Real Estate Ecosystem under IBC

Abstract

The insolvency laws in India are in its empirical stage, however they fail to mitigate a lot of issues including and not limited to low recovery rates, huge haircuts, prolonged delays, digitalisation of insolvency ecosystem, shortage of resources etc. Since India is a developing nation, real estate is one of those sectors which is on its peak and has the maximum number of disputes arising out of it. There are various laws and amendments which are constantly being implemented to resolve these disputes in the most efficient manner. However, the homebuyers remain stuck in long legal battles which keep on draining their hard-earned money and their dream of owning a house for which they had spent their lifetime savings becomes a hard nut to crack.

This research paper highlights how the Code has evolved from its initial stage, specifically in dealing with insolvency in the real estate sector. The readers are going to get a basic structure as to what insolvency laws specify when it comes to the bearings of homebuyers and the real estate developers. The paper further goes on to illustrate various challenges faced by the allottees even after the amendments made in the Code. The author, by way of this paper has highlighted some major suggestions which can be used as a tool to mitigate these challenges.

Introduction and objective

Seeking to facilitate the ease of doing business in India, the Insolvency and bankruptcy Code, 2016 (“Code”) was enacted by the lawmakers of the country, comforting the distressed organizations and creditors by way of restructuring and process of insolvency. The Code greatly empowered the creditors and has been constantly putting in efforts to get the maximum value of the organizations in all sectors. Including other sectors, Insolvency and Bankruptcy (“IBC”) laws in India have greatly impacted real estate sector in terms of greater transparency and accountability between the home buyers and investors. Along with addressing a number of long-pending real estate cases, a trust has been built in the investors and homebuyers for real estate projects/developers, adding to the overall growth of the real estate sector.

The Code being in its nascent stage, has built a robust mechanism to mitigate the challenges pertaining to real estate ecosystem including change in status of homebuyers as financial creditors, expediting the real estate investment resolutions, stricter guidelines for developers towards homebuyers, timely delivery, increased liquidity by maximizing the value of distress assets. The process of Corporate Insolvency Resolution Process (“CIRP”) may be initiated against a company by a creditor/s with the objective of reviving the company or getting maximum possible value by way of liquidation.

Evolution of real estate ecosystem

Completing its sixth year, the insolvency regime has curbed the unfair benefits that developers had over the stakeholders and other financial creditors during the resolution process. With the objective of providing a fair playing field for all the stakeholders, resolving disputes, and ensuring better transparency, constant attempts are made by way of amendments, judicial pronouncements etc. Few of the game changing insertions in the real estate ecosystem have been mentioned below: –

1. Relaxation of minimum threshold for homebuyers

Addressing the issues pertaining to the minimum threshold required for filing CIRP by the homebuyers, the minimum threshold limit was revised vide IBC (Second Amendment) Act, 2020. The amendment introduced the revised threshold limit for homebuyers wherein the requirement for initiating the CIRP against the real estate developer was changed to at least least 100 Homebuyers or 10% of the total Homebuyers of the same project, whichever is less. The constitutional validity of the amendment was upheld by the Apex Court [1], in addition it was observed that the date of default may be different for every creditor but as on the date of filing the application, the threshold should be met and that would suffice.

2. Change of status of homebuyers as financial creditors

Initially the homebuyers had very limited rights in the resolution process as they were not considered as secured financial creditors, leaving no option for them but to wait for the resolution plan to be completed. The issue was encountered vide insertion of explanation under Section 5(8) (f), Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018, wherein payments made by the homebuyers were considered as financial debt thereby recognizing them as financial creditors. The courts have opined in this issue that the homebuyers are categorized as financial creditors under Section 5(7) of the Code [2]. This has significantly impacted the homebuyers as now they are part of the decision-making process and have a say in the resolution process.

3. Better accountability and transparency

The inception of the Code has put a mandate on the real estate developers to update the home buyers and investors on regular time intervals about the progress of the project. Further the real estate developers are now under an obligation to provide relevant information as sought by the homebuyers and investors. The timelines have become stricter and timely possession is required as promised by the real estate developers. With the increase in the accountability of the developers, the credibility of the real estate sector has increased, building trust among homebuyers, investors, and developers.

4. Pre-packaged insolvency resolution process for real estate sector.

Ideally suited for real estate project, insertion of the concept of PPIRP has provided major relief to several stressed real estate companies as per Explanation I of Section 54K of the Code. The Code allows the stressed corporate debtor to file an application jointly with a financially stronger real estate company, to facilitate early resolution. One such case, benefiting from the PPIRP, was seen in the year 2021, wherein the PPIRP application was admitted by the NCLT Delhi allowing Loon Land Development Limited to join hands with M3M construction Private Limited to furnish the base resolution plan which was eventually approved by the financial creditors in Form 4.

