Status of Homebuyers in IBC

By Shivanjali Shukla, Student at Jindal Global Law School

Introduction

The status of a home buyer in insolvency proceedings has been a contentious issue for the past couple of years. The matter holds a lot of significance since it involves the rights of the home buyers against the developers who are the corporate debtor in an insolvency proceeding. Under the current framework of The Insolvency and Bankruptcy Code (the Code), there are three categories of creditors: (i) Financial Creditor, (ii) Operational Creditor, and (ii) Other creditors. During the nascent stage of the Code, the homebuyers were neither considered as financial nor as operational creditors, on account of which they suffered huge losses for the advances made. However, in 2018 with the advent of the Insolvency and Bankruptcy Code, (Second Amendment) Act, 2018, the home buyers were conferred the status of ‘financial creditor’ wherein any amount which was raised from a real estate allottee was deemed to create a ‘commercial effect of borrowing’. Despite the amendment of 2018, the position remained unsettled and numerous changes were made time and again due to which the position of home buyers always remained unsettled. The present article tries to study the entire journey of home buyers under the Code till date, and analyse the effectiveness of the amendments made keeping in mind the homebuyers.

Meaning of financial and operational creditors

The Corporate Insolvency Resolution Process (CIRP) can be initiated by financial creditors and operational creditors. Section 5(20) of the Code defines ‘Operational Creditor’ as “any person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.” Simpliciter, their liability arises out of a certain transaction on operations. Further, in order to qualify as an operational creditor, the debt must be in the nature of operational debt defined under Section 5(21) of the Code which requires debt involving supply of goods and services or repayment of dues. On the other hand, under Section 5(7) of the Code, a financial creditor is defined as “a person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred.” A financial creditor also qualifies under Section 5(7) only after the debt falls under the category of financial debt under Section 5(8) of the Code. Supreme Court had in the case Swiss Ribbons Ltd. v. Union of India, further explained the concepts of financial creditor and operational creditors and distinguished between the same. The court had observed that, “A perusal of the definition of ‘financial creditor’ and ‘financial debt’ makes it clear that a financial debt is a debt together with interest, if any, which is disbursed against the consideration for time value of money. On the other hand, an ‘operational debt’ would include a claim in respect of the provision of goods or services, including employment, or a debt in respect of payment of dues arising under any law and payable to the Government or any local authority.” The court had also pointed out that the contracts involving financial creditors are commonly meant to assist the corporate debtor to either set up and/or operate its business. In contrast, operational creditors usually lend money so as to ensure supply of goods and services in the operation of business.

Judicial interpretation on the categorisation of homebuyers

The predicament of deciding the nature of home buyers has found its way to judicial bodies as well. Varied interpretations have been provided over the period of time which has worsened the existing dilemma, let alone solve it. While few cases consider home buyers to be operational creditors, others have also termed them as financial creditors. In Col. Vinod Awasthy v. AMR Infrastructure Limited, the main issue before the court was to decide whether a flat purchaser would fall under the definition of ‘operational creditor’, the  Tribunal dismissed the case at the admission stage itself and stated that the definition of operational debt only includes- ‘goods, services, employment and government dues’ which was further upheld in the case of Mukesh Kumar v. AMR Infrastructure Limited and Pawan Dubey and Another v. J.B.K. Developers Private Limited.

On the other hand, in Nikhil Mehta & Sons (HUF) v. AMR Infrastructure Limited, where the applicants had agreed to buy three units with ‘assured return’ through a sale-purchase agreement, the NCLT held that the contract had a ‘commercial effect of borrowing’ and the home buyer was categorised as ‘financial creditor’. It was observed that the transaction in this particular case was in the nature of loan and constituted ‘financial debt’ within the code. On appeal, NCLAT upheld NCLT’s observation. Apart from this, the common judicial trend has observed that if the amount taken by the developer from any home buyer has been shown under the head of borrowing in the financial statements, then that would make homebuyers ‘financial creditors.’

The issue again came up for discussion in the recent landmark case of Chitra Sharma v Union of India. The apex court decided not to follow the precedents and set a new benchmark. In this case, the real estate mogul Jaypee Infratech Limited owed around Rs. 15000 crores to the home buyers and around Rs. 10000 crores to the public sector banking. Although the company owed more to the home buyers, the banks had priority over home buyers as previously held by courts. The three-judges bench observed that, “This is a citizenry problem, a human problem of great magnitude. IDBI cannot be selfish. The homebuyers have invested their lifetime savings in these projects.” The court ordered to prepare a resolution plan which would also protect the interests of home buyers. Subsequently, the Insolvency and Bankruptcy Board of India amended the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“CIRP Regulations”) and introduced the concept of ‘other creditors.’ This new category of creditors could not initiate CIRP against the corporate debtor and was only allowed to file their claims.

