IBC Ordinance; Home Buyers to be Treated as Financial Creditors

IBC Ordinance; Home Buyers to be Treated as Financial Creditors

[Riya Goyal]

The President has recently given his nod to promulgate an ordinance amending the insolvency law, recognising homebuyers as financial creditors to real estate developers. This settles a long drawn controversy created by various conflicting court decisions regarding the status of homebuyers as being financial or operational creditors, which was further deepened by the IBBI issuing a claim form for “creditors other than financial or operational creditors”[1] To understand the implications of this ordinance, it is pertinent to first understand the meaning of financial and operational creditors.

Section 5(8) of the Code defines ‘financial debt’ to mean a debt along with interest, if any, which is disbursed against the consideration for the time value of money and inter alia includes money borrowed against payment of interest, etc., As per earlier interpretations of the definition, the contract between the real estate developer and the homebuyer were seen as simple sale and purchase agreements  and not as a ‘financial debt’. The only exception to this view was the  assured return scheme contract, in which there was an arrangement wherein it was agreed that the seller of the apartments would pay ‘assured returns’ to the home buyers till possession of property was given.[2] However such judgments were given considering the terms of the contracts between the home buyers and the seller and were fact specific, thus no consistency existed.

Further Section 5(20) of the Code defines operational debt as “debt that may arise out of the provision of goods or services including dues on account of employment or a debt in respect of repayment of dues arising under any law for time being in force and payable to centre or local authority”. In relation to this the NCLT in Col. Vinod Awasthy v. AMR Infrastructure Ltd. (Principal Bench-Delhi)[3] had ruled that, notwithstanding the presence of an assured return clause, a purchaser of a flat cannot be treated as a provider of ‘goods’ or ‘services’ to the builder and therefore, does not qualify as an ‘Operational Creditor’ and cannot initiate Insolvency Process in that capacity.

This Non-inclusion of home buyers within either the definition of ‘financial’ or ‘operational’ creditors may be a cause for worry since it deprives them of, first, the right to initiate the corporate insolvency resolution process (“CIRP”), second, the right to be on the committee of creditors (“CoC”) and third, the guarantee of receiving at least the liquidation value under the resolution plan.This puts into jeopardy the future of millions of homebuyers in a situation where Delay in completion of underconstruction apartments has become a common phenomenon. the records indicate that out of 782 construction projects in India monitored by the Ministry of Statistics and Programme Implementation, Government of India, a total of 215 projects are delayed with the time over-run ranging from 1 to 261 months.[4]

To resolve this issue a committee was constituted under the Corporate Affairs Ministry to  review the various financial terms of agreements between home buyers and builders and the manner of utilisation of the disbursements made by home buyers to the builders,it was evident  that the amounts so raised are used as a means of financing the real and are thus in effect a tool for raising finance, and on failure of the project, money is repaid based on time value of money. This could be covered under Section 5(8)(f)of the Code, which is in the nature of residuary entry to cover debt transactions not covered under any other entry, and the essence of the entry is that “amount should have been raised under a transaction having the commercial effect of a borrowing.”

An example has been mentioned in the entry itself i.e. forward sale or purchase agreement. Though a forward contract to sell product at the end of a specified period is not a financial contract. It is essentially a contract for sale of specified goods, however if they are structured as a tool or means for raising finance, there is no doubt that the amount raised may be classified as financial debt under section 5(8)(f)[5]. Drawing an analogy, in the case of home buyers, the amounts raised under the contracts of home buyers are in effect for the purposes of raising finance, and are a means of raising finance. Thus, the Committee deemed it prudent to clarify that such amounts raised under a real estate project from a home buyer fall within entry (f) of section 5(8).

This demonstrates eminent common sense and appears to be a correct application of the concept of ‘time value of money’. It recognizes that a purchaser of a real estate unit is under no obligation to pay a substantial amount of money as down-payment if the possession of the unit is not likely to be handed over to him in the near future. In that scenario, the builder would have to arrange finance from independent sources for the development of the project. This would not only require collateral/security but involve imposition of extremely onerous conditions, including but not limited to a relatively exorbitant rate of ‘interest’. Simply put, a bank lending money to the builder, needless to state, would qualify as a ‘Financial Creditor’ and entitled to all the rights emanating from such an arrangement under IBC, including the right to initiate insolvency process under IBC, in case of a default in repayment of debt.

From that viewpoint, if the builder succeeds in inviting funds from an individual purchaser, as opposed to a Bank, on much more favorable terms, in that case – it does not stand to reason as to why that individual purchaser should not be entitled to similar protection as a Bank, when it is essentially serving the same purpose. Any other view discriminates between an individual purchaser of a real estate unit and the Bank, and to the former’s detriment.

It also needs to remembered that the purchaser of a real estate unit under such an arrangement is parting with a huge amount of money upfront, but getting the possession of the subject real estate unit much later; therefore, he deserves to be recouped for the period during which he is deprived of the use and enjoyment of ‘money’ and is also not in possession of the unit. If that is not the case, then why would a rational buyer defer receipt of benefit/consideration to the future, if he could have the same consideration now. For instance, a purchaser willing to make payment of a huge amount at one shot may very well go in for house that is ready to move-in, rather than hold up his investment for a future benefit.

Alternatively, if he does not want to make a huge payment upfront, he may not pay the builder a substantial down-payment and invest the same money in something else and earn interest instead. Now, since he does not take that option and pays that money to the builder instead (without corresponding delivery of possession of property), he deserves to be rewarded for the delayed possession, which in this case is through the ‘Assured/Committed Return’ Scheme. The opportunity cost of foregoing the use of a substantial amount of money, while waiting for the possession of the unit, has to be kept in mind. Since a buyer stays out of enjoyment of money as well as the property, for a long period of time, the consideration for him to still make the payment and wait for the real estate unit is nothing but the periodic ‘Assured Return’ that he is guaranteed, which has the affect of offsetting, at least to some extent, the risk factor and uncertainty inherent in delayed possession.

Money today is more valuable than same amount of money tomorrow. Possession of a sum of money today is certain but expectation of the same amount of money in future involves uncertainty. There is a possibility that the future money never gets repaid and possession of the property never delivered. This is where ‘Assured-return’ scheme kicks in and tries to neutralize that risk. This is the concept of ‘time value of money’, and forms the cornerstone of all banking and financial systems.

The payment of ‘interest’ on the amount paid by purchaser is nothing but recognition of ‘time value of money’. The ordinance would  correctly bring within the fold of ‘Financial Debt’ such an arrangement and would allow the purchaser to invoke insolvency as a ‘Financial Creditor’. Protection of ‘time value of money’ was one of the driving forces behind IBC.

[1] Form F, IBBI (Insolvency Resolution Process for Corporate Persons), Regulations, 2016

[2] Nikhil Mehta v. AMR Infrastructure, NCLAT, New Delhi, Company Appeal (AT) (Insolvency) No. 07/2017, Date of decision – 21 July, 2017.

[3]  NCLT, Principal Bench, Delhi in CP No. (IB)-10(PB)/2017; Date of Decision 20.02.2017.

[4] Khyati Rathod and Niharika Dhall, ‘India: Delays in Construction Projects’, (Mondaq, 24 January,2017), , accessed 01 March, 2018.

[5] Ibid 2