India: Understanding The Legal Position Of Flat Buyers Under The Insolvency And Banking Code: Whether Financial Creditors, Operational Creditors, Or A Third/Separate Class Of Creditors?

Last Updated: 24 August 2017
Article by Anirban Bhattacharya and Bharat Chugh

The Jaypee Infratech Insolvency has once again brought to the fore the issue of legal position of flat buyers and remedies available to them under the Insolvency and Banking Code ("IBC"). This article is an attempt to briefly discuss as to whether such flat buyers qualify as 'Operational' or 'Financial' Creditors; or they constitute a separate class of creditors, and if yes, the extent of their rights under IBC.

The recent NCLAT decision in Nikhil Mehta v. AMR Infrastructure1 is a good starting point. In this case the NCLAT ruled that a purchaser of real estate, under an 'Assured-return' plan, would qualify as a 'Financial Creditor' for the purposes of the Insolvency and Banking Code ("IBC") and therefore, entitled to initiate insolvency process against the builder, in case of non-payment of such 'Assured/Committed return'.

The facts in Nikhil Mehta (supra) were pretty straightforward: The Appellant had booked a residential unit, office space and a shop in a project being developed by AMR. The unit remained a 'paper project' and was never delivered to the Appellant. Fortunately, the Appellant had a MoU with AMR, whereby, in view of a substantial down-payment made by the Appellant, AMR had assured 'Assured/Committed returns' to them, from the date of execution of the MoU till the handing over of the physical possession of the unit(s).

All was good as long as AMR kept paying the 'Assured returns'; however, the payments dwindled and then stopped altogether. The cheques issued in discharge of liability also bounced. Despite various demands, no further payments were made. This, the Appellant argued, was in contravention of the MoU and amounted to non-payment of admitted 'debt' and on this premise Insolvency Process was initiated by the Appellant in the capacity of 'Financial Creditor(s)'.

The NCLT dismissed the Application ruling that the agreement in question was a 'pure and simple agreement of sale and purchase of a piece of property and has not acquired the status of a financial debt as the transaction does not have consideration for the time value of money. The NCLT held that the monies were not disbursed by the Appellant 'against the consideration for the time value of money', and the clause relating to 'assured return' is associated with the delivery of possession and is not a 'Financial Debt', whichever way one looks at it.


Aggrieved by the decision, the Appellant appealed to the NCLAT, where it was argued that through this mechanism of 'Assured returns', a huge amount of money was mobilized by AMR to aid the development of the project, without any semblance of a collateral or security. In absence of this scheme, AMR would have been constrained to procure this amount from financial institutions. This amount was secured from unsuspecting buyers on the guarantee of 'Assured/Committed returns'. It was argued that this made the Appellant more akin to an 'Investor' or 'Creditor' to whom money is owed, rather than a mere purchaser of property. Reliance was further placed on the admitted and documented payment of 'Commitment Charges' by AMR to the Appellant under the head of 'Financial Costs'. This, according to the Appellant, manifested that AMR itself treated the liability towards the Appellant as a 'Financial Debt' owed to a 'Financial Creditor' and not merely consideration received towards allotment of unit.

Flat Buyers as 'Financial Creditors'

The NCLAT ruled in favour of the Appellant and held it to be a 'Financial Creditor'. The decision read: "It is clear that Appellants are 'investors' and has chosen 'committed return plan. The Respondent in their turn agreed upon to pay monthly committed return to investors."

It is palpable that what weighed heavily with the NCLAT was the fact that the amount deposited by 'investors', including the appellant "was shown as committed return while giving the 'financial cost'/at par with interest on loans". Further, AMR had deducted Tax at source ("TDS") on the 'Assured return' payments made to the Appellant under the head of 'Interest, other than Interest on securities', thereby making the entire arrangement more identifiable as a loan than anything else, on which periodical interest was due and payable.

NCLAT further ruled that the 'debt' in this case was disbursed against the consideration for the 'time value of money' which is the key ingredient to be satisfied in order for an arrangement to qualify as 'Financial Debt' and for the lender to qualify as a 'Financial Creditor', under the scheme of IBC.

In this regard, it was observed "For every calendar month the Corporate Debtor (AMR) was liable to pay committed return w.e.f January, 2009 till the date of handing over of the possession to the appellants. Therefore, it is clear that the amount disbursed by the appellants was "against the consideration of the time value of money and the Respondent-Corporate Debtor raised the amount by way of sale-purchase agreement, having a commercial effect of borrowing".

With these observations, Appellant was held to be a 'Financial Creditor'.

L & L Comment-

Though the judgment does not incisively examine the nuances of the concept of 'time value of money' and the various types of arrangements included within the definition of 'Financial Debt' u/s 5(8) of IBC, however, what cannot be taken away from it is the fact that it is extremely intuitive and logically sound. It demonstrates eminent common sense and appears to be a correct application of the concept of 'time value of money'. It recognizes that a purchaser of a real estate unit is under no obligation to pay a substantial amount of money as down-payment if the possession of the unit is not likely to be handed over to him in the near future. In that scenario, the builder would have to arrange finance from independent sources for the development of the project. This would not only require collateral/security but involve imposition of extremely onerous conditions, including but not limited to a relatively exorbitant rate of 'interest'. Simply put, a bank lending money to the builder, needless to state, would qualify as a 'Financial Creditor' and entitled to all the rights emanating from such an arrangement under IBC, including the right to initiate insolvency process under IBC, in case of a default in repayment of debt.

