Position of a Seller of an Immovable Property under the Insolvency and Bankruptcy Code, 2016

[Lavanya Pathak and Pallavi Mishra are advocates practicing in the Delhi High Court]

Under the Insolvency and Bankruptcy Code, 2016 (“IBC”), there is a clear scheme of categorization of creditors for the purpose of initiation of the corporate insolvency resolution process (“CIRP”). This categorization lies at the core of the waterfall mechanism for distribution of assets prescribed under section 53 of the IBC. While the waterfall mechanism applies to a very limited extent during the resolution process, as prescribed under section 30(2), the categorization brings with itself plethora of rights including inter alia the right initiate the CIRP, the right to file a claim, voting rights in the committee of creditors (“CoC”) and minimum entitlement in the resolution plan or liquidation process under section 30(2) or section 53, as the case may be. As such, it is often a matter of great debate as to whether a ‘debt’ would be in the nature of an ‘operational’ or ‘financial’ debt.

While the law is settled as to the treatment of many classes of creditors, lately, a question regarding the treatment of the debts of a seller of an immovable property, such as a land, has raised a conundrum.  This post particularly delves into examining the treatment to be accorded to a ‘seller of an immovable property’ under the IBC based on considerations extending to: (i) necessity of ‘disbursal’ to constitute ‘financial debt’; (ii) exclusion of immovable property from the definition of ‘goods’ under the definition of ‘operational debt’; and (iii) the ambit of ‘other creditors’ as category of creditors.

The post concludes along the lines that the claim of a seller of an immovable property arising out of a sale agreement can neither be treated as a financial debt nor an operational debt but may be included within a separate category of “other creditors” under the IBC. While this conclusion is derived from the legislative intent and judicial proceedings, the authors examine the effect of holding as such on the rights of this category of creditors, and suggest a way forward.

Necessity of ‘Disbursal’ to Constitute ‘Financial Debt’

Primarily, to assess whether a person may be categorized as a financial creditor, the existence of a debt is a sine qua non. Keeping this assessment in view, it is pertinent to note that the nature of a sale agreement usually either involves an auction of the underlying immovable property or payment of consideration, either paid upfront or in installments with imposition of an interest rate. In the context of the nature of the sale agreement, an argument that may arise is whether in case of payment owed to a seller in installments for sale of an immovable property, the imposition of interest can qualify as a “debt” under the IBC.

According to the authors’ view, primarily, a seller of an immovable property cannot be treated as a financial creditor as the dues of the seller arise against the installment sums payable for the sale of property, and not pursuant to any ‘debt’ which was ‘disbursed’ to the corporate debtor. Under section 5(8) of the IBC, ‘financial debt’ has been defined as under:

“Section 5(8): “Financial Debt” means debt alongwith interest, if any, which is disbursed against the consideration for the time value of money.”

Consequently, for a ‘debt’ to qualify as a ‘financial debt’, two ingredients must be satisfied: there must be a ‘disbursal’ of debt; and such disbursal must be against the time value of money. In Anuj Jain, IRP for Jaypee Infratech limited v. Axis Bank Ltd, the Supreme Court held that any of the transactions stated in the sub-clauses (a) to (i) of section 5(8) would fall within the ambit of financial debt only if it carries the ‘essential elements’ as stated above. The Supreme Court reiterated the necessity of ‘disbursement’ in Pheonix Arc Pvt. Ltd. v. Spade Financial Services Limited and Pioneer Urban Land and Infrastructure Ltd v. Union of India. The Court quoted the Black’s Law Dictionary on the meaning of the word disbursement” to mean “(t)he act of paying out money, commonly from a fund or in settlement of a debt or account payable….for a particular purpose.”

Additionally, with respect to the status of a seller of an immovable property, the National Company Law Appellate Tribunal (“NCLAT”) in Namdeo Ramchandra Patil v. Vishal Ghisulal Jain dealt with the question of dues of a landowner under a joint development agreement and held that it shall not be treated as a ‘financial debt’, since there was no disbursement as it was “not a case where an amount has been raised from the Appellants – the Landowners”. These observations of the NCLAT were also confirmed in Ashoka Hi-Tech Builders Pvt. Ltd. v. Sanjay Kundra.

Hence, based on the first test of the necessity to constitute ‘financial debt’, the seller of an immovable property cannot be held to be a financial creditor since under a sale agreement a seller is not disbursing any debt to the corporate debtor, but merely claims dues against the sale of land.

