Reimagining Insolvency Resolution: Reverse CIRP A Game-Changer For India’s Real Estate Sector

When a real estate developer defaults on the repayment of debts, the financial institutions are compelled to initiate insolvency proceedings in order to recover the amount of debt incurred for the development of projects. Also, the financial institutions, being lenders, can take over the possession of the unfinished projects of the developer and auction them to recoup the debt amount. Homebuyers are the most vulnerable parties in this dispute between developers and financial institutions because their possession of their flats/ apartments is delayed due to litigation over the properties.

The National Company Law Tribunal (“NCLT”) ruled in the case of Nikhil Mehta & Sons (HUF) & Ors. v. AMR Infrastructure Ltd.^[1] that real estate developers’ “assured return” deposits were essentially debt u/s 3(11) of the Insolvency and Bankruptcy Code, 2016 (“IBC”). In addition, an Explanation was added to Section 5(8)(f) of the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 to make it clear that a homebuyer’s funding towards a real estate project would be treated as a debt for bankruptcy purposes.^[2] Therefore, a homebuyer will be classified as a “financial creditor”.^[3] Accordingly, homebuyers can now begin the Corporate Insolvency Resolution Process (“CIRP”) u/s 7 of the Insolvency and Bankruptcy Code, 2016.^[4] When challenged, the Supreme Court upheld the constitutionality of the Insolvency and Bankruptcy (Second Amendment) Act, 2018 (“2018 Amendment Act”)^[5], stating that homebuyers’ investments are used by developers and promoters to finish their projects, so the homebuyers should be represented in the Committee of Creditors (“CoC”) through an authorized representative.^[6] The CoC ought to have a voice for homebuyers’ interests after the Supreme Court ruled in favour of them in the case of Chitra Sharma v. Union of India.^[7] In Bikram Chatterji v. Union of India^[8], the Supreme Court took the same perspective as in Chitra Sharma v. Union of India when addressing the insolvency resolution of the Amrapali Group.

Homebuyers in India have legal recourse by way of three main sets of legislation: the Consumer Protection Act of 1986 (“COPRA”), the Real Estate (Regulation and Development) Act of 2016 (“RERA”), and the Insolvency and Bankruptcy Code of 2016 (“IBC”). Homebuyers who have been affected by a builder’s or promoter's default may file claims in various forums and tribunals established under the appropriate legislation in order to seek redress and resolve the ensuing disputes. However, these laws, especially IBC 2016, have not been very effective in addressing and alleviating homebuyers’ concerns. According to IBBI reports, there were a total of 6811 CIRPs out of which 1430 were admitted by the National Company Law Tribunal (“NCLT”) as of 30 June 2023; 371 of those CIRPs had been set aside due to an appeal, withdrawal, or settlement, and another 257 had begun liquidation proceedings.^[9] There have only been 185 real estate companies saved by the IBC, constituting less than 13% of all real estate CIRPs.^[10]

Therefore, in 2020 the National Company Law Appellate Tribunal (“NCLAT”) developed the novel concept of ‘Reverse CIRP’ within the framework of the Insolvency and Bankruptcy Code, 2016, allowing the Promoter to induce funds in a specific real estate project as a lender while remaining outside the insolvency process. The concept of reverse CIRP is not addressed anywhere in the Code. The rationale behind the fresh approach was to provide homebuyers with some much-needed relief. NCLAT decided that this innovative method of insolvency resolution would be effective enough to protect the interests of real estate buyers and stimulate economic growth by allowing the project to be completed notwithstanding the default.

Reverse CIRP – An Alien Concept

NCLAT is recognized as being the birthplace of the Reverse Corporate Insolvency Resolution Process (“Reverse CIRP”). Reverse CIRP is a form of Corporate Insolvency Resolution Process (“CIRP”) in which a company’s promoters are permitted to invest in a project as a lender while remaining outside of the process. The traditional CIRP was unable to uphold the interests of homebuyers to an adequate degree, and as a result, it was subject to a variety of critiques on this front. As a result, the courts investigated the various grounds and presented a novel concept, which they termed “Reverse CIRP”. This idea is presented in order to deal specifically with the problems that are associated with real estate. In the case of Flat Buyers Association Winter Hills-77 v. Umang Realtech Pvt. Ltd. through IRP and Others^[11], the NCLAT introduced the concept of the ‘Reverse Corporate Insolvency Resolution Process’. The NCLAT mentioned that in the case that any promoter of the real estate company in question intends to play the role of a lender by infusing funds for the completion of the project, but agrees to remain outside of the CIRP, this will not be considered a violation of the CIRP.

