Homebuyers Triggering IBC – Mischief Managed?

Amidst the debate on homebuyers' claims in insolvency disputes, the Ministry of Corporate Affairs formed the Insolvency Law Committee ("ILC") which rendered its report in March 2018. Amongst other agendas, ILC focused on resolving the significant confusion regarding the status of homebuyers of under-construction apartments as creditors under the Insolvency and Bankruptcy Code, 2016 ("IBC"). Resultantly, moving forward with the ILC report, the President approved the Insolvency & Bankruptcy (Amendment) Ordinance 2018 ("IBC Ordinance"), which was notified with immediate effect on 06 June 2018.[1] The IBC Ordinance has sought to resolve the difference in positions taken by the National Company Law Appellate Tribunal ("NCLAT") and the Hon'ble Supreme Court of India, and henceforth classified homebuyers as 'financial creditors' for the purposes of the Corporate Insolvency Resolution Process ("CIRP"). The intent behind such classification is to enable homebuyers to participate in the insolvency resolution process in a constructive and egalitarian manner. The much needed reforms also seek to put to rest the homebuyers' ambiguous statuses, which arose in Jaypee Infratech[2] and Amrapali Group[3] cases.

The IBC Ordinance has amended the definition of financial debt under Section 5(8)(f) by adding another 'Explanation', which states: "An amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing." Thus, an amount paid by a homebuyer in a real estate project would now amount to financial debt under the IBC. The classification of homebuyers as financial creditors and the inclusion of amount owed by them as financial debt has its advantages but there are also certain negative repercussions, which are discussed below.

The Mischief Corrected:

The IBC was legislated with a view to streamline and consolidate laws concerning financial distress in India. IBC regulates (a) insolvency due to inability to pay debt, and (b) voluntary liquidation of a company. Under the IBC, the operational creditor, financial creditor, employees of a distressed company and the distressed company itself, are eligible to make an application to the NCLT for the commencement of the CIRP. (Section 6, IBC) On admission of the application, CIRP commences, an insolvency resolution professional ("IRP") is appointed and a period of moratorium is declared. (Sections 13 & 14, IBC) Moratorium is the period under CIRP where all pending suits and proceedings related to debt of the company are abated. The concept of moratorium keeps all pending suits at abeyance (whether before a Courts or Tribunal) till the conclusion of CIRP.

In the recent past, there have been numerous cases petitioned by the homebuyers against real estate companies before the National Consumer Disputes Redressal Commission ("NCDRC") for deficient services. In the peculiar cases of Jaypee Infratech and Amparali Group (supra), aggrieved homebuyers claimed deficiency in service on the part of developers post payment of full consideration. However, the developers thereafter filed insolvency applications before the NCLT. As described above, once the insolvency applications were admitted, the moratorium period was declared and the homebuyers' suits/ complaints were abated. This meant that the developer companies could proceed with the resolution plan under IBC while the homebuyers were left remedy-less.

Further, in case a distressed company proceeded with liquidation under IBC, the homebuyers are almost certain to get nothing from the proceeds of sale. This is because they are ranked last in the waterfall provision providing for distribution of assets. (Section 53, IBC)

Another glaring issue has been the status of the homebuyers and the discrepancy between the stand of the Hon'ble Supreme Court vis-à-vis the NCLAT. While the Hon'ble Supreme Court in cases such as Jaypee Infratech and Amrapali (supra), tried to protect the homebuyers' interests, the NCLAT through various judgments[4] settled the law that unless the homebuyers' agreement provided for an 'assured returns' clause, the homebuyer could not trigger IBC as a financial or operational creditor. Even though, the 2017 amendment to the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2017 inserted Regulation 9A titled 'Claims by other Creditors', by virtue of which homebuyers could file claims before the IRP; they could still not trigger IBC, or voice concerns at the Committee of Creditors ("CoC") or participate in the resolution process.

The afore-stated issues were identified as the foremost problems that were sought to be addressed by the present amendment.

With the enactment of the IBC Ordinance, the homebuyers are now classified as financial creditors. They are now empowered as (a) applicants eligible to initiate CIRP under Section 7 of the IBC, (b) represent themselves in the CoC, and (c) have a better chance at receiving re-payment of their investment because they would be third in the ranks of receivers (post payment of secured creditors and employees' dues) in the hierarchy of distribution of proceeds of the liquidation sale. The IBC Ordinance has thus positively enabled homebuyers to initiate the insolvency process against an erring defaulting company, and even seek the benefits of the resolution plan or liquidation proceeds as the case may be.

