Insolvency and Bankruptcy Code 2018: Home buyers on par with other creditors now

Published: July 5, 2018 1:56:44 PM

In view of the amendments brought about by the Ordinance, home buyers will no longer have to run from pillar to post just to be heard in case insolvency proceedings are initiated against the developer.

Insolvency and Bankruptcy Code 2018, Home buyers, financial creditors, RERA, real estate, under construction homes, insolvency proceedings, developerIn view of the provisions of the Ordinance, allottees will now take precedence over non-financial unsecured creditors and jump ahead in the line to stand as unsecured creditors.

Prior to 2016, state laws governed the rights of under-construction home buyers and as such, the laws differed from state to state. The Centre for the first time enacted a central law, viz the Real Estate (Regulation and Development) Act, 2016 (“RERA”), in order to govern the contract between developers and home buyers, and provide a consistent and level-playing field to the home buyers of under-construction homes throughout India.

However, in light of the recent events, specifically insolvency proceedings initiated against Jaypee Infratech, the inadequacy of the RERA to address the concerns of home buyers in case of corporate insolvency of a developer came to the fore. The Centre has tried to address this inadequacy in the newly-promulgated Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 (the “Ordinance”) which inter alia seeks to balance the interest of home buyers in a corporate insolvency proceeding by specifically providing that an amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing, thereby making allottees financial creditors for the purposes of the Code.

Home buyers as financial creditors

The Ordinance has inserted an Explanation to the definition of ‘financial debt’ contained in sub section (8) of Section 5 of the Insolvency and Bankruptcy Code, 2016 (the “Code”) which Explanation states that ‘any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing’. The Ordinance borrows the definitions of ‘real estate project’ and ‘allottee’ from RERA.

A ‘real estate project’ has been defined under sub section (zn) of Section 2 of RERA as the development of a building or a building consisting of apartments, or converting an existing building or part thereof into apartments, or the development of land into plots, or apartments as the case may be, for the purpose of selling all or some of the said apartments or plots or building and includes the common areas, the development works, all improvements and structures thereon, and all easement, rights and appurtenances belonging thereto.

An ‘allottee’ has been defined under sub section (d) of Section 2 of RERA as a person to whom a plot, apartment or buildings, as the case may be, has been allotted, sold (whether as freehold or leasehold) or otherwise transferred by the promoter, and includes the person who subsequently acquired the said allotment through sale, transfer or otherwise, but does not include a person to whom such plot, apartment or building, as the case may be, is given on rent.

Thus, buyers of under-construction flats are deemed to be owed a financial debt by the developer and therefore are financial creditors under the Code (as amended by the Ordinance).

Rights of home buyers in case of insolvency of the developer under the Code

# Participation in the Committee of Creditors: The benefit for a home buyer of being classified as a financial creditor is that under Section 21 of the Code, as a financial creditor, an allottee will be entitled to participate in the committee of creditors and will have some say in the resolution process. The vote share of the home buyers will be proportionate to the value of their advances.

# Distribution of assets: Section 53 of the Code provides the following order of distribution of assets of the corporate debtor (developer): (a) the insolvency resolution process costs and the liquidation costs; (b) (b) (i) workmen’s dues (ii) debts owed to a secured creditor who have relinquished their security under section 52 of the Code; (c) wages and any unpaid dues owed to employees other than workmen; (d) financial debts owed to unsecured creditors; (e) (i) amount due to the Central or State Government on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, (ii) debts owed to a secured creditor for any amount unpaid following the enforcement of security interest; (f) any remaining debts and dues; (g) preference shareholders, if any; and (h) equity shareholders or partners, as the case may be.

In view of the provisions of the Ordinance, allottees will now take precedence over non-financial unsecured creditors and jump ahead in the line to stand as unsecured creditors.

Initiation of insolvency proceedings by a home buyer

Whether home buyers will be able to initiate insolvency proceedings against a defaulting developer is a grey area. As per Section 6 of the Code, financial creditors can initiate the insolvency proceedings against a corporate debtor upon the corporate debtor ‘committing a default’. The default referred to is default in payment of monies by the corporate debtor to the financial creditor. Generally, terms of allotment letters and agreements for purchase of under construction flats provide for repayment of the monies by the developer only upon termination of the allotment. Thus, for any default in repayment to have occurred, the home buyer must first terminate the agreement/ allotment entered into with the developer and demand a refund of the monies paid towards such allotment. It remains to be seen whether allottees will be able to actually initiate insolvency proceedings in the absence of such termination and demand for refund.

Moreover, in some cases developers used to direct the home buyers to pay allotment consideration to a group entity or land-owning entity due to some internal arrangement between such entity and the developer. In such cases home buyers may be left without any recourse under the Code in case of insolvency of the developer given that monies have not actually been paid to the developer at all. This aspect is yet to be examined in the Courts of law in the background of the amended Code. It is pertinent to note here that the aforesaid payment mechanisms are no longer permitted under RERA.

Effective step forward

Generally, home buyers are interested in getting constructed homes and not merely their money back. RERA is the only law in India today which recognises this and specifically provides (under section 8) rights to the competent authority or association of home buyers to step in and complete construction in case the registration of the developer is revoked. Under section 7 of RERA, registration of a developer can be revoked by the Authority constituted under RERA in case of non-compliance with law or unfair or fraudulent practices by a developer or false representations made by the developer etc. RERA does not cover an eventuality of insolvency of a developer. In case of insolvency proceedings being initiated against the developer, home buyers may not have any option but to look to the Code for enforcing their rights.

In view of the amendments brought about by the Ordinance, home buyers will no longer have to run from pillar to post just to be heard in case insolvency proceedings are initiated against the developer and will have a right to be involved in the resolution process. However, whether such home buyers can insist on getting constructed flats under the Code is to be seen and it’s likely that at best they will receive refund of their monies paid. Whether interest and compensation would be part of that refund also needs to be evaluated.

It is important to note that the amendment is brought about by an ordinance promulgated by the President under Article 123 of the Constitution and, as such, is required to be laid before both Houses of Parliament and shall cease to operate at the expiration of six weeks from reassembly of Parliament, or if before the expiration of the aforesaid period resolutions disapproving it are passed by both Houses, upon passing of the second of those resolutions. The Ordinance may also be withdrawn at any time by the President.

(By Sudip Mullick (Partner) and Sneha Oak Joshi (Senior Associate), Khaitan & Co)

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