The present article is written by Adv. Radhika Roy who practices at Delhi High Court and Supreme Court of India.
The recent Supreme Court judgement dated August 9, 2019[i] has become the nouveau bone of contention in the country. Disposing off a batch of 180 petitions, Justices R.F. Nariman, Sanjiv Khanna and Surya Kant, delivered a momentous decision declaring the 2018 amendments made to the Insolvency and Bankruptcy Code, 2016 (hereinafter, “the Code”), specifically the Explanation added to Section 5(8)(f), as constitutional, thereby deeming allottees of real estate projects to be “financial creditors” under Section 7 of the Code. In order to comprehend the import of this decision, one must delve into the history of the amendment of the Code and therefore, understand the context regarding its promulgation.
THE ADVENT OF HOMEBUYERS
The Insolvency and Bankruptcy Code, 2016 was brought into existence on May 26, 2016 and was an attempt to synthesize the various legislative frameworks that existed for resolution of insolvent and bankrupt entities in a time-bound manner. It has already been subjected to three bouts of amendments, the most controversial of it being the one taking place in 2018, pursuant to the recommendations stipulated in the Insolvency Committee Report[ii] dated 26th March, 2018.
On 21st July, 2017, the National Company Law Appellate Tribunal (hereinafter, “NCLAT”), held that amounts raised by developers under assured return schemes retained the status of “commercial effect of a borrowing”. This was apparently evident from the annual returns of the developers as the amount raised was displayed as “commitment charges” under “financial costs”. As a result, allottees were held to be “financial creditors” within the meaning of Section 5(7) of the Code as a “financial debt” was owed to them as per Section 5(8).
In August 2017, Jaypee Infratech was taken to the NCLT Allahabad Bench by a bank under Section 7 of the Code. In the Order that was passed by the Apex Court[iii] in the following month, a representative was appointed on behalf of the home buyers to participate in the Committee of Creditors (hereinafter, “CoC”). Post the Order dictated for Jaypee Infratech, along with Amrapali, the Insolvency Committee Report was released, and it was the recommendations of this Report which were subsequently adopted in the Amendment.
WHAT DOES THIS AMENDMENT ENTAIL?
Before we proceed, we must take into account the waterfall mechanism enumerated under Section 53 of the Code which provides for the order of distribution of money from the sale of liquidation assets amongst the stakeholders in such proceedings. As per this waterfall mechanism, when a company is liquidated, the money recovered from the selling of assets is distributed amongst the creditors. First in line are the secured financial creditors such as banks, then there are unsecured financial creditors and, so on. More often than not, the creditors who are not secured financial creditors are deprived of their chance to receive anything. The Insolvency and Bankruptcy (Second Amendment) Act, 2018 allows for clarification of the definition of “financial creditor” by encompassing the term “allottees” under it, thereby giving them a fair chance to receive their dues as well as to be represented on the CoC.
Section 7 of the Code allows for a financial creditor to file an application (either individually or jointly) in NCLT for initiating the corporate insolvency resolution process against a defaulting company. By way of the insertion of the Explanation to Section 5(8)(f) and thus, clarifying that homebuyers are financial creditors, the Code now gives the power to the homebuyers to initiate an insolvency resolution process, be represented on the CoC, and to possess a guarantee of receiving a certain amount in case of liquidation.
First and foremost, the term “allottee” has been defined in Section 2(d) of the Real Estate (Regulation and Development) Act, 2016 (hereinafter, “RERA”). In addition to the above, Section 18 of RERA gives the allottees the right to demand a refund of the entire amount paid by the allottees as well as any interest to be claimed for delayed possession.
While the judgement dictates for a harmonious reading of both the Code and RERA, it has also dictated that in the event of a conflict, the role of RERA would be subservient to that of the Code.
The argument advanced on behalf of the Centre is quite odd. It is stated that “the Code is not a recovery mechanism”; it remains ambiguous whether the recovery of the Company or the recovery of the creditors is being referred to here. The other argument that is stated is that the crevices in the Code which do not allow for the full recovery of the monies of the homebuyer are pinpointed. While RERA specifically provides a provision for the grievance redressal of the homebuyers, the Code gives primacy to the health of a company. Therefore, the need to encompass homebuyers as financial creditors seems prima facie redundant. A multiplicity of legislation will only lead to multiplicity of hardships for the common man.
At this point, an aggrieved homebuyer possesses three options of recovering their losses – vide the Code, RERA as well as the Consumer Protection Act. Section 19 of RERA enumerates the rights and duties of an allottee. It delineates the refund of the amount paid by the allottees along with interest in accordance with the terms of the agreement for sale.
However, the judgement states that as the Code was promulgated subsequently, it has an overriding effect as it is assumed that the Parliament had been aware of the earlier Act. The problem arises wherein it is stated that RERA is for an individual allottee’s benefit, while the Code allows a disgruntled allottee to file an application for insolvency resolution if there exists any issue with the management. The judgement fails to consider the knowledge of an average allottee when it comes to the working of a company and that their need to trigger the Code is limited to their share of the financial debt. Therefore, providing an allottee with the power to initiate an insolvency resolution proceeding is quite misplaced and unnecessary.
