From Unseen to Foreseen: The Financial Creditor Status of Homebuyers in IBC
Har
5th Year BA LL.B (Hons.), Hidayatullah National Law University, Raipur
Abstract
Aiming to maximize asset value, encourage entrepreneurship, increase credit availability, and balance the interests of all stakeholders, the Insolvency and Bankruptcy Code, 2016 (hereinafter termed as ‘Code’) unifies and amends existing regulations pertaining to the resolution of insolvency in a timely manner.
At first, there were no provisions in the Code that addressed homebuyers’ rights against real estate developers who were in default. Judges’ interpretations led to the gradual introduction of these laws. The Amendment of 2018, tackled the predicament faced by homebuyers under the Code by categorizing them as “financial creditors.”
This essay will examine the journey through which the Homebuyers were granted the Financial Creditor status in the Code. Additionally, we will critically analyse how categorising homeowners as financial creditors has impacted the sector of Bankruptcy and Insolvency by understanding these new found principles of Reverse CIRP and Project-Wise Insolvency Resolution and find solutions on how to tackle questions relating to the same.
Need For Considering Homebuyers as Financial Creditors: An Overview
India is currently establishing the framework for a developed market economy. This entails removing outdated laws and drafting new ones that are appropriate with the state of the industry. The Government of India is making a significant effort with Code to make doing business in the nation easier. The government is closely monitoring the results of court proceedings as the law develops, and it has demonstrated that it moves quickly to eliminate any ambiguities.[1]
Since owning immovable property is regarded as a necessary and significant investment of income, the real estate sector in India is one of the sacrosanct sectors. In the past twenty years, however, a number of builders have failed to fulfill their commitments to timely deliver the apartments, and as a result, a large number of these homebuyers have taken legal action under the “Consumer Protection Act of 1986 and the Real Estate (Regulation and Development) Act of 2016”.
Several real estate titans were forced into NCLTs following the introduction of the Code. Nevertheless, the Code lacked clarification regarding whether homebuyers’ purchases would be classified as operational or financial debt. Due to a lack of clarification regarding the homebuyers’ status as operational or financial creditors, several of their petitions were denied.
Different kinds of creditors exist for a corporation, and each has unique goals and interests. Their concerns are therefore distinct when the bankruptcy resolution process starts, and they need to be taken into consideration in different ways. Different creditors are accommodated differently by insolvency systems. In terms of rights and powers, IBC recognizes three categories of creditors: Operational Creditors (hereinafter termed as ‘OC’), Financial Creditors (hereinafter termed as ‘FC’) and Other Creditors.
As defined by the Code, “financial debt” is defined as borrowed sums plus interest paid back against the time value of money. It comprises traditional loans, money raised through a variety of financial instruments, lease or hire purchase obligations, discounted or sold receivables (not non-recourse receivables), money from borrowing-like transactions, hedging derivative transactions, and obligations pertaining to guarantees, indemnities, and other instruments issued by banks or other financial institutions. The explanation attached to this clause, which was added by the 2018 amendment, is of interest to us because it provides that money reserved for a real estate project which is collected from an allottee is deemed as a commercial effect equivalent to borrowing money. The words “allottee” and “real estate project” have the same meanings as defined in RERA 2016.[2]
“Operational debt” essentially includes payments associated to employment, responsibilities resulting from the delivery of goods or services, and statutory dues owing to government agencies.
The Legal Battle
According to Section 6 of the Code, a Corporate Debtor (hereinafter termed as ‘CD’) may start the Corporate Insolvency Resolution Process (hereinafter termed as ‘CIRP’) on its own, through an FC, an OC, or a default. The NCLT denied the developer’s request to begin insolvency proceedings in “Col. Vinod Awasthy v. A.M.R Infrastructure Ltd”.[3], citing the inability of the homebuyer to qualify as an OC. Since the money the developer was paid is not a demand for the provision of products or services, employment, or legal debts owed to the government, it does not drop under the concept of operational debt.
The Homebuyers were powerless to interfere since, in the majority of situations, they were not regarded as either operational or financial creditors. Furthermore, the process for filing claim forms by FC and OC alone was initially established by the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016. Homebuyers had challenges even during the claim filing process because their claims fell into the “other creditors” category. The IBBI[4] i.e., The Insolvency and Bankruptcy Board of India revised the guidelines pertaining to claim forms to incorporate the claims of “other creditors” after the predicament of home buyers gained attention.
