The Insolvency and Bankruptcy Code, as mentioned in the objects and reasons, was enacted to provide effective resolution procedure for timely resolution of debtors, and to maximise the value of the debtor’s assets. To pursue these objects, it provides a comprehensive procedure, named the Corporate Insolvency Resolution Procedure (CIRP) to resolve insolvencies in a strict time-bound manner. At times, however, certain situations arise before the adjudicating authorities, where adherence to the entire CIRP procedure would put all the stakeholders under distress.
This situation, however, arose before the National Company Law Appellate Tribunal (NCLAT) in a recent case of the Flat Buyers Association v. Umang Realtech Pvt. Ltd.
Insolvency Resolution Process under the IBC
An application for initiation of CIRP is made by the operational or financial creditor on the occurrence of default by any Corporate Debtor (CD). During the completion of this process, a moratorium under Section 13(1)(a) is issued by the NCLT, which prevents all judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets, or termination of essential contracts to be instituted or continued against the Corporate Debtor. Post the acceptance of an application, an Interim Resolution Professional (IRP) is appointed to take charge of the corporate debtor. The IRP is responsible for the constitution of the Committee of Creditors (COC), and appointment of the Resolution Professional (RP).
Subsequently, a resolution plan (a bid document), constituting the terms of the proposal (including payment structure to various lenders, business plan along with its assumptions, transaction structure, etc), is proposed before the Committee of Creditors. On acceptance with the requisite majority provided under the IBC, a plan would be passed or the CD would have to go through liquidation.
Home Buyers as financial creditors under the IBC
Post the second amendment to the IBC dated August 2018, the home buyers of a Real Estate and Infrastructure Project were declared ‘financial creditors’ under Section 5(8) of the IBC. This provided them with a right to approach the adjudicating authorities on the occurrence of any default in delivery of possession or delay in completion of the project by a real estate developer.
The Umang Real-Estate case
The case involved an application by two home buyers of the Umang Realtech Pvt. Ltd.’s Winter Hill – 77 Gurgaon Project to initiate CIRP against the CD. The NCLT accepted the petition of the home buyers for initiation of the CIRP against the CD, and ordered the financial creditors to deposit an amount of Rs 2 lakhs with the IRP to meet the daily expenses of the CD, and to keep it a going concern.
An appeal against the order of the NCLT was filed by the Home Buyers Association. In the appeal, the home buyer’s association claimed that, since the stakeholders have mutually come up with a plan, immediate delivery of possession is promised by the CD, with a condition that the home buyers repay their outstanding dues towards their flats to the CD. It was further agreed amongst the parties that the CD will utilise the amount received from the home buyers to repay their dues to other third-party financial creditors.
Subsequently, the IRP made a claim stating that the amount declared by the NCLT (Rs 2 lakhs) is too negligible to meet the regular expenses of a CD involved in the Real estate business. This was done to prevent the stalling of the CD’s projects, once it goes through the CIRP process.
The NCLAT, in this case, took note of this fact and decided to experiment with the existing methods of the CIRP so that right of the project developers is not compromised. The tribunal ordered for the completion of the existing project by the CD, and to deliver immediate possession of flats. This move was termed by them as ‘Reverse CIRP’. As mentioned by the tribunal, the purpose behind passing of such an order was to make the investors bear the fruits of their investment, to ensure that the business of the CD remains a going concern, and to save the employment of the unorganised employees of the project.
We have already discussed all other aspects of the Umang real-estate judgement.
Analysis
In circumstances like these, where stakeholders have mutually come up with a viable option to resolve the financial stress of the CD, adopting measures such as reverse CIRP is a probable step of recognising and ensuring the rights of the home buyers.
The step taken by the NCLAT is based on the ‘equality for all’ approach. This approach, however, is in direct contradiction to the current law of distribution declared by the Supreme Court in the landmark Essar Steel case. This practical step, against the status quo Law, is termed by the tribunal as an ‘experiment’ which was necessary for the effective implementation of the IBC’s object of maximising the assets of the CD. Quoting from the judgement, the tribunal mentioned that
“to stay experimentation in things economic is a grave responsibility, and denial of the right to experiment is fraught with serious consequences”.
Investment of the Home-buyers, termed as a ‘financial debt’ demands quick delivery of the plot’s possession as its only effective fruit. This view follows from the SC’s judgement in the Pioneer Infrastructure case, where it has mentioned that a refund, or any other financial compensation is not a plausible option of repaying the dues of home buyers.
The judgement has its effects on the following aspects
Settlement of claims amongst ‘secured’ and ‘unsecured’ creditors
Due to the financial distress in business of the CD, even after the passing of a resolution plan, it becomes difficult to pay off entire debts of all classes of the creditors, while keeping the CD a going concern. This makes the equitable and effective distribution of amounts to different classes of creditors an essential need.
