Revisiting the Second Proviso to Section 7(1), IBC, 2016: In Re Manish Kumar Ruling

[By Pranav Karwa and Gaurav Karwa]

Pranav is a student at the National Law University, Jodhpur and Gaurav is a student at the West Bengal National University of Juridical Sciences.

Recently, in the case of Manish Kumar v Union of India (“Manish Kumar Ruling”), the Supreme Court upheld the constitutional validity of all the provisos added to Section 7(1) of the IBC, 2016 (“Code”) via the  IBC Amendment Act, 2020 (“the Amendment”).

The second proviso to Section 7(1) of the Code introduced a new threshold for filing an application to initiate CIRP by Home-Buyers. As per the proviso, the allottees under a real estate project can apply to initiate the CIRP process only if not less than 100 allottees file it under the same real estate project or one-tenth of the total number of allottees under the same real estate project, whichever is lower. Various writ petitions were filed by real-estate creditors challenging the constitutionality of the Amendment, including the provisos added to Section 7(1) of the Code. The primary allegation in these petitions was that the Second and Third proviso to Section 7(1) violates Article 14 and 19(1) (g) of the Constitution of India. It was also alleged that the impugned provisos are in clear violation of the Supreme Court verdict in Pioneer Urban Land and Infrastructure Ltd. and Anr v. Union of India as in that case, it was observed that Home-Buyers are deemed financial creditors without any restriction imposed on them for initiating CIRP.

The authors highlight the key observations by the Supreme Court in Manish Kumar Ruling and in the backdrop of this decision, examine the utility of the Second Proviso to Section 7(1). The authors conclude by suggesting certain better alternatives which comprehensively address the mischief sought to be resolved by the Second Proviso to Section 7(1).

Manish Kumar Ruling

While setting aside the petitioners’ arguments in the Manish Kumar Ruling, the Supreme Court observed that there is no real discrimination against Home-Buyers. The Court opined that an intelligible differentia exists between Home-Buyers and other financial creditors as there is the heterogeneity, numerosity, and individuality in decision-making in the case of Home-Buyers. In the Court’s view, the Second Proviso to Section 7(1) of the Code acts as a deterrent for individual homebuyers filing frivolous claims before the NCLT. Thus, the Apex Court held that the Second Proviso to Section 7(1) of the Code is constitutionally valid and just because the proviso causes some inconvenience and difficulties to the Home-Buyers is not reason enough to strike it down.

Overall, the Manish Kumar Ruling is a major setback for Home-Buyers who want to initiate a CIRP under Section 7(1) of the Code, individually or in small groups.

However, on a positive note, the Court has clarified that not all the Home-Buyers, applying under Section 7(1), must have pending dues against real-estate project developers. It will be enough if the total dues satisfy the threshold limit of ₹1 crore.

Examining the Utility of Second Proviso to Section 7(1)

It is the view of the authors that the Second Proviso to Section 7(1) of the Code was not necessary in light of the already existing safeguards in the Code which prevent initiation of CIRP by frivolous claims Various concerns of the project developers could have been addressed by alternate mechanisms, which were not taken into account by the Court in the Manish Kumar Ruling.

There are safeguard mechanisms already existent under the Code to ensure that there is a check on mala fide applications, where a single home buyer intends to change the real estate developer’s management. For instance, penalties ranging from ₹1 lakh to ₹1 crore on fraudulent or malicious initiation of proceedings are provided under Section 65 of the Code. Further, as held in Naveen Raheja v Shilpa Jain & Ors, the NCLT also reserves the power to impose additional costs on such mala fide applications.

Moreover, Section 75 of the Code envisages a penalty ranging from ₹1 lakh to ₹1 crore in the scenario where the financial creditor under Section 7(1) omits to disclose any material fact in the application. Thus, merely the fact that a single real estate allottee is filing a complaint does not mean that the Code is being used as a debt recovery mechanism, as there already exist sufficient safeguards to ensure that the NCLT does not entertain the malicious application.

Furthermore, an observation by the Supreme Court in Pioneer Urban gives more power and discretion to the NCLT to filter patently frivolous and malicious applications; the Court said that “when a home buyer makes an application, the NCLT’s satisfaction will be with both eyes open – the NCLT will not turn Nelson’s eye to genuine defenses raised by real estate developers.”  Moreover, it was also observed by the Supreme Court that as soon as the tribunal admits an application, it becomes a proceeding in rem from a proceeding in persona. Therefore, after the initiation of the proceeding, the entire matter goes out of the individual allottees’ control and becomes a collective action. In this light, the fear that an individual Home-Buyer may use the Code to force the real estate developer’s liquidation is unfounded and without any backing. This is because, after the constitution of the Committee of Creditors, the issue of whether liquidation or corporate restructuring is to take place is decided collectively by voting in the Committee of Creditors.

Lastly, the Second Proviso is not an unambiguous provision free of all anomalies. For instance, that the Amendment, introducing the Second Proviso to Section 7(1), does not clarify as to whether the prescribed limit of 100 or 10% of the total number of allottees, whichever is less, is to be satisfied only at the stage of initiation of CIRP or whether it must be maintained throughout the proceedings. The consequence of such ambiguity is that the real-estate developers will take advantage of the same and may strike an out-of-court settlement with one or more allottees, rendering the proceedings infructuous. The Supreme Court in the Manish Kumar Ruling has completely ignored this ambiguity while declaring the Amendment constitutionally valid.

Concluding Remarks and Suggestions

The authors believe that there was no legislative necessity for introducing the new threshold via the Second Proviso to Section 7(1) in light of existent safeguards and ambiguities in the proviso. Moreover, the Manish Kumar Ruling has curtailed the remedy available to the Home-Buyers. It has affected the case of individual and small groups of Home-buyers who otherwise satisfy the ₹1 crore threshold. The Code being a beneficial legislation, an individual Home-Buyer must have been provided with the opportunity of initiating the CIRP as sufficient checks and balances are already present in the Code, as mentioned above, which should have been considered by the Court.  Further, apart from providing a threshold limit for Home-Buyers to initiate CIRP, other alternatives could have been envisaged by the legislature.

The authors are in agreement with the suggestion, that provisions for increasing the penalty already provided under Section 65 of the Code may create the necessary deterrence against malicious applicants. Moreover, the authors concur with the observation, that some of the defences, such as force majeure, could have been provided by the legislature to the real estate developers for protection against frivolous applications.

Hence, the authors are of the view that in light of the existing safeguards under the Code, as stated above, the threshold introduced by the Second Proviso to Section 7(1) is redundant.

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