The Hon’ble NCLAT held in the case of Nikhil Mehta and Sons (HUF) v. AMR Infrastructure[5] that sum derived by developers under “Assured Return Schemes” had the “commercial effect of a borrowing,” which was made evident by the developer’s annual returns, where the amount raised was listed as “commitment charges” under the heading of “financial costs.” This ruling brought clarity to the legal position. This led to the definitive decision that these allottees qualified as “FC” under Section 5(7) of the IBC and could, therefore, request the start of the CIRP process for a corporate debtor.
The Supreme Court issued a historic ruling in the Bikram Chatterji v. U.O.I.[6] case to defend the rights of Amrapali Group distressed homebuyers. The developer, bankers, and statutory authorities were found to have colluded, as the court pointed out anomalies in the project financing, land lease, and fund diversion. Homebuyers were not given any special treatment under the Code; therefore, they had no rights at all during the insolvency resolution procedure. Aware of the possible injustice, the court revoked Amrapali Group’s Real Estate (Regulation and Development) Act registration and ordered the “National Buildings Construction Corporation (NBCC)” to finish the outstanding projects (RERA). Thousands of homebuyers who were impacted by the builder’s activities found relief with this ruling.
Distressed Jaypee Infratech Limited homebuyers petitioned the Supreme Court for remedy in the case of Chitra Sharma v. Union of India[7]. They maintained that their debts, which were paid as advances to the corporate debtor, were more than the sums owing to banks. Homebuyers were at a disadvantage since banks were given preference under as “FC.” The Supreme Court stepped in to protect homebuyers’ interests in response to the plea. It issued interim directives designating designated agents to speak on behalf of homebuyers at meetings of the Committee of Creditors (hereinafter termed as ‘CoC’) in accordance with Code’s Section 21. The goal of this action was to close the gap in the insolvency resolution procedure between banks and homebuyers.
The Much-Awaited Amendment
The court emphasized that although homebuyers are important stakeholders, the Code did not adequately identify their interests. The government formed the Insolvency Law Committee (hereinafter termed as ‘ILC’), which is led by Injeti Srinivas, to address issue. Homebuyers were denied important rights, including the ability to start the CIRP and be represented on the CoC, as a result of their exclusion from financial and operational creditor categories, according to the ILC. An Amendment Ordinance passed in 2018 put homebuyers under the FC category in order to address this. Their acknowledgement rendered them indispensable to the CoC, bestowing upon them voting privileges commensurate with their percentage of the debt. In the Jaypee case, thousands of impacted homebuyers received redress when the court recognized their claims under the revised Financial Creditor criteria.
Voices Against the Amendment
In the 2019 case of Pioneer Urban and Land Infrastructure Co. Ltd. Vs. Union of India[8], several real estate companies contested the constitutional validity of the amendment in the Supreme Court by filing numerous writ petitions alleging violations of Articles 14 and 19 of the Constitution. The Petitioners contended that Homebuyer shouldn’t be treated like FC because their primary concern is getting their apartment or flat delivered, not the health and survival of the CD or its operations. To the dismay of fellow allottees, a trigger-happy allottee who feels wronged by the hold-up in receiving his apartment may initiate the procedure.
At the request of the assignee, an excellent management team may be terminated and replaced. In the worst scenario, if a resolution is unsuccessful, the company may finally dissolve through liquidation. A company’s liquidation can never be in anyone’s best interest, lest the majority of allottees suffer. The amendment faced opposition on the grounds that it was discriminatory and arbitrary, and that its effects were out of proportion to the problems it was intended to solve.
The parties also cited legal arguments from earlier decided instances. For example, in Innoventive Industries v. ICICI Bank[9], the court made a distinction between FC and OC with regard to the extent of their legal powers.
The builder advocate also brought up Swiss Ribbons Vs. Union of India[10], in which the court had established a number of attributes for financial creditors. Based on these attributes, the builders attempted to persuade the court that real estate allottees are more appropriately classified as operational creditors than financial creditors.
The Supreme Court lined in favor of the homebuyers, maintaining the constitutionality of the amendment and concluding that Article 19 had not been violated. The petitioners’ fundamental rights under Article 19(1) are not unjustly restricted by the change, which is adopted in the public interest (g). No one can have their property taken from them without a law that complies with the constitution.
