Amendment to Section 7 of The IBC: A Well-Intentioned Constitutional Fallacy?

[Ridhi Arora and Hitoishi Sarkar are III Year B.A. LL.B (Hons.) students at Gujarat National Law University]

Section 3 of the Insolvency and Bankruptcy (Amendment) Act, 2020 (‘Amendment’), added certain provisos to section 7 of the Insolvency and Bankruptcy Code, 2016 (‘Code’) whereby special conditions were added for real estate allottees to qualify as a financial creditor under the Code. The Amended Code provides that for a real estate allottee to qualify as a financial creditor, the section 7 application needs to be filed jointly by “not less than one hundred of such allottees under the same real estate project or not less than ten per cent of the total number of such allottees under the same real estate project.” The amendment to section 7 of the Code comes in conflict with settled positions of law and certain fundamental rights guaranteed under the Indian Constitution by creating a “class within a class.”

This post seeks to analyse the constitutionality of the amendment to section 7 of the Code while also examining the permissibility of a retrospective application of the aforementioned amendment. 

The issue of “class within a class”

By way of the Insolvency and Bankruptcy (Second Amendment) Act, 2018, allottees of real estate projects were brought within the ambit of Financial Creditors under the Code. The Supreme Court had in Pioneer Urban Land and Infrastructure v. Union of India concluded that the debt owed to allottees under real estate projects constitutes financial debt within the meaning of section 5(8) of the Code and effectively brings them in the ambit of “creditors”. The Court relied on the reasoning that so long as an amount was raised with an aim to bring profit to both the parties, i.e., the home buyer in the form of an apartment/flat and the real estate developer in the form of monetary benefit, such a transaction would be of a commercial nature and would be subsumed within section 5(8) of the Code. However, post the amendment to the Code, irrespective of their claim amount, a home buyer will have to unnecessarily comply with the condition given in the amended section 7, i.e., to bring 100 real estate allottees or 10% of the total allottees under a real estate project in order to approach the Adjudicating Authority.

The essential implication of this amendment is that it dissects financial creditors under section 7 into two classes i.e., real estate allottees, and other financial creditors. This is because while other financial creditors will have to satisfy only the claim amount under section 4 of the Code to file an application, real estate allottees will also have to find the requisite number of applicants and ensure that the said number remain intact until the filing of the Petition and final adjudication of the Petition. 

The Supreme Court has in State of U.P v. Committee of Management, Mata Tapeshwari Saraswathi Vidya Mandir, Sansar Chand Atri v. State of Punjab, and E. V. Chinnaiah v. State of Andhra Pradesh frowned upon such legislative instruments that seek to create a “class within a class.” For instance, in the case of Mata Tapeshwari Saraswathi Vidya Mandir, while adjudicating upon the validity of a notification that created a class within a class of Junior High Schools that would disentitle them from receiving any aid, the Court ruled that “creation of a class within a class was unconstitutional and arbitrary, thus making it ultra vires the Constitution.” 

The ghost of “retrospective application”

A pertinent bone of contention regarding the aforementioned amendment is that it has been given retrospective effect. This implies that even allottees who had their matters pending before the National Company Law Tribunal or the National Company Law Appellate Tribunal before the amendment was brought into force will have to comply with the amendment’s stipulation. The position of law with respect to the retrospective application of amendments made to the Code came for consideration before the Supreme Court in B.K Educational Services v. Parag Gupta, wherein the Court upheld the validity of clarificatory amendments of a procedural nature made to the Code that do not affect substantive rights of financial creditors. 

The consequence of the amendment to section 7 of the Code is that it seeks to alter the decision of the Supreme Court in Pioneer Urban Land by providing for additional qualifications for an allottee to seek relief under section 7 of the Code. A Constitution Bench of the Supreme Court in Cauvery Water Disputes Tribunal, Re had ruled that “the legislature can change the basis on which a decision is given by the Court and thus change the law in general, which will affect a class of persons and events at large. It cannot, however, set aside an individual decision inter parties and affect their rights and liabilities alone.” 

Thus, it is a well-settled principle of law that a binding judicial pronouncement between the parties cannot be made ineffective with the aid of any legislative power by enacting a provision which in substance overrules such judgment. The same has been most effectively reiterated in The State of Karnataka v. The Karnataka Pawn Brokers Assn.,wherein it was observed that “the Legislature cannot set at nought the judgments which have been pronounced by amending the law, not for the purpose of making corrections or removing anomalies but to bring in new provisions which did not exist earlier.”

The amendment interferes with the decision of the Supreme Court by laying down a prerequisite for real estate allottees to bring claims against developers under section 7 of the Code; and introduces provisions to the Code which bring limitations to the rights of the allottees which had been affirmed by the Court in Pioneer. The practice of the legislature making amendments to the law to invalidate the effect of the decisions pronounced by the courts has already been frowned upon in Karantaka Pawn Brokers Assn. Therefore, the amendment to the Code comes at loggerheads with settled decisions of the Supreme Court and is also against the fundamental rights enshrined in the Indian Constitution.

Conclusion 

While the amendment to section 7 may have been well-intentioned as it seems to protect the real estate sector from frivolous insolvency litigations, a better approach could be to enact a sector-specific insolvency statute which is a prevalent practice in several other jurisdictions. For instance, in the United Kingdom, the procedures for insolvency of bodies licensed under the Energy Act, 2004 are provided in the legislation itself and the claims of policyholders of an insurer are made under the Financial Services Compensation Scheme (FSCS) for up to 90% of the policy value. The Banking Act, 2009 introduced modified insolvency regimes to revive failing banks and other financial institutions. To preserve the interests of creditors in specific sectors like real estate, the Indian insolvency law needs to be more specialised to accommodate the special needs and challenges that each sector possesses.

Ridhi Arora & Hitoishi Sarkar

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