Earlier this year, the Ministry of Corporate Affairs (MCA) proposed some sweeping changes in the insolvency regime for real estate projects.

The Bill in respect of these amendments to the Insolvency and Bankruptcy Code, 2016 (IBC) is likely to be tabled in the upcoming monsoon session of the Parliament. The proposed amendments are seemingly triggered by the limited success rate of IBC in resolution of real estate projects.

As per the data released by the Insolvency and Bankruptcy Board of India (IBBI), as on December 2022, only 8% of the insolvency cases in the real estate sector have resulted in approval of a resolution plan and approximately 25% have resulted in liquidation. The remaining are either under appeal/review or have been withdrawn post the admission order.

The IBC was brought into force in December 2016, soon after the enactment of the Real Estate (Regulation and Development) Act, 2016 (RERA), which was envisioned as a special law for effective consumer protection and standardisation of business practices and transactions in the real estate sector.

At the time of its enactment, IBC did not have any specific provision dealing with the rights of allottees of real estate projects. Subsequently, in light of judicial pronouncements holding that customer advances had the commercial effect of borrowing, the IBC was amended to specifically include allottees as 'financial creditors'.

This entitled homebuyers to initiate a corporate insolvency resolution process (CIRP) against a defaulting real estate developer as well as participate in the committee of creditors (CoC) of such developer. Thereafter, the IBC was further amended to specify a threshold for allottees to initiate IBC action in order to limit frivolous applications.

Further, their participation in the CoC was to be through an authorised representative who would act on the instructions of more than 50% of the allottees. Despite these statutory dispensations, timely and effective resolution of stressed real estate projects has been marred by an inadequate success rate.

Real challenges

Some of the challenges have been sought to be innovatively addressed by courts by permitting project-wise or 'reverse' CIRP in certain cases, where the promoters have been permitted to arrange for funds from their own sources and complete the other projects under the overall supervision of the resolution professional (RP).

However, this approach does not address the complexities such as applicability of moratorium at the entity level as opposed to project level and dealing with claims of entity level creditors.

Recently, in Umang Realtech's insolvency process (where the concept of 'reverse CIRP' was pioneered), the National Company Law Appellate Tribunal (NCLAT) has clarified that the moratorium is applicable only to the specific project undergoing CIRP and not to the other projects of the developer.

This is contrary to the stance taken by the NCLAT in the insolvency of Supertech Limited, where it was held that the moratorium is applicable to the corporate debtor as a whole.

In the Umang Realtech case, the NCLAT has also gone on to state that its decision cannot be treated as a general guidance or interpretation regarding moratorium but it is a case-specific dictum.

Interestingly, in the case of Supertech Limited, the NCLAT had ordered the constitution of the CoC to be limited to the concerned project undergoing CIRP, which was challenged before the Supreme Court.

On May 11, the Supreme Court passed an interim order holding that if the directions of the NCLAT were to be overturned and the CoC was to be constituted for the corporate debtor as a whole, it is likely to cause immense hardship to the homebuyers of the other ongoing projects which are outside the CIRP.

Whilst the Supreme Court has relied on the balance of convenience principle to afford relief to the homebuyers, such uncertainty regarding fundamental aspects of the resolution process surely does not bode well for stakeholders.

Solution for homebuyers?

When it comes to protecting the interests of the allottees, IBC is not a one-stop solution. Permitting homebuyers to initiate insolvency action and participate in the CoC is empowering but not necessarily effective for getting their homes or recovering their dues.

Homebuyers have thus far been treated as unsecured financial creditors under the IBC, which implies that in a liquidation scenario they would be behind secured lenders such as banks and financial institutions.

Notably, under the Transfer of Property Act, 1882, a buyer is entitled to a charge on the property to the extent of the purchase money paid by her along with interest. This statutory right provided to a buyer is subject to a contract to the contrary.

Therefore, in the absence of a specific waiver by the buyer in the agreement for sale, she would have a charge on the property. Generally, the builder-buyer agreements as well as the model form of agreement for sale prescribed by most RERA authorities, including in Maharashtra, do not incorporate such specific waiver by the buyer.

A 'secured creditor' is defined under the IBC as a creditor in favour of whom security interest is created. If homebuyers are held to be 'secured creditors' under the IBC, not only will they get the same treatment as other secured lenders in liquidation, they will also be entitled to their liquidation value as a priority payment in case they dissent to a resolution plan, which is a right available to dissenting financial creditors.

This right of homebuyers does not appear to have been considered by any judicial pronouncement and homebuyers continue to be treated as unsecured creditors under the IBC.

On the other hand, whilst RERA also empowers the RERA authorities to revoke the registration of a real estate project and take over the completion of the project after providing a right of first refusal to the association of allottees, there have not been too many instances where this power has been exercised by the RERA authorities.

This power has been exercised mostly in cases where the construction is largely complete, but developers have siphoned funds/abandoned the project, and not in cases where there is a genuine stress.

When it comes to the interplay between IBC and RERA, it is a settled position that once a moratorium is imposed under IBC, proceedings under RERA would be stayed. Given that most real estate projects are funded by lenders, it may not be worthwhile for the RERA authorities or the association of allottees to take over the development where there is a possibility of the entity being taken to IBC.

The way ahead

One of the measures which may be considered under RERA to improve the outcome for homebuyers is adoption of a conciliation mechanism by all RERA authorities. RERA empowers the RERA authorities to take measures to facilitate amicable conciliation of disputes between the developers and the allottees. However, such conciliation forums have been set up only in a few states, such as Maharashtra and UP.

The conciliation forum can serve as an alternative mechanism for resolution of disputes in an efficient and cost-effective manner and also help alleviate the burden on RERA authorities. Another step, which is also pending consideration before the Supreme Court, would be to introduce a uniform model builder-buyer agreement to be followed in all states which would prevent builders from inserting 'contracting out' clauses unfavorable to homebuyers.

When it comes to formulating an effective resolution mechanism under the IBC, it is important to be mindful of the nuances of the real estate sector. Homebuyers as a class of financial creditors are the most numerous and heterogeneous. Unlike other financial creditors whose aim is to maximise recovery, homebuyers are more interested in the completion of the project and possession of their property.

Additionally, where an entity houses multiple projects, it is possible that only one or some of the projects are stressed. In such cases, a project-wise CIRP may be effective since disruption to the other ongoing projects would be minimised.

The amendments proposed by the MCA seek to provide a specialised resolution framework for real estate projects, where project-wise resolution will be permitted. It is also proposed that the RP will be empowered to transfer ownership and possession of completed units to the allottees during the moratorium, with the consent of the CoC.

As is mostly the case, the devil would lie in the details, since it would be needed to be seen how the issues pertaining to applicability of moratorium at the entity level as opposed to project level and claims of entity-level creditors will be dealt with in the proposed amendments.

Another aspect which would need consideration is the adjudicating authority's discretion to initiate project-wise CIRP on a case-to-case basis. These provisions could also be misused by errant promoters to push projects which may not be commercially viable for them without impacting their other projects. Therefore, it is imperative that the proposed amendments have necessary safeguards against misuse of this special framework.

This update has been contributed by Aastha (Partner) and Rohan Mitra (Associate) and was first published byThe Economic Times (Prime).

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