of afore-noted difference depending on the nature of the contract between the allottees and real estate developers vis-à-vis other Financial Creditors. The nature of the transaction is the reasonable differentia for classification of the allottees. The classification made by the legislature includes all persons who are similarly situated under the Code based on the nature of the contract with the Corporate Debtor.

Second, though the Preamble of the Ordinance and the IBC Amendment, 2020 does not state any specific reason behind the imposition of minimum threshold on the allottees, the object behind the amendment is unarguably to solace the miseries of the real estate developers and slump of the real estate market due to nearly all real estate holders entangled in the insolvency proceedings before the Tribunal. The real estate developers were forced to reply to multiple independent applications by individual allottees against the same project. Their inclusion as Financial Creditors inundated the Tribunal for insolvency when they already had other remedies. The Code has also been used as a "debt recovery mechanism" by several allottees instead of revival or resolution of the company. Numerous real estate companies faced liquidation despite an entity being a going concern. Thus, the reasonable classification made by the legislature has been made for a reasonable purpose i.e. curtail the mala fide triggering of the CIRP with the sole purpose of refund against going concerns. The minimum threshold has been inserted for the allottees to keep the real estate industry alive and responsive to the need for infrastructure in the country.

Third, the classification has a reasonable nexus with the object sought to be achieved by the legislature. The imposition of the minimum threshold will filter the applications and chock the malicious initiation of the resolution proceedings against real estate developers by an individual allottee. A single allottee cannot now single-handedly topple down the management or existence of real estate developer or use it as "debt recovery mechanism".

Thus, differentiation in the second proviso of section 3 is based on a reasonable classification have an object and most importantly, the classification made has reasonable nexus with the object sought to be achieved. The second proviso is on the contours of Article 14 of the Constitution and is not manifestly arbitrary or discriminatory.

III. Whether the retrospective applicability of section 3 of the IBC Amendment, 2020 is manifestly arbitrary and excessive?

As above-noted the third proviso of section 3 of the IBC Amendment, 2020 makes the amendment in section 7 operate retrospectively. This clause puts the amendment in section 7 in hot water. It has been contended by the Petitioners that the proviso sets the clock backwards for the allottees who had approached the Tribunal before 28.12.2019.

At the outset, it is apposite to quote from the Hitendra Vishnu Thakur v. State Of Maharashtra wherein the Supreme Court held as follows:

"A statute which affects substantive rights is presumed to be prospective in operation unless made retrospective, either expressly or by necessary intendment, whereas a statute which merely affects procedure, unless such a construction is textually impossible, is presumed to be retrospective in its application, should not be given an extended meaning and should be strictly confined to its clearly defined limits" (para. 26).

First, it may be noted, from the afore-quoted observation of the Court that the general principle of applicability of a statute is always subject to the legislative text and intent. The legislature can expressly direct the operation of a statute to any effect regardless of the nature of right affected by the amendment. In the present case, the text of the third proviso is clear and gives the amendment a retrospective effect. Thus, principally the third proviso may be held as intra vires. The legislature has the wide discretion to legislate prospectively as well as retrospectively.

However, this legislative discretion in not unsurmountable in all situations. This may be noted with an example from the recent decision of the Supreme Court in the HCCL Case (supra). Herein, the Court held that the Arbitration and Conciliation (Amendment) Act, 2015 applies to court proceedings as pending on or new filed after 23.10.2015 irrespective on the date of commencement of the arbitral proceedings. The Court struck down section 87 inserted by the legislature in 2019 which mandated that the amendments of 2015 will only apply to the arbitral proceedings commenced after 23.10.2015 and the court proceedings arising therefrom. The Court departed from the clear legislative intent expressed in section 87 on the ground of hardships and mischiefs which the continuance of the old law existing before the amendment would cause to parties. The Court had regard to the adverse consequences due to non-applicability of the amendments and override the legislative intent.

