IBC Amendment Ordinance 2018: At Crossroads With RERA

[Garima Mehra and D Sharma are both Advocates]

The Insolvency and Bankruptcy Code (Amendment) Ordinance 2018 (the “Ordinance”) was recently promulgated by the President. It incorporates the key recommendations of the Insolvency Law Reform Committee’s (“ILRC”) report published on 3 April 2018 (Report).
One of the significant recommendations is the inclusion of homebuyers within the ambit of financial creditors. The definition of financial debt under section 5(8) of the Insolvency and Bankruptcy Code 2016 (“IBC”) has been broadened by specifically including within it any amount raised from an allottee under a real estate project, being an amount having the commercial effect of a borrowing and thus falling within the purview of clause (f) of this sub-section which includes all amounts raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing.

Previously, the homebuyers were neither classified as a financial creditor nor an operational creditor and the ILRC had recommended in its report that homebuyers be considered as financial creditors. The Ordinance also provides that a large block of creditors be allowed to participate in meetings of the committee of creditors (“CoC”) through an authorised representative.
Under the previous dispensation, there was significant confusion regarding the status of buyers of under-construction apartments and whether they were to be recognized as creditors under the IBC. Multiple judgments have categorized them as neither fitting within the definition of financial nor operational creditors. Further, the Insolvency and Bankruptcy Board of India (“IBBI”) issued a new claim form for “creditors other than financial or operational creditors”, which gave an indication that home buyers are neither financial nor operational creditors. It effectively created a third class of creditors.

The non-inclusion of homebuyers within either the definition of ‘financial’ or ‘operational’ creditors was a cause of worry since it deprived them of, first, the right to initiate the corporate insolvency resolution process (“CIRP”), and second, the right to be on the CoC and third, the guarantee of receiving at least the liquidation value under the resolution plan.

The Ordinance changes all that and recognises that the amounts raised under the contracts with homebuyers are in effect for the purposes of raising finance, and are indeed used as a means of raising finance. It may be noted that the funds given by home buyers as advances for their purchase is usually very significant as a proportion of the total cost, and frequent delays in delivery of possession may thus have a huge impact on the home buyers. The word “time value” appearing in the definition of financial debt in section 5(8) of the IBC has been interpreted to mean compensation or the price paid for the length of time for which money has been paid. Thus by way of the Ordinance, the Government deemed it prudent to clarify that such amounts raised under a real estate project from a home buyer fall within under section 5(8). Accordingly, as financial creditors, the home buyers will be a part of the CoC with the ability to participate in decision making under the CIRP and, in the event of liquidation, they will fall within the relevant entry of the liquidation waterfall under section 53 of the IBC.

Some critics have argued that the Real Estate (Regulation and Development) Act, 2016 (“RERA”) would be made redundant if homebuyers are made financial creditors under the IBC. However, the primary objective of RERA is to create a transparent system between homebuyers and builders so that their respective rights and obligations are clearly defined and the conflicts between them are minimised. The IBC, on the other hand, becomes applicable for resolving the bankruptcy situation or for distributing the sale proceeds of the assets of the company that undergoes liquidation. In case of a conflict, the provisions of the IBC will override the provisions of RERA, as the IBC deals with a special situation in an otherwise RERA governed entity.

RERA deals with the sectoral law, securities, insurance etc. to impart transparency and responsibility in this sector while IBC is a framework which pertains to the issues of insolvency and subsequent liquidation of companies cutting across sectors. According to section 238 of IBC, the provisions of the IBC shall have overriding effect in case of any inconsistency with any other law for the time being in force.

Similarly, section 89 of RERA provides that it would prevail in case of similar inconsistencies. At the same time, there are no ‘inconsistencies’ between RERA and IBC. Both laws bear different purposes and they operate differently. Accordingly, the proceedings under the RERA ought to continue simultaneously with the IBC proceedings. Any issue relating to the determination of some rights of the buyer could be dealt under the RERA, while the recovery proceedings could be treated as per the provisions of the IBC.

However, there is still a possibility that these complex issues could continue to create overlaps. Considering that many home buyers have pinned their hope on these legislations to rescue them from errant builders, it remains a sensitive subject. The judiciary will have to chart the way forward on how the treatment of homebuyers as financial creditors under IBC might affect RERA which is sector specific. As new developments emerge in this field, the legislature will have to take on a balanced approach considering the desired cleansing effect intended by both the legislations.

– Garima Mehra and D Sharma