Above: Under-construction flats are a common sight, with many projects facing huge delays/Photo: Anil Shakya

In a welcome move, the apex court has upheld the law elevating the status of allottees of real estate projects to creditors in order to ensure greater accountability of the promoters

By Venkatasubramanian

Those who have invested their wealth in a home are vital stakeholders in building projects. In the beginning, the Insolvency and Bankruptcy Code (IBC), enacted in 2016, recognised only three categories of stakeholders—corporate debtors, financial creditors and operational creditors. However, special enactments, including the Consumer Protection Act, 1986, and the Real Estate (Regulation and Development) Act, 2016 (RERA), conferred rights on allottees of real estate projects which the IBC divested.

Thus, when 646 home buyers in projects floated by Jaypee Infratech Limited (JIL) approached the Supreme Court in 2017, it was persuaded by the view that the liquidation of JIL would not subserve the interests of home buyers.  The Court recognised that a home for the family is a basic human yearning.  In diverse contexts, it has been held by the Supreme Court to be a part of the right to life as a fundamental constitutional guarantee. All the counsel for the home buyers appealed to the Court to exercise its jurisdiction to ensure complete justice for them instead of leaving them at the mercy of the liquidation process.

The concerns of the home buyers were sought to be assuaged by the Insolvency and Bankruptcy
(Amendment) Ordinance, 2018, which came into force on June 6, 2018. As a result of this, home buyers were first brought within the purview of financial creditors. A “financial creditor” is defined in Section 5(7) as “any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred”. “Financial debt” is defined as debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes any amount having the commercial effect of a borrowing.  As a result of the change in the definition of “financial debt”, amounts raised from allottees under real estate projects are deemed to be amounts “having a commercial effect of a borrowing”.  Hence, outstandings to allottees in real estate projects are statutorily regarded as financial debts. Such allottees were brought within the purview of the definition of “financial creditors”.

Section 7 of the IBC creates a statutory right in favour of financial creditors to initiate the corporate resolution process. Thus, the Supreme Court held in the Chitra Sharma v Union of India (2017) case that being financial creditors under the IBC, allottees in a real estate project necessarily constitute a part of the Committee of Creditors (CoC). The Supreme Court reiterated this ruling in Bikram Chatterji v Union of India, involving the Amrapali Group.

Based on these twin judgments, the Insolvency Committee Report suggested amendments to the Code, seeking to clarify, as a matter of law, that allottees of real estate projects are financial creditors. After the Ordinance inserted three amendments to the Code, Parliament passed the IBC (Second Amendment) Act, 2018, to replace it.

On August 9, the Supreme Court bench of Justices RF Nariman, Sanjiv Khanna and Surya Kant upheld the constitutional validity of this Act in Pioneer Urban Land and Infrastructure Limited v Union of India.

The bench dismissed the argument of the petitioners that the Act violated two facets of Article 14. One, that the amendment is discriminatory inasmuch as it treats unequals equally, and equals unequally, having no intelligible differentia; and two, that there is no nexus with the objects sought to be achieved by the Code. The petitioners argued that the amendments fly in the face of the objects sought to be achieved by the Code, that is, to maximise value of assets so that the shareholders of a corporate debtor do not suffer from bad management or poor management.

Thus, the petitioners contended before the Supreme Court that the “bad eggs” alone were looked at. They said the entities who had completed building projects in time and were compliant with the law could yet be jeopardised by petitions filed under Section 7 of the Code to blackmail them into making payments. This, they said, would divert funds which were otherwise to be used for the project. Therefore, the petitioners challenged the amendments to IBC as manifestly arbitrary, excessive, disproportionate, irrational and without determining principle.

The petitioners alleged infraction of their fundamental right under Article 19(1)(g) of the Constitution, and the amendments, not being a reasonable restriction in the public interest under Article 19(6) would, therefore, have to be struck down. The petitioners relied on RERA to argue that it addresses all concerns of the allottees, and therefore, the enactment of a sledgehammer to kill a gnat would render the amendments excessive and disproportionate. Through the amendment, Parliament brought in persons who are not financial creditors by forcibly inserting a square peg in a round hole, the petitioners argued.

They submitted that allottees of real estate projects are a huge, amorphous and disparate lot, and including them as financial creditors would be unworkable as thousands of petitions would flood the National Company Law Tribunal (NCLT). When they are represented on the CoC, they would speak in different voices, being concerned only with their own investment, having no concern whatsoever for the financial betterment of the corporate sector.

The centre submitted before the Supreme Court that sufficient play in the joints must be given to the legislature when it comes to economic legislation, and every experiment that the legislature undertakes should not be interfered with by the Court. The government argued that the real reason for including allottees as financial creditors is because they finance the project in which they will ultimately be given flats/apartments.

Distinguishing RERA from IBC, the Supreme Court held that the object of the former is to see that real estate projects come to fruition within the stated period and to see that the allottees are not left in the lurch and are able to realise their dream of a home or are paid compensation along with the interest. At the same time, the Supreme Court cautioned, recalcitrant allottees are not to be tolerated as they must also perform their part of the bargain, namely, pay instalments as and when they become due and payable. RERA thus ensures that the flat/apartment is constructed and delivered to the home buyer in time, barring which compensation and/or refund with interest comes their way.

If, however, the allottee wants the corporate debtor’s management itself be removed and replaced so that the corporate debtor can be rehabilitated, he may prefer Section 7 application under the Code, the bench held.

The IBC, it said, is beneficial legislation which can be triggered to put the corporate debtor back on its feet in the interest of unsecured creditors like allottees. The allottees, it said, were vitally interested in the financial health of the corporate debtor so that a replaced management may then carry out the real estate project as originally envisaged and deliver the flat/ apartment as soon as possible and/or pay compensation.

As the Amendment Act is made in public interest, it cannot be said to be an unreasonable restriction on the petitioners’ fundamental right under Article 19(1)(g), and there is no infraction of Article 300-A as no person is deprived of property without authority of a constitutionally valid law, the bench held.

Clarifying the law, the bench held that the expression “borrow” is wide enough to include an advance given by the home buyers to a real estate developer for “temporary use”, i.e., for use in the construction project so long as it is intended by the agreement to give “something equivalent” to money back to the home buyers. The “something equivalent” in these matters is obviously the flat/apartment, the bench suggested.

The bench was emphatic that the amounts raised from allottees under real estate projects would be subsumed within Section 5(8)(f) of the IBC even without adverting to the explanation introduced by the Amendment Act. The bench drew attention to the fact that the threshold limit to trigger the Code is purposely kept low—at only Rs 1 lakh—making it clear that small individuals may also trigger the Code as financial creditors. This would include debenture holders and bond holders, along with banks and financial institutions to whom crores may be due.

The bench underlined that the Insolvency Law Committee itself had no doubt that given the “financing” of the project by the allottees, they would fall within Section 5(8)(f) of the Code as originally enacted. The amendment adds an explanation to Section 5(8)(f), by way of clarification, that any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing.

The bench directed “recalcitrant States” to appoint permanent adjudicating officers, a RERA and Appellate Tribunal within a period of three months from August 9, and asked the centre to ensure that NCLT and NCLAT are manned with sufficient members to deal with litigation that may arise under the Code especially from the real estate sector.