From that viewpoint, if the builder succeeds in inviting funds from an individual purchaser, as opposed to a Bank, on much more favorable terms, in that case - it does not stand to reason as to why that individual purchaser should not be entitled to similar protection as a Bank, when it is essentially serving the same purpose. Any other view discriminates between an individual purchaser of a real estate unit and the Bank, and to the former's detriment.

It also needs to remembered that the purchaser of a real estate unit under such an arrangement is parting with a huge amount of money upfront, but getting the possession of the subject real estate unit much later; therefore, he deserves to be recouped for the period during which he is deprived of the use and enjoyment of 'money' and is also not in possession of the unit. If that is not the case, then why would a rational buyer defer receipt of benefit/consideration to the future, if he could have the same consideration now. For instance, a purchaser willing to make payment of a huge amount at one shot may very well go in for house that is ready to move-in, rather than hold up his investment for a future benefit.

Alternatively, if he does not want to make a huge payment upfront, he may not pay the builder a substantial down-payment and invest the same money in something else and earn interest instead. Now, since he does not take that option and pays that money to the builder instead (without corresponding delivery of possession of property), he deserves to be rewarded for the delayed possession, which in this case is through the 'Assured/Committed Return' Scheme.

The opportunity cost of foregoing the use of a substantial amount of money, while waiting for the possession of the unit, has to be kept in mind. Since a buyer stays out of enjoyment of money as well as the property, for a long period of time, the consideration for him to still make the payment and wait for the real estate unit is nothing but the periodic 'Assured Return' that he is guaranteed, which has the affect of offsetting, at least to some extent, the risk factor and uncertainty inherent in delayed possession.

Money today is more valuable than same amount of money tomorrow. Possession of a sum of money today is certain but expectation of the same amount of money in future involves uncertainty. There is a possibility that the future money never gets repaid and possession of the property never delivered. This is where 'Assured-return' scheme kicks in and tries to neutralize that risk. This is the concept of 'time value of money', and forms the cornerstone of all banking and financial systems.

The payment of 'interest' on the amount paid by purchaser is nothing but recognition of 'time value of money'. The judgment correctly brings within the fold of 'Financial Debt' such an arrangement and allows the purchaser to invoke insolvency as a 'Financial Creditor'. Protection of 'time value of money' was one of the driving forces behind IBC.

This judgment is all the more important for one more reason: Earlier this year, the NCLT in Col. Vinod Awasthy v. AMR Infrastructure Ltd. (Principal Bench-Delhi)2 had ruled that, notwithstanding the presence of an assured return clause, a purchaser of a flat cannot be treated as a provider of 'goods' or 'services' to the builder and therefore, does not qualify as an 'Operational Creditor' and cannot initiate Insolvency Process in that capacity.

The present judgment will go on to ensure that purchasers of real estate will have an effective remedy under the IBC regime, and provide much needed succor to purchasers of 'paper houses' in 'paper towns', and ensure that what they are left with are not mere 'paper promises' and 'paper returns'.

However, with respect to flat buyers whose contracts do not incorporate such/similar clauses, it appears that they might not qualify as 'Financial' or 'Operational' creditors, and are therefore, disentitled from invoking insolvency process under IBC. However, much would depend on the nature of their agreement with the builder. Having said that, even those flat buyers, who do not qualify as either 'Financial' or 'Operational' creditors, may still file their claims with the Insolvency Resolution Professional ("IRP") in terms of form F3, provided of course, the insolvency process otherwise stands initiated at the behest of an 'Operation' or 'Financial' creditor. For those flat buyers who are interested in taking possession of their units on payment of balance amounts, once the Insolvency process is in motion, the collective wisdom of the IRP and the Creditors Committee governs whether the Company goes towards a revival (which may mean continuance of projects and delivery) or liquidation, in which case the assets are liquidated, and in all probability, flat buyers end up being entitled only to refund of their money, either as Financial or other creditors, depending on the nature of their agreement with the builder. In either case, the flat owners would be well advised to file their claims, distinctively specifying their preference for unit, rather than refund of their monies, by way of abundant caution, within their claim (Form F or C, as the case may be). Needless to state, all this raises a number of challenges, including the practicability of the maximum time limit of 270 days for evolving and presenting a revival plan failing which the Company goes into liquidation, earmarked within which is a period of 14 days for filing of claims by creditors and mere seven days for the IPR to verify those claims. All this also raises certain pressing issues as to the impact of the insolvency process on flat owners' loan agreements with their respective Banks/Financial Institutions and what happens should they continue to pay/stop paying their EMIs. In view of the prevailing uncertainty and vacuum, it is expected that judiciary would fill these gaps and clarify and streamline the process of insolvency for flat owners, without compromising/diluting the value of underlying assets.


* Authored by Anirban Bhattacharya, Partner & Bharat Chugh, Managing Associate at Luthra and Luthra Law Offices, New Delhi. (Views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of the firm).

1. Company Appeal (AT) (Insolvency) No. 7 of 2017; Judgment delivered on 21st July, 2017. The judgment has been followed by the NCLAT recently in Anil Mahindroo & And v. Earth Iconic Infrastructure (P) Ltd (Date of Decision 02.08.2017) to the same effect.

2. NCLT, Principal Bench, Delhi in CP No. (IB)-10(PB)/2017; Date of Decision 20.02.2017.

3. The Insolvency and Bankruptcy Board of India ("IBBI") recently on 16 August, 2017 amended the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, and the Insolvency and Bankruptcy Board of India (Fast Track Insolvency Resolution Process for Corporate Persons) Regulations, 2017 and introduced a form (Form F) for submission of claims by creditors other than financial and operational creditors to the interim resolution professional ("IRP") by virtue of the newly inserted regulation 9A under the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 carves out a detailed provision for filing and proving claims by other creditors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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