5. Introduction of provisions pertaining to Authorized representatives (“AR”)

The concept of AR was introduced under Regulation 16A, wherein the class of creditors were enabled to participate in the resolution process effectively through an AR. The AR is appointed to put forward the interest and decisions of a class of creditors on relevant agenda items proposed in the COC meetings. In the real estate sector, the role of AR is very significant as the interests of homebuyers are secured by the AR. The concept of AR was further strengthened after the clarification received by the apex court with respect to the status of the homebuyers as financial creditors [3]. Thus the homebuyers were entitled to be represented by an AR in the COC.

Impediments

The insolvency laws have strengthened over time, however there are few challenges which are being currently faced in the IBC ecosystem; few of them are listed below: –

1. Implementation of PPIRP

Due to lack of awareness and policy framework, PPIRP is unable to be used as a popular tool for resolution. The major setbacks are seen in terms of obtaining buy-in of base resolution plan from sizeable unorganized home buyers, proposal of the RP by a financial creditor who is not a related party of the corporate debtor and holds not less than 10% of the value of financial debt, unregularized framework pertaining to the two meetings.

2. Fear of ending in liquidation

In cases where resolution plan is accepted, the chances for the company to survive and continue as a going concern increases, however where resolution plan is rejected for any reason, the company is left with no alternative but to go in liquidation. Further the Code has nowhere mentioned whether homebuyers will be categorized as secured or unsecured creditors if a company goes into liquidation, due to which their standing in the waterfall arrangement cannot be ascertained. As per the present law although homebuyers have the right to be a part of the Committee of Creditors. But if a company goes into liquidation, then as per Section 53, homebuyers will be categorized as unsecured creditors and they will fall at the bottom of the arrangement. Thus, inducing the secured lender and creditors to hold out for liquidation rather than resolution of the company.

3. Criticism by homebuyers over the revised thresholds

The threshold limit set in the case of Manish Kumar Vs. Union of India, attracted a lot of criticism by the homebuyers. The major reason being that the date of filing of the application is considered to be the date of default as per the principle laid down in this case. It is on the date of filing the application that the threshold has to be met which becomes a challenge for the creditors as some of them decide to go for different legal remedies which are available out there, in certain cases real estate developers approach a group of allottees with an idea of settling the dispute therefore leaving them remediless under the Code. This principle has completely impaired the rights of the allottees to approach the Adjudicating Authority independently, as in the case of other financial and operational creditors. Further it places the homebuyers behind every other operational creditor in terms of initiation of CIRP for any default above INR 1 (one) Cr.

4. Distinction between homebuyers and other financial creditors

Homebuyer though financial creditors are not equivalent to other financial creditors such as banks, the rational is that financial institutions are more inclined towards repayment of the debt be it by way of revival or by means of winding up, they don’t mind receiving payment of their debts even if it is subject to a massive haircut. Same is not the case with homebuyers, their interest is not in getting the payment of their deposits rather they look forward to getting the ownership of the property for which they have been waiting so patiently.

Contemporary Insolvency Process

To counter the complexities in the real estate sector, the Indian courts have time and again established novel concepts including reverse CIRP, project-based insolvency and consolidated CIRP, etc. These concepts have been used as an experiment by the insolvency tribunals in certain cases to effectuate more realistic chances of project completion, securing the interests of the stakeholders. Few of these concepts are elaborated below: –

1. Reverse CIRP

The courts observed that the homebuyers were not contended by the traditional CIRP, thus, to safeguard the interest of the homebuyers, the courts embraced the concept of reverse CIRP in the Indian legal system. The concept of Reverse CIRP was originated by the NCLAT [4], which enabled the promoters of the real estate company to stay outside the CIRP who agreed and intended to play the role of a lender by infusing money. The method was adopted with the intention to put into motion the pending real estate project into successful construction or conclusion, thereby allowing the allottees to take possession without any intervention from the third party.

2. Reverse CIRP to be Project-specific

In the general parlance when an application is filed by the homebuyers to initiate CIRP in a real estate project, the Adjudicating authority accepts the application and the CIRP process is commenced against the whole group or company or developer. Due to the CIRP against the whole group or company the other healthy projects of the entire company are affected, considerably impacting the interests of homebuyers and the real estate company. To tackle such issue, the insolvency courts kept the reverse CIRP project-specific [5], making the resolution plan specifically restricted to the project in default and rest of the projects untouched.

