Introduction
A booming population, growing income and rapid urbanization has made India one of the fastest-growing major economies of this century. As per the World Bank[i], India’s GDP grew from USD 37 billion in 1960 to USD 3.18 trillion in 2021, registering an annual average growth over 5 per cent[ii]. India’s real estate sector has been the second biggest contributor to its economy, standing at USD 200 billion in 2021[iii]. However, while the real estate market expanded aggressively, the industry was almost opaque, unregulated, and unaccountable and there was a need for a legislation to protect consumers i.e., the homebuyers. Even the enactment of the Real Estate (Regulation and Development) Act, 2016 (“RERA”) failed to completely address struggle of homebuyers, largely due to varying levels of implementation across states[iv].
In 2016, the Insolvency and Bankruptcy Code, 2016 (“Code”) was enacted with a primary focus on revival of companies. It aimed to protect these insolvent companies from its erstwhile management and death by liquidation. As aggrieved homebuyers across the country were facing difficulties in getting the possession of their homes on time, individual homebuyers approached the National Company Law Tribunals (“NCLT”) seeking insolvency of the real estate developers. The Code, which initially did not include homebuyers as creditors, has evolved significantly to carve out a unique insolvency process to protect the interests of the homebuyers.
Status of homebuyers under the Code
Under the original enacted Code, homebuyers were not specifically included under the definition of ‘financial creditor’ or ‘operational creditor’. This led to uncertainty with respect to homebuyers’ position under the Code. The National Company Law Appellate Tribunal (“NCLAT”) in Nikhil Mehta and Sons (HUF) v. AMR Infrastructure[v] held that amounts raised by developers from homebuyers under assured return schemes had the "commercial effect of a borrowing" and therefore homebuyers were held to be ‘financial creditors’ under the Code and hence, were eligible to apply for commencement of the corporate insolvency resolution process (“CIRP”) for the real estate developer. Thereafter, the Supreme Court in Chitra Sharma v. Union of India[vi] recognized homebuyers as financial creditors. Further, to ensure that homebuyers are protected in the CIRP, the Supreme Court nominated a senior counsel to represent the cause of the homebuyers in the Committee of Creditors (“CoC”) - which is the decision-making body in the CIRP.
Subsequently, to resolve the issue of the status of homebuyers under the Code, the legislature enacted the Insolvency and Bankruptcy Second (Amendment) Act, 2018 (“2018 Amendment”) wherein homebuyers were brought within the purview of ‘financial creditors’ under the Code[vii]. Being financial creditors, homebuyers could not only trigger CIRP of the real estate developer, but also be a part of the CoC. The constitutional validity of the 2018 Amendment was upheld by the Supreme Court in Pioneer Urban Land and Infrastructure Ltd. v. Union of India[viii], wherein the Supreme Court observed that in real estate projects, money is raised from the homebuyers against consideration for the time value of money. Even the total consideration agreed at a time when the apartment is non-existent or incomplete, is significantly less than the price the buyer would have to pay for a ready flat, and therefore, he gains the time value of money.
However, after the 2018 Amendment, individual homebuyers started filing cases, some of which were motivated by frivolous reasons or mala fide intentions, burdening the insolvency tribunals. This necessitated the Insolvency and Bankruptcy Code (Amendment) Act, 2020[ix] (“2020 Amendment”) which prescribed that at least 100 homebuyers / 10% percent of total homebuyers (whichever is lower) from the same real estate project should support the initiation of CIRP against the developer. The constitutional challenge to the 2020 Amendment was dismissed by the Supreme Court in Manish Kumar v. Union of India[x]. The Supreme Court explained that the rationale behind confining the homebuyers to the same real estate is to promote the object of the Code. The homebuyers in one project may not have much of a complaint, while the complaints of homebuyers in another project of the same developer may be serious. Therefore, it is reasonable that the homebuyers filing the application be drawn from the same real estate project.
Reverse CIRP – an innovation
In Flat Buyers Association Winter Hills v. Umang Realtech Pvt. Ltd.,[xi] (Umang Realtech) the NCLAT laid down an experimental process of “Reverse CIRP” to safeguard the rights and interests of homebuyers. In this case, certain homebuyers initiated CIRP against the defaulting developer. One of the promoters of the developer agreed to remain outside the CIRP and play the role of a financer to ensure the CIRP is successful, and the homebuyers take possession of their flats during the CIRP without any third-party intervention. Thus, it would be possible to complete the project and hand-over the flats to the homebuyers within a time period laid down by the NCLAT. This proposal was also agreeable to the homebuyer’s association.
In such a situation the NCLAT laid down the basic scheme of Reverse CIRP:
· If CIRP is initiated against a developer by homebuyers (financial creditors) or financial institutions (other financial creditors) or operational creditors of one project, that CIRP is confined to that particular project only. It cannot affect any other project of the same developer.
· Homebuyers, financial creditors or operational creditors of one project cannot file a claim before the insolvency professional of any other project.
· A secured creditor such as a financial institution or bank cannot be given preference with respect to the flat over the homebuyers.
