3 May, 2018
India is witnessing a revolutionary moment in dealing with the problem of non-performing assets and rescuing companies which have become such non-performing assets. As is usual, any such revolution, will be accompanied by uncertainty and opposition, even if such changes are brought about by a statute which is enacted by the Parliament. The Insolvency and Bankruptcy Code, 2016 (Code), is such a revolutionary law. The Code in its very short life of about fifteen months has faced various challenges. Some of these were dealt by the judiciary and the others through ordinance and amendments to the Code. However, as the success of the Code depends of the actual rescue of the distressed corporate debtor, the Government of the day has been trying to further streamline and strengthen the corporate insolvency resolution process. A 14-member Insolvency Law Committee (Committee) was formed in November 2017 to review the Code. The Committee has recently released its report (ILC Report) suggesting noteworthy amendments to the Code and various other Regulations framed thereunder.
One of the crucial issues which has been highlighted by the Committee in the ILC Report relates to the status of buyers of under construction apartments as creditors under the Code. The existing jurisprudence on the subject indicates that the home buyers do not fit within the definition of ‘financial’ or ‘operational’ creditors. It was discussed by the Committee that the home buyers fund a significant part of the construction of projects and therefore, the amounts so raised should be classified as financial debt. It was analyzed by the Committee that the current definition of financial debt is sufficient to include the amount raised from home buyers and the same just needs to be clarified in the Code so that such home buyers have an equitable right to participate in the insolvency resolution process of a corporate debtor. Accordingly, the ILC Report recommends classification of such home buyers as financial creditors under the Code, which will inter alia allow them to initiate corporate insolvency resolution process (CIRP) against a corporate debtor, participate in the meetings of committee of creditors (CoC), and the guarantee of receiving at least the liquidation value under the resolution plan.
In the case of Jaypee Infratech Limited, a real estate company, which involves almost 40,000 home buyers being adversely affected due to the admission of the company in CIRP, the Hon’ble Supreme Court of India had directed the interim resolution professional to make necessary provisions to protect the interests of the home buyers and appointed a representative to participate in the meetings of the CoC to espouse the cause of the home buyers. In Nikhil Mehta and sons v. AMR Infrastructure Limited, the National Company Law Appellate Tribunal held that the home buyers will be treated as financial creditors, however the same was due to specific clauses in the agreement. Requisite clarification was therefore sought from the Committee in light of the ambiguity in treatment of home buyers under the Code.
In our view, the recommendation of bringing home buyers at par with other financial creditors may not be the best solution to protect their interests, especially keeping in view that they are protected under other laws such as the newly enacted Real Estate (Regulation and Development) Act, 2016 (RERA). RERA, which inter alia lays down the framework governing real estate developers, was enacted to safeguard the interests of the home buyers especially in the primary market, given the general practice of unilateral structuring of contracts for sale of properties by the construction companies. Furthermore, the provisions of Consumer Protection Act, 1986 also allow the aggrieved home buyers to approach the Disputes Redressal Commission having relevant jurisdiction for their disputes with the developers. The Supreme Court of India has also held that in case of a disagreement with a real estate developer, individual buyers can move a group complaint before the National Consumer Disputes Redressal Commission directly if their cumulative claim falls within its jurisdiction.
As per the provisions of the Code, once the CIRP is triggered vis-à-vis a corporate debtor, the home buyers can file their claims to the insolvency resolution professional (IRP). However, currently there are no provisions in the insolvency law which allow them to have a say in approving the final resolution plan for the corporate debtor. The Committee acknowledged that a corporate debtor having a large number of financial creditors, such as home buyers, would face practical challenges in ensuring their participation in the CoC meetings. Accordingly, it was proposed that an insolvency professional (other than the IRP) shall be appointed by the insolvency court, i.e., the National Company Law Tribunal on the request of the IRP, to act as the authorized representative of the home buyers, thereby restricting their discretion in appointing their own representative. The ILC Report further provides the manner in which an authorized representative can act and attend such meetings on their behalf. As per the ILC Report, the authorized representative shall vote on behalf of the financial creditors to the extent of the voting share of each such creditor, and as per their instructions. Since a real estate company is likely to have a large number of home buyers as compared to financial institutions, seeking instructions from each one of them would probably result in delaying the entire rescue process especially on grounds of divergence of views and interests inter se home buyers and varied interest between financial institutions and home buyers.
It may be contended that if the proposal for treating home buyers as financial creditors is accepted, the consequent representation of home buyers on the CoC may frustrate the object of the corporate insolvency resolution process, i.e., rescuing the defaulting borrower within a time bound manner. The very objective of the CoC meetings is to have constructive decision-oriented discussions for revival of the corporate debtor and the home buyers may not be able to appreciate the commercial perception of the other financial creditors on the CoC. In other words, the home buyers are likely to be more concerned about getting possession of their property or return of their entire capital with cost of capital, which may not be possible under a rescue process. As is visible in most of the rescues that have taken place, financial creditors have accepted to take significant hair-cuts in rescuing the defaulting corporate debtor. A home buyer having invested substantial part of his/her life savings, may not agree to any such hair-cuts or a limited financial solution to the problem. Further, keeping this view, banks and financial institutions may not be incentivized to initiate proceedings against residential real estate developers as the participation of home buyers in the rescue process may significantly jeopardize the decision-making ability of other financial creditors.
Another ramification of this proposal may include deterrence of the prospective investors as getting the resolution plan approved by the CoC will become difficult unless some sort of concrete relief is provided to the home buyers, which may differ from the relief being provided to the other financial creditors. The prospects of litigations and the courts being supportive of the cause of home buyers may substantially increase the risk of prospective investors.
Considering the challenges discussed above and to keep the Code sector neutral, we are of the view that the Code should, as an alternate to treating home buyers as financial creditors, provide for protection of their interest by ensuring that the haircut, if any, that is required to be taken by home buyers cannot be below the haircut taken by any other key stakeholders, such as, secured financial creditors or employees. Further, as the home buyer may be more interested in getting possession of the property, a prospective investor may be required to include in its rescue plan, the extended timeline for delivering such homes to the home buyers.
The ILC Report provides that the home buyers will fall within the relevant entry in the liquidation waterfall under the Code. However, the place of the home buyers in the waterfall structure has not been clarified. In our view, to protect the home buyers in a liquidation situation, home buyers should be placed higher than the unsecured creditors and be given a priority status at par with secured creditors and workmen’s dues so that their interests are protected to the extent of the other key stakeholders.
Although it appears that the proposed recommendation has been made in consonance with one of the underlying objectives of the Code to balance the interests of all the stakeholders, treatment of home buyers as financial creditors and consequent representation on the CoC may not achieve the key purpose of the Code, i.e. to rescue a defaulting corporate debtor. Hopefully, the Government will soon take an informed decision on the recommendations keeping in mind the consequences which may follow.
For further information, please contact:
Souvik Ganguly, Partner, Acuity Law
al@acuitylaw.co.in