The IBC Ordinance has also ensured stricter regulation of real estate companies that sought to take benefits of the loopholes in IBC earlier.

More Mischief Created?

While regarding homebuyers as financial creditors removes the mischief of allowing the builders to have moratorium declared, fraudulently preventing the homebuyers from receiving the re-payment of their money; there appears to be a practical hurdle created that might threaten the very ethos of IBC.

The Indian real estate sector, for the most part, functions on the funds that are collected by the builders/ developers through the initial allotment to homebuyers. Now, that both the banks and the homebuyers are financial creditors, the IBC Ordinance has inserted some provisions on how the CoC will function, however there are some ambiguities, that are yet to be clarified.

The IBC Ordinance has added Sub-Section 6A in Section 21, which provides that a class of creditors, who exceed a specified number, would be represented by a resolution professional in the meetings of CoC. It also provides that the said Class is empowered to appoint the resolution professional themselves to protect their interests and voice their concerns. Further, Sub-Section 7 has now been modified and it provides that it will be the Insolvency and Bankruptcy Board of India ("Board"), which will decide the manner of voting and voting share for each of the consortium/ class of creditors. The concern that arises is whether the homebuyers, who have been allowed to participate in the CoC have the necessary expertise to productively contribute to the resolution exercise, in line with the purpose and intent of IBC?

In the example of Jaypee Infratech, as stated above, each of the 32,000 allottees had paid amounts varying between Rs. 40 lakhs and Rs. 1 crore[5], while the funding from the banks was limited to Rs. 8000 crores, approximately. The homebuyers have invested at-least double the amount compared to the banks, thus, on a plain reading of the IBC Ordinance, it appears that the homebuyers would have majority stake and a greater voting share.

However, the IBC was created with the vision to achieve efficient and time-bound redressal for distressed companies. One of the ways in which time-bound resolution has been achieved so far is because the CoC consists of financial creditors, mostly banks, which have the professional expertise to pass swift resolutions and even waive a percentage of their re-payment, owing to the larger scheme of issues being resolved[6]. However, the homebuyers are not expected to waive hefty amounts of their savings/ investments, thus, creating a greater possibility for deadlocks and delay in passing of resolution plans.

It now has to be seen how the IBC Ordnance will be applied practically, which, to a considerable extent depends upon the Board's regulations that will define the voting share and consequently the parameters of the homebuyers' participation. The Board, while ensuring that the creditors are represented proportionally, will have to balance the interests of the corporate debtors and banking institutions as well, all while keeping in mind the ethos, aims, objectives and vision of the IBC.

There also appears to be a looming threat to this amendment, in the form of a constitutional challenge, on the ground that the homebuyers have been given a special status as receivers of services; while no other services are covered by the IBC. It is thus, left to be seen whether the builders/ developers welcome this sword of Damocles over their head or challenge it, like many other provisions of the IBC pending challenge before the Hon'ble Supreme Court.

Conclusively, while the IBC Ordnance sought to correct one mischief, it might have created another and the Board is in the best position to manage this mischief and assist in the proper application of the law.

 Ms. Suriti Chowdhary and Ms. Shivani Vij, Advocates, Practicing at Delhi, available at suritichowdhary@gmail.com and shivanivij.nliu@gmail.com     

[The opinions expressed in this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of LiveLaw and LiveLaw does not assume any responsibility or liability for the same]

[1] Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018.

[2] https://www.financialexpress.com/industry/jaypee-homebuyers-to-soon-get-refunds/1131403/

[3] http://indianexpress.com/article/india/supreme-court-directs-amrapali-to-meet-home-buyers-5099113/.

[4] Nikhil Mehta and Sons (HUF) v AMR Infrastructure Ltd. 2017 SCC OnLine NCLAT 377; Pawan Kumar Dubey v AMR Infrastructure Ltd., Company Appeal (AT) Insolvency No. 40 of 2017 

[5] https://www.firstpost.com/business/jaypee-infratech-insolvency-the-mess-just-got-messier-and-home-buyers-may-continue-to-lose-out-4039127.html

[6] https://www.businesstoday.in/opinion/prosaic-view/npa-nclt-reserve-bank-of-india-liquidation-banks-ibc-process/story/265782.html