[Saurabh Gupta is a third year student at the National Law School of India University. He is an Editor of the Indian Journal of International Economic Law and Law School Policy Review]
The Supreme Court in Pioneer Urban Land and Infrastructure v Union of India [2019 SCC OnLine SC 1005] (“Pioneer”) upheld the constitutional validity of the Insolvency Code (Second Amendment) Act of 2018 (“2018 Amendment”). There were many contentious issues for consideration before the three-judge bench. I shall be limiting my discussion to the Court’s classification of allottees as financial creditors. I argue in disagreement with the Court’s decision of upholding the inclusion of all allottees as financial creditors under the Insolvency and Bankruptcy Code, 2016 (“IBC”) and critique the reasoning used by the Court.
The statement of objects and reasons to the 2018 Amendment refers to the recommendations of the Insolvency Law Committee (“ILC”) Report, published by the Ministry of Corporate Affairs in March 2018, as the basis for the changes introduced through the Amendment. The Supreme Court in Pioneer too refers to the same. While the ILC made a recommendation to include allottees as financial creditors, the basis for doing so was a discussion of the decisions of the National Company Law Tribunal (“NCLT”) and the National Company Law Appellate Tribunal (“NCLAT”) prior to the 2018 Amendment. However, the ILC has reached a conclusion quite different from what these cases have actually held.
Under the IBC, a financial creditor is one who is owed a financial debt. The definition of financial debt is provided in section 5(8) of the IBC to mean “a debt along with interest, if any, which is disbursed against the consideration for the time value of money”. The requirement of a disbursal ‘against the consideration for the time value of money’ is a prerequisite to satisfy this definition.
In Nikhil Mehta & Sons (HUF) v. AMR Infrastructure Limited [C.A. (I.B.) No. 543/KB/2017 arising out of C.P. (I.B.)/170/KB/2017] , the NCLT and NCLAT both agreed that an advance payment by an allottee to the real estate developer is not a financial debt in and of itself. This case is significant since it was the first judgement which allowed allottees to initiate the process under section 7 of the IBC. Both the tribunals held ‘consideration for the time value of money’ to be a prerequisite for a debt to be financial debt. The case involved a ‘committed returns scheme’, under which the homebuyers pay for their property while the developer makes periodic payments to the homebuyers until the handing over of possession. In Nikhil Mehta, the NCLT held that the allottees could not be financial creditors since there was no consideration against the time value of money. However, this was overruled by the NCLAT.
The NCLAT accepted committed returns as consideration for time value of money. The payments under the committed returns scheme were being made until the transfer of possession to the allottees. The NCLAT observed that the allottees had to simply make advance payments in order to receive benefits under the committed return scheme. According to the tribunal, this demonstrated that the committed returns to the allottees were in consideration of the advance payments made by the allottees to the developer. Further, since provision of committed returns in consideration for advance payments allowed the developer to raise finances for the project without any other obligation, the committed return scheme was held to be an instrument to raise money. Thus, the NCLAT justified how where there was a committed returns scheme in the case of homebuyers, advance payments could fall under the definition of financial debt (section 5(8)(f) of the IBC). This has been followed by the NCLT in many cases including Neelam Singh v Megasoft Infrastructure [(2017) SCC Online NCLT 10612], Anubhuti Aggarwal v DPL Builders Pvt. Ltd [(2017) SCC Online NCLT 12672], Pawan Dubey v J.B.K. Developers [(2018) SCC Online NCLT 794].
This shows the conceptual significance given to ‘consideration for the time value of money’ in characterizing a debt as financial debt. While the ILC Report discusses the same, it bases its recommendation on a different point. It interprets Nikhil Mehta as saying that while all forwards sales may not include financial debt, if structured as a tool for raising finance, these would qualify as financial debt. It then compares this to homebuyers who help finance the construction of a project, thus characterizing the advance payments made by homebuyers as financial debt. This interpretation is clearly averse to what Nikhil Mehta actually held, since in that case the committed returns scheme was the basis to satisfy the prerequisite of ‘consideration for the time value of money’.
In Pioneer, it was argued by the respondents that even transactions between the real estate developers and the allottees illustrated ‘consideration for time value of money’. The respondents argued that the allottees gained time value of money due to the benefit that they acquired by making advance payments rather than paying for the property after the completion of the project. This assumed that the latter would be more expensive for the allottees, thus the gain. Hence, the argument essentially hinged on the assumption that the allottees were gaining by making advance payments, and this gain was in terms of time value of money.
