The Forgotten Creditors: IBC's Dual Approach For Homebuyers And Other Consumers
The Insolvency and Bankruptcy landscape in India underwent a significant transformation with the enactment of the Insolvency and Bankruptcy Code (IBC) in 2016. One of the most intriguing aspects of the IBC is its impact on consumers, particularly those who find themselves in precarious situations when companies they have transacted with go under the insolvency process. Imagine...
The Insolvency and Bankruptcy landscape in India underwent a significant transformation with the enactment of the Insolvency and Bankruptcy Code (IBC) in 2016. One of the most intriguing aspects of the IBC is its impact on consumers, particularly those who find themselves in precarious situations when companies they have transacted with go under the insolvency process. Imagine a scenario where a consumer buys a plane ticket, looking forward to a much-anticipated trip, only to find out the next day that the airline has declared insolvency or a home-buyer who tends to put all his savings into a real estate project knowing later that the builder has gone bankrupt and is facing insolvency. Though the homebuyers have statues like RERA that tend to safeguard their interest but there are scenarios where they do tend to opt for the insolvency code as well. This consumer, like many others in similar predicaments, suddenly becomes an unintentional creditor. The IBC, while primarily focused on addressing the claims of financial and operational creditors, also provides provisions for consumers to assert their rights and seek remedies. However, the journey for consumers in the insolvency process is fraught with challenges and complexities.
Homebuyer as Financial Creditor| RERA-IBC Standoff
Under the Insolvency and Bankruptcy Code (IBC) 2016, creditors are categorized into two distinct groups: financial creditors, defined under Section 5(7), and operational creditors, defined under Section 5(20). Financial creditors are entities that provide financial assistance or loans to companies, while operational creditors are those who supply goods and services. However, there was significant ambiguity regarding the classification of homebuyers within the IBC framework. Earlier before the amendments there was lack of clarity whether homebuyers should be considered financial creditors or operational creditors, leading to confusion about their legal standing under the Code. In 2018, the Insolvency and Bankruptcy Code saw its first major amendment. This included a crucial change with the introduction of an explanation under Section 5(8)(f), which explicitly recognized homebuyers who have made payments for allotments in real estate projects as “financial creditors.” This change empowered homebuyers to initiate the CIRP against developers who default.
The same was also upheld by the Supreme Court in Chitra Sharma v. Union of India [1] and Bikram Chatterji v. Union of India[2] stating that considering the significant changes introduced by the IBC amendment through the Ordinance, and the ongoing proceedings in this Court aimed at protecting homebuyers, the court stated that it would be appropriate and necessary to ensure complete justice. To safeguard the interests of all parties involved, the CIRP should be revived, and the CoC should be reconstituted according to the amended provisions to include homebuyers. The NCLAT also in the case of Nikhil Mehta and Sons (HUF) v. AMR Infrastructure Ltd[3] stated that the funds raised by developers through assured return schemes were deemed to have the “commercial effect of a borrowing.” This was evident from the developers' annual returns, where these amounts were listed as “commitment charges” under “financial costs.” Consequently, such allottees were classified as “financial creditors” under Section 5(7) of the Code.
Later the amendment was challenged in the case of Pioneer Urban Land and Infrastructure Limited and Ors. Vs. Union of India and Ors,[4] wherein the court upheld the constitutional validity of the judgement and stated that the term “borrow” broadly encompasses an advance given by homebuyers to a real estate developer for “temporary use,” specifically for use in the construction project, if the agreement intends to return “something equivalent” to money to the homebuyers. In these cases, the “something equivalent” is clearly the flat or apartment. Additionally, the term “commercial effect” is significant, as “commercial” typically refers to transactions primarily aimed at generating profit. As a result, this form of transaction will be considered as a financial transaction under RERA.
The case of Manish Kumar vs UOI[5] also dealt with the same issue while also analysing different approaches that the consumer can adopt to seek desired remedy. While analysing the applicability of RERA and the code, the court stated that given the distinct domains within which these two enactments operate, allottees are provided with different parallel remedies under RERA. These remedies ensure that their flat or apartment is constructed and delivered on time, or otherwise, they receive compensation and/or a refund with interest. However, if an allottee seeks to replace the management of the corporate debtor to rehabilitate the company, they may file a Section 7 application under the IBC.
Similarly in the case of the Swaraj Infrastructure (P) Ltd. v. Kotak Mahindra Bank Ltd [6] the court gave a proper difference between the working mechanism of both the statues. It stated that once a Section 7 application under the Insolvency and Bankruptcy Code (IBC) is triggered, the process becomes a proceeding in rem, meaning it goes beyond the control of the allottee who initiated it. Under the IBC, they may never recover the full principal amount, let alone interest, because once the petition is admitted, the resolution professional must advertise and find a resolution plan, typically from another developer. This plan must be approved by at least 66% of the Committee of Creditors and pass challenges before the NCLT and NCLAT before new management can take over, complete construction, or issue refunds. Depending on the approved resolution plan, the homebuyer may face a long wait for project completion and might not get their full investment back with interest if no suitable plan is found, potentially leading to the corporate debtor's liquidation.
In contrast, approaching the Real Estate Regulatory Authority (RERA) is likely to result in earlier project completion by the designated persons or full refunds with interest, compensation, and penalties, if applicable. Therefore, an allottee who moves an application under Section 7 of the IBC typically does so out of complete loss of faith in the developer's management, hoping another developer will take over the project. However, this comes with the risk that if no one steps forward, the corporate debtor will be wound up, and the allottee will have to wait for whatever is distributed in the liquidation process.