2018 amendment

In 2017, the Insolvency Law Committee (“Committee”) was constituted under the Chairmanship of Sh. Injeti Srinivas, Secretary, Ministry of Corporate Affairs for the purposes of making recommendations to the government on issues arising from the implementation of the Insolvency and Bankruptcy Code 2016. The committee observed that the home buyers should be treated as ‘financial creditors since the nature of financing is quite unique in real estate projects and home buyers should be allowed to participate equitably in the insolvency proceedings. In the wake of this report, the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 was promulgated. This ordinance resulted in home buyers being classified as financial creditors and the amount paid by home buyers to real estate developers was considered to be financial debt.

The Pioneer Urban Case and the IBC ordinance 2019

The constitutionality of the 2018 amendment act was contested in the case of Pioneer Urban Land and Infrastructure Limited v. Union of India calling it violative of Article 14, 19(1)(g) r/w 19(6), and 300-A of the Constitution. It was argued that the consumer protection act and the RERA confer home buyers with enough remedies against real estate developers. However, the Hon’ble Supreme Court ruled in favour of home buyers and held that since the amount received by developers is done for profit-making, therefore it has a commercial effect of borrowing. Thus, homebuyers should be included in the ambit of ‘financial creditors.’

Although the Pioneer Urban case tried to settle the issue, there was still chaos among the real estate developers, which lead to another ordinance been passed in 2019. The Insolvency and Bankruptcy (Amendment) Ordinance, 2019 imposed a minimum threshold on the number of homebuyers who could initiate the insolvency process. The new rule imposed a requirement that the corporate insolvency process could be initiated against real estate developer only when the application has been filed by at least 100 allottees or a minimum of 10 per cent of the total allottees (whichever is less) against the corporate debtor. This was again challenged before the Supreme Court. The most recent position can be discussed with respect to the case of Manish Kumar v. Union of India where the SC had initially issued a stay order on the rule under the 2019 ordinance which dismissed the applications of the home buyers in the first stage itself if the minimum threshold requirement was not getting fulfilled which has been discussed in the next section.

The latest position- Manish Kumar and Others v. Union of India

In the case of the Manish Kumar and others vs Union of India, the verdict was a disappointing one for the home buyers. The case was filed by a group of allottees against the amendments to the Insolvency and Bankruptcy Code. It was contended by the petitioners that the second proviso to Section 7(1) of the code was violative of Article 14 and 21 of the Indian Constitution. While Article 14 allows for discrimination on the grounds of reasonable classification, the new amendment is violative of article 14 and since it creates a class under the category of financial creditors and that the state must show intelligible differentia for creating such a distinction. On the other hand, the State argued that the amendment act was constitutional and was part of an economic measure. Moreover, it was a measure to decrease the burden on the judiciary. The three-judge bench observed that if a single allottee is allowed to initiate a CIRP proceeding, it can jeopardise the entire project. Furthermore, the court said that in case of default on part of the real estate developer, the single allottee can alternatively approach consumer court and also RERA authorities instead of taking the recourse of IBC. With regards to the second amendment as well, the court dismissed the claims of the petitioners and held that the thirty-day time limit is not difficult to comply with. Collectively, the court held that the amendments had reasonable classification and it also had intelligible differentia and were therefore constitutional and valid.

Conclusion

While the recent amendment and the judicial trend seem tilted in the favour of real estate developers, it is of great significance to know and understand that the judgment in the case of Manish Kumar was a balanced one. While the homebuyers have been given the status of financial creditors, it was important to make sure that such a position was not misused. Huge real estate projects will always have some tussle with few homebuyers on the financial aspect. However, it is important to understand that the same shall not always lead a company towards CIRP. While the collective stance of the home buyers is respected, individual home buyers do have the alternative recourse of going through consumer courts and RERA. Thus, for now the position seems to have settled a bit but one never knows for how long, considering that the debate has been going for the past two years.

7 Replies to “Status of Homebuyers in IBC”

  1. Thus, in view of the above, it has been held by the court that home buyers deserve the same protection that other financial creditors enjoy under the IBC.

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