Developments after the Amendment
Following the 2018 Amendment, individual homeowners began lodging claims, some motivated by minor grievances or ulterior motives, which burdened the insolvency court. Consequently, the Amendment of 2020 became necessary which stipulated that to start the CIRP against a developer, there must be support from at least 100 homebuyers or 10% of all homebuyers from the same real estate project.
The Adjudicating Authorities, after the above-mentioned amendments have exercised their powers of interpretation and have formulated some principles such as Reverse CIRP and Project-Wise Insolvency Resolution, which give further comfort to homeowners but also pose questions about their validity under the Act.
Project-Wise Corporate Insolvency Resolution[11]
This method was applied recently in the case of Vidarbha Industries v. Axis Bank Limited[12]. According to this method, just the project where the default occurred will be subject to insolvency process if a petition is filed against a CD managing several projects. By emphasising on troubled properties within a particular scheme instead of the entire corporate structure, these proposed revisions aim to increase the likelihood of a successful resolution by streamlining the resolution process for stalled projects.
This strategy has two important benefits:
- Initially, by resolving problematic projects individually that contributed to insolvency, the debtor can concentrate on the rest of the initiatives while safeguarding the interests of the complaining homebuyers.
- Secondly, by using this tactic, a customized resolution plan that takes into account the specific goals of relevant parties as well as the current status of the real estate project may be created.
Reverse Corporate Insolvency Resolution Process
In the Flat Buyers Association Winter Hills v. Umang Realtech[13], NCLAT first acknowledged the notion of reverse insolvency. This innovative tactic was developed to protect the rights of allottees in real estate projects whose goal was concerned with regaining proprietorship of their properties as opposed to the goals of rest of the creditors, who were focusing on collecting their debt.
When the aggrieved homebuyers move for CIRP via the finance bank of the project, reverse CIRP is started. The project’s promoter then presents a resolution plan, which frequently calls for extra finance from outside sources like lenders, in order to guarantee the project’s timely completion. Banks and homebuyers together form the CoC, which assesses the viability of the suggested strategy.
Third-party resolution plans are not accepted under Reverse CIRP, in contrast to the regular CIRP procedure. After the project is successfully completed, the Resolution Professional under Sec. 7 of the Code files an application to have the CIRP case disposed off. Nonetheless, the Resolution Professional (hereinafter termed as ‘RP’) may use the standard CIRP procedure if there are project delays or financial difficulties.
Analysis of the Developments
With the novel concepts of Project-wise Insolvency Resolution and Reverse CIRP, The Code has recognised the important role played by homebuyers in the development of the economy. However, past events have made it clear that the act urgently needs to be reviewed in order to either significantly change it or propose a new act designed to handle real estate-related issues.
A significant problem surfaced in the Flat Buyers Case.[14], when most of the CoC with the power to vote on a resolution plan was formed of the homebuyers of real estate and lacked the skill to evaluate the profitability of the corporate debtor. This instance demonstrated the allottees’ lack of business acumen in contrast to financial firms or banks.
The lack of a specific procedure in the Code for project-wise insolvency of a CD, which resulted from judicial interpretation by the NCLAT without legislative support, is another important finding. This suggests that legislative reforms are required to establish a clear procedure for insolvency of real estate projects.
A further difficulty is the information asymmetry that allottees have, which causes delays in submitting their claims within the deadline. To complicate things even more, some allottees could not even live in the same jurisdiction as the project. All interested parties cannot be reached via the existing public announcement procedure under Section 15 of the Code, which is restricted to newspapers having a large distribution in the CD’s registered office area.[15]
Furthermore, even if the Reverse CIRP plan is used, Section 29A of the Code is against of it, which forbids CD’s promoters from participating in the resolution process. To bring Reverse CIRP into line with the goals of the Code, changes are required due to this misalignment.[16]
Proposed Solutions
The Ministry of Corporate Affairs has suggested changes to the Code, including a formal framework for project-wise insolvency, in recognition of these difficulties. The proposed changes provide the NCLT the authority to determine whether a CD in real estate deserves project-wise insolvency depending on the particulars of each case.[17]
To enable project-wise insolvency, the proposed adjustments must include both substantive and procedural changes. It would be appropriate to create specific measures that would enable NCLTs to separate projects involving CD, admit only those that require insolvency, and reject others.
Broadening the scope of public notifications and requiring mandatory contact between the RP and homebuyers are crucial steps in addressing information asymmetry.