The experience of homebuyers under the Insolvency and Bankruptcy Code (IBC) has been marked by both advancements and obstacles. Although legislative amendments have enhanced their rights, judicial approach has also upheld their rights with giving them an option to be either a financial creditor or opt for RERA proceedings. The whole scenario depends upon the representation of the home-buyer and the consensus of the majority. In the end the legislature does recognize them under the category of financial creditor but the major decision-making power remains with the quorum of home-buyers in the end. The court in the case of Manish Kumar V UOI[7], noted that in a real estate project, there could be hundreds or even thousands of allottees are present and allowing a single allottee, acting as a financial creditor to make an application under Section 7 could potentially jeopardize the interests of other allottees.
Consumers as operational creditors-Jet Airways Insolvency
In contrast to home-buyers being treated as financial creditors, consumers in other scenarios are considered under the ambit of the operational creditor. A key difference between both was analysed in the case of Swiss Ribbons Pvt.Ltd and Ors vs Union of India[8] where the tribunal had interpreted the definition of both the categories of creditors. A Financial Creditor, as defined in Section 5(7) of the Insolvency and Bankruptcy Code (IBC), is "a person to whom the debt is owed, including a person to whom such debt has been legally assigned." Financial debt, as outlined in Section 5(8) of the IBC, refers to debt along with interest, which is disbursed in exchange for the time value of money. This also encompasses amounts raised through investments in debentures, bonds, or other forms of securities.
An operational creditor is defined as a person to whom the debt is owed which includes the person to whom such debt has been legally transferred, explained under Section 5(20) of the Insolvency and Bankruptcy Code. It refers to the debt which arises out of the provision of goods and services, including employment contracts and any amount which is payable under any law.
While analysing the jet airways report consumers would usually comprise of people who would be categorised as the TICKET-REFUND group. As per the list of creditors of October, 2020, a total of 5174 are categorised under the same and out which a total of Rs 3,120 crores have been claimed.[9] Therefore a ticket consumer is considered as an operational creditor whereas a Home-Buyer considered as a financial creditor.
In my opinion while analysing the statement made by the court in the case of Nikhil Mehta and Sons (HUF) v. AMR Infrastructure Ltd[10], a transaction made by a consumer under this head shall also be considered as a financial transaction. A ticket consumer should be afforded similar considerations as a homebuyer. Both consumers make payments in advance with the expectation of receiving a product or service—in the case of a ticket consumer, a flight, and in the case of a homebuyer, a property. If the company providing these goods or services undergoes insolvency, both ticket consumers and homebuyers face similar risks of non-delivery or incomplete fulfilment of their transactions. Therefore, recognizing ticket consumers on par with homebuyers under the IBC ensures equitable protection of their interests and rights in insolvency proceedings and considering them as financial creditors will have a huge impact as it would also give them voting rights and be part of a COC.
In conclusion, the evolution of the Insolvency and Bankruptcy Code (IBC) in India has brought significant changes, particularly impacting consumers such as homebuyers and ticket consumers. The amendments recognizing homebuyers as financial creditors have empowered them to seek remedies under the IBC, enhancing their ability to initiate Corporate Insolvency Resolution Processes (CIRP) against defaulting developers. This legal recognition, coupled with the protective framework of RERA, offers homebuyers multiple avenues to safeguard their investments and ensure project completion.
On the other hand, other consumers, typically categorized as operational creditors, face similar uncertainties in insolvency scenarios, highlighting the need for consistent protection across consumer categories under the IBC. Recognizing other consumers on par with homebuyers in terms of their rights and remedies would ensure equitable treatment and enhance consumer confidence in the insolvency resolution process. Moving forward, further refinements and judicial clarity are necessary to address complexities and ensure the effective implementation of these provisions. By upholding consumer rights and streamlining legal frameworks, India can strengthen investor trust and promote sustainable development in the real estate and airline industries alike.
Views are personal.
References
Case Laws
- Chitra Sharma v. Union of India (2018) SCC OnLine SC 874
- Bikram Chatterji v. Union of India, (2020) 16 SCC 356
- Swiss Ribbons (P) Ltd. v. Union of India, (2019) 4 SCC 17
- Nikhil Mehta and Sons (HUF) v. AMR Infrastructure Ltd (2017) SCC OnLine NCLAT 377
- Pioneer Urban Land and Infrastructure Limited and Ors. Vs. Union of India and Ors, (2019) SCC OnLine SC 1039
- Manish Kumar vs UOI (2017) LL 2021 SC 25
- Swiss Ribbons Pvt. Ltd and Ors vs Union of India (2019) 4 SCC 17
Articles and Reports
- List of Creditors under regulation 13(2) of IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016: Jet Airways Report (October 2020)
- Key differences between financial and operational creditors under IBC 2016. King Stubb & Kasiva. (2023, April 10). https://ksandk.com/insolvency/key-differences-between-financial-and-operational-creditors-under-ibc-2016
[1] 2018 SCC OnLine SC 874
[2] 2020 16 SCC 356
[3] 2017 SCC OnLine NCLAT 377
[4] 2019 SCC OnLine SC 1039
[5] 2017 SCC OnLine SC 884
[6] 2019 3 SCC 620
[7] LL 2021 SC 25
[8] 2019 4 SCC 17
[9] List of Creditors under regulation 13(2) of IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016: Jet Airways Report (October 2020)
[10] 2017 SCC OnLine NCLAT 377