Supreme Court upholds IBC amendment on homebuyers as financial creditors

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Supreme Court upholds IBC amendment on homebuyers as financial creditors
16 Aug 2019

Introduction

On 9 August 2019, the Supreme Court of India (‘SC’) has pronounced its judgment in a matter which will have significant implications on the rights of home buyers (‘Judgment’).

The Judgment went into examining the constitutional validity of certain amendments made to the Insolvency and Bankruptcy Code, 2016 (‘IBC’) by the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 (‘Amendment Act’).

The SC upheld the constitutional validity of the provisions under challenge. Consequently, allottees in real estate projects (‘Homebuyers’) shall be treated as ‘financial creditors’ under the IBC. The allottees shall be entitled to invoke the provisions of the IBC and initiate the corporate insolvency resolution process against real estate developers.

Background

For a better understanding of the Judgment, it will be helpful to understand the jurisprudence behind the law involved.

The genesis of the matter before the SC arose from 3 (three) previous judicial decisions. In the first, the National Company Law Appellate Tribunal (‘NCLAT’) held that the amounts raised from Homebuyers by developers under ‘assured return schemes’ had the ‘commercial effect’ of a borrowing. As a result of this, Homebuyers would fall within the purview of the definition of ‘financial creditors’ under the IBC.

In the other two decisions (of the SC), orders were passed wherein the Homebuyers were allowed representation in the meetings of the committee of creditors constituted under the IBC.

The Insolvency Law Committee was also constituted and came out with its report on 26 March 2019. This report recommended the inclusion of Homebuyers as financial creditors under the IBC. On the basis of this report, the Government promulgated the Insolvency and Bankruptcy Code Amendment Ordinance, 2018 and once parliament was in session, enacted the Amendment Act which amended sections 5(8)(f), 21(6A) and 25A of the IBC.

It was in light of this context, various writ petitions were filed before the SC challenging the constitutional validity of the various amendments made to the IBC by the Amendment Act. All these matters were combined and were heard as a single matter.

The Judgment

The SC analyzed the arguments put forth by the parties involved and decided that the provisions of the Amendment Act under challenge were not violative of the Constitution of India. The rationale employed by the SC in determining various facets of the challenge is set out below:

  • The rationale behind the amendments to the IBC: The SC relied on the report of the Insolvency Law Committee and the reasons contained therein for justifying the inclusion of Homebuyers as financial creditors under the IBC.

The SC agreed with the rationale of the Insolvency Law Committee that in light of the significant delays in completion of flats/ apartments that have now become commonplace and the fact that substantial amounts are raised from the Homebuyers by errant developers, the Homebuyers deserve to be financial creditors and have a place in the committee of creditors of the developer.

  • Interplay between the IBC and the RERA: The SC considered the provisions of the IBC and the Real Estate (Development & Regulation) Act, 2016 (‘RERA’), with particular reference to sections 88 and 89 of the RERA and section 238 of the IBC. Based on its reading of the non-obstante clause in both enactments and the wording contained in section 88 of the RERA, the SC concluded that it was difficult to consider the argument of the Petitioners that the RERA was a special statute that had precedence over the IBC (which was a general statute).

The SC held that the remedies to Homebuyers under the IBC were in addition to the remedies available to them under the RERA.

  • Challenge basis Article 14 (on the ground of discrimination) of the Constitution: The SC considered the argument that the provisions of the IBC were discriminatory. After consideration, the SC rejected the argument of discrimination relying on the principles of law that apply when challenges are made against laws on account of discrimination. A notable observation of the SC in this regard was that in relation to economic legislation, the legislature has the liberty to conduct experiments in the public interest.

The SC also held that the Homebuyers can be equated with other individual financial creditors such as debenture holders and fixed deposit holders.

  • Challenge basis Article 14 (on the ground of arbitrariness), Article 19(1)
  • and Article 300- A of the Constitution: The SC rejected the challenge that Homebuyers actually fall within the parameters of an operational creditor as opposed to a financial creditor as set out therein.

