INTRODUCTION TO IBC

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The Insolvency and Bankruptcy Code of 2016 is a remarkable step toward easing of exit by companies who are insolvent. Before the IBC was introduced, companies had to undergo a lengthy and tedious process of filing documents with various authorities and would take a lot of time to complete the process. Under the IBC framework, companies who file insolvency petition has to complete the resolution process within a maximum of 280 days. In many ways, introduction of IBC has led to the increase in the ease of doing business in Indian.

The resolution process involves constitution of a ‘Committee of Creditors’ (CoC) who are the ultimate decision makers in the process. Creditors of a company are divided into operational and financial creditors. Operational creditors are those to who ‘operational debt’ is owed and these are not a part of the CoC. Financial creditors on the other hand, form a part of the CoC and actively participate in the decision-making process of the resolution plans put forth by an ‘appointed resolution professional’. It is therefore the duty of the financial creditors to ensure that the operational creditors get their due when the company is wound up.

With the framework of the IBC briefly explained, let us now understand the 2018 amendment to the IBC which was challenged before the Supreme Court of India and what the court held.

The 2018 amendment of Insolvency and Bankruptcy Code

Before looking into the amendments made to the IBC, light must be shed on the circumstances that led to the promulgation of the ordinance which finally became the amendment act.

The issue began when allottees who entered into ‘assured returns/committed returns’ agreements with developers filed several petitions against the real estate developers, under the code. Under the ‘assured returns/committed returns’ agreement when substantial portion of the sale consideration is paid to a developer, he shall pay a certain amount on a monthly basis to the allottees, from the   date of execution of agreement to the date of allottees being given possession. The batch petitions culminated in Nikhil Mehta and Sons (HUF) vs AMR Infrastructure Ltd. in NLCAT.

In this case, NCLAT observed

“Amounts raised by the developers under the said scheme had commercial effect of a borrowing.”

It was further noted that the developers annual returns showed that the amount raised through the scheme was under the head ‘commitment charges’ under the head ‘financial costs’. It was therefore held that the allottees were held to be financial creditors within the meaning of section 5(7) of the code.

The second case which is relevant to our discussion is the case of Chitra Sharma & ors. V Union of India. In this case IDBI Bank initiated proceedings against Jaypee Infratech Ltd. alleging default of a loan amount of up to 526 crores. The relevant ratio of NCLT is that it appointed a representative of the homebuyers, the allottees, to participate in the meetings of the Committee of Creditors in order that their interest be protected. In another case concerning Amrapali Group, a substantially similar order was passed around the same time that the Chitra Sharma order came out.

In observance of the growing trend of the court’s decisions with respect to the real estate developers and the allottees, the Insolvency Law Committee proposed the following amendments to the code.

The relevant amendments made to the code are:

  1. Allottees of real estate projects are deemed to be financial creditors under the code
  2. Allottees can trigger the code pursuant to Section 7, IBC
  3. They are entitled to be represented in the CoC by authorised personnel

Amendments were made to (i) explanation to section 5(8)(f), (ii) Section 21(6A) (b), (iii) Section 25A of the code.

The case of Pioneer Urban Land and Infrastructure Ltd and Anr vs Union of India

In the instant case, the 2018 amendment was challenged as ultra vires Article 14 of the Constitution of India. The Real Estate Companies had 4 preliminary objections.

  1. If homebuyers were classified as financial creditors, it implies that unequals are being treated equally. Such a classification in the absence of an intelligible differentia is unreasonable.
  2. Further, under article 14 of the Indian Constitution, any act has to have a nexus with the object sought to be achieved by the parent legislation under the authority of which the impugned action is undertaken. It was contended that the 2018 amendment was contrary to the object of IBC. It was reasoned that a few disgruntled allottees are now equipped to bring an entire project to standstill and it is not the case of IBC to promote or encourage insolvency proceedings.
  3. The Real Estate (Regulations and Development) Act, 2016 (RERA) provides for a separate remedy to address the grievances of allottees.
  4. As against what was held in the case of Nikhil Mehta, it was contended that giving advance payment for flat allotment cannot be regarded as ‘financial lending’.

This peculiar case which has seen more than 200 real estate companies challenging the impugned legislation has attracted a lot of traction as it involved a lot of unresolved questions on the interplay between IBC and RERA amongst other contentious areas of IBC.

The full judge bench of Justices R F Nariman, Sanjiv Khanna a

nd Surya Kant held that the amendment does not violate Article 14, 19(1)(g). the court also denied that the amendment was arbitrary, excessive, disproportionate and unreasonable’.

The court has distinguished between homebuyers as financial creditors vis-à-vis operational creditors and has highlighted the need to classify homebuyers as financial creditors. The court said that unlike operational creditors, developers have an interest or stake in the corporate debtor.

One of the primary and significant constructs which was answered by the judges was the alleged unreasonable classification lacking intelligible differentia which is hit by Article 14. The court said that the impugned legislation does not treat unequally equally. In this regard, the court said:

“So far as unequals being treated as equals is concerned, home buyers/allottees can be assimilated with ther individual financial creditors like debenture holders and fixed deposit holders, who have advanced certain amounts to the corporate debtor.”

Hon’ble Supreme Court on the contention that there already exists a parallel remedy in RERA under section 88, said that the present remedy was an additional one and the allottees are not barred from seeking other remedies available to the homebuyers/allottees. In this sense, the remedy under IBC and RERA are to be read within each other.

Concluding remarks

The judgement of Pinoeer Urban Land and Infrastructure Limited vs Union of India is pivotal and significant to the present-day context, adding to the development of the Indian insolvency jurisprudence. The takeaways from the judgment are twin-fold – (i) the 2018 amendment is not violative of Articles 14, 19(1)(g) or 300-A and (ii) RERA is to be harmoniously read with IBC.

As disturbing as it may sound, there yet exists unchartered territories under the umbrella of homebuyers’ inclusion in IBC. Questions of ‘disputed debt’, ‘third-party interests’, ‘the dilemma of secured vs unsecured homebuyers’ still remain unanswered and contentious. In only over three years, the pace with the IBC has evolved, it is only a matter of time before these points of law are answered too.

Yasaschandra Devarakonda

Student Reporter Reporters’ Committee, INBA