3. Consolidated CIRP or Group insolvency

Numerous times the entire development of the project and resolution of debt is dependent on multiple businesses having connection with the project. Therefore, initiating separate CIRP against the two inter-connected companies reduces the chances of revival and completion of the project, influencing the interests of homebuyers, other financial creditors, and stakeholders. To counter such issue, the insolvency courts in India have in few cases implemented the concept of consolidated CIRP, wherein the CIRP of related corporate debtors were combined and consolidated and dealt by single insolvency professional. The NCLAT in the case of Edelweiss Asset Reconstruction Company Limited v. Superlative Infrastructure Private Limited [6], observed that group CIRP was necessary for successful CIRP, as the project was dependent on the five companies who owned the land jointly with corporate debtor. Similarly, in the case of Lavasa Corporation Limited v. Warasgaon Assets Maintenance Limited [7], the court observed that subsidiary company and holding company were interdependent and thus consolidation of CIRP was necessary. In the case of LIC Housing Finance Limited v. SRS Real Estate Limited and Ors [8], a similar approach was followed by the NCLT. This process curbed the entity-to-entity approach and secured the interests of the homebuyers, other financial creditors, and stakeholders.

Recommendations

1. For smooth implementation of the PPIRP in the real estate ecosystem, the appointment of AR and initiation of CIRP should take place in the same meeting. Further the appointment of AR should precede the conveying of meeting for engagement of resolution process. A robust mechanism should be built to develop trust between the corporate debtor and the financial creditors, including the homebuyer. Steps should be taken towards spreading awareness and knowledge pertaining to the PPIRP.

2. Though recognized by courts in India, full-bodied provisions should be added in the existing insolvency laws pertaining to the advanced mechanisms including reverse CIRP and consolidated CIRP, with the view to completion of the pending constructions, ultimately securing the interest of the homebuyers, other financial creditors, and developers under the real estate sector.

3. The term “authorized representative” should be inserted in the Code. Further, as the role of an AR is very substantial and crucial, provisions pertaining to change of the AR during the CIRP along with detailed process, role and obligation should be inserted in the current insolvency regime.

4. The legislation should facilitate the allotees in order to enable them to approach the Adjudicating Authority like any other financial creditors and operational creditors. The revised minimum thresholds considering date of filing of an application to be the date of default, should be reconsidered as it impairs the right of the individual allotees to approach the Adjudicating Authority.

Conclusion

The real estate sector contributes a considerable percentage in the GDP of India; thus, it becomes very important to protect the interests of the relevant players of the industry. The

inception of the code has brought some relief to the homebuyers, other financial creditors, and stakeholders, facilitating them with a safer playing ground. It is pertinent to mention that the insolvency laws in India are still in its nascent stage, however the proactive approach of the judiciary and legislation have safeguarded the interests of the homebuyers and other financial creditors in the real estate ecosystem time and again. The experiments undertaken by the insolvency court are indeed applaudable and reflect the positive approach to implementing new concepts in the existing insolvency legal framework. However, on the implementation aspect, a lot needs to be done. Considering the current insolvency regime, the next few years should be planned to counter all the present impediments and challenges in the real estate insolvency system, including the few mentioned above, by way of a full proof mechanism. Without a doubt there still remains a lot which needs to be attained to stand up to the standards set by the mature jurisdiction, however the Code is expected to witness some remarkable changes in the upcoming years.

Footnotes:

1. Manish Kumar Vs. Union of India [2012 SCC Online 30]
2. Nikhil Mehta and Sons v. AMR Infrastructure [Company Appeal (AT) (Insolvency) No. 7 of 2017]
3. Pioneer Urban Land & Infrastructure Vs. Union of India [2019 SCC OnLine SC 1005]
4. Flat Buyers Association v. Umang Realtech Pvt. Ltd. [Company Appeal (AT) Ins. No. 926 of 2019]
5. Flat Buyers Association Winter Hills v. Umang Realtech Pvt. Ltd. [2021 SCC OnLine NCLAT 3173]
6. (2021) 9 SCC 657
7. 2021 SCC OnLine Bom 1843
8. 2012 SCC OnLine NCLT 4255

Authors: Ketan Mukhija (Partner) [pictured below] and Shorya Singhal (Associate)

Disclaimer: The views expressed in this article are those of the authors and is not intended for any solicitation of work. Readers are always advisable to take prior legal consultation before proceeding formally.