Like in HCCL Case (supra), the Court may hold the third proviso manifestly arbitrary and excessive in light of the hardships and anomalies which arise due to retrospective applicability of the second proviso of the IBC Amendment, 2020. To briefly note, the allottees do not have a public record of the allottees against whom the Corporate Debtor has made default. The all-exercise made before the Tribunal by the allottees and all costs incurred by the allottees will run futile if they fail to consolidate all the allottees and meet the required minimum threshold. Similarly, the second proviso and the third proviso give rise to several anomalies. For example, what is meant by the term "modified" under the third proviso? What will be the effect, if the minimum threshold subsequently falls below the requisite threshold? Who all allottees may be included to meet the requisite threshold? In light of these hardships and anomalies, the Court may override the legislative intent regardless of the allottees having a substantive right or a procedural right.

Second, it may also be examined whether an individual allottee of real estate project, particularly who had applications pending before the Tribunal had a substantive right or procedural right to initiate the CIRP. On the one hand, it may be contended that limitation merely changes the process of initiating the CIRP by imposing a minimum threshold as a regulatory measure. Moreover, it merely changes the forum for individual allottee and a party can never have a vested right in forum. Thus, the retrospective applicability of the amendment in section 7 vide the third proviso is valid.

On the other hand, it may be averred that the Code provides a special remedy. The remedy under the Code is right in rem (para. 29, 31, & 39, Pioneer). An individual allottee cannot seek remedy to revive a Corporate Debtor before any other forum. Moreover, the Supreme Court in C.I.T v. Dhadi Sahu held that "the right becomes vested when the proceedings are initiated in the tribunal or the court of first instance" (para. 21). Thus, the third proviso it does not merely amend the procedure but takes away a substantial right of the parties who had applied to the Tribunal before the promulgation of the Ordinance i.e. 28.12.2019. The Supreme Court in Manujendra Dutt v. Purendu Prosad Roy Chowdhury had appositely held that a new law bringing about change in the forum does not affect pending actions. The Court pertinently observed as follows:

"Though s. 29 was deleted by the Amendment Act of 1953 the deletion could not affect pending proceedings and would not deprive the Controller of his jurisdiction to try such proceedings pending before him at the date when the Amendment Act came into force" (para. 4).

Thus, the third proviso may be held ultra vires as it takes away a remedy available before the special forum and will set the clock backwards for individual allottees if they fail to comply with the second proviso i.e. minimum threshold.

Given this nature of remedy before the Tribunal which has facets of both, the substantive law and the procedural law and a provision wherein the legislative intent is clear, it would be interesting to see how the Supreme Court determines the issue. On the one hand, the intent of the legislature and the object of the amendment is clear. There exists no anomaly in the interpretation of the third proviso. The legislature intends to revive the real estate industry. The economic slump due to epidemic Covid-19 furthers the conclusion that the amendment needs to apply to the pending applications as the companies will be reviving from the economic slump when the Court now will hear the application. On the other hand, the amendment which alters or destroy an existing right or attaches a new disability in respect of past transactions is generally presumed to have prospective applicability. The hardship caused to the allottees, the costs incurred in initiating the process and its futility due to retrospective applicability warrant only prospective applicability, i.e. applications filed after 28.12.2019 or the date of decision in the writ petitions challenging the amendment.

Concluding Remarks

To conclude, it must be remembered that an Act or an amendment therein is always presumed to be constitutional. The burden is on the Petitioners to prove the unconstitutionality which is consequentially high due to presumption of constitutionality. The allottees have indeed invested their life savings to buy homes which have been dilly-dallied by the Corporate Debtors for years. However, in view of the author, a bar of 100 or 10% of the total number of allottees is reasonable, particularly when the slump in the real estate industry can be manifestly noted.

The amendment is an attempt of the legislature to balance the equities between allottees, real estate developers and the real estate market. However, the legislature appears to have gone a step further while attempting to balance the equities. The third proviso is most susceptible to the unconstitutionality on the ground of arbitrariness and excessiveness under Article 14 of the Constitution. The second proviso which as afore-noted imposes minimum threshold is merely regulatory in nature and such a legislative mechanism is already existing under different codes like the Companies Act, 2013.

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