Resolution procedures can be accelerated and made more efficient by creating specific NCLT Benches for real estate insolvencies. These extensive changes are essential to improving the Code’s ability to manage insolvencies in the real estate industry and safeguarding the interests of all parties concerned.
The Amendment ought to clearly delineate the necessary conditions for putting Reverse CIRP into effect. The promoter has to get approval from all creditors unanimously in order to save the project.
Conclusion
The Code is a monument to the government’s dedication to stakeholder protection and business efficacy as the country works toward becoming a mature market economy. A careful balance between the rights of different creditors and troubled homeowners is ensured by the changing landscape, which has been fashioned by judicial acumen and legal advancements. The changes affirm the inclusive nature of the insolvency resolution process while also filling key gaps.
Though novel, the rise of project-wise insolvency and reverse insolvency tactics has highlighted the shortcomings in the current legal system. These tactics have demonstrated potential in safeguarding buyers’ interests and expediting the conclusion of problematic projects; nonetheless, they necessitate legislative support and conformity with the Code’s overall goals.
Important steps toward resolving these issues include the suggested solutions, which include creating dedicated NCLT Benches for real estate insolvencies, improving stakeholder communication, and formalizing project-specific insolvency procedures. The integrity and efficacy of the Code across a range of industries depend on these reforms, which are also crucial for guaranteeing the prompt and effective settlement of real estate insolvencies.
With the use of the solutions provided, The Code can be better implemented to rescue the interests of homebuyers while also allowing CD to emerge out of insolvency as is proposed in the objectives of the Code.
The Code is a vital component of the country’s business-friendly atmosphere in this ever-changing legal landscape. The Code’s ability to adjust to new circumstances shows how resilient India’s legal system is. In the future, tackling new difficulties and maintaining the values of justice, fairness, and transparency for all parties concerned will depend on the dedication to improving and strengthening the Code.
References:
[1] Swati Gandhi and Rama Sharma, Supreme Court upholding the status of Homebuyers as Financial Creditors: Paving a Roadmap towards Beneficial Legislative Jurisprudence, IIIPICAI (17 Feb., 2024, 4:32 PM), https://www.iiipicai.in/wp-content/uploads/2022/07/16-21-Article-Supreme-Court-upholding-the-status-of-Homebuyers-as-Financial-Creditors-Paving-a-Roadmap-towards-Beneficial-Legislative-Jurisprudence-Swati-Gandhi-and-Rama-Sharma.pdf.
[2] Ibid.
[4]Swati Gandhi and Rama Sharma, Supreme Court upholding the status of Homebuyers as Financial Creditors: Paving a Roadmap towards Beneficial Legislative Jurisprudence, IIIPICAI (17 Feb., 2024, 4:32 PM), https://www.iiipicai.in/wp-content/uploads/2022/07/16-21-Article-Supreme-Court-upholding-the-status-of-Homebuyers-as-Financial-Creditors-Paving-a-Roadmap-towards-Beneficial-Legislative-Jurisprudence-Swati-Gandhi-and-Rama-Sharma.pdf.
[11] Vidushi Puri & Kandarp Jha, Empowering the Revival of the Real Estate Sector: The Transformative Impact of the Insolvency and Bankruptcy Code, IBC Laws (7th Mar, 2024), https://ibclaw.in/empowering-the-revival-of-the-real-estate-sector-the-transformative-impact-of-the-insolvency-and-bankruptcy-code-by-vidushi-puri-kandarp-jha/#_ftn4.
[13] (2020) ibclaw.in 166 NCLAT.
[14] Ibid.
[15] Shivkrit Rai, Insolvency and Bankruptcy Code needs a separate regime for the real estate sector, Bar and Bench (6th May, 2023, 7:02 PM), https://www.barandbench.com/columns/insolvency-and-bankruptcy-code-needs-a-separate-regime-for-the-real-estate-sector.
[16] Ayush Mathur, Legislative Integration of Reverse CIRP in Real Estate Insolvency, CBCL.NLIU, https://cbcl.nliu.ac.in/insolvency-law/legislative-integration-of-reverse-cirp-in-real-estate-insolvency/.
[17] Shivkrit Rai, Insolvency and Bankruptcy Code needs a separate regime for the real estate sector, Bar and Bench (6th May, 2023, 7:02 PM), https://www.barandbench.com/columns/insolvency-and-bankruptcy-code-needs-a-separate-regime-for-the-real-estate-sector.
