Game of Homes: Interplay between RERA and IBC

Game of Homes: Interplay between RERA and IBC
21/04/2018 , by , in EXPERT ZONE

Happiness does not last forever! No one has experienced this bitter truth like the Indian home buyer. The government brought the Real Estate (Regulation and Development) Act, 2016 (“RERA”) in force on May 1, 2016 and the Insolvency and Bankruptcy Code, 2016 (“IBC”) on May 28, 2016. The former instilled the homebuyer with a sense of hope, as it protects the rights of the home buyers. The homebuyer was king. But in the not so far off distance, a rebel was ready to tarnish the reign of the new king, the creditor. In simpler words, the IBC has raised several doubts and concerns about the rights of home buyers vis – a – vis the creditors.

The IBC allows the creditors of a real estate developer to make an insolvency application before the National Company Law Tribunal (“NCLT”) and initiate insolvency resolution proceedings against the real estate developer company (“Company”). During these resolution proceedings, the promoters lose control over their Company and an insolvency resolution professional (“IRP”) is appointed, who takes over the reins of the Company. The objective of the resolution process is to approve and adopt a resolution plan which would allow the Company to continue operating as a going concern. If this resolution plan fails, liquidation proceedings are initiated which are intended to essentially wind up the Company. A question arises as to what happens to the rights of the home buyer in such a scenario.

 

The Creditor Conundrum:

The IBC contemplates two (2) kinds of creditors, financial and operational. Financial creditors are those who have given debts to the Company in the nature of loans, debentures, etc. Whereas operational creditors are those to whom money is to be paid for the goods or services provided by such persons. One of the biggest questions that has arisen is whether or not a home buyer will be considered to be an operational creditor under the IBC. The NCLT has held in multiple cases[1] that home buyers are mere allottees of flats and not operational creditors of the Company. However, the courts have also held that if the Company agrees to give a periodic assured return to the home buyer, the home buyer will then be considered to be a financial creditor[2]. In the Jaypee case[3], the apex court took note of this anomaly and sought clarification from the central government. In the backdrop of this chaos, the Ministry of Housing and Urban Affairs issued a circular introducing a new category of creditors and several experts are of the view that home buyers would fall under the head of this new category of “other creditors”.

The IBC provides that an insolvency application can be made by a financial creditor, an operational creditor or the Company itself. Therefore, if the home buyer is designated as an “other creditor”, it would mean that while the home buyer cannot initiate insolvency proceedings, they can get a piece of the pie if the Company is liquidated. Even then, the home buyer is entitled to a piece of the pie only after financial creditors, workmen, employees, operational creditors and the government have received their dues. Which begs the question whether or not the home buyer will get anything at all?

The latest report of the Insolvency Law Committee has recommended that home buyers be treated as financial creditors under the IBC since in essence, the amounts paid by the home buyers are a means of raising finance. It is important to remember that this is merely a recommendation and not a law at the moment. Assuming the home buyer does get recognised as a financial creditor by fiction of law, the question then arises what would be their rights and obligations vis-à-vis the other lenders and creditors who will then have a justifiable argument that they are taking a much higher risk compared to the home buyer and should therefore have priority.

 

Question of Control:

The IBC provides that when an insolvency application has been admitted against a Company, the control over the Company has been taken over by the IRP. Even though RERA does not provide that the Real Estate Regulatory Authority (“Authority”) can take over control of the project and complete it when the Company is insolvent, it is safe to assume that insolvency of the Company will lead to him breaching his obligations under of RERA.

Several experts were of the view that this would lead to a conflict between the IRP and the Authority. Some however feel otherwise, as RERA does not allow the Authority to take over control of the Company but only of the projects registered under RERA. The IRP on the other hand will take over control of the entire Company. How the IRP and the Authority will work together is yet to be seen. But one can fairly imagine that it will not be smooth sailing, especially for the home buyers who may be a disjointed community in the whole proceedings.

 

Homebuyers and the liquidation process:

On the initiation of the liquidation process under the IBC, the assets of the Company are taken over by the IRP and are sold to the highest bidder. The IBC excludes assets held in trust for third parties from the liquidation estate to be distributed by the liquidator. Therefore, a reasonable argument could be made that the monies received by the Company or the flat constructed should be held in trust for the home buyer until the occupancy certificate has been received and possession of the flat has been transferred to the home-buyer. In fact, it could be considered a prudent measure to insert language in the agreement for sale that the monies being received and flats to be constructed by the Company be held in trust for the home buyers and shall not form part of the liquidation estate.

While this seems to be a happy solution, it may not go down well with the developers and lenders. As it is the Company needs to keep 70% of its receipts from home buyers in a separate designated account as per RERA and now this would imply that he cannot show any part of the receipts as his income. This would also raise the question of the ability of the Company to create a charge on the project or receivables as he is now only the trustee of the same.

 

Conclusion

It cannot be denied that the IBC as it presently stands is not best suited to developers or home buyers. At the same time, the position of the home buyer under the IBC is still being scrutinized and until the same is crystallised, the home buyer cannot breathe easy.

Considering the slump that the real estate market is currently undergoing, it seems prudent for the government to take quick steps and give impetus to the real estate sector. This could be done by making special rules for the insolvency resolution and liquidation of real estate and infrastructure companies which have a long gestation period for their products (i.e. flats and other infrastructure) to generate revenue. If such rules are made, the central government will have to navigate the subject matter in such a way that the interest of the creditors, developers as well as that of the home buyers is protected. This may seem like a herculean task and it probably is, but it is also the need of the hour!

 

 

  • By, Vivek Daswaney, Partner at IndusLaw, Mumbai

 Mr. Vivek Daswaney was assisted by Mr. Shreshth Bhartia (articled clerk) and Ms. Raavi Mehta (intern) in preparing this article.

 

[1] Col Awasthy v. AMR Infrastructure Limited, 20th February, 2017; Pawan Dubey & Ors. v. J.B.K. Developers, (Company Appeal (AT) (Insolvency) No. 07 of 2017)

[2] Nikhil Mehta and Sons v. AMR Infrastructure Limited, 21st July, 2017

[3] IDBI v. Jaypee Infrastructure Limited, 9th August, 2017

 

 

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