· While satisfying their claims, some homebuyers may agree to opt for another flat or a flat in another tower if not allotted to anyone yet. In such cases, their agreement can be modified by the insolvency professional, with the counter signature of the promoter and the homebuyers. This will enable some homebuyers to get earlier possession and be relieved from paying interest to banks or rentals.
· No refund is allowed to homebuyers.
In such a Reverse CIRP, the interest of the homebuyers is protected and there is a better chance of completion of projects. To summarize, Reverse CIRP involves submission of a resolution plan by the promoter providing for the timely resolution or completion of a project of the developer. This promoter is required to infuse funds from outside as a lender. The CoC comprising of the homebuyers and banks interested in the completion of project then assess the viability of the submitted resolution plan, and there is no invitation of a fresh resolution plan from third party resolution applicants. After the project is successfully completed as per the approved plan of the promoter, the insolvency professional is required to move an application seeking disposal of CIRP application. However, where the project is not completed, then the insolvency professional will proceed with the CIRP.
At the outset, it is observed that the Reverse CIRP process propounded in Umang Realtech is one which is shaped by the facts of the case. It cannot therefore be a perfect prototype for other real estate insolvency cases. To use or not to use the Reverse CIRP will be a fact-dependent decision. Insolvency tribunals found it fit to employ the concept of Reverse CIRP in Ram Kishor Arora, Suspended Director of M/s. Supertech Ltd. v. Union Bank of India,[xii] wherein the NCLAT limited the Reverse CIRP to only one project of the developer. Thereafter, the Supreme Court in the case of Anand Murti v. Soni Infratech Pvt. Ltd.[xiii] reiterated the position and directed to keep the CIRP in abeyance and permitted the erstwhile promoter of the developer to complete the construction of the real estate housing project within a stipulated time period. In Rajesh Goyal v. Babita Gupta[xiv], the NCLAT allowed funding from the promoter for the completion of the project so as to safeguard the interests of all stakeholders including homebuyers.
Reverse CIRP and the objectives of the Code
Reverse CIRP has being objected on several grounds, primarily being that the Code does not provide for such a scheme, and it is an outcome of judicial overreach. In the recent case of Mr. N. Kumar v. Tata Capital Housing Finance Ltd[xv]., the NCLT observed that there is no concept of limited or project specific CIRP anywhere in the Code, and it is therefore beyond the purview of the Code. The second major objection is that Reverse CIRP scheme is directly in conflict with section 29A of the Code and therefore not permissible. Section 29A of the Code prohibits promoters of defaulting corporate debtor to be part of the resolution process. However, in Reverse CIRP, the promoters are required to fund the project and assist in its completion.
Despite the objections, Reverse CIRP has not been invalidated by the Supreme Court. Rather, it has been employed in certain cases. However, to resolve any ambiguity, Reverse CIRP is required to be aligned with the objective of the Code i.e., (i) resolution of insolvency, (ii) maximization of value of the corporate debtor, and (iii) balancing the interest of all stakeholders. So, the scheme of Reverse CIRP is required to be tested against the threefold objectives of the Code.
Real estate business is India is carried out through separate projects. Under RERA, the real estate developer is required to maintain separate bank account[xvi] for every assignment it undertakes, wherein 70% of the cash collected from homebuyers must be used for building and land expenses. Therefore, restricting the resolution process to specific projects would be an easier and efficient way to resolve the insolvency of a developer. In Umang Realtech, the NCLAT had disallowed homebuyers from claiming for refund of sums paid during the Reverse CIRP. This would ensure that the project is completed, and the homebuyers are allotted the apartments, while the developer is saved from liquidation, thereby promoting the objectives of survival and continuity in the operations of the corporate debtor. By restricting the resolution to only specific projects, the time spent on resolution is reduced, thereby leading to maximization of the value of assets. Therefore, Reverse CIRP, as an initiative, seems to be in tune with the interests of the Code.
An aspect also to be considered is the difference between homebuyers and other secured financial creditors such as banks, financial institutions and other non-banking financial institutions. These secured creditors can enforce the security held by them in case their loans remain unpaid. This security is often the apartments being developed by the developer. At the same time, homebuyers would want possession of these apartments for which they have invested their life savings. In such a situation, it’s possible that the secured financial creditors would push for liquidation of the developer by voting against resolution plans, to ensure preference in distribution of assets under the liquidation waterfall in the Code instead of trying to complete the project. This would be against the interest of the homebuyers and also contrary to the object of the Code. Reverse CIRP balances the interests of both these classes of creditors.
Additionally, homebuyers unlike other financial creditors, do not have the commercial wisdom to decide which resolution plan is most beneficial to them. Reverse CIRP remedies this as it ensures that the promoter pools in funds to complete the project. In the case of Amit Katyal v. Meera Ahuja and Ors.[xvii], the Supreme Court had noted that unlike other financial creditors like banks and financial institutions, it would be “harsh and unjust” on homebuyers where the resolution plans provide for high percentage of haircuts in the claims. It should be noted that out of 1,234 cases of CIRPs in the real estate sector, only 72 have yielded successful resolution plans[xviii].
