Insolvency proceedings of Jaypee Infratech Limited is one of the most keenly watched proceedings under the IBC.  Apart from the introduction of a new class of creditors, the proceedings have also seen the Supreme Court intervening in insolvency resolution process to protect the interests of home buyers.

Background

Trilegal is representing the largest consortium of home buyers of Jaypee Wish Town Noida in the insolvency resolution proceedings of Jaypee Infratech Limited (JIL).  The ongoing proceedings are being seen as a litmus test for the successful implementation of the Insolvency and Bankruptcy Code, 2016 (IBC) as they involve critical questions regarding the rights of banks vis-à-vis the rights of home buyers in real estate projects.

Key Developments

In addition to seeking an intervention of the Supreme Court in the insolvency resolution process (IRP) of JIL, home buyers have challenged the constitutional validity of various sections of the IBC and the regulations framed thereunder. The decision of the Supreme Court is now awaited on the said challenges to constitutionality, as well as the rights of banks vis-à-vis the rights of home buyers.

The following key developments have taken place so far in relation to insolvency proceedings of JIL:

(a) Introduction of a new class of creditors on 16 August 2017; and

(b) Intervention by the Supreme Court in the IRP of JIL on 11 September 2017.

A summary of these developments and their likely impact on insolvency proceedings in the future is discussed below.

Development I- Introduction of a New Class of Creditors

Until 16 August 2017, the IBC recognized three categories of creditors for the purposes of an IRP: (i) financial creditors; (ii) operational creditors; and (iii) employees and workmen of the corporate debtor.

Under the IBC, financial creditors include banks or other financial institutions or persons who have provided loans or other form of debt to the corporate debtor.

In the context of the definition of 'operational creditors' under the IBC, the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT), adopted a strict interpretation of the term 'operational creditor' and held that only entities that provide goods or services to a corporate debtor would be classified as operational creditors.  In other words, the term 'operational debt' was held to not include any advance paid by a purchaser of goods or recipient of services under the IBC.  Such a purchaser was therefore precluded from initiating IRP against the corporate debtor.

On 16 August 2017, a fourth category of 'other creditors', i.e. creditors who are neither financial nor operational creditors, was introduced by the Insolvency and Bankruptcy Board.

Impact of Development I- Treatment of Advance for Goods or Services in IBC

While the jurisprudence on 'operational creditors' is evolving, an entity that has paid an advance for goods or services is unlikely to be treated as an operational creditor under the IBC.  Such an entity is more likely be treated as an 'other creditor'.

'Other creditors' cannot initiate insolvency proceedings and do not have a say in the resolution process of the corporate debtor.  Unlike financial and operational creditors, the resolution plan need not provide for any payments to other creditors or for discharge of liabilities towards other creditors.

Accordingly, since the rights of 'other creditors' are limited and rank fairly low in the liquidation waterfall, it may be preferable for an entity making an advance payment to structure such a payment in the form of a financial debt or a secured debt by creating a contractual buyer's lien.  This may ensure better protection in the insolvency resolution and liquidation process.

Development II- Intervention by Supreme Court in IRP

The Supreme Court initially stayed the IRP of JIL to protect the interest of the home buyers of JIL.  The Supreme Court subsequently allowed the resolution process to continue subject to the condition that an interim resolution professional will submit an interim resolution plan within 45 days incorporating all necessary measures for protecting the interest of the home buyers.

The Supreme Court has issued this order under Article 142 of the Constitution of India which vests in it the power to pass any order as is necessary for doing complete justice in any cause or matter pending before it.

Impact of Development II- Risk of Court Intervention in IRP of Companies having Direct Obligations towards Retail Customers/Home Buyers

This order of the Supreme Court may lead to other courts also taking similar measures to protect the interests of real estate buyers in insolvency proceedings or even in cases where companies have direct obligations towards retail customers.

Consequently, lenders or operational creditors of such a company may have to bear significant losses in the IRP or liquidation process as they risk losing their priority in insolvency resolution process or over liquidation proceeds to the extent necessary to protect the interests of such buyers/customers.

Key Takeaways

These developments have ramifications for both, purchasers of goods or services making advance payments as well as for lenders/operational creditors of companies that have direct obligations towards real estate buyers or retail customers.

With the perspective of deriving better protection under the IBC, purchasers of goods or services making advance payment may consider structuring advance payments as a financial debt or secured debt and a lender/operational creditor of an entity having direct obligations towards retail customers, may need to factor in the risk of losing its priority in liquidation proceeds while assessing the credit worthiness of the borrower.

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