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A Critical Analysis of Allottees as Financial Creditors Under IBC 2016

Abhay

The author is a student at Nmims Kirit P. Mehta School of Law, Mumbai


Introduction


The real estate industry has a catalytic function in propelling any economy forward. Due to ever-increasing hindrances in the development and delivery of real estate projects, the falling trust of potential homebuyers (real estate allottees) may account for the majority of the decline in this sector. As a consequence, the real estate allottees found their hard-earned money tied up in a project with no end in sight, which sometimes never saw the light of day. This anxiety of uncertainty was exacerbated by the absence of legal remedies that might give rapid and effective redress.


The Real Estate (Regulation and Development) Act, 2016 (RERA) & the Insolvency and Bankruptcy Code, 2016 (IBC) were well-received changes by real estate sector players, including lenders and homebuyers. While allottees and homebuyers continue to be the primary beneficiaries of the RERA, lenders were also pleased and embraced the enactment because it established checks and balances from the lender's perspective, guaranteeing the completion of real estate projects, thereby facilitating sales and the repayment of loans to lenders. On the other hand, IBC, 2016 was changed to contain explicit provisions allowing homebuyers to participate in resolution proceedings against real estate developers as creditors. Homebuyers and lenders have been in conflict over recovering their respective properties and debts from defaulting real estate developers for quite some time.


Allottee as a Financial Creditor


The rights of homebuyers within the framework of insolvency proceedings have been explored from time to time and especially after both 2018 & 2020 amendments in the Insolvency and Bankruptcy Code, 2016 (IBC, 2016), their status as an “allottee” under the Real Estate (Regulation and Development) Act, 2016, (RERA, 2016), has witnessed a significant change. Previously, homebuyers were considered 'other creditors' and not 'financial creditors' or 'operational creditors,' limiting their ability to initiate insolvency proceedings against a defaulting builder/developer as they were not legally entitled to any minimum payout in the corporate insolvency resolution process ("CIRP") of a real estate company.

The 2018 Amendment added an explanation to Section 5(8) (f) of the Code which stated that the homebuyers would be considered financial creditors because the amount they claim from these builders would be seen as financial debt and thus they are entitled to representation on the committee of creditors as well as can initiate the CIRP. Over 150 real estate developers had challenged the constitutionality of the aforementioned amendment before the Apex Court in the case of Pioneer Urban Land and Infrastructure Ltd. v. Union of India.


The Petitioner contended that the amendment violated Article 14, 19(1) (g) read with Article 19(6), 300 A of the Indian Constitution. The petitioner also contended that initiating CIRP would also lead to the duplication of remedies as the homebuyers already have recourses under the Consumer Protection Act of 1986 and the RERA, 2016, and also the allottees can also blackmail the developers by filing Section 7 petitions leading in the diversion of funds specifically allocated for the completion of the project. It was stressed that good management can be removed/replaced by an allottee turning a solvent company into an insolvent company and also emphasised that a single characteristic of the financial creditors as decided by the Apex Court in the case of Swiss Ribbons Pvt. Ltd. vs. Union of India didn’t apply to an allottee, further, RERA, 2016 should prevail as it is a specific act whereas IBC, 2016 is a general code.


The Supreme Court elaborated on the relationship between RERA and the IBC while affirming the constitutionality of the amendment. The Court explained the rationale behind the current amendment, as outlined by the Insolvency Law Committee, which established that the delays in delivery or possession by developers have become very regular. The Court held that “the sale agreement between the developer and the homebuyer has the commercial effect of a borrowing, thus the amount obtained from the homebuyers against consideration for the time value of money comes under the scope of financial debt u/s 5(8) (f) of the Code” and therefore, the homebuyers should be considered as financial creditors. The Court also emphasized that there has to be an establishment of an apparent case under Section 7 of the IBC by the homebuyer establishing the default on the part of the developer/promoter and the onus shifts to the developer/promoter to show that the concerned homebuyer is a defaulter and therefore is not entitled to any refund or compensation. The Court also stressed the point that the developers can point out the fraud & malicious intent of the buyers, which would come under the scope of Section 65 of the IBC. If the default is established under Section 65 of the IBC, the Adjudicating Authority may impose a penalty which is not less than one lakh rupees extending up to one crore rupees, leading to the dismissal of the liquidation process.