On 18 January 2023, the Government of India proposed certain amendments[xix] to the Code which inter alia include amendments to improve the outcome of real estate cases. It has been proposed that in case of CIRP of real estate developers, the NCLT may at its discretion, admit the case but apply the CIRP provisions only with respect to such real estate projects which have defaulted. Accordingly, the CIRP will apply only these projects who shall be recognized as distinct from the larger entity for the limited purpose of resolution, and the other projects of the developer shall not be affected. This will protect lenders and homebuyers in stressed projects, without any risk to other projects that the real estate developer company may be developing.
Conclusion
The introduction of Reverse CIRP solves the problem of conflicting claims of secured and unsecured creditors, as sometimes the secured financial creditors would push for liquidation of the developer to ensure preference in distribution of assets, instead of saving the project. On the flipside, where the developer is genuinely unable to complete projects, Reverse CIRP would only delay the CIRP leading to value erosion. Also, while Reverse CIRP seems to be in harmony with the intent of the Code, it should be noted that in Reverse CIRP, the insolvency resolution is not of the corporate debtor i.e., the real estate developer company, but rather individual projects of the corporate debtor. Under the present scheme of the Code, CIRP can only be initiated against a company and not against individual projects of the company, and therefore unless this lacuna is filled via an amendment to the Code, Reverse CIRP would continue to be a concept alien to the Code.
While the authors are aware that Reverse CIRP is a judicial experiment, in order to prevent an insolvent real estate developer from escaping from the resolution process under the Code, the authors believe that Reverse CIRP should not be the default insolvency process for such developers. Rather, on initiation of CIRP, the resolution professional should collate data on the creditors of the developer, status of completion of all projects and the financials and credit worthiness of the developer, and further scrutinize the probable preferential, undervalued and fraudulent transactions, financial frauds and misuse of funds by the erstwhile management. Then, if a promoter of the developer genuinely shows an interest in completion of a project and this is agreeable to the homebuyers and the lenders, a particular project may be excluded from the CIRP and should be subjected to Reverse CIRP. In the meanwhile, the CIRP of the other projects should continue. In essence, Reverse CIRP should be treated as an alternative to CIRP in specific cases only after assessing the overall financial health of the developer. Only then, Reverse CIRP would uphold the Code’s objectives.
Authors: Souvik Ganguly, Renjith Nair and Altamash Qureshi
The information contained in this document is not legal advice or legal opinion. The contents recorded in the said document are for informational purposes only and should not be used for commercial purposes. Acuity Law LLP disclaims all liability to any person for any loss or damage caused by errors or omissions, whether arising from negligence, accident, or any other cause.
[i] https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?end=2020&locations=IN&start=1990
[ii] GDP growth (annual %) - India | Data (worldbank.org)
[iii] India Real Estate Industry Analysis, https://www.ibef.org/industry/indian-real-estate-industry-analysis-presentation
[iv] Boston Consulting Group and Omidyar Network India, Five Years On: An assessment of RERA https://www.bcg.com/five-years-on-assessment-of-rera
[v] Nikhil Mehta and Sons (HUF) v. AMR Infrastructure, (2017) SCC NCLAT 859
[vi] Chitra Sharma v. Union of India, (2018) 18 SCC 575
[vii] Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, Amendment of section 5.
[viii] Pioneer Urban Land and Infrastructure Ltd. v. Union of India, (2019) 8 SCC 416
[ix] Insolvency and Bankruptcy Code (Amendment) Act, 2020, Amendment of section 7
[x] Manish Kumar v. Union of India, (2021) 5 SCC 1
[xi] Flat Buyers Association Winter Hills v. Umang Realtech Pvt. Ltd, (2020) SCC NCLAT 1199
[xii] Ram Kishor Arora, Suspended Director of M/s. Supertech Ltd. v. Union Bank of India, (2022) SCC NCLAT 239
[xiii] Anand Murti v. Soni Infratech Private Limited, (2022) SCC SC 519
[xiv] Rajesh Goyal v. Babita Gupta and Others, (2021) SCC NCLAT 4139
[xv] Mr. N. Kumar v. Tata Capital Housing Finance Ltd, IA(IBC)/1245(CHE)/2020
[xvi] Real Estate (Regulation and Development) Act, 2016, Section 4(2)(D)
[xvii] Amit Katyal v. Meera Ahuja and Others (2022) 8 SCC 320
[xviii] The Quarterly Newsletter of the Insolvency and Bankruptcy Board of India, July – September 2022
[xix] Invitation of comments from the public on changes being considered to the Insolvency and Bankruptcy Code, 2016, https://ibbi.gov.in/uploads/whatsnew/7f55e29ae9c0023184a3895f849cd2ef.pdf
This article first appeared in the June 2023 issue of Insolvency and Restructuring International (Vol 17, No 1), and is reproduced by kind permission of the International Bar Association, London, UK. © International Bar Association.