The initiation of insolvency process in the case of Jaypee Infratech and other real estate companies has brought to light a potential loophole in the Insolvency and Bankruptcy Code (IBC) 2016 — that it overlooks the interests of the buyers who have booked the property but are yet to get it registered in their names. In such a case, the IBC does not provide any remedy to the homebuyers even though they have paid most of the apartment cost. In the event of liquidation following a failed resolution of a real estate company, while the secured lenders or the banks will have recourse to the under-construction property that may be mortgaged to them, the people who have taken a home loan will be among the last to any receive compensation from the leftover liquidation proceeds.
Taking cognisance of these gaps in the law, the Supreme Court last week stayed insolvency proceedings against Jaypee Infratech, but on Monday, modified its earlier order, directing Jaiprakash Associates (the parent company of Jaypee Infratech) to deposit Rs 2,000 crore by October 27 with its registry. The Court also asked the interim resolution professional (IRP) in the case to take over its management and work out a plan to protect the interests of homebuyers and creditors.
Since homebuyers are customers of the real estate companies, the IBC does not provide them any remedy, as the law can be invoked only by entities that have lent funds for earning interest or by the corporate debtors themselves. While financial and operational creditors can trigger corporate insolvency resolution process (CIRP) in case of a defaulting company under Section 7 and Section 9 of the IBC, respectively, no such remedy is available to the customers of a company, thereby creating problem for homebuyers in the real estate projects. Lawyers dealing with insolvency cases note that the government will have to amend the Section 9 of the IBC to enforce “third-party rights” such as in the case of homebuyers.
There are certain other liabilities that do not figure in either Section 7 or Section 9 of the IBC. Unsecured loans given without any interest — such as zero coupon bonds — have no claim under the IBC. The Central government is aware of these implications of the enactment of the IBC and is working to protect the interests of the homebuyers, said a senior official with the Insolvency and Bankruptcy Board of India (IBBI). The government might amend Section 9 of the Code to provide the status on an operational creditor to the homebuyers who have paid substantial money to the builders.
Over 30,000 homebuyers have been affected by initiation of corporate insolvency resolution process against companies such as Jaypee Infratech, Amrapali Silicon City, among others. “Unless there is an amendment in the Section 9 of the Bankruptcy Code, the present law does not empower the consumer or the homebuyer to file for claims,” said Manoj Kumar, Partner & Head at advisory firm Corporate Professionals Capital Pvt. Ltd, which is also dealing with some of the insolvency cases under the IBC.
A review of cases being heard at various benches of the National Company Law Tribunal (NCLT) shows that individual investors, who have put in money to buy shop or apartments through a “committed return plan” offered by a builder, can initiate insolvency process against the builder in the event of a default. These are the plans in which the builder takes lump sum funds from the individual investor, with the promise to pay monthly rental till a certain period.
While such cases are admissible under the IBC, a homebuyer does not have any remedy under the bankruptcy law. Indeed, in such cases, the NCLT has advised the homebuyers to approach consumer courts or seek remedy under the “general law of the land”. A lawyer working on such cases explained how it will be a “double whammy” for the property buyer. “While the consumer may have paid 95 per cent of the apartment cost, he or she will be last person to whom the company will pay anything in the event of a liquidation, while his lender will have the ‘first charge’ over the mortgaged apartment on which he/she may be paying EMIs regularly,” he said.
The IBBI had introduced a new form under the insolvency law to enable a person who has to receive a payment from an insolvent company to seek the claim. This enabled homebuyers to submit proof of their claims, but they still have no clear right when the assets of a company will be distributed in the event of liquidation.
Under the IBC, the priority of distribution of assets during liquidation follows a certain order: first, payment to be made for the insolvency resolution process costs and the liquidation costs paid in full, second, workmen’s dues and debts owed to a secured creditor, third, wages and any unpaid dues owed to employees other than workmen. This is then followed by financial debts owed to unsecured creditors, any amount due to the Central or state government, any remaining debts and dues, preference shareholders and equity shareholders — in that order. Customers do not figure at all in this payment of priority list, even though they may have paid substantial money and still not receive the goods (flats, etc).
With stressed assets piling up in the banking system, the government last year enacted the IBC to speed up process of resolution of bad loans. The NCLT benches have so far taken decision on 655 cases under the IBC, NCLT President Justice M M Kumar said on August 31. This number includes over 200 cases that have been admitted across various benches of the NCLT while the other cases were not admitted for resolution under the law.