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HOMEBUYERS AS FINANCIAL CREDITORS: AN IMPERFECT SOLUTION

This piece has been authored by Shivansh Mehta, a fourth-year student at Rajiv Gandhi National University of Law, Punjab.

The Insolvency and Bankruptcy Code, 2016 (IBC) was amended in 2018 by the Central Government to bring some much-needed reforms. One of the most significant amendments was the inclusion of any amount raised from an allottee with respect to a real estate project within the ambit of the term “financial debt”.[i] Thus, the homebuyers will now be considered as “Financial Creditors” under IBC.


The amendment empowers the homebuyers to initiate corporate insolvency resolution process under Section 7 of the Code against defaulting promoters. The homebuyers will also be entitled to be represented on the Committee of Creditors (COC) through an authorized representative and will possess voting rights as well.


Backdrop

The amendment comes in the backdrop of several high-profile cases of declaration of insolvency by real estate promoters such as Amrapali, Jaypee Infratech and Supertech which affected thousands of homebuyers who were left without any recourse to insolvency proceedings under IBC. Further, the homebuyers were barred from filing complaints against the defaulting promoters, who had filed for insolvency, during the moratorium period.

Accordingly, in its report dated March 2018, the Insolvency Law Committee recommended the recognition of homebuyers as financial creditors under IBC to address these concerns. While the amendment has brought much – needed relief to the homebuyers, it raises more questions than it answers.


1) Homebuyers: whether secured or unsecured financial creditors

The difference between an unsecured and secured financial creditor lies in the priority of payment in the event of liquidation. The new amendment grants the homebuyers the status of financial creditors but does not address the question as to whether they will be considered as secured creditors or unsecured creditors. Thus, the status of the Homebuyer might fluctuate depending on various factors such as the type of agreement, stage of completion and creation of an association of allottees.


2) Logistical problems

Section 25A, as introduced by the amendment, allows the homebuyers to participate and vote in the Committee of Creditors through a representative authorized by them.[ii] However, in large scale real estate projects the number of allottees goes into thousands and it would be very difficult to choose a single representative who can represent the interests of all homebuyers. Further, irrespective of the quantum of debt, any allottee possessing a letter of allotment will be now considered as a financial creditor.


3) Subrogation of rights of homebuyers to Banks

As a general practice, many homebuyers enter into a tripartite agreement with the developer and the bank to finance their purchases. Such agreements create third party interests by subrogating the rights of the homebuyers in the favour of the banks. The Allahabad bench of NCLT has held that the homebuyers would not be considered as financial creditors if they have subrogated their rights to third parties.[iii]


4) Voting share of homebuyers

The voting share of the parties in the Committee of Creditors is proportionate to the amount owed to them. The amount owed to individual Homebuyers is significantly less in comparison to the amount owed to other financial creditors such as banks etc which would result in the homebuyers having negligible influence over the actions of the Committee Thus, the voting share of homebuyers must be calculated on a collective level instead of computing their voting shares individually. Further, clarifications are needed regarding computation of voting shares in cases when some homebuyers fail or refuse to vote.

It is also important to note that the benefit of the amendment will be more effective in such cases where the voting share of the homebuyers exceeds 35 Percent. This is so because a resolution on a major decision will be passed in the Committee of Creditors only if it garners the support of more than 66 percent of the total voting share of the financial creditors.


5) Classification of Homebuyers as Operational Creditors

It is widely believed that the relationship of Homebuyers towards developers bears more resemblance to that of an operational creditor rather than a financial creditor. The main reason for not classifying them as operational creditors is that the code refers to the provision of goods and services and does not contemplate immovable property within the ambit of operational debt. However, this lacuna could have been addressed by expanding the definition of “Operational debt”. Further, this relationship can hardly be classified to be one of a financial nature even though the Homebuyer’s money is ultimately utilized for financing the debtor’s business. The utilization of funds cannot be considered as an adequate criterion to classify the relationship between the parties as financial since the sellers of goods and services may use the advance money received from customers to finance their business activities.


6) Concerns of Operational Creditors

The T. K. Vishwanathan headed Bankruptcy Law Review Committee (BLRC) excluded the operational creditors from being a part of the committee of creditors because of two reasons. First, the operational creditors were considered as incapable to assess the viability and decide on matters of insolvency of the defaulting entity. Secondly, the operational creditors were considered as unwilling to assume risks of postponing payments for better future prospects of the entity.

However, this amendment will now allow thousands of individuals to be part of the Committee of Creditor irrespective of their ability to assess viability or willingness to negotiate existing terms and conditions of repayment which the BLRC considered important enough to disqualify operational creditors. Additionally, with the inclusion of homebuyers in the category of financial creditors, the rank of operational creditors in the hierarchy of repayment will reduce even further.


Conclusion

The amendment to treat Homebuyers as financial creditors is indeed a step in the right direction, however, the amendment can at best be considered as an incomplete solution which fails to address much larger concerns. Even though the amendment has brought much-needed relief to the homeowners, it will drastically affect the interests of other creditors in an adverse manner. Lastly, in a Code which lauds itself for its time-bound insolvency resolution process, the creation of a committee of creditors having thousands of members might itself hamper and impede the resolution process.

[i] Insolvency and Bankruptcy Code, 2016, Section 5(8)(f).

[ii] Insolvency and Bankruptcy Code, 2016, Section 25A.

[iii] Ajay Walia V. M/s. Sunworld Residency Private Limited, (2018) 210 CompCas 0405.

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Rajiv Gandhi National University of Law, Punjab

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© Rajiv Gandhi National University of Law Punjab, 2020