In the regular CIRP, the Promoter gets eliminated, the priority is given to the banks and financial institutions, and presumably, homebuyers get the worst bargain; as a result, it failed to achieve the objective of the IBC for businesses in real estate. Also, the majority of the real estate companies eventually went into liquidation, and very few of those who attempted to implement a resolution plan were successful. As a result, the NCLAT came up with an innovative concept called reverse CIRP. It was also a very controversial decision due to the fact that the Promoters would once again be in charge of the company’s operations; previously, the consensus was that the Promoters should be omitted from the main company’s affairs. This novel approach will be successful unless and until the homebuyers receive their money; otherwise, it will contradict the spirit of the IBC.

Objectives Of Reverse CIRP

1. Protect allottees: The reverse CIRP makes certain that each allottee who has been allocated a flat/ apartment gains possession of their property in accordance with the terms that were agreed upon during the signing of the agreement with the builder. This process protects the rights of prospective homebuyers and assures that they will receive the flats/ apartments that were promised to them.
2. Secured creditors to take a backseat: In the context of flats/ apartments, allottees, who are considered unsecured financial creditors, have an edge over banks, which are secured financial creditors. This inclination arises from the fact that the primary concern of banks is the timely reimbursement of loans, whereas the primary concern of allottees is the timely acquisition of possession of their allotted flats/ apartments. As a consequence of this, the interests of allottees tend to be better linked with the objective of safeguarding the property they have invested in during the insolvency process.
3. Avoid removal of Promoter: The builder is provided with the option to complete the project and deliver possession of flats or apartments to allottees while working together with either the Interim Resolution Professional (“IRP”) or the Resolution Professional (“RP”). This cooperative approach is more likely to provide favourable outcomes for CIRP by allowing the project to continue as a going concern. It assures that the interests of both the builder and the allottees are considered, which could lead to the successful completion of the project and the fulfilment of promises to property buyers within the context of the insolvency processes.
4. Project-wise CIRP: The Indian judicial system has demonstrated the importance of undertaking experiments on the IBC frequently. In the case Swiss Ribbons (P) Ltd. v. Union of India^[12], the Supreme Court made the statement referring, inter alia, to various American decisions in paras, that the legislature must be given free play in the joints when it comes to economic legislation. This Hon’ble Court referred to the Swiss Ribbons^[13] case and decided in the Essar Steel India Ltd. (CoC) v. Satish Kumar Gupta^[14] that the Insolvency Code is a legislation which deals with economic matters and, in the larger sense, deals with the economy of the country as a whole. To experiment with things economic is a grave responsibility, and denial of the right to experiment is fraught with serious consequences to the nation. In the case, Flat Buyers Association Winter Hills-77 v. Umang Realtech Pvt. Ltd. through IRP and Others^[15], the NCLAT for the first time adopted the concept of ‘Project-wise CIRP’. The rationale behind this was to maximize the value of the assets in order to establish a balance between the claims and rights of all the creditors. In the case of Manish Kumar v. Union of India^[16], the Supreme Court stated its perspective that allottees may have various concerns in relation to different projects, and therefore including all of the projects in CIPR would be an onerous task. However, in the case of Mr. N. Kumar RP of M/s. Sheltrex Developers Pvt. Ltd. v. M/s. Tata Capital Housing Finance Ltd.,^[17] the Chennai Bench of the NCLT went against earlier judgements and held that this concept cannot be applied generally and that its application is dependent on the facts and circumstances. It added that project-wise CIRP is beyond the horizons of the IBC.

Principles Laid Down By NCLAT In Reverse CIRP

1. The claims of homebuyers who are unsecured financial creditors at the CIRP stage shall have priority over the claims of secured financial creditors with respect to the flats/ apartments of the corporate debtor that have been approved for them.^[18] This principle relies on the equality for all approach, which stipulates that the virtue of CIRP of companies must be done while maintaining a balance between the interests of all of the stakeholders.^[19]
2. In order to maximize the assets of a particular project, the resolution of real estate companies is made project-specific. The claims of homebuyers of one project cannot be brought before the Resolution Professional who is appointed for another of the real estate company's projects. This principle recognizes that one project's default should not hinder the development of other projects. Numerous variables affect the success of a project, including the land, location, workforce, etc. Hence, non-completion of a specific project should not diminish the spirits of real estate firms.

