[Vanshika is a student at National Law University Odisha.]
In recent years, the landscape of insolvency and bankruptcy law in India has witnessed transformative changes, particularly in the acknowledgment and treatment of homebuyers as pivotal stakeholders in the resolution processes of financially distressed real estate companies. One of the landmark amendments to the Insolvency and Bankruptcy Code 2016 (IBC or Code) has been the recognition of homebuyers as financial creditors, thereby allowing them to initiate corporate insolvency resolution process (CIRP) against insolvent real estate developers. Despite this amendment, there still exists uncertainty with respect to treatment of homebuyers during the liquidation of the real estate companies, posing challenges to their rights and interests. This article delves into the evolution of homebuyers’ status under the IBC, highlighting both the legislative enhancements that have fortified their position and the ongoing challenges that diminish their rights. Lastly, the author discusses the recent amendment in the the IBC (Liquidation Process) Regulations 2016 (Liquidation Regulations), which is a significant step in securing the interests of homebuyers and providing them certainty during the liquidation proceedings of real estate companies.
Homebuyers as Financial Creditors under the IBC
The rights of the homebuyers within the framework of the IBC have been strengthened progressively through a series of legislative amendments in the Code. Currently, the homebuyers are regarded important stakeholders, assimilated into the committee of creditors, which is vested with the authority to decide on the future course for a corporate debtor. The genesis of homebuyers’ rights recognition can be traced to the IBC (Second Amendment) Act 2018 (2018 Amendment), marking the inaugural instance where homebuyers were categorized as financial creditors under the IBC. This recognition is based on the fact that the investments made by homebuyers in real estate projects have the commercial effect of a borrowing, thereby qualifying as a ‘financial debt’ under Section 5(8) of the IBC as the amounts raised from homebuyers contribute significantly to the financing of the construction of flats / apartments.
The constitutional validity of the 2018 Amendment was further upheld in the landmark judgment of Pioneer Urban Land and Infrastructure v. Union of India, where the Supreme Court of India observed that the homebuyers are entitled to trigger the Code to put the corporate debtor back on its feet, given their vital interest in the financial health of the corporate debtor. This is attributed to the substantial contribution of homebuyers towards the completion of construction projects, sometimes to the extent of 100% of the project being funded by them alone. Consequently, they have a right to initiate a CIRP application under Section 7 of the Code thereby underscoring their integral role in the insolvency resolution process.
Further, the IBC (Amendment) Act 2020 amended Section 7 by introducing a minimum threshold for filing an application under Section 7 of the Code against a corporate debtor. As per the amendment, the CIRP proceedings may be initiated collectively, either by not less than 100 of total homebuyers within the same real estate project or not less than 10% of the total number of such homebuyers under the same real estate project, whichever is less. This amendment has subsequently clarified the status of homebuyers within the framework of the IBC.
The Precarious Position of Homebuyers during Liquidation
One significant challenge that persists in limiting the rights of homebuyers pertains to their status during the liquidation of a corporate debtor. As a company enters liquidation, the distribution of sales proceeds is governed by the hierarchy stipulated under Section 53 of the IBC. Within this framework, Section 53 accords a lower priority to unsecured creditors relative to secured creditors. It is important to distinguish between the status of being a financial creditor and that of being a secured creditor; typically, financial creditors such as banks and financial institutions are deemed secured creditors owing to the creation of security interests in their favour by the corporate debtor. However, through various judgements homebuyers have been recognized as unsecured financial creditors. This classification stems from the contractual arrangement between a homebuyer and a real estate developer under Section 13 of the Real Estate (Regulation and Development) Act 2016, which does not create any security interest in favour of the homebuyer. This essentially means that during the liquidation process banks and financial institutions, as secured financial creditors, are prioritized above homebuyers as per the waterfall mechanism created under Section 53 of the IBC. This prioritization entails that the homebuyers may only receive the proceeds or possession of flats after the debts owed to other financial creditors have been settled. Such an arrangement undermines the objective of the 2018 Amendment, which sought to safeguard the interests of homebuyers vis-à-vis other financial creditors as they have made valuable investments by contributing hard earned monies in the hope of obtaining a roof over their heads. Further, homebuyers often finance their purchases by taking loans. Given the unresolved questions regarding their status in liquidation scenarios and their potential subjection to the provisions of the IBC, the liquidation of a corporate debtor could represent an adverse outcome for homebuyers.
Balancing the Rights of Homebuyers with Secured Creditors’ Interests
It is imperative to note that even in the past, the rights of homebuyers have been prioritized over the claims of banks to prevent the sale of properties by banks as a means of enforcing their security interests. In the case of Union Bank of India v. Rajasthan Real Estate Regulatory Authority, it was held by the Rajasthan High Court that banks are precluded from enforcing their security interests against real estate developers pursuant to Section 13 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), in a manner that compromises the rights of allottees. Essentially, the court observed that any recourse exercised by banks or financial institutions, in response to a default by a real estate developer under the ambit of the SARFAESI Act, shall be taken without causing any prejudice to the interests of homebuyers. This judgment establishes a crucial legal precedent, emphasizing the necessity of balancing the interests of secured creditors with that of homebuyers.
Similarly, during the liquidation of a corporate debtor under the IBC, there exists a need to balance the prioritization of dues of banks and financial institutions with the rights and interests of homebuyers who have made substantial investments in the project with the expectation of acquiring possession of their flats. This approach is consistent with one of the fundamental objectives of the IBC, which aims to harmonize the interests of various stakeholders within the framework of insolvency proceedings.
Recent Amendment to the Liquidation Regulations
The IBC has once again proved its dynamic nature by addressing the aforementioned issue in a manner that safeguards the interests of stakeholders in an insolvency proceeding. Recently, on 12 February 2024, the Liquidation Regulations have been amended with the intent to strengthen the rights of the homebuyers. As per the amendment, flats / apartments, possession of which is given to the homebuyers, within a real estate project prior to the commencement of the liquidation process shall not be included within the liquidation estate of the corporate debtor. This ensures that properties transferred to homebuyers will be retained by them, notwithstanding the liquidation of the developer. Although the exact standing of homebuyers vis-à-vis other financial creditors regarding claims under Section 53 remains to be clarified, this amendment secures the rights of purchasers by guaranteeing that the properties possessed by allottees are exempted from the assets comprising the liquidation estate.
Conclusion and Way Forward
The recent amendment to the Liquidation Regulations has introduced a measure of certainty and clarity for homebuyers who have taken possession of their apartments. However, the position of buyers who are yet to take possession and have disbursed significant amounts towards the completion of their flats still remains unresolved. If homebuyers are relegated to the provisions of the Code in the event of a real estate company’s liquidation, then they would find themselves receiving their claims only after the settlement of dues of other financial creditors. This scenario effectively undermines the objectives of the 2018 Amendment. As a result, the liquidation process of real estate entities could have a detrimental impact on homebuyers. It is imperative, therefore, that legislative clarifications be made to safeguard the interests of homebuyers during such liquidations. At the very least, they should be accorded equivalent status to that of other financial creditors, such as banks, as per Section 53 of the IBC, in the hierarchy of claim entitlements. Implementing such measures would not only secure the interests of the homebuyers but also crystallize their rights within the framework of the IBC.
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