Hope for home buyers in bankruptcy code

After the recent dispute concerning Insolvency Law, which involved Jaypee Infratech and its flat buyers, there has been a debate on a possible amendment to the Insolvency and Bankruptcy Code (IBC).

The IBC as should be well-known is not a sectoral law. This means that it doesn’t cater to the demands and needs of any specific industry. The real estate sector, like any other sector, has its own unique business models and practices. The issue at hand involves a large number of flat buyers, who had put in their hard-earned money into real estate projects of Jaypee Infratech, which is now facing a possible liquidation through the IBC.

The regime under IBC has a priority order in terms of settlement of debt of the company with its creditors. This means that after liquidation of the company, the money so realised will be distributed among the stakeholders on the basis of the priority accorded to them. The banks, which are secured creditors, are on a higher priority than unsecured creditors.

The above is a cause of contention. This means that the money realised after a possible liquidation of Jaypee Infratech will only be available to settle the debt with the banks, and there will be very little or probably nothing left for the flat buyers. A lot of legal opinions, therefore, are in the favour of amending the IBC and creating an exception for the real estate sector. The government also, according to news reports, is mulling over such an amendment.

The problem with such an amendment is the nature of the Code itself. As stated above, it’s not a sectoral law and such exceptions created on demands by particular sectors are not in the interest of the healthy development of the insolvency regime in the country. The new regime anyway has just been initiated in the country. The government should not allow the stakeholders in different sectors of the economy to hold the insolvency regime to ransom.

On 11th September, the Supreme Court ordered that the management of the company be taken over by an Interim Resolution Professional (IRP). This was a welcome clarification which made sure that the administration under the IBC remained untouched. Another order, by the apex court on Monday, has granted a relief to flat buyers too, in the form of an explicit assurance that their money will be returned to them.

The flat buyers, quite literally, are not creditors of any kind to a real estate company. Since they are buying something from a company, they are just the consumers for the company’s services. The argument on behalf of the flat-buyers in the Supreme Court itself contends that they should be considered as secured creditors.

If this is accepted, then the cause of contention naturally subsides. In the case of Nikhil Mehta Vs AMR Infrastructure, the National Company Law Appellate Tribunal (NCLAT) has itself given flat buyers the status of secured creditors. This will elevate them to the status of banks and will be able to voice their concern in a more forceful manner. However, even if they were to be treated as secured creditors, they will still have to bear a certain amount of risk, like the banks.

The most viable solution to the current problem exists under Section 36 of the IBC. This provision talks about the assets of third parties, held in the form of trust by the company undergoing liquidation. The flat buyers are technically partial owners of the real estate, which the company has sold to them, and the company is holding the property in trust.

The current situation, therefore, appropriately fits the requirements of the provision. Section 36 mandates that all such properties which are held in trust for third parties, will not be part of the liquidation estate i.e., the sum of assets which will be used to repay the creditors.

The mechanism above will alienate the debt of the company owed to flat buyers from the rest of the creditors. This doesn’t need any amendment to the law too. The government at most can clarify the position through a notification. The amending power should be exercised sparingly by the Parliament, as has been a settled practice in most legal systems.

There are always certain doubts which come up after a new legislation is put in force. They are mostly handled by the judiciary, and in very rare cases require an amendment by the Parliament. The case of IBC is definitely not that of a rare-case scenario where an amendment is needed.

If indeed such an amendment comes through, it can also open floodgates for demands in other sectors too. All the industries, which take an advance in the course of their business, like the automobile industry, can demand a sector-specific exception in the form of another amendment to the law.

Moreover, amendment to any law is a lengthy and cumbersome process which could mean loss of valuable time in the meanwhile. It is to be clearly understood here that any dilution of the IBC will not be in the interest of the RBI’s plan to handle the current NPA problem through it. In the current situation only IBC is the best bet to resolve the NPA problem.

Therefore, if the rights of the banks are altered in any non-meaningful way, it could render RBI’s plan in jeopardy, which in turn could have its hostile consequence on the economy itself. Hence, it is in the best interest of the government, that it doesn’t amend the IBC and instead exercise better remedies, which are available in the code itself. (Courtesy: Firstpost; The writer is a Research Fellow with the Department of Humanities and Social Sciences, IIT Bombay, Mumbai)

By Raghav Pandey