The tribunal pointed out that differentiating amongst the ‘secured’ and ‘unsecured creditors’, and by rejection of the ‘Equality for all’ principle, the Supreme Court (SC) in the Committee of Creditors of Essar Steel v. Satish Kumar mentioned that neither the IBC, nor any regulation enacted under it, provided for an equal percentage-wise distribution of the same amount of proceeds under a resolution plan amongst all classes of creditors. According to the tribunal in the present case, where the defaulting real estate developer is on the verge of finishing the project, this principle of giving preferential treatment to the ‘secured creditors’ should not be applied. Tribunal, towards the end of the judgement concluded that since the flats or the plots of an infrastructure company are contractually approved for allottees of those projects, giving any preference to the secured creditors of such company is unjust.
While citing the decision of the Hon’ble SC in Pioneer Urban Land and Infrastructure Co Ltd. v. Union of India, the tribunal mentioned that since there is no other mode (refund) of repaying the dues of the home buyers, allotment of flats and plots of the project remains the only way of repayment. Hence, secured creditors such as banks and financial institutions cannot be allotted with asset (flat/apartment) by preference over the allottees (Unsecured Financial Creditors) for whom they were approved initially.
Supply of Essential Goods and Services
Rs. 2 lakh, according to the tribunal was minimal to ensure the supply of essential goods and services, and to ensure the going concern status of the CD. The CD, required immediate resources to finish the common amenities like swimming pool, club house etc. as promised to the allottees. Since they do not fall under the list of essential goods mentioned under the Regulation 36 of the CIRP, the NCLT did not take those amenities into consideration, while determining the amount to run the expenses.
The NCLAT, mentioned this as another limitation of the CIRP, as it averts the maximizing the value of the CD’s assets. It mentioned that these provisions pertaining to the process put both the homebuyers and project developers under distress.
Applicability of a Resolution Plan to other Projects
Another aspect of the judgment which marks a path-breaking precedent for subsequent similar issues to be adjudicated by tribunals, was with respect to the applicability of the resolution plan. According to the NCLAT, a resolution plan proposed and passed by the COC of one project should not be affecting any other projects of the same real estate company (CD) in other places. The reasoning given by the NCLAT behind such judgement was the different land, different allottees owning plots in that land, and different financial institutions funding those projects. Hence, assets of the CD, which are pertaining to a completely different project are not to be maximised.
Restriction on Filing Petitions on Occurrence of Default
The petition in the case was filed by two home buyers out of the group of 624 allottees in total. The applicants filed the petition for the initiation of CIRP, going against the aggregate will of the other creditors. While adjudicating, the NCLAT gave precedence to the mutual solution achieved by the aggregate will of all the allottees, which included the immediate delivery of possession to the allottees, in return of the promise from the allottees to repay the outstanding amount consideration towards their plots to the CD.
Legislative amendments triggered by the case
Post the ruling of the NCLAT, the parliament enacted the Insolvency and Bankruptcy Code (Amendment) Act 2020. Following were the amendments which were triggered by the NCLAT’s ruling:
Restrictions on the filing of Insolvency Resolution Process by certain Financial Creditors
To prevent such cases where an application by few allottees is filed without assent or will of the other allottees, a minimum threshold for initiating CIRP is prescribed. According to the amendment, an application by home buyers u/s 7(1) of the IBC should be jointly made by at least 100 such creditors or 10% of their total number. It also clarifies that where such application was already filed before the commencement of the 2020 amendment, those applications must be amended, within 30 days of enactment of the Act.
Supply of essential goods and services
The amendment inserted Sub Section (2A) to Section 14 of the IBC. The amendment provides for the RP/IRP to maintain the supply of ‘critical goods and services’. This broadens the ambit of the term ‘essential goods and services’ as provided under Regulation 36 of the 2016 IBC (CIRP) Regulations. This further provides the IRP/RP an autonomy to decide the value of costs to meet the regular expenses of the CD, and keep it a going concern. This amendment would ensure that any IRP appointed in a CIRP will be given adequate autonomy to take the right amount to meet the expenses of the CD.
Conclusion
The experiment performed by the NCLAT acts as a practical solution for resolving such entangled disputes amongst the distressed Real – estate companies and homebuyers. Since neither the liquidation of such CD’s, nor the long staling of the completion of projects would serve any benefit to the homebuyers, this step seems to be a viable option for the time being. However, since the existing law does not render any such power to the tribunals, this act of the NCLAT falls beyond the statutory limits of the IBC. For this reason, the NCLAT ordered to restrict the applicability of this experiment to the specific case before it, and prohibited its effect any proceedings in other projects against the same developers.
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