Exclusion of Immovable Property from the Definition of ‘Goods’ under the Definition of Operational Debt

In addition to the above test, the seller of an immovable property cannot also qualify as an “operational creditor” within the meaning of section 5(20) of the IBC since the definition of “operational debt” as given under section 5(21) means a claim in respect of the provision of “goods and services”. It is settled that the sale of land cannot be considered a “service”.

To see whether ‘land’ can be considered a ‘good’ under section 5(21), reference is to be placed on the definition of “goods” under section 2(7) of the Sale of Goods Act:

2(7). “goods” means every kind of movable property other than actionable claims and money; and includes stock and shares, growing crops, grass, and things attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale.

It is crystal clear that immovable property is excluded from the scope of ‘goods’ and, as such, a seller of land cannot be held to be an ‘operational creditor’ under the IBC since land does not qualify as ‘good’ . The NCLAT in Somesh Choudhary v. Knight Riders Sports Private Limited has also considered the definition of goods under the Sale of Goods Act to determine whether dues against sale of trademark would constitute an ‘operational debt’ under the IBC. While relying on the decision of the Supreme Court in Vikas Sales Corporation v. Commissioner of Sales Tax, it was observed that “even incorporeal rights like trademarks, copyrights, are ‘Movable Property’ and are included in the ambit of definition of ‘goods’ under the provisions of Sale of Goods Act, 1930.” However, despite the expansive interpretation given by the NCLAT, it is rather obvious that dues arising from the sale of immoveable property cannot be included under the definition of goods under section 2(7) of the IBC.

‘Other Creditors’ as a Category of Creditors Who are Neither Operational nor Financial

Keeping in view the foregoing discussion, the legislature was conscious that within the scheme of the IBC there may be categories of creditors whose debts are neither financial nor operational in nature. Therefore, in 2017, by way of an amendment to the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“CIRP Regulations”), a new ‘Form F’ was introduced for submission of claims by creditors other than financial and operational creditors. Regulation 9A of the CIRP Regulations provides for a detailed process for filing of claims by ‘Other Creditors’.

Considering the intent and purpose of having a residuary provision for the claims of creditors not having a financial or operational debt, the seller of immoveable property should be treated under the ambit of ‘Other Creditor’. In Shubhankar Bhowmik v. Union of India, the High Court of Judicature at Tripura, as upheld by the Supreme Court, held that a decree holder who does not fall within the definition of an ‘operational creditor’ or a ‘financial creditor’ is liable to be treated as ‘other creditor’. The observations of the Court in this regard as reproduced as under:

“15. Since the claims cannot be classified as operational or financial, appropriate provisions (Regulation 9A) and forms (Form F) for filing of claims is provided in the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016. This is also reflected in the title to Form F which reads “Proof of Claim by Creditors (Other than Financial Creditors and Operational Creditors).”

In light of the foregoing judgement, it is the authors’ view that an applicant who is claiming dues as a seller of land under a sale agreement is liable to be treated as ‘other creditor’ as the pre-requisites of ‘financial debt’ and ‘operational debt’, as defined under the IBC, are not met.

Protecting the Rights of Sellers of Immovable Property

The authors find that the scheme of the IBC is clear in as much as the sellers of immovable property can neither be treated as financial nor as operational creditors. However, this raises a perplexing situation in cases where the corporate debtor, being a developer, has started real estate projects on the land, against which the dues of the seller have not been cleared. On one hand, taking away the land during the CIRP process would virtually frustrate resolution and, on the other, it is imperative that the landowner get their legitimate dues.

To determine whether there will be any adverse repercussions by treating such creditors as ‘other creditors’, it is important to analyze the different between treatment of various category of creditors under the IBC.

While there is no difference in treatment in the event of liquidation as section 53 uses the words ‘secured’ and ‘unsecured’ creditor, it is clear that for the purposes of resolution, the IBC seems to be designed such that while financial creditors are given voting rights in the CoC, operational creditors are given minimum entitlements to ensure their treatment is not prejudicial. ‘Other creditors’ are not protected beyond the general mandate of ‘fair and equitable distribution’ under the resolution plan and will also have no right to initiate CIRP.

However, it is the understanding of the authors that, practically, such a treatment will not be prejudicial for this category of creditors since the transfer of their immovable property, which generally forms an integral part of the estate of the corporate debtor, would be subject to their consent and the consent of the adjudicating authority when waivers or concessions are sought by the resolution applicant. Thus, it will be incumbent on the successful resolution applicant to provide adequate treatment of their dues.

– Lavanya Pathak & Pallavi Mishra