India: Home Buyers = Financial Creditors: Supreme Court Reigns

Last Updated: 15 August 2019
Article by Abhilash Pillai and Tarun Agarwal

The Supreme Court in Pioneer Urban Land and Infrastructure Limited vs. Union of India (Pioneer Judgment)1, has upheld the constitutionality of the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 (Amendment Act)2. Through the Amendment Act3, the 'real estate allottees' (home buyers), as defined under Section 2(d) of the Real Estate (Regulation and Development) Act, 2016 (RERA), were brought within the ambit of 'financial creditor' under the Insolvency and Bankruptcy Code, 2016 (IBC).

A three judges' bench headed by Hon'ble Mr. Justice Rohinton Nariman disposed off a batch of over 150 petitions filed by the real estate developers challenging the constitutional validity of the Amendment Act. The Supreme Court also held that the RERA has to be read harmoniously with the IBC and, in the event of a conflict, the IBC will prevail over the RERA.

Home Buyers are Financial Creditors – Raison d'être

Under the IBC, 'financial creditor' means any person to whom a 'financial debt' is owed and includes a person to whom such debt has been legally assigned or transferred to4. In the context of home buyers, the Supreme Court relied upon the recommendations made by the Insolvency Law Committee Report5, and emphasised the fact that the amounts raised from home buyers contributes significantly to the financing of the construction of such flats/ apartments.

This being the case, the legislature considered it important to insert an explanation into Section 5(8)(f) of the IBC, vide the Amendment Act, clarifying that home buyers are to be treated as financial creditors so that they can trigger the insolvency process under Section 7 of the IBC.

In addition, the home buyers being financial creditors are entitled to be represented in the Committee of Creditors (CoC) through their authorised representative. The Supreme Court, in the Pioneer Judgment, observed that there is no good reason to exclude the home buyers from representation in the CoC and, hence, they cannot be excluded from the definition of 'financial creditor'.

After a detailed analysis of the relevant definitions, the Supreme Court observed that the sale agreement between developer and home buyer would have the 'commercial effect' of a borrowing, which means that money is paid in advance for temporary use so that a flat/apartment is given back to the home buyer. Further, the Supreme Court clarified that both parties have 'commercial' interests in the same – the real estate developer seeking to make a profit on the sale of the apartment, and the flat/apartment purchaser profiting by such sale of the apartment. The Supreme Court thus came to the conclusion that the amounts raised from the home buyers under real estate agreements, with profit as the main aim, are, in fact, subsumed within the definition of 'financial debt' under Section 5(8)(f) of the IBC, even without adverting to the explanation introduced by the Amendment Act.

Having said that, the Supreme Court has cleared the dust from retrospective applicability of the Amendment Act by holding that home buyers were included in the main provision, i.e. Section 5(8)(f) of the IBC with effect from the inception of the IBC. It has further clarified that the explanation was added later in the year 2018 only to clear up any doubts that had arisen in its implementation.

Home Buyers and Operational Creditors – Uniquely Different!

The Supreme Court observed that real estate developers fall squarely within the object of the IBC, as originally enacted, insofar as they are financial debtors and not operational debtors. The Court pointed out the following unique and intelligible differences in this regard:

  • 'Real estate developers' vis-à-vis 'operational debts' – in comparison to general cases, wherein the person who supplies goods and services is the 'creditor', in real estate contracts the developer who is the supplier of the flat/apartments is, in fact, the 'debtor' in as much as the home buyer funds his own apartment by way of advance payments.
  • Interest/ stake of the operational creditor in the corporate debtor – unlike the case of a home buyer, who is vitally concerned with the financial health of the corporate debtor (for otherwise, the real estate project may not be brought to fruition), an operational creditor does not have an interest in or stake in the corporate debtor.
  • Time value of money – in real estate projects, money is raised from the home buyers against consideration for the time value of money (both the home buyer and the developer gain and benefit from the time value of money even though the payments may be made in installments). On the other hand, in an operational debt, there is no consideration for the time value of money, since the consideration of the debt is the value of the goods or services either sold or availed from the operational debtor.
  • Documentary evidence for the due amount – unlike in the case of operational debt, the documentary evidence for amounts being due and payable by the real estate developer is available in the form of the information being provided compulsorily under the RERA.

Thus, in view of the above, it has been held by the court that home buyers deserve the same protection that other financial creditors enjoy under the IBC.

Two-Step Scrutiny

The Court has made it clear that adjudication of the Section 7 application under the IBC is not a futile exercise and the National Company Law Tribunal (NCLT) has to satisfy itself with both eyes open. In this regard, it has observed as follows:

  • Establishment of a prima-faciecase under Section 7 of the IBC in terms of Section 4 of the RERA, every developer/ promoter is required to submit all the important information related to the real-estate project to the concerned authority set-up under the RERA. Armed with this information (provided by the promoter or real estate developer itself), the home buyer can approach the NCLT under Section 7 of the IBC to trigger the corporate insolvency resolution process (CIRP) and needs to at least prima-facie establish that a 'default' exists in relation to any amount due and payable to the home buyer.
  • Shifting of onus to the promoter/ developer once the home buyer has made a prima facie case, the onus shifts to the promoter/ real estate developer to show, on the basis of the agreement and the applicable RERA Rules and Regulations, that the home buyer is himself a defaulter and would, therefore, not be entitled to any relief including payment of compensation and/or refund, which will then entail dismissal of the application filed under Section 7 of the IBC.

The Supreme Court has pertinently observed that apart from the aforesaid discharge of burden of proof, the real estate developer can also point out to the NCLT if the CIRP has been invoked fraudulently, with malicious intent, or for any purpose other than the resolution of insolvency by the home buyer. Speculative investors (buyers not genuinely interested in purchasing a flat/apartment), and home buyers taking coercive measures to get their money back, are a few illustrations provided by the Supreme Court that will fall within the ambit of Section 65 of the IBC.

Conclusion

The Supreme Court has taken a significant leap in holding that the IBC is a 'beneficial legislation' that can be invoked by unsecured financial creditors like home buyers.

Keeping in mind that time is of the essence under the IBC, the Court has also reminded the Government that it must provide adequate infrastructure to the NCLTs and the National Company Law Appellate Tribunal (NCLAT) for expeditious disposal of applications filed by home buyers under the IBC. It has also asked the Government to appoint permanent adjudicating officers, real estate regulatory authority and its Appellate Tribunal within three months from the date of the Pioneer Judgment.

In essence, the judgment re-affirms the rights of home buyers as financial creditors under the IBC. While this is a landmark judgment for genuine home buyers, there is a long battle in store for the real estate industry, which is already reeling from severe liquidity issues and other operational hurdles.

Footnotes

1 Judgment dated August 09, 2019 in Writ Petition(s)(Civil) No. 43/2019

2 See Insolvency and Bankruptcy Code (Second Amendment) Act, 2018

3 See Explanation to Section 5(8)(f), Section 21(6A)(b) and Section 25A of the IBC

4 See Section 5(7) of the IBC

5 See Report dated March 26, 2018 of Insolvency Law Committee chaired by Shri Injeti Srinivas

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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