Shortcomings Of Reverse CIRP

There is no doubt that the implementation of the Insolvency and Bankruptcy Code of 2016 has brought a significant amount of relief to both real estate developers and allottees; yet there are still certain aspects that remain completely unresolved.

1. Inconsistency in monitoring mechanism of provisions u/s 4(2)(l)(D) RERA Act, 2016

One of the challenges is that the mechanism for monitoring how the promoters utilize their money is inconsistent. According to Section 4(2)(l)(D), “seventy percent of the amounts realized for the real estate project from the allottees, from time to time, shall be deposited in a separate account to be maintained in a scheduled bank to cover the cost of construction and the land cost and shall be used only for that purpose”.^[20]

In the case Flat Buyers Association Winter Hills-77 v. Umang Realtech Pvt. Ltd. through IRP and Others^[21], the Tribunal gave the Resolution Professional a directive to ensure that the project could be finished with the funds provided by the lender and amounts generated from allottees. Nevertheless, the tribunal did not make any reference to this 70% requirement of RERA. The concept of reverse CIRP was affirmed by the Supreme Court in the cases Anand Murti v. Soni Infratech Private Limited and Another^[22] and Amit Katyal v. Meera Ahuja^[23]; however, the Hon’ble Court failed to mandate the 70% requirement in either case. In addition, the concept of project-wise CIRP was upheld by the Tribunal in the case of Whispering Tower Flat Owner Welfare Association v. Abhay Narayan Manudhane, Resolution Professional of the Corporate Debtor and Others,^[24] but there was no mention of the 70% threshold in the decision. However, in the case of Ram Kishor Arora Suspended Director of M/s. Supertech Ltd. v. Union Bank of India and Another^[25], NCLAT ordered the RP to make sure that all money and receivables were kept in a separate account.

As a result, there is a lack of consistency in the approach taken by the courts and tribunals regarding the putting of a reference to the monitoring mechanism under RERA for the utilization of funds by the Promoters.

1. Conflict with Section 29A of the IBC, 2016

It is evident and deducible from an analysis of the NCLAT’s reasoning in Flat Buyers Association Winter Hills-77 v. Umang Realtech Pvt. Ltd. through IRP and Others^[26] that the alien concept of reverse CIRP and its formulation in that case are not supported by any source of law. NCLAT has superseded the legislature’s rationale in the reverse CIRP process with its own promoter-driven process. The NCLAT has introduced this fresh concept and terminology, both of which run antithetical to the provisions outlined in section 29A of the Code.

Section 29A disqualifies the promoter of the debtor company from becoming a resolution applicant.^[27] In the Chitra Sharma v. Union of India case, the Supreme Court u/s 29A of the Code precludes the backdoor entry of promoters who may attempt to regain control of the entity.^[28]

In Flat Buyers Association Winter Hills-77 v. Umang Realtech Pvt. Ltd. through IRP and Others^[29], the NCLAT coined the terms ‘intended lender’ and ‘outsider financial creditor’ to describe promoters who intend to act as lenders while remaining outside the CIRP process. The purpose here is that the allottees would be able to get their flats/ apartments faster without involvement from outside parties. This objective, however, conflicts with provisions of the Code that advocate separation from the suspended management once CIRP has been initiated.

The NCLAT appears to have loosened this crucial provision of the Code. This does not imply that the process has no inherent value. Undoubtedly, this legal move has provided homebuyers with relief. However, it is not recommended that this decision be made contrary to the law without a sufficient analysis of its implications. If proper measures are not in place, one of these repercussions could be the Promoter diverting off funds. While judges in Ram Kishor Arora Suspended Director of M/s. Supertech Ltd. v. Union Bank of India and Another^[30] specified the transfer of 70% of the funds to a separate RERA account, in other cases, including Flat Buyers Association Winter Hills-77 v. Umang Realtech Pvt. Ltd. through IRP and Others no such condition was imposed. Consequently, despite the fact that this judicial intervention was a positive development for the allottees, it continues to be implemented without adequate guidance. In the absence of strict adherence to the language of the law, the onus should fall primarily on the courts to establish the necessity and legality of the aforementioned deviation. This would increase the stakeholders’ confidence in judicial intervention while also assuring a degree of predictability.

However, the obligation is not being met because of questions about the promoter’s accountability, which could result in the misappropriation of funds and raise concern about the veracity of the reverse CIRP process. As may be shown in the current case of Section 29A, inconsistency in the application of the law goes against the principles of law and may also circumvent the legislative purposes of the Code itself.