Second, the number of homebuyers in any given case can range from hundreds to thousands. For instance, in the Jaypee Infratech case, 25000 homebuyers were left in the lurch and were afflicted by the resolution process. The status of a “financial creditors” entails being represented in the Committee of Creditors in order to safeguard their interest.
Fortunately, The Amendment Bill passed in 2019 specifies that, in cases where the debt is owed to a class of creditors beyond a specified number, the opportunity to be represented on the CoC by an authorized representative exists. This representative will vote on the basis of the decision taken by a majority of the voting share of the creditors they represent. This is a welcome change as there was always the possibility of representatives of financial creditors such as banks, hijacking the CoC.
However, the problem that may arise in the instant case is the confliction of views, which is bound to crop up in situations involving a large number of people. Homebuyers largely form an unorganized sector. There exists a possibility that quite a few homebuyers may not have their problems addressed in a proper manner, thereby rendering the very purpose of safeguarding the interests of homebuyers in jeopardy. It could lead to an unequal or non-redressal of grievances, and thereby aggravate the situation with excessive delays.
In order to remedy the same, before homebuyers enter the real estate market, there must exist a provision for the appointment of a representative and an estimated allocation of funds in the event of liquidation, that can be agreed upon by the homebuyers. This could reduce unnecessary hardships at a later stage and additionally, allow for quicker facilitation of the insolvency resolution process.
Third, the ambiguity revolving around whether homebuyers are secured financial creditors or unsecured financial creditors remains, and therefore, has an important implication on the priority of payments upon liquidation. This poses a Catch-22 situation wherein categorizing homebuyers as secured financial creditors can lead to unequal equality, and thereby can force banks to raise their recovery rate and thus, cause problems related to financing the project for both real estate developers as well as the allottees, or it could categorize homebuyers as unsecured financial creditors, thereby keeping the stability of their recovery in a limbo. The judgement should have clarified the same as it can lead to problems at a later stage.
Fourth, one can observe a trend of socialism emerging in the judicial pronouncements with respect to the Code. Along with this judgement, the 2019 Amendments have also been challenged, and Justice Nariman has noted the discrimination that might exist against operational creditors on account of a CoC comprising only of financial creditors. In the case of Essar Steel, the resolution plan submitted by ArcelorMittal was rejected as the CoC had decided that the financial creditors would get 90% of their claims while operational creditors would get 10%.
While the zeal to equate all creditors, financial and operational, is commendable, it fails to consider that the differences exist for a very important reason. It not only violates Article 14 of the Constitution by disregarding intelligible differentia, but it also fails to display a nexus of the Amendment with the object sought to be achieved by the Code. Turning a blind eye to the security interests of financial creditors can lead to a downfall in the recovery rate of banks and financial institutions. Lack of stability in receiving returns can lead to stricter norms for disbursement of loans, thereby lowering the ease of doing business. There is a possibility that interest rates on home loans could increase, in order for banks to protect their own interests when pitted against those of a homebuyer.
In addition to the above, the object of the Code is pertinent to note here. The Code was promulgated for the resuscitation of ailing companies. Winding up of companies have always had a negative impact on the economy of the country. By recognizing the deficiencies in the management of a company and trying to rectify the same, the CoC’s primary duty was to revive the institution. However, as homebuyers have now been clubbed under the head of financial creditors, and being individuals who are primarily watching out for their own self-interests, the company might come under the hammer. Homebuyers, in a practical sense, will not be concerned with the revival of a company, thereby defeating the very object of the Code.
One must keep in mind that the Code was promulgated as India had the slowest rate of insolvency resolutions as per figures released by the World Bank. It takes a minimum of 4.3 years for the entire process to unfold and unfurl. Despite the time-bound manner in which the Code was supposed to regulate the functioning of such resolutions, there has been no significant improvement as such.
In the case of Swiss Ribbons v. Union of India[iv], the constitutionality of the Code was upheld on the foundation that legislature must be allowed a certain degree of deference by the courts when it comes to economic legislation. The 2018 Amendment was upheld as constitutional on the basis of this judgement. It must be noted, on the contrary, that when it comes to economic legislation, it is highly important to exercise caution. Trial and error cannot be the norm when it comes to the economy as people’s livelihoods depend on it. Experimentation, while commendable at certain junctures, cannot be done when it entails playing with the lives of the common man. However, this Amendment came at an opportune moment and was specifically inserted for the common man and to appease middle-class voters ahead of the 2019 elections. Therefore, it is hard to assess whether the Amendment was for the benefit of the economy as a whole, or was a populist move.
While the move to allow for a representative of the allottees on the CoC gives way to fair representation, providing an allottee the power to decide whether the management of a company needs to be overhauled is unnecessary and does not benefit either the real estate developer or the allottee at the end of the day. In conclusion, in order to benefit the allottees, a specific time-bound and simplified legislation must be enacted, or RERA must be amended, so as to prevent speculative investment on behalf of the allottees and to protect them as well as the developer in the long run.
[i] Pioneer Urban Land & Infrastructure Limited & Anr. v. Union of India & Ors, Writ Petition (Civil) No. 43 of 2019
[iii] Chitra Sharma & Ors. V. Union of India, Writ Petition (Civil) No. 744 of 2017
[iv] (2019) 4 SCC 17