However, such an understanding of ‘time value of money’ seems incongruous. In fact, it is in dissonance with various authorities that have been cited by the Supreme Court itself in this judgement. According to Black’s Law Dictionary, ‘time value’ refers to the “price associated with the length of time that an investor must wait before an investment matures or the related income is earned.” Basically, the time value of money refers to the price of deferring the spending power of money to a later time. For instance, in case of loan, the time period until the repayment of the amount is an illustration of this, since this money cannot be used by the creditor until it is repaid.
In case of real estate developers, the money paid in the form of advance payments is to purchase the property. Thus, it cannot be said that the spending power of money is being deferred to a later time. The allottee has nothing to lose by spending money at a later time instead of making advance payments, since the money is not going to be repaid. The allottee already uses the money when making advance payments. Merely because the allottee obtains a better deal by making the payment in advance does not mean there is a ‘time value of money’ associated. If this were to be the case, then any company that pays to get its machinery manufactured rather than buying it on retail would be gaining time value of money. Simply saving money on a transaction is not equivalent to gaining time value of money.
Even in Nikhil Mehta, the NCLAT clarified that forward sale agreements and transactions involving advance payments that create financial debt are different. An additional requirement that made the sale transaction a tool to raise finance was required, and this was identified as the committed return scheme by the NCLAT. The Supreme Court in Pioneer upheld the validity of an Amendment Act that deems all allottees as financial creditors, and that too on an erroneous understanding of what constitutes ‘consideration against time value of money’.
Having demonstrated why the Supreme Court erred in classifying allottees as financial creditors, I shall now comment on the consequence of the Court’s analysis in Pioneer. A classification based on such loose reasoning sets a bad precedent. If we were to go strictly by the analysis given by the Supreme Court in this case, the significance of ‘consideration for the time value of money’ is vastly diluted. The way that the court has accepted time value of money for allottees, simply because they gain due to advance payments, gives basis to others for making a similar argument. In case of insurance companies, the premia charged can be compared to advance payments, since both are made in order to acquire some product at a later point in time, which might be more expensive if paid in its entirety at a later time. Further, while developers use money raised by way of advance payments to fund the projects, insurance companies use this money for investments. Essentially, both the developer and insurance company raise money by way of advance payments or premia. An argument can be made by the insured to say theirs is a financial debt too. Thus, the Supreme Court’s disregard for the committed returns logic accepted by NCLAT in Nikhil Mehta sets a bad precedent in IBC jurisprudence.
Further, the ILC Report quite conspicuously accepts that the state of the real estate industry played a key role in the recommendation for inclusion of allottees as financial creditors. However, without a clear conceptual boundary as to what qualifies as financial debt, the Supreme Court in Pioneer has validated a sector specific amendment by upholding the constitutionality of the 2018 Amendment. Due to the inadequacy of justification for inclusion of all allottees as financial creditors, the Court has hampered certainty and predictability under the IBC. There may now be other instances where such treatment is demanded (the insurance sector, for instance), without a reasonable claim to the same backed by an unambiguous conceptual reasoning.
Thus, in order to achieve the policy goal of protecting homebuyers in an industry plagued with problems, the Supreme Court seems to have upheld an amendment that may have far reaching consequences for the IBC in the future.
– Saurabh Gupta
We have the practice of real estate developer charging differing per sft prices for different customers – say upto june he charges price x but later from july onwards he charges price of x plus additional amount. In the light of the practice, can you give your views whether the time value of money concept cannot be read into the contract based on industry practice. I will advocate that the time value of money is implicit in such practices. It need not necessarily be reflected in payment of interest which is more explicit. Can you review and throw more light on this.
As far as insurance companies are concerned, they are ‘financial service providers’ (s. 3(16), 3(17), 3(18)), hence they are not covered under the definition of corporate person (s. 3(7)). However, Central Govt. can notify certain financial service providers to be included in IBC, that it did on 15 Nov 2019 (Financial Service Providers and Application to Adjudicating Authority) Rules 2019), however, that included only certain NBFCs. So, the embargo continues on the insurance companies.