The insolvency code is being wielded against real estate companies that accumulated large debts in order to outpace the competition. Tushar Chawla, Alpana Srivastava and Ishani Nayyar explain
India’s new insolvency regulations i.e. the Insolvency and Bankruptcy Code, 2016 (IBC), sets the ground for a much-needed creditor-driven insolvency resolution mechanism. The IBC simplifies the legal framework regarding insolvency and bankruptcy of corporates, individuals and partnerships among others. The code ensures a faster and smoother resolution process for stressed assets in the country. It attempts to simplify the process of insolvency and bankruptcy proceedings by handling matters using the National Company Law Tribunal (NCLT) and debt recovery tribunals (DRT).
Impact on real estate sector
The IBC has made a vast impact on the real estate sector. According to a report published in 2015, non-performing assets (NPAs) in real estate were worth ₹60 billion (US$947 million). There are several developers that have for various reasons delayed their loan repayments. Creditors can file an application against such defaulting developers.
Within the sector, developers are defaulting on payments rather than home buyers. Intense competition has led to a massive accumulation of land as developers built up land banks as a strategic weapon against one another. Borrowing for this purpose and the development of land meant that the burden of interest on the developers was enormous, and in excess of what could be met by the development and marketing of residential properties and commercial floor space. So, leading developers have stopped servicing debt. The impact on construction is reflected in their development and in recent decline in cement production, which is commonly used as a proxy for real estate growth.
The banks are hesitant to lend as they work on cleaning up balance sheets and finding funds to recapitalize themselves. This has affected the housing sector. Here too, while credit and demand for housing are still growing, they are fast losing momentum. Trapped between rising interest and other costs and faltering demand that affects prices, the real estate sector is experiencing a severe version of the crisis stemming from the inability of the system to sustain growth-driven by private debt-financed spending.
Before the 2000s, banks were wary because of the long maturity, low liquidity and higher risk associated with lending to this sector. Partly because banks dropped that reticence and hugely increased lending to a few large borrowers in this sector, they are now finding themselves burdened with large NPAs. This has set off the bad debt resolution process based on the IBC, which in turn comes as a boon for the investors. The introduction of the Real Estate (Regulation and Development) Act, 2016 (RERA), has further addressed the loose ends in the real estate sector.
The IBC consolidates and amends all laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of value of assets of these persons, and to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders. It provides a complementary ecosystem for insolvency, and aims to ensure smoother settlement of insolvency cases, enable faster turnaround of businesses and provide for creation of a database of creditors.
The IBC provides a time-bound insolvency resolution process – 180 days after the process is initiated, plus a 90-day extension – for resolving insolvency. The code provides for a expedited insolvency resolution process within 90 days after the process is initiated, plus a 45-day extension for resolving insolvency in fast-track mode. Over the last two years, 300 cases have been registered under the IBC.
Recent judgments
A bench headed by Chief Justice Dipak Misra, who had heard several petitions of home buyers against real estate companies such as Unitech, Supertech and Amrapali, heard the public interest litigation on 6 October 2017. Currently, the moment insolvency proceedings are initiated against a real estate company, execution of enforceable decrees of courts and the consumer forums are rendered ineffective, as they cannot be executed. Moreover, no fresh cases can be initiated by hassled home buyers against such companies.
[ihc-hide-content ihc_mb_type=”show” ihc_mb_who=”3″ ihc_mb_template=”2″ ]
The Supreme Court on 18 September 2017, asked around 400 home buyers of embattled Jaypee Group to intervene in the main matter in which several buyers have moved the court, seeking relief in the issue relating to the insolvency proceedings. A bench of Chief Justice Dipak Misra, Justice AM Khanