Homebuyers Gets Status of Financial Creditors – Supreme Court Upheld IBC 2018 Amendment

Posted On - 24 October, 2019 • By - Rajdev Singh

The Hon’ble Supreme Court of India’s bench comprising of
Justices R F Nariman, Sanjiv Khanna and Surya Kant in the matter of Pioneer Urban Land and Infrastructure
Limited vs. Union of India
[1] while rejecting a batch of more than 200 petitions
filed by the real estate developers challenging the constitutionality of the
Insolvency and Bankruptcy Code, 2018 Amendment (“2018 Amendment”), which
granted status of “Financial Creditors” to the homebuyers and gave them the
right to be represented in the committee of creditors by authorized
representative, has upheld the constitutional validity of the 2018 Amendment.

Financial Creditors: Insolvency and Bankruptcy Code, 2018 Amendment

The Insolvency and Bankruptcy (Amendment) Ordinance, 2018,
(“2018 Ordinance”) which came into force on 6th June 2018 provided clarity
on the status of homebuyers under the Insolvency and Bankruptcy Code (“IBC”).
Section 5 (8) (f) of the IBC was amended to bring homebuyers within the
purview of “Financial Creditors” as defined under the IBC. Section 5 (7) of the
IBC defines Financial Creditors as “any
person to whom a financial debt is owed and includes a person to whom such debt
has been legally assigned or transferred to.”

“Financial Debt” is defined under Section 5 (8) of the IBC
as “a debt along with interest, if any, which is disbursed against the
consideration for the time value of money and includes:

(a) money borrowed against the payment of interest; 

(b) any amount raised by acceptance under any acceptance
credit facility or its de-materialized equivalent;

 (c) any amount raised pursuant to any note purchase
facility or the issue of bonds, notes, debentures, loan stock or any similar
instrument; 

(d) the amount of any liability in respect of any lease or
hire purchase contract which is deemed as a finance or capital lease under the
Indian Accounting Standards or such other accounting standards as may be prescribed; 

(e) receivables sold or discounted other than any
receivables sold on nonrecourse basis; 

(f) any amount raised under any other transaction,
including any forward sale or purchase agreement, having the commercial effect
of a borrowing;

 (g) any derivative transaction entered into in
connection with protection against or benefit from fluctuation in any rate or
price and for calculating the value of any derivative transaction, only the
market value of such transaction shall be taken into account; 

(h) any counter-indemnity obligation in respect of a
guarantee, indemnity, bond, documentary letter of credit or any other
instrument issued by a bank or financial institution; 

(i) the amount of any liability in respect of any of the
guarantee or indemnity for any of the items referred to in sub-clauses (a) to
(h) of this clause;”

 2018 Ordinance has
inserted an explanation in Section 5 (8) (f) of the IBC to bring homebuyers
under the purview of “Financial Creditors” which is read as below:

“(i) any amount raised from an allottee under the real
estate project shall be deemed to be an amount having commercial effect of a
borrowing, or

(ii) the expressions “allottee” and “real estate project”
shall have the meanings respectively assigned to them in clause (d) and (zn) of
section 2 of the Real Estate (Regulation and Development) Act, 2016;”

That the amount advanced to the real estate developers by
the homebuyers under the real estate projects shall be deemed to have the
commercial effect of borrowing and the said amount shall come under the
definition of “Financial Debt”.

Henceforth, the flat allottees who were given the status
of financial creditors under the IBC can initiate corporate insolvency
resolution process against the real estate developers by filing petition under
Section 7 of the IBC and further are entitled to be a part of the committee of
creditors with voting rights in proportion to the amount of financial debt
owed.

Grounds on Which the Amendment was Challenged by the Real
Estate Developers

  1. The amendment violates Article 14 of the
    Constitution of India as it treats unequal equally and equals unequally
    having no intelligible differentia. Real estate developers and borrowers
    are treated equally whereas they are unequal.
  2. The amendment has no nexus with the object
    sought to be achieved by the IBC. 
  3. The amendment violates Article 19(1)(g) and
    Article 300-A of the Constitution of India as in the case of a real estate
    developer who completes projects on time and never defaults, can be
    removed or replaced by somebody if a single allottee manages to obtain an
    insolvency order from NCLT.
  4. The amendment would dissuade foreign investors
    from investing in India.
  5. Flat/apartment allottees do not come under the
    purview of financial creditors as in the event of any breach of agreement
    on the part of the real estate developer, the homebuyers are entitled to
    get a refund of the amount paid by them, which does not make them
    financial creditors.
  6. The amendment is against the UNCITRAL
    Legislative Guide on Insolvency Law as the difference between financial
    creditor and the operational creditor was ignored. Homebuyers should fall
    under the category of operational creditors and not financial
    creditors. 

Financial Creditors: Judgement

The Hon’ble Supreme Court of India, in this present case,
has delivered a significant judgment by upholding the constitutional validity
of the Insolvency and Bankruptcy Code, the 2018 Amendment, and re-affirming the
status of homebuyers as “Financial Creditors”.

i.     Constitutional Aspect

The three judges’ bench has upheld the constitutionality
of the amendment of Section 5 (8) (f) of the IBC and has held that the
amendment does not violate any rights of the real estate developers and is not
in any way arbitrary or discriminatory. The bench has further observed
that “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 homebuyers, the amounts raised under the
contracts of home buyers are in effect to raise 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).”

Further, it has been held that the amendment does not
infringe Article 14, 19 (1)(g) read with Article 19(6) or 300-A of the
Constitution of India.

ii.    Homebuyers need to prima facie establish that a “default” exists to trigger the IBC

To trigger the corporate insolvency resolution process,
the homebuyers need to prima facie establish that a
default exists with regards to any unpaid amount. Once a homebuyer has
established that a default exists in relation to unpaid amount from the
developer, then the onus shall shift on the developer to show that the
homebuyer is itself a defaulter as per the agreement entered between both the
parties and Real Estate Regulatory Authority (“RERA”) Rules and Regulations and
hence, the homebuyer is not entitled to any compensation or refund of the
amount. If the developer can successfully prove the same, then it will amount
to the dismissal of the petition under Section 7 of the IBC. 

iii.    IBC and RERA to be read harmoniously

The bench has held that the homebuyers can avail remedy
under the Consumer Protection Act, RERA as well as IBC. Further, the bench has
said that RERA is not in derogation to any statute, but in the event of any
conflict between IBC and RERA, the former shall prevail. The bench has also
made it clear that RERA should be read in harmony with IBC. 

Conclusion

In this landmark verdict, the Hon’ble Supreme Court of
India has reaffirmed the status of homebuyers as financial creditors with
voting rights and has upheld the constitutional validity of the 2018 Amendment.
Through this judgment, the distressed homebuyers are given the power to take
legal actions against the real estate developers by triggering the IBC. The
Hon’ble Supreme Court of India has also directed the Government of India to
provide proper infrastructure to the NCLTs and NCLAT for speedy disposal of the
petitions filed under the IBC by the homebuyers. Further, the Court has also directed
the Government of India to appoint Adjudicating Officers, Real Estate
Regulatory Authority and Appellate Tribunals within three months from the date
of passing of the judgment. The Hon’ble Supreme Court of India, through
this landmark judgment has rightly held that IBC is a beneficial legislation
and the distressed homebuyers can trigger IBC in the event of default on the
part of the real estate developers and can recover their dues from the
liquidated assets of the corporate debtor.

  [1] MANU/SC/1071/2019

Contributed By – Rajdev Singh, Partner
Pathik Choudhury, Associate

King Stubb & Kasiva,
Advocates & Attorneys

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