The SC has taken the view that the IBC is a beneficial legislation as the underlying intent is to ensure that the existence of the corporate debtor (that is, the real estate developer) is continued and eventually the Homebuyers either receive their units or compensation for the money paid by them. In light of this the SC was of the view that the inclusion of Homebuyers within the meaning of financial creditors was not manifestly arbitrary.

  • Challenge to section 21(6A) and 25A of the IBC: The SC considered the argument that given the different and sometimes conflicting interests of Homebuyers, they cannot be said to be a homogenous class. In such a situation, the process of voting on their behalf by a representative at the committee of creditors would not be fruitful.

After consideration, the SC took the view that this argument was unsustainable in light of the insertion of section 25(3A) to the IBC through the recent amendment, which clarifies the manner of voting by an authorized representative in the committee of creditors.

  • Reading down the provisions of the IBC: The SC considered the argument that in the event that the constitutional validity of the provisions of the Amendment Act are upheld, certain provisions need to be ‘read-down’ or diluted in their application in order to conform with Articles 14, 19(1)(g) and 300-A of the Constitution. The SC rejected this argument on the ground that as the provisions have been held to be valid, there is no need for any ‘reading-down’ of any provision.
  • Interpretation of section 5(8)(f) of the IBC: Last, the SC went into the argument that section 5(8)(f) as it stood prior to the insertion of the explanation through the Amendment Act was exhaustive in nature and that its meaning was to be understood on the basis of the other clauses of section 5(8). In doing this, the SC looked into the proposition that the basic ingredient for a financial debt was the existence of a loan of money made with or without interest, that had to be returned as money.

The SC disagreed with this contention and took the view that section 5(8)(f) was always intended to be a residuary section and subsumed within it all transactions that did not fall within the purview of the other subsections of section 5(8). The SC also stated that there is no requirement for the debt to be returned in the form of money (as is the case with ‘classic’ lending), as long as the money lent has the commercial effect of a borrowing. The SC reasoned that it is the Homebuyers who advance money to real estate developers as a loan to construct the project.

Further, the SC also held that the explanation inserted to section 5(8)(f) was merely clarificatory in nature and even without the addition of the explanation, the section already covered within its ambit the financial debt owed to Homebuyers by real estate developers.

Key implications for real estate developers

The Judgment has now put beyond doubt that Homebuyers are to be treated as financial creditors under the IBC. This means that Homebuyers will now be entitled to invoke the corporate insolvency resolution process set out in the IBC under section 7, by means of an application to the National Company Law Tribunal. However, the admission of the application made by the Homebuyer would be subject to the satisfaction of the National Company Law Tribunal based on the evidence of default furnished by the Homebuyer.

The Judgment opens the door for the Homebuyers to consider 3 (three) modes of recourse against errant real estate developers – under the RERA, under the IBC as well as under the Consumer Protection Act, 1986. These remedies that are provided to the Homebuyers are independent of each other and can be pursued by the Homebuyers as per their choice.

Whether Homebuyers will approach the NCLT under the IBC as their first resort remains to be seen given that the IBC is not for recovery of individual debts, but for the overall resolution of insolvency of a corporate debtor. Accordingly, the initiation of the process under the IBC does not guarantee the Homebuyer that he will receive any payment in respect of the amounts due to him. Homebuyers are likely to approach the NCLT under the IBC only when there is no hope of receiving the possession of their units or for the return of their money.

In case the insolvency resolution process is initiated, a real estate developer may still be able to avoid the entire process by offering a solution to the Homebuyers who can then withdraw their application before the NCLT in terms of section 12A of the IBC. Further, the Judgment also notes that in case of a triggering of the IBC, the erstwhile management of the real estate developer may, (subject to the qualifications set out in section 29A), submit a resolution plan which can then be voted upon by the committee of creditors.

Conclusion

The Amendment Act is a welcome change with regard to the law for specific relief. It has made the Act more specific, direct and clear.

The provisions have been carefully drafted so as to maintain the balance of interests of the parties. It not only makes specific performance a rule but also provides for an added remedy of substituted performance. Further, the Amendment Act provides for the designation of special courts and disallows the grant of injunction in relation to infrastructure projects in order to avoid delays.

All the amendments have thus been added to make the law consonant with the current industrial requirements, economic development and to facilitate ease of doing business in the country.