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Decoding IBC and its role in India's real estate landscape

After getting off to a rocky start, can the Insolvency and Bankruptcy Code, 2016 and the Insolvency and Bankruptcy Code (Second Amendment) Bill, 2019 secure investors who are stuck with non-performing real estate projects?

Yudhist N Singh and Adit Singh

Since its introduction in 2016, the Insolvency and Bankruptcy Code of 2016 (IBC) has faced several hurdles and undergone significant teething problems, especially while dealing with companies which are focused on the real estate sector in India.

Originally, the IBC was introduced by the Indian parliament with a view to consolidate and alter the archaic rules pertaining to insolvency and bankruptcy and to ensure maximum availability of credit while dealing with non-performing assets.

After the introduction of the IBC, ambiguity arose as to what category of creditor's real estate investors and/or allottees ("Investors") fall under. Inevitably, several investors filed cases against real estate companies, preferring petitions under Section 7 of the Act (which deals with debts owed to a financial creditor and the method of making applications for initiating insolvency by financial creditors).

In order to address these concerns, on 16 November 2017, a committee was setup by the government to provide its comments and views. The committee took into consideration, amongst other things, various conflicting cases before the courts concerning the status of Investors while making its report.

Close

The committee submitted its report dated 26 March 2018, wherein it was recommended that an explanation was to be added to Section 5 (8) (f) (definition of what constitutes a "financial debt" under the IBC) which would empower investors to attain the status of a financial creditor and would enable them to approach the insolvency court(s) (NCLT) under Section 7 of the IBC as a financial creditor. Subsequently, the Parliament approved the amendment to the IBC.

It is pertinent to mention that previously, in the matter of Nikhil Mehta & Sons (HUF) & Ors. Vs. M/s AMR Infrastructures Ltd. ("AMR Judgment") dated July 21, 2017, the NCLAT had observed  that investors who had been promised an 'assured return' by real estate companies would fall under the category of financial creditors as the monies owed to them would fall under the definition of a 'debt' as defined under Section 3(11)  of the IBC.

The AMR judgment had clarified that 'financial debt' is a debt along with interest which is disbursed against the consideration for the time value of money. Therefore, there was confusion on whether Investors who did not fall under this category of 'assured returns' would be treated as financial creditors.

Several real estate companies were aggrieved by the above-mentioned amendment made to the IBC and approached the Supreme Court to strike down the amendment as unconstitutional. In its judgment dated 9 August 2019 of Pioneer Urban Land and Infrastructure Limited and Ors. Vs. Union of India and Ors. ("Pioneer Judgment"), the Supreme Court upheld the amendments made to the IBC. The Supreme Court observed that legislations such as the IBC and Real Estate (Regulation and Development) Act, 2016 ("RERA") would run concurrent to each other, and in case of a conflict, the IBC would prevail over RERA. It was further held in this case that Investors were already subsumed within Section 5 (8) (f) of the IBC and that the amendment was a mere clarification.

Based on the observations made in the Pioneer Judgment, the clarity provided to Investors resulted in a surge in filing of Section 7 petitions under the IBC against various real estate companies. In several of these cases, projects which were close to successful completion have been dragged into insolvency.

While some of the investors argued that they wanted their properties completed, the others argued that they wanted their investments to be returned via the insolvency process. This led to widespread panic and skepticism among Investors, leaving them with one unanswered question – will IBC help us get our money back?

The Insolvency and Bankruptcy Code (Second Amendment) Bill, 2019

On December 12, 2019, another bill was introduced in Parliament titled The Insolvency and Bankruptcy Code (Second Amendment) Bill, 2019 (“Second Amendment bill”). The Lok Sabha has referred the Second Amendment bill to a standing committee on the 23 December 2019. The standing committee has three months to submit its report before the Lok Sabha.

A feature in the Second Amendment bill is that it seeks to amend Section 7 of the IBC which deals with financial creditors approaching the Insolvency Courts against a corporate debtor. The Second Amendment bill specifically seeks to add a proviso to Section 7 which provides minimum thresholds for initiating insolvency proceedings. The proviso reads as follows:

"Provided further that for financial creditors who are allottees under a real estate project, an application for initiating corporate insolvency resolution process shall be filed jointly by not less than one hundred of such allottees under the same real estate project or not less than ten per cent of the total number of such allottees under the same real estate project, whichever is less."

Therefore, the Second Amendment bill seeks to impose a restriction on fresh petitions being filed under Section 7 of IBC by Investors. In terms of the bill, at least one hundred (100) Investors of a particular real estate project or ten percent of the total investors will have to approach the court collectively.

For residential real estate projects, this would entail that a considerable number of homebuyers shall have to discuss and agree whether they want to initiate insolvency proceedings or explore other legal options. Previously, even a single aggrieved homebuyer could initiate insolvency proceedings based on the amended provisions of the IBC. Consequently, this amendment shall radically reduce the number of cases being filed under Section 7 against real estate companies.

Conclusion

In the judgment of Swiss Ribbons Vs. Union of India on 25 January 2019, the Supreme Court has made it abundantly clear and observed that the IBC is proving to be a fruitful legislation with over 3,300 cases successfully disposed off or settled in an expeditious manner.

It held that economic legislations such as the IBC would be presumed to be constitutionally valid at the very outset. The court had observed that the implementation of the Code is taking place under the supervision of the government and expert committees. Justice Nariman had finally observed as follows:

"These figures show that the experiment conducted in enacting the Code is proving to be largely successful. The defaulter's paradise is lost. In its place, the economy’s rightful position has been regained."

Based on the above facts and judgments, it has become evident that the IBC (and presumably in the future - the Second Amendment bill) is here to stay. IBC is fast becoming a pivotal financial resolution legislation in India. While it may be argued that the IBC has faced its fair share of problems at the initial implementation stage, given the pro-active approach of the government on dealing with these issues, it can be concluded that the IBC along with its amendments shall play a vital role in the future of the Indian economic landscape.

The Indian real estate sector has suffered greatly in terms of non-performing assets and incomplete projects. After decades of decadence enjoyed by the promoters of these companies, the only remaining option (especially for the abandoned/failed projects) appears to be taking over the management of these companies and ensuring that the remaining assets are disposed effectively to pay back the monies owed to real estate Investors in an expeditious manner.

(The authors are advocates regularly advising on insolvency matters based in New Delhi)
Moneycontrol Contributor
first published: Dec 27, 2019 02:28 pm

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