The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018, ("Ordinance") which came into force on 6th June, 2018 provides for various amendments to the Insolvency and Bankruptcy Code, 2016 ("the Code"). One of the most significant changes made in the Code pertains to the definition of financial debt and financial creditors.
The Ordinance now accords any homebuyer, the same position of a financial creditor for the purposes of instituting and/or proceeding with the insolvency resolution process under the Code.
These amendments were sanctioned after a committee chaired by Shri Injeti Srinivas issued its 'Report of the Insolvency Law Committee' ("Report") in March, 2018 recommending that home buyers be treated as financial creditors owing to the unique nature of financing in real estate projects and the treatment of home buyers by the Hon'ble Supreme Court in ongoing cases.
The effect of this grant of financial creditors status to homebuyers means that they will now be treated at par with banks and institutional creditors and will be given priority while recovering dues from insolvent real estate companies. This also places homebuyers at a higher priority than non-financial unsecured creditors and ensures that they will be allowed to equitably participate in an insolvency resolution process and be a part of the committee of creditors ("CoC").
At first blush, this Ordinance seems to have achieved the laudable objective of protecting the interest of homebuyers within the framework of the Code. But a CoC empowered to decide on the fate of a corporate debtor, which comprises of not only financial institutions but also thousands of individuals and entities from all walks in life comes with its own challenges and may well become a logistical nightmare.
The Ordinance read with the Code provides under Section 25A for an authorised representative to participate and vote in meetings of the CoC on behalf each of the financial creditor he represents by casting his vote in respect of each financial creditor to the extent of their voting share in accordance with the prior voting instructions of each of such creditors.
To take the example of Prem Singh Khamesra & Ors. Vs. Jaypee Infratech Limited & Ors., there were as many as 2460 home buyers who would now form part of the CoC. In large townships this number could well be multiplied several times. It would very cumbersome for any authorised representative to take into account the individual voting share and vote of each such flat purchaser. Also, any person as long as he has an allotment letter in his favour, will become a financial creditor irrespective of the quantum of his "financial debt".
Voting share depends on financial debt
The extent of dues owed to each homebuyer would logically pale in comparison to the dues owed to any financial creditor. As such, the voting share of homebuyers should ideally not be calculated by the dues owed to them individually but instead as the total dues owed to them as a whole. Additionally, it is likely that some homebuyers may fail to vote and the votes of the remaining homebuyers may also thus fail to carry any weight. One possibility of resolving this was put forth by the lawyers representing the homebuyers of Jaypee Infratech Limited, in their letter addressed to the chairperson of IBBI where they suggested extrapolating the votes of the homebuyers who have actually voted to the whole class of such creditors.
Double whammy to operational creditors
Let's go back to November, 2015 when the Bankruptcy Law Review Committee ("BLRC") chaired by T.K. Vishwanathan released its report reasoning that members of the creditors committee have to be creditors both with the capability to assess viability, as well as be willing to modify terms of existing liabilities in negotiations. With this reasoning, operational creditors have been left out of the CoC since they were thought to be neither able to decide on matters regarding the insolvency of the entity, nor willing to take the risk of postponing payments for better future prospects for the entity.
However, thousands of individuals and other entities solely by reason of buying a flat have now become part of the CoC, with no relation to the aforesaid ability and willingness which the BLRC deemed so important while operational creditors still sit out.
Without representation on the CoC, a resolution plan can legally envisage payment of only liquidation value to operational creditors. Now with the advances by all homebuyers being defined as financial debt which ranks higher than unsecured operational dues while distributing assets, the liquidation value to operational creditors (who are usually unsecured) would further reduce.
A quick fix solution?
It is without doubt that in real estate projects, financial institutions alone cannot simply decide the fate of projects. Even if resolution plans contemplate bringing in a new developer to complete projects to facilitate repayment, undoubtedly flat owners must have a say in deciding such new developer. The Real Estate (Regulation and Development) Act, 2016 ("RERA") in any event provides for consent of two-third allottees of a project for a change in the developer of a project. In that sense, the Ordinance does attempt to balance the interest of homeowners and financial lenders by allowing participation by both in the CoC.
As far as homebuyers are concerned, the Ordinance is a step in the right direction, as it gives to homebuyers decisive powers which were hitherto restricted only to financial lenders. As is said however, great responsibility follows inseparably from great power. If the rights given to homebuyers are not exercised responsibly with the willingness and capability so emphasised by the BLRC, it could seriously jeopardise the interests of other creditors especially financial lenders who are already on shaky ground post-RERA. A more circumspect approach, harmonising RERA and the Code and allowing remedies to both homebuyers and financial creditors under the aforesaid statutes made for their respective benefit, perhaps is needed.
Keeping in mind the tight deadlines prescribed under the Code which is one of the strongest merits of this reformed insolvency law, the formation and operation of an unwieldy CoC with so many individual voters could itself effectively derail and delay the whole resolution process.
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.