Any allocation of preferential rights to homebuyers puts the rights of banks in peril
The Supreme Court, in the case of Pioneer Urban Land and Infrastructure Ltd and Anr vs Union of India, recently pronounced that the challenge to Section 5(8)(f) among other provisions of the Insolvency and Bankruptcy Code, 2016 (IBC) is not sustainable and the provision introduced through an amendment is constitutional.
The said judgement came out earlier this month and has resulted into proliferation of insolvency proceedings, where now any and every aggrieved homebuyer can initiate insolvency proceedings, and which they already are, against the real estate company. This above-mentioned Section defines what a financial debt is, in the sub-clause (f) the amendment added an explanation, which said that any amount raised for a real estate project will have an effect of commercial borrowing, similar to raising money through banks.
The effect of this and the subsequent SC decision is that homebuyers will now be treated as ‘financial creditors’ as opposed to ‘operational creditors’, which was previously the case.
Conceptually, financial creditors are the creditors who agree to take debt and lend credit to a business to help run it. The most obvious financial creditors, therefore, are banks and NBFCs. On the other hand, operational creditors are the ones who take debt in the usual course of business.
Consider the auto industry. Here, the unpaid tyre supplier to the car manufacturer will be an operational creditor because he holds a debt from supplying goods which forms part of the value chain and not because he directly lent money to the car manufacturer.
This becomes a little tricky in the real estate sector. A real estate corporation in most cases takes loans from a bank to fund a housing project and also secures advances from its customers, who are homebuyers. There is a very fine line of difference here. Because homebuyers are still not lending money, they are essentially paying for a product, which is the home.
Therefore, calling them financial creditors is wrong as it goes against the basic grain of economics. The entire intent of passing this amendment was to accord higher priority to homebuyers if and when the real estate company liquidates, and also to give them a say in the deliberations of the Committee of Creditors (CoC), which takes a call on the proposed resolution plans.
The above argument might be construed as against the interest of homebuyers because it is presumed that they are middle to low income Indians and have put in their hard-earned money and hence, the legislature should try and put in their interests to the forefront.
However, this is not the case. Considering homebuyers as financial creditors treats them at par with banks, and any allocation of preferential rights to them is to the detriment of the rights of the banks. Therefore, any benefit which now accrues to homebuyers will be a loss for banks.
Here, banks, on the other hand, which are mostly public sector ones and are run by the tax payer money, represent the interests of much more and less affluent Indians than homebuyers. They also represent interests of much smaller and retail investors and depositors. Hence, any detriment to the interest of banks will be damaging for many more Indians and these will be those who are less likely to afford these losses.
After all homebuyers in metros, the interests of whom this amendment caters to, represent a share of the relatively affluent population, who in the first place can afford a house in a metro like New Delhi, Mumbai or Bengaluru. Given the current health of the banking system, such an amendment makes even lesser sense.
Moreover, giving homebuyers a seat at the CoC is also not a wise decision because the CoC debates on financial technicalities of a resolution plan, which is difficult to be understood by an average homebuyer as opposed to professional bankers. Hence, homebuyers can now potentially block a financially sound resolution plan for the plain want of financial understanding.
Also, homebuyers have a very huge anti-liquidation bias because naturally they will want their homes instead of a truncated amount which they invested, which is mostly the case whenever a corporation is liquidated. In a situation where only liquidation is the wisest way forward, homebuyers can simply block it.
Hence, the government as well the courts have erred here. The sooner they correct themselves, the better it will be for the real estate sector.Raghav Pandey is an Assistant Professor of Law at Maharashtra National Law University, Mumbai. He tweets @raghavpandeyy. Views are personal.Get access to India's fastest growing financial subscriptions service Moneycontrol Pro for as little as Rs 599 for first year. Use the code "GETPRO". Moneycontrol Pro offers you all the information you need for wealth creation including actionable investment ideas, independent research and insights & analysis For more information, check out the Moneycontrol website or mobile app.