Misuse of Section 7, IBC 2016


The number of Homebuyers in a real estate project might range from hundreds to thousands. If a single Homebuyer, as a financial creditor, is permitted to commence an insolvency proceeding against the real estate developer, the rights of all other Homebuyers and creditors may be jeopardized. In order to prevent single Homebuyers from initiating insolvency proceedings, a suggested requirement for Homebuyers initiating insolvency proceedings under the Code was established. The Insolvency and Bankruptcy Code (Amendment) Act, 2020 ("2020 Amendment Act") stipulates that “at least 100 Homebuyers or 10% of the total Homebuyers of the same project, whichever is lower, may file an insolvency application against the real estate developer.” This was again contested before the Supreme Court in the case of Manish Kumar v. Union of India, in which the Supreme Court affirmed the introduction of this additional criterion by noting that permitting individual homebuyers to use the insolvency procedure would lead to misappropriation of the existing provisions.


A problem that has now come to the surface is that Homebuyers are initiating insolvency proceedings based on the aforesaid specified threshold and later dropping the case after resolving the dispute with the promoters of the real estate developer. This could impose enormous strain on the real estate developer and might prejudice the best interests of other creditors of the real estate developer who are not in favour of such insolvency proceedings.


In the case of Amit Katyal v. Meera Ahuja, the Supreme Court observed that if the withdrawal application of the homebuyer is rejected and insolvency proceedings are effectively continued, the Homebuyers, like all other creditors, will only be able to recover the payouts stipulated in the resolution plan authorized by the committee of creditors. Typically, resolution plans stipulate a substantial proportion of haircuts for all creditors, so severely decreasing their recoveries. Unlike other financial creditors like banks and financial institutions, the impact of such haircuts will be overly harsh and unfair for Homebuyers. It is pertinent to note that if the insolvency proceedings of the real estate developer fail, it will lead to the developer’s liquidation and homebuyers would mostly be the last stakeholder to get the proceeds from the sale of assets as the homebuyers are unsecured creditors. Secured financial creditors, employees, and workmen of the developer would be the first to receive the proceeds. Therefore, the Homebuyers would be at risk of losing their money, which would defeat the purpose of the 2018 Amendment Act, which was to safeguard, promote, and balance the interests of homebuyers.


Conclusion


The Apex Court has repeatedly emphasized that the Code is not a recovery instrument and that its purpose is to save failing enterprises by reviving them via the timely execution of resolution plans. It is notable that, if the real estate developer fails to deliver the unit or project within the agreed-upon timeframe, Homebuyers have access to more efficient recourses under the Consumer Protection Act, 2019, and RERA, 2016. Due to the inadequacies that have permeated the insolvency resolution process, any application filed by Homebuyers under the Code to rescue a real estate developer is a time-consuming activity that will, in the majority of cases, negatively affect all parties concerned with the real estate project, especially the Homebuyers.


Initiation of the insolvency proceedings against a real estate developer by the Homebuyers would have a negative impact on both the real estate developers as banks and other financial institutions may restrict access to financing, which in turn may negatively impact other projects and may cause the cash flow issues resulting in a solvent real estate developer becoming insolvent, and the Homebuyers who might confront even more delays in either getting their money back or receiving the property they dreamt of. In the benefit of the real estate sector, which involves the real estate developer, financial institutions with access to the real estate developer, and Homebuyers, the legislature may need to reconsider the position of the Homebuyers as financial creditors under the Insolvency & Bankruptcy Code.


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