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Position of Home-buyers under the Insolvency and Bankruptcy Regime

Position of Home-buyers under the Insolvency and Bankruptcy Regime

Insolvency and Bankruptcy Code, 2016 [1] (hereinafter referred to as “The Code”) was introduced for several reasons. The primary reason was, to create an appropriate system for the insolvency process and reduce the time taken to conclude the same. Another reason was to provide an opportunity for the corporate debtor to redeem itself. The idea was not to drain the corporate debtor of all of its assets but to assist in reviving it in the best possible manner.

The Code has witnessed the introduction of numerous rules and regulations by the Insolvency and Bankruptcy Board of India [2] (hereinafter referred to as “IBBI”). It has also been amended since 2016, precisely three times [3]. For instance, the definition of Financial Creditors has always been in the centre of legal interpretation due to its wide spectrum of scope. A financial creditor can file an application for insolvency against a corporate debtor by the virtue of Section 7 of The Code.

An operational creditor must first send a demand notice to the corporate debtor u/s 8 and then after meeting the limitation period, can approach the adjudicating authority to apply. However, unlike operational creditors, a financial creditor can directly make an application to the adjudicating authority.

In the Second Amendment, 2018 [4], the code included another aspect to the scope of a financial creditor. Section 5 (8) (f) of The Code defines financial debt as a transaction of a sale or purchase which could be classified as borrowing having commercial effect. The amendment added an explanation to the abovementioned provision stating that an allottee of real estate project would fall under the said category.

The above-mentioned implied that an allottee of a real estate project or a home-buyer [5], could be considered to be a financial creditor. This further implied that an allottee would have a right to apply for insolvency against the real estate project on breach of agreement.

This particular provision of the second amendment was challenged in the landmark judgment of Pioneer Urban Land and Infrastructure v Union of India, WRIT PETITION (CIVIL) NO. 43 OF 2019 [6]. The abovementioned case was adjudicated by a three-judge bench.

The counsels for the petitioner argued on several grounds, few are summarized as below:
Violation of Article 14 (Right to equality) of The Constitution of India – The counsel argued that the amendment violated Article 14 as it does not contain intelligible differentia. The unequal were treated equally and equals unequally. The counsels contended that the amendment beat the core value of The Code which was to safeguard the corporate debtor. It could, lead to insolvency of a perfectly solvent company and ultimately winding up.

Violation of Article 19 (1) (g) (Right to practice any business) of The Constitution of India – The counsels contended that due to the arbitrariness of the amendment, the petitioner would be compelled to wind up its operations. Moreover, the amendment does not fall under the purview of reasonable restrictions. Thus, the amendment violates Article 19 (1) (g) of the petitioner.

Specific legislation already exists– The counsels argued that the amendment was unnecessary since a legislation solely dedicated to real estate already exists. The said legislation is the Real Estate (Regulation and Development) Act, 2016 (RERA). The legislation fundamentally deals with real estate division and provides remedies for disputes. Thus, an amendment in general legislation was redundant as RERA is already sufficient.

Does not fall under the characteristics drawn under Swiss Ribbon Case – The counsels argued based on the landmark judgment of Swiss Ribbon Pvt. Ltd. v Union of India, WRIT PETITION (CIVIL) NO. 99 OF 2018 [7]. They stated that allottees do not meet the characterizations of financial creditors laid in Swiss Ribbon case. Which confirms that the amendment is arbitrary.

Alongside the abovementioned arguments, inter alia, the counsels referred to case laws and drew comparative analysis of UNCITRAL Legislative Guide on Insolvency Law, 2005 and Bankruptcy Law Reforms Committee Report (2015) to state that the allottees could more proficiently fit in the category of operational creditors.

The counsels for the respondents responded with the appended arguments out of several others;
Amendment covered by Swiss Ribbon – The Additional Solicitor General (ASG) argued that the amendment is completely in compliance with the Swiss Ribbon case. It covers all the characterizations as laid down by the Court. In Swiss Ribbon the court stated that the legislature must have sufficient space to experiment with laws when it comes to economic legislations. The court stated that the legislature must have the freedom to do so and the judiciary must not interfere with the process.

Insolvency Committee Report – The amendment was ordained in pursuance of this report. The ASG states that the report states the accurate reason why allottees were included in the definition of financial creditors. It is because, in essence, the allottees finance the real estate project wherein they ultimately get an apartment. Operational creditors provide services and not investments, thus the allottees fit better in the category of financial creditors.

The Code is not a recovery mechanism – The ASG drew the attention of the court to the fact that The Code does not demand recovery from the corporate debtor, rather ensures to keep its operations as a going concern. The respondents would be ones who would have to wait out the entire insolvency process to get their share. They would not even be first in line for repayment out of all the creditors. The corporate debtor’s best interest would be kept as a priority.

Section 5 (8) (f) inclusive definition – The ASG argues that even without the explanation added by the amendment, the allottees would still include real estate agreements. The court after deliberation and hearing both the sides gave its ratio as appended;

Freedom of economic legislation – The court upheld the ratio of the same court held in Swiss Ribbon which stated that the legislature must have leeway to experiment when it comes to economic legislature. Keeping the constitutional validity aside, the legislature must have the freedom to devise economic legislature with the courtesy of the court.

Reason for the Second amendment – The court supported the resolution of the Insolvency Law Committee in its report found that over the past few years, delay in real estate project had become a trend. So much so that it was affecting the allottees financially. To curb the situation in hope of changing the trend, the amendment was brought into effect and allottees were drawn under the scope of financial creditors. This would by extension allow the allottees also to be a part of the Committee of Creditors.

Section 5 (8) (f) inclusion of allottees – The court held that the monies that are paid by the allottees raise the investment required by the real estate project. This amount which is raised and its utilization, automatically falls under the definition of financial debt even without taking into account the explanation. The explanation was added by way of amendment just to clear any doubts.

IBC over RERA – The court observed the conflict that arose between the applicability of RERA and IBC. The court noted that the second amendment was brought in force in 2018 which was much after RERA was executed. The parliament while devising the second amendment did take into consideration conflicts arising from RERA and applied the principles in a manner that it does not defy the said legislation.

The court noted that RERA would not be considered to be a special act and IBC would override it. In any case, both legislations operate in different areas, RERA safeguards the interest of investors and IBC focuses on rehabilitating corporate debtors.

Constitutionality of allottees as financial creditors – The court observed that it is not possible to classify real estate companies to have a construct built on intelligible differentia. It also stated that it is not justified to say the classification is substantially arbitrary because it does not hold any direct relation to the salient features of the Code.
The court provided the benefit of presumed constitutionality to the Insolvency Law Committee that conjured up the report. It states that the legislature while formulating the amendment appreciated and interpreted the requirement of the community and people at large.

Directions of the Court

• All states and UTs to appoint adjudicating officers (permanently), Appellate Tribunal and a Real Estate Regulatory Authority within 90 days of the judgment.

• The NCLAT and NCLT must be well-staffed to deal with cases arising out of the real estate sector by January 2020 (second week) [8].

• The stay orders already arranged would not have a retrospective effect until the application is reassessed by NCLT.

As of the present date scenario, the Parliament introduced a third amendment to the Code, The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019, wherein the legislators added a proviso to Section 7. The proviso requires for an application of insolvency filed by a creditor, including allottees, to be filed jointly. The joint application could be by either one hundred creditors of the corporate debtor or one-tenth of the total number of financial creditors [9].


Stages of Corporate Insolvency Process