Home Construction IBC amendment: It’s effect on the Real Estate Developers
IBC amendment: It’s effect on the Real Estate Developers

IBC amendment: It’s effect on the Real Estate Developers

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Kshitij Sancheti,
partner.

Real estate for long has been considered the most beneficial and sought-after avenue for investors in India. After having witnessed ex-ponential growth over the past couple of decades, the market trends indicate that investment in the real estate has stagnated. Homebuyers were dissuaded from investing in real estate given the heavily delayed and terminally sick housing projects haemorrhaging their investments.                 

The recourses available to distressed home buyers was to either file a consumer complaint before the Consumer Disputes Redressal Forum or before Real Estate Regulatory Authority (RERA), wherein the relief al-though effective, would have taken years to receive. Thanks to the growing popularity of Insolvency and Bankruptcy Code (IBC) speedy re-lief given by the National Company Law Tribunal (NCLT), some home buyers decided to approach the NCLT, forcing the tribunal to decide whether a home buyer would qualify as an ‘operational creditor’ or ‘financial creditor’.  

The National Company Law  Appellate Tribunal (NCLAT)  held that home buyers were to be classified as ‘financial creditors’ due to the assured return scheme in the contract, in which there was an arrange-ment wherein it was agreed that the seller of the apartments would pay ‘assured returns’ to the home buyers till possession of property was given. It held that such a transaction was in the nature of a loan and constituted a ‘financial debt’ within the Code. Interestingly, the home buyers who had an assured returns clause in their agreement could file an insolvency petition and others could not. However, after initiation of insolvency process the other home buyers could submit their claim to the resolution professional.     

This conundrum was addressed by the Government by introducing the amendment no. 26 of 2018 vide The Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 on August 17, 2018, granting homebuyers also referred to as the ‘Real Estate Allottee’ (allottee) a status of “Financial creditor”. This amendment was a suggestion made by the Insolvency Law Committee in its report in March 2018.  An explanation was added to Section 5(8)(f) of the Code, clarifying that allottees are to be treated as financial creditors so that they can trigger the insolvency process under Section 7 of the IBC.             

The Code defines a financial creditor as anyone who has extended any kind of loan or financial credit to the debtor. Therefore, with the ra-tionale that the money raised from homebuyers is a means to finance construction, and therefore, ought to be treated as any other financial creditor. Further, by being considered as financial creditors, these allottees will be represented on the committee of creditors by an authorised representative who will vote on their behalf. This committee would be responsible for taking key decisions related to the resolution process, such as appointing the resolution professional, and approving the resolution plan to be submitted to the NCLT.  It also implies that real estate allottees can initiate a corporate insolvency resolution process against the debtor i.e. the real estate developers.            

The constitutional validity of this amendment was questioned and subsequently upheld by the Supreme Court (SC)  because the sale agreement between developer and home buyer would have the ‘commercial effect’ of a borrowing since money is paid in advance for temporary use so that a flat/apartment is given back to the home buyer, subsumed within the definition of ‘financial debt’ under Section 5(8)(f) of the IBC. Additionally, the SC also held that RERA has to be read harmoniously with the IBC and, in the event of a conflict, the IBC will prevail over the RERA.       

It is pertinent to note that the priority of the allottees is not clear in the event of liquidation under the Code. In case of liquidation, secured creditors are paid first after payment of the resolution fees and other resolution costs.  Secured creditors are those whose loans are backed by collateral (security).  This is followed by payment of employee wages, and then payment to all the unsecured creditors. While the Bill classifies allottees as financial creditors, it does not specify whether they would be treated as secured or unsecured creditors.          

During the course of the of hearings in the case, the SC’s attention was guided over the fact any “trigger happy” or disgruntled allottee, either with some malicious intent or himself being a defaulter, could initiate the insolvency proceedings before the NCLT.  

The developers in this case also argued that in a falling real estate market, the allottee may not want to go ahead with his obligation to take possession of the property under RERA and thereby might misuse the IBC as a coercive measure and get back the money already paid by them. They also contended that the case of home-buyers do not in-volve “debt”, there is no “borrowing”, there is no “disbursal” and no “sum raised”. The allottees ought to be deemed as operational credi-tors. Besides, there is already a special enactment, RERA, dealing with the issues surrounding home-buyers.

Mitali More,
Associate Settle Legal,
Advocates.

The SC has pertinently observed that apart from the aforesaid dis-charge of burden of proof, the real estate developer can also point out to the NCLT if the Corporate Insolvency Resolution Process (CIRP) has been invoked fraudulently, with malicious intent, or for any purpose other than the resolution of insolvency by the home buyer, the application for insolvency would fall within the ambit of Section 65 of the IBC. 

The SC bench noted that in such a case, the onus would be on the al-lottee to make out a prima facie case of default. Thereafter, the bur-den would be on the promoter/real estate developer to prove that the allottee is himself a defaulter and would, therefore, on a reading of the agreement and the applicable RERA Rules and Regulations, not be entitled to any relief including payment of compensation and/or refund, entailing a dismissal of the said application.    

This will give a huge arc of protection to builders whose defaults were involuntary or because of external incontrollable factors.

The new amendment although introduced with the intention of creat-ing safeguards for the allottee, also fails to address a few important aspects and gives rise to a whole new crop of issues. A few allottees triggering the IBC might affect and hamper the ability of the other al-lottees seeking possession of their apartment. The interest of an earnest developer and his operations will also get affected which may be otherwise healthy but in trouble due to market conditions.   

Therefore, this amendment although goes to give the allottees an op-tion to go forum shopping, it will certainly threaten the operations of real estate developers held hostage by malicious prosecution by trigger
happy allottees.

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