1. Ambiguity about the creation of the Committee of Creditors

The creation of the Committee of Creditors provides creditors with a forum for presenting their demands to the Representative Professional. As the formation and voting rights granted to the Committee of Creditors were one of the most crucial features of IBC, the decision to forego its formation was a noteworthy deviation.

In the case of Flat Buyers Association Winter Hills-77 v. Umang Realtech Pvt. Ltd. through IRP and Others^[31], the homebuyers and secured creditors wanted the promoter to lend the funds necessary to revive the insolvent project. Therefore, there was no injustice, and no Committee of Creditors was formed in this case. However, this decision cannot be considered a precedent that departs from the IBC scheme. It is essential to notice, however, that without the formation of a Committee of Creditors, it would be difficult to address the conflicting demands of different groups of creditors.

The Supreme Court also reiterated that the Committee of Creditors has the ultimate decision-making authority regarding whether or not the corporate debtor should be reinstated.^[32] The legislative history of the IBC further illustrates that the legislature has always intended to grant the Committee of Creditors supreme status without judicial intervention.^[33]

The Insolvency Law Committee emphasized the importance of the Committee of Creditors in deciding what happens to the corporate debtor and in holding the Resolution Professional accountable for its duties.^[34] The Committee further stated that it approves the Resolution Professional's actions and ensures that he carries out his responsibilities accurately and without treating any creditor unfairly.^[35] In the absence of the formation of a Committee of Creditors, supervision of the Resolution Professional's accountability and other functions cannot be carried out. As the formation of a Committee of Creditors is a fundamental scheme under the IBC, reverse CIRP must not conflict with its formation.

The introduction of reverse CIRP has been hailed as a solution to the long-standing issue of conflicting claims between secured and unsecured financial creditors. This problem often arises when secured financial creditors advocate for the liquidation of a real estate developer, prioritizing their own interests in asset distribution u/s 53^[36] over the completion of the project. However, it is essential to consider both sides of the coin when evaluating reverse CIRP. While it addresses the aforementioned conflict, it can also potentially lead to delays in the CIRP and value erosion in cases where the developer is genuinely unable to complete projects.

One crucial aspect to note about reverse CIRP is that it deviates from the traditional CIRP approach. In reverse CIRP, the insolvency resolution is not focused on the corporate debtor, i.e., the real estate company as a whole, but rather on the individual projects of the corporate debtor. Under the current framework of the Insolvency and Bankruptcy Code, 2016, CIRP can only be initiated against a company and not against the individual projects of the company. This gap in the legislation needs to be addressed through an amendment to the Code to fully integrate reverse CIRP into the legal framework. Until this loophole is closed, reverse CIRP will remain a concept that does not align seamlessly with the existing legislation.

While it is acknowledged that reverse CIRP represents a judicial experiment aimed at preventing insolvent real estate developers from evading the resolution process under the Code, there are valid concerns regarding its default application. Rather than making reverse CIRP the default insolvency process for such developers, a more nuanced approach is suggested. When CIRP is initiated, the resolution professional should undertake a comprehensive assessment, collating essential data on the developer’s financial creditors, the status of project completion, and the developer’s financials and creditworthiness. Additionally, the Resolution Professional should scrutinize any potential preferential, undervalued, or fraudulent transactions, financial irregularities, and the misuse of funds by the previous management.

Subsequently, if the Promoter of the developer demonstrates a genuine interest in completing a specific project, and this proposal is agreeable to the homebuyers and lenders involved in that particular project, then that project may be excluded from the CIRP and instead subjected to reverse CIRP. This approach allows for flexibility and customization in addressing the unique circumstances of each developer and project. Meanwhile, the CIRP for the remaining projects can continue as usual. In essence, reverse CIRP should be regarded as an alternative to CIRP, applicable only in specific cases after a thorough assessment of the overall financial health of the developer. This approach ensures that Reverse CIRP aligns more closely with the underlying objectives of the IBC.

While reverse CIRP holds promise in resolving conflicts between secured and unsecured financial creditors in the real estate sector, it is imperative to recognize its limitations within the current legislation. To fully integrate reverse CIRP into the Insolvency and Bankruptcy Code, 2016, legislative amendments are necessary. Moreover, making reverse CIRP the default insolvency process for insolvent real estate developers may not be ideal. Instead, it should be employed selectively, based on a comprehensive evaluation of the developer’s financial condition and the willingness of stakeholders to complete specific projects. This approach strikes a more balanced chord, upholding the overarching objectives of the Code while addressing the complexities of the real estate industry.

Views are personal.