Changing Positions of ‘Home-Buyers’ Under Insolvency and Bankruptcy Code, 2016: Marred with Uncertainty

A Glance At The Predicament Of Real-Estate Sector

Delay in completion of under-construction apartments has become a common phenomenon in contemporary India. The records indicate that out of 782 construction projects in India monitored by the Ministry of Statistics and Programme Implementation, Government of India, a total of 215 projects are delayed with the time overrun ranging from 1 to 261 months.[1] Delays in projects have a direct bearing on the overall cost of construction. For example, from 2010 to 2015, the cost of cement (per bag) increased by 74%, steel increased by 34%, bricks increased by 69%, sand increased by 240% and skilled labour (on a per day basis) increased by 96%.[2] It is therefore, understandable, that the cost overrun in delayed projects has resulted in approx 24.77% increase in the original cost of the projects, amounting to Rs. 1,09,359 crore.[3] Delays in a project also increase the likelihood of disputes between the parties and needless to say, these disputes have derailed the projects and thus the average duration for settlement of disputes is more than 7 (seven) years in India.[4]

Another study released by the Associated Chambers of Commerce and Industry of India, revealed that 826 housing projects are running behind schedule across 14 states as of December 2016.[5]

Position of home-buyers as creditors priorthe insolvency and bankruptcy code (second amendment) act, 2018:

Prior to the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, there was no clarity regarding the rights of home-buyers, neither as financial creditorsnor as operational creditors under Insolvency and Bankruptcy Code, and 2016 (hereinafter referred to as “Code”).[6] Thus, home-buyers were unable to assert their rights for initiating an insolvency resolution process and participate in Committee of Creditors (CoC). This ambiguity enabled real estate developers to continuously evade the claims of home-buyers.

The prolonged plight of these home-buyers in an on-going dispute before the Supreme Court, Chitra Sharma vs. Union of India,[7]and similar concerns faced by the customers of Amrapali Group[8] of companies depicted that the interest of these stakeholders needed to be addressed. The home-buyers raised claims for refund of INR 100 billion (USD 1.5 billion) against JaypeeInfratech Limited (“JIL“), being the subsidiary of the JaiprakashAssociates Limited (JAL) due to non-allotment of 24,125 apartments. Herein, the aggregated claim value of home-buyers was almost equivalent to that of the financial creditors. Yet due to lack of safeguards or substantial provisions under the Code in that regard, there was no locus standi of the home-buyers to approach the court for claiming their interest on the under-construction flats. In that light Rule 9-A along with Form F of the Insolvency and Bankruptcy Board of India (Insolvency Resolution of Corporate Persons) Amendment Regulations, 2017 came into effect and another “class of other creditors” was included to safeguard the interest of the homebuyers as other class of creditors where they are neither classified as financial creditors nor operational creditors.[9]Considering the nature of transactions that occur between these homebuyers and the developers and owing to the unique nature of financing in real estate projects, serious inadequacy was felt as they were only classified under “class of other creditors”.

Effect of non-inclusion led to serious uncertainty:

The non-inclusion of home buyers within either the definition of ‘financial’ or ‘operational’ creditors caused worry since it deprives them of, first, the right to initiate the corporate insolvency resolution process (“CIRP”), second, the right to be on the committee of creditors (“CoC”), and third, the guarantee of receiving at least the liquidation value under the resolution plan.

Multiple judgments have categorized these homebuyers as neither fitting within the definition of ‘financial’ nor ‘operational’ creditors.[10]In one particular case,[11] they have been classified as ‘financial creditors’ due to the assured return scheme in the contract, in which there was an arrangement 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 was held that such a transaction was in the nature of a loan and constituted a ‘financial debt’ within the Code.

Considering the above scenario the absolute need to categorize and bestow a significant position on these homebuyerswas recognized by the Insolvency Law Committee in March, 2018. The Report of the Insolvency Law Committee[12] agreed that amounts raised under home buyer contracts is a significant amount, which contributes to the financing of construction of an asset in the future and intended to recommend that home buyers should be treated as financial creditors.The Committee also noted to the fact that significant confusion had arisen regarding the status of buyers of under-construction apartments (“home buyers”) as creditors under the Code. Then ultimately by virtue of the Insolvency and Bankruptcy (Second Amendment) Act, 2018 these homebuyers were categorized as financial creditors by inserting the “Explanation” clause under Section 5(8)(f)of the Code.

The rationale behind inclusion of “explanation” clause under section- 5(8)(f) of the code.

Section 5(8)(f) of the Code defines ‘financial debt’ to mean a debt along with interest, if any, which is disbursed against the consideration for the time value of money and inter alia includes money borrowed against payment of interest, etc. The current definition of ‘financial debt’ under section 5(8) of the Code uses the words “includes”, thus the kinds of financial debts illustrated are not exhaustive.[13]  The phrase “disbursed against the consideration for the time value of money” has been the subject of interpretation only in a handful of cases under the Code. The words “time value” have been interpreted to mean compensation or the price paid for the length of time for which the money has been disbursed. This may be in the form of interest paid on the money, or factoring of a discount in the payment.

On a plain reading of section 5(8)(f), it is clear that it is a residuary entry to cover debt transactions not covered under any other entry, and the essence of the entry is that “amount should have been raised under a transaction having the commercial effect of a borrowing.” An example has been mentioned in the entry itself i.e. forward sale or purchase agreement. The interpretation to be accorded to a forward sale or purchase agreement to have the texture of a financial contract may be drawn from an observation made in the case of Nikhil Mehta and Sons (HUF) v. AMR Infrastructure Ltd.:

A forward contract to sell product at the end of a specified period is not a financial contract. It is essentially a contract for sale of specified goods. It is true that some time financial transactions seemingly restructured as sale and repurchase. Any repurchase and reverse repo transaction are sometimes used as devices for raising money. In a transaction of this nature an entity may require liquidity against an asset and the financer in return sell it back by way of a forward contract. The difference between the two prices would imply the rate of return to the financer.

(Emphasis Supplied).

Thus, not all forward sale or purchase are financial transactions, but if they are structured as a tool or means for raising finance, there is no doubt that the amount raised may be classified as financial debt under section 5(8)(f). Drawing an analogy, in the case of home buyers, the amounts raised under the contracts of home buyers are in effect for the purposes of raising finance, and are a means of raising finance. Thus, the Committee deemed it prudent to clarify that such amounts raised under a real estate project from a home buyer fall within entry (f) of section 5(8).

Present scenario:

Along with other obstacles in effective implementation of the Code, the issue of the deprived home-buyers has been quite critical as massive protests and extensive litigations are witnessed. The present situation considering the position of these homebuyers is still undergoing a lot of skepticism. The projects intended to be delivered are being continuously delayed as understood from the closely monitored annual record of the Ministry of Statistics and Programme Implementation, Government of India.[14] The delays could be common and would arise because of various possibilities and not merely with the motive to defraud. The real estate sector will be doomed if all the homebuyers would approach the builders for their demands and therefore there has to be a balance maintained between a mere delayed projects but solvent builders and legitimate claims for insolvency against the builders, who are indeed insolvent.

Furthermore, the Hon’ble Supreme Court has stayed the proceedings before the NCLT in case of homebuyers claim so as to reevaluate and reconsider the constitutionality of the amendment in Section 5(8)(f) of the Code. A writ petition in the matter of Pioneer Urban Land and Infrastructure along with other tagged matters have been filed before the Hon’ble Supreme Court challenging the constitutional validity of the same amendment which has declared the home-buyers as financial creditors.[15]

Thus, needless to say that the Code is still a work-in-progress and the resolution processes of the companies currently under insolvency present a shambolic picture and more clarity on the position of these homebuyers with regard to insolvency proceedings would come into light only after the authoritative declaration of law by the Apex Court in the aforesaid case. The buyers have a glimmer of hope of the rehabilitation of the builders who could ensure delivery of flats much to the delight of the buyers. To conclude, the amendment has given some relief to homebuyers though not in entirety. However, the overall strictness in the regulatory environment would make things difficult for the unscrupulous builders, and this industry would view significant structural changes and consolidation in the medium to longer term. One significant change that has already occurred is the increase in demand for completed inventory as compared to under-construction/ yet to be constructed inventory.

[1]National Statistical Commission, Annual Report 2015­- 16, MINISTRY OF STATISTICS AND PROGRAMME IMPLEMENTATION (8th March, 2019, 12:16 PM), http://www.mospi.gov.in/sites/default/files/annual_report/nsc_AR_2015-16.pdf

[2]CSIR- Central Building Research Institute, Study on Improvement in Rates and Ratios used in the Estimates of Gross Value Added Construction and Gross Fixed Capital Formation, MINISTRY OF STATISTICS AND PROGRAMME IMPLEMENTATION (6th March, 2019, 12:16 PM), http://www.mospi.gov.in/sites/default/files/publication_reports/Final_Report_CBRI_27oct16.pdf

[3]Supra, note 1

[4] Press Release dated 31 August 2016 issued by Press Information Bureau on the reform passed by the Cabinet Committee on Economic Affairs.

[5]LavinaMulchandani, Why are housing projects delayed? Industry, buyer groups hope to have answers soon, HINDUSTAN TIMES (March 01, 2019, 13:55 PM), https://www.hindustantimes.com/real-estate/why-are-housing-projects-delayed-industry-buyer-groups-hope-to-have-answers-soon/story-abMs34y2V7h8G92aVur9SJ.html

[6]BanikinkarPattanayak, Bankruptcy Code: Are homebuyers secured financial creditors?, FINANCIAL EXPRESS (15th March, 2019, 15:15 PM), https://www.financialexpress.com/market/exclusive-bankruptcy-code-are-homebuyers-secured-financial-creditors-read-builder-agreement-carefully/1241276/

[7]Chitra Sharma vs. Union of India, MANU/SC/0834/2018 (India)

[8]PTI, Supreme Court directs Amrapali Group to meet home buyers on March 17, 2018, THE INDIAN EXPRESS (7th March, 2019, 15:30 PM), https://indianexpress.com/article/india/supreme-court-directs-amrapali-to-meet-home-buyers-5099113/

[9]IBBI (Insolvency Resolution Process for Corporate Persons), Regulations, 2016.

[10]Col. Vinod Awasthy v. AMR Infrastructure Ltd., CP No. (IB) 10 (PB) 2017, MANU/NC/0443/2017

[11]Nikhil Mehta v. AMR Infrastructure, MANU/NL/0124/2017

[12]Insolvency Law Committee, Report of The Insolvency Law Committee, MINISTRY OF CORPORATE AFFAIRS (23rd March, 2019, 15:05 PM), http://www.mca.gov.in/Ministry/pdf/ReportInsolvencyLawCommittee_12042019.pdf

[13]B.V.S. Lakshmi v. Geometrix Laser Solutions Private Limited, MANU/NL/0221/2017

[14] Supra, note 1

[15]Pioneer Urban Land And Infrastructure Limited &Ors. Vs. Union of India and Ors., MANU/SCOR/07031/2019

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