The arbitrary imposition of the requirement of ‘a Resolution Plan meeting the Liquidation Value’, without considering the amount brought in by homebuyers goes against the legislative intent and causes the failure of CIRP.
The article is about the curious case of failure of the Corporate Insolvency Resolution Process (CIRP) of a real estate developer (Corporate Debtor/ ‘CD’), wherein the Resolution Plans submitted by homebuyers were rejected due to the reason of not meeting the liquidation value and fair value as estimated by the registered valuer under regulation 35 of the CIRP Regulations, 2016[1]. Due to absence of any viable resolution plan, the CIRP was deemed as a failure and the project had gone into liquidation. Though this may sound like a common occurrence in CIRP, a closer look shows an entirely different picture. A closer scrutiny would reveal that the CD had developed the barren land on which the project was proposed using the amount collected from the homebuyers before defaulting, which was valued by the Registered Valuers to reach the ‘fair value’ and ‘liquidation value’. The irony is that when the CD went into CIRP, the project had not received any resolution plans so the homebuyers had brought in a resolution plan as a last resort, which was rejected for not meeting the minimum liquidation value which is essentially the asset constructed with the same homebuyers money.
To understand the irony involved, it is essential to grasp the general functioning of the CIRP and the role of the valuation in determining the success of a CIRP. When a CIRP is invoked against a Corporate Debtor, the management of the CD is dismissed and an Interim Resolution Professional(IRP)/Resolution Professional (RP) is appointed who takes over the business of the CD on behalf of the Committee of Creditors (CoC). The objective of the Resolution Professional is to facilitate the submission of a resolution plan from a Prospective Resolution Applicants (PRA) by providing all necessary details that a stranger might require to submit a resolution plan. The Section 30 of the IBC sets out strict criteria to be followed in submission of a resolution plan, chief among which is that the resolution plan submitted must meet the Liquidation Value, i.e. the Resolution Plan should bring in more money than what the CD would fetch if its assets are liquidated.
To this end the Resolution Professional commissions two registered valuers to independently calculate the liquidation value of the CD. If the values reached by the valuers differs, the RP appoints a third registered valuer and the average of the two closest estimates of a value shall be considered for determining the fair value and the liquidation value of the CD[2]. As per the guidelines issued by the Valuation Standards Board ICAI, the registered valuers follow either the ‘Cost approach’ which “involves valuing an asset based on the cost that a market participant shall have to incur to recreate the asset/ a replica of the asset to be valued, adjusted for obsolescence”[3] or the ‘Market approach’ which relies “on relative valuation to arrive at the value of a business, based upon how similar assets are priced in the market”[4]. The Cost approach is used to calculate the value of the building by calculating the amount spend in construction of the asset while the Market approach is used to calculate the value of the land and together the valuation amount is reached. Though no single method is universally applicable to all valuation purposes as the underlying purpose of the valuation can impact the basis of value to be utilised, generally these approaches used to reach the Valuation of the real estate project provides a true representation of its value for a prospective resolution applicant.
As per Section 30 of the IBC, the resolution plan should meet the Liquidation value and the same was intended to ensure that any plan that was brought in would be a better alternative to liquidating the assets of the CD. The blanket requirement of meeting the Liquidation was enforced as all the PRA are third party strangers to the project, who has not invested a dime in the project while all related parties to the project[5] are banned from filing a resolution plan. It is here that the established law lacks in as it has not considered the role of a Homebuyers’ Association as a Prospective Resolution Applicant.
The issue arises when the same valuation matrix used to determine the fair value and liquidation value is arbitrarily imposed on a resolution plan brought in by homebuyers, without considering the amount already invested by these Homebuyers, which essentially requires the homebuyers to bring in double the amount than a normal stranger resolution applicant. For example, in a real estate project the CD had collected Rs.10 Crore as advance sale consideration from various homebuyers after entering into Agreement for Sale and Construction for allotted residential units and the liquidation value of the project was estimated by the registered valuer at Rs.9 Crore. A normal Prospective Resolution Applicant needs to spend at least Rs.9 Crore to meet the requirement u/s 30 and acquire the project while a homebuyer Association bringing in a resolution plan would have to bring in Rs.9 Crore over and above the 10 Crore already paid to the CD, thus having to pay a cumulative sum of Rs.19 Crore to acquire the same project that a stranger PRA gets for half the same price.
This issue is further aggravated when considering the fact that the Profit Margin for a Successful Resolution Applicant of a real estate developer CD is very slim as the profit, if any, that an SRA can make is from selling the asset of the CD which in a real estate project is the unsold stock (residential units) to prospective buyers. Usually in real estate project, the CD would have allotted most of the residential units to allottees/homebuyers so as to raise the capital for construction of the project, which reduces the saleable assets of the CD thereby reducing the Profit margin, which in turns reduces the number of Resolution Plans.
The lack of Prospective Resolution Applicants had prompted the 4th Amendment to the CIRP Regulations[6], wherein regulation 37m was introduced to allow for project wise resolution plans. This amendment has allowed the Homebuyer Associations from relying solely on strangers to bring in resolution plans and to instead bring in a resolution plan by pooling in enough money for their specific residential project, and to complete the construction of the Project and get the residential units registered in favour of the allottees. Thus, forcing these homebuyers, who are already stretched thin from spending their life savings to acquire a home, to bring in an amount equivalent to the liquidation value of the project, has tied the hands of these homebuyers and as a result the project goes into liquidation in which case the homebuyers are given pennies on the dollar.
The issue of forcing the liquidation value on these homebuyers without considering the amount already invested by them has in effect has nullified the legislative intent behind the amendment of September 2022 and is curbing the ability of the homebuyers from bring a resolution plan thereby forcing the CIRP into liquidation and rendering the homebuyers homeless.
References:
[1] Insolvency and Bankruptcy Board Of India (Insolvency Resolution Process For Corporate Persons) Regulations, 2016, reg 35
[2] Ibid Reg 27
[3] Technical Guide on Valuation (Revised Edition 2021), Valuation Standard Board ICAI (first published 2018 reprinted 2021) pg. 30
[4] Ibid pg. 34
[5] Insolvency and Bankruptcy Code, 2016 s.29A
[6] Insolvency Resolution Process for Corporate Persons(Fourth Amendment) Regulations, 2016, 16th September, 2022
