India: Recognition of homebuyers: Sympathy without security

Last Updated: 17 September 2018
Practice Guide by Varsha Banerjee

By Ms Varsha Banerjee, Associate Partner & Ms. Juhi Bhambhani, Associate.

The fate of homebuyers when a real estate developer (RED) undergoes a corporate insolvency resolution process (CIRP) under the Insolvency and Bankruptcy Code, 2016 (IBC), has been intensely deliberated. An amendment of the IBC through an ordinance of 6th June, 2018 recognized the rights of homebuyers in a CIRP by deeming the amounts they pay to a RED to have the commercial effect of a borrowing, thus clearly making them financial creditors. Homebuyers may now initiate a CIRP and will have representation in the committee of creditors (CoC), u/s 7 of the IBC, with voting rights in proportion to the amounts they have paid to a RED. This is reflected in amendments dated 3rd July, 2018 to the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, which lay down the procedure for appointing an “Authorized Representative” in respect of a class of creditors.

Under this amendment, the interim resolution professional has been mandated to appoint three insolvency professionals to represent the interests and concerns of each class of creditors. The homebuyers being a specific class of creditors, they will be assigned one insolvency professional who will represent the interest of homebuyers – as a class – and exercise their voting rights in the CoC, in proportion to their financial debt.

However, despite the changes brought about by the recent ordinance, protection and preservation of the rights of homebuyers lies only in the due approval and implementation of a resolution plan for the RED. Where the resolution plan is not approved or agreed, the RED will face liquidation.

With resolution of the RED, homebuyers may get their homes or a refund of part of their investment as may be decided by the CoC, where they have representation and voting rights. However, if a resolution plan cannot be finalized and approved, and the RED goes into liquidation homebuyers may get nothing as they will be ranked as unsecured creditors and, with the staggered priority for recovery of dues under section 53 of the IBC, will lose out to creditors with security interest, who have a prior claim over the amounts that are realized from liquidating assets of the RED. Thus, banks and other financial institutions will appropriate to themselves the majority of the RED’s assets, leaving little for the unsecured homebuyers.

To give some perspective to the unfairness that will be suffered by unsecured homebuyers, one may contrast this outcome with the example of shareholders, who occupy the lower rungs of the distribution mechanism under section 53 of the IBC. They justifiably stand a much lower chance of recovery in the event of liquidation because, as investors in the RED, they have knowingly subscribed to the inherent risk of failure of the RED’s business enterprise. This means that the sympathy shown by deeming homebuyers as financial creditors is superficial and affords no actual relief, when viewed in the context of a liquidation scenario.

Thus, owing to the lower priority, if unsecured homebuyers do not recover amounts they have advanced, through the approval of a Resolution Plan, the IBC and the 2018 ordinance do not in any manner come to the rescue of such homebuyers. No protection has been afforded to homebuyers for recovery of the amounts at the stage of liquidation. Thus, it may be that the IBC and the 2018 Ordinance could fail to comprehensively protect the interests of home buyers, which prevail at the stage of both resolution as well as liquidation. For this reason, the scope of the 2018 Ordinance is incomplete; its application being limited to only the resolution process and its provisions may need to be re-looked in a liquidation scenario.

However, the present state of affairs serves as a compelling factor to motivate the homebuyers to push for a viable resolution plan in order to recover its dues. The stranded home buyers of the insolvent Jaypee Infratech Ltd. (‘JIL’) are a case in point: They have vehemently opposed a proposal by Jaiprakash Associates Ltd. (‘JAL’), to reacquire JIL. The home buyers have validly argued before the Supreme Court that an entity that is itself insolvent and is debarred by the amended Section 29A of the IBC cannot take over the management of JIL. This point is strengthened by the fact that the delay and non-delivery of flats is majorly attributable to the mismanagement by JAL. The fact that the Supreme Court has been taking into account the concerns of the home buyers at every stage of the insolvency process only serves to emphasize that it is indispensable a that the voice and concerns of the home buyers be made part of the entire insolvency proceedings under the IBC.

This article is for information purpose only. It is not intended to constitute, and should not be taken as legal advice, or a communication intended to solicit or establish commercial motives with any. The firm shall not have any obligations or liabilities towards any acts or omission of any reader(s) consequent to any information contained herein. The readers are advised to consult competent professionals in their own judgment before acting on the basis of any information provided hereby.

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