Homebuyers’ arsenal adds financial creditor status

By Aditya Vikram Dua and Satish Anand Sharma, SNG & Partners
24 August 2018

With the recent amendment in the Insolvency and Bankruptcy Code, 2016 (IBC), effective 6 June 2018, the status of homebuyers who are allottees of a real estate project is raised to financial creditors, enabling them to initiate the corporate insolvency resolution process (CIRP) against defaulting builders. Before this amendment, an allottee in a real estate project who wished to bring action against a defaulting builder had the following options:

Aditya DuaSenior associateSNG & Partners
Aditya Dua
Senior associate
SNG & Partners

  • sThe allottee could approach a civil court and file a suit for an injunction, damages or refund of the amount paid and interest against the defaulting builder. The allottee could also initiate criminal action by filing a criminal complaint under provisions of the Indian Penal Code, 1860, for cheating and breach of contract.
  • Under the Consumer Protection Act, 1986, homebuyers are regarded as consumers if the dwelling is purchased for their own use and not for any commercial purpose, which permits homebuyers to approach consumer forums to bring an action against the builder for deficiency in services under the agreement between the homebuyer and the builder.
  • A homebuyer could approach Competition Commission of India against a builder taking undue advantage of its dominant position to the disadvantage of the homebuyer.
  • Under section 31 of the Real Estate (Regulation and Development) Act, 2016, a homebuyer/allottee can file a complaint with the Real Estate Regulatory Authority where the builder makes false promises to the home purchaser and does not comply with its statutory obligations.

When the IBC was introduced in May 2016, homebuyers were not recognized as creditors, so they were not able to initiate the CIRP or be a part of the committee of creditors (CoC) and were not given priority for repayment of their dues in case of liquidation. The adjudicating authorities and the appellate tribunal in their orders had not admitted homebuyers’ pleas for initiating the CIRP as they neither qualified as financial creditors nor as operational creditors.

The Insolvency and Bankruptcy Board of India, through a notification dated 16 August 2017, permitted creditors other than financial and operational creditors to file claims before the interim resolution professional in Form F.

Satish Anand SharmaSenior associateSNG & Partners
Satish Anand Sharma
Senior associate
SNG & Partners

The 2018 amendment provided significant relief to homebuyers by recognizing the amount received from an allottee under a real estate project as having commercial effect as a borrowing and thus being a financial debt.

Although the amendment has been lauded by stakeholders, it raises certain practical concerns. The right to initiate the CIRP has been vested in homebuyers but the appropriate event for invoking the CIRP has not been clarified in the IBC. While the IBC expressly defines “default” in respect of a debt, this definition would not be applicable in case of an allottee.

Further, the amendment empowers an allottee to be a part of the CoC. This may become a challenge from the perspective of other financial creditors (such as banks and other lenders), as the parameters on which such lenders take decisions may differ greatly from the ones on which homebuyers will take a decision. Operationally also it may be hard to work where a lot of homebuyers will be involved and the homebuyers and the other members of the CoC may become deadlocked. From the perspective of homebuyers, it will bring more transparency to the CIRP.

While the amendment has raised the status of allottees to financial creditors, it does not specify whether they would be regarded as secured or unsecured creditors in the event of liquidation. Financial creditors, both secured and unsecured, have equal rights in approval of a resolution plan, but if the corporate debtor goes into liquidation, the dues are paid in accordance with the waterfall mechanism under section 53 of the IBC, which places the secured creditors higher than the unsecured creditors. So, it is crucial to specify whether allottees would be considered as secured or unsecured creditors under the IBC.

The amendment includes within its scope allottees of real estate projects for commercial as well as for residential purposes. No distinction is made between real estate for personal use and commercial purpose. Since the object of the amendment was to confer protection on homebuyers, it ideally should have made a distinction with respect to the final use of the real estate project, as has been provided under the Consumer Protection Act.

The amendment is a welcome step in respect of the status of homebuyers under the IBC. However, it is expected to face certain initial practical hurdles in its implementation.

SNG & Partners has offices in Delhi, Mumbai and Singapore. Aditya Vikram Dua is a senior associate. Satish Anand Sharma is a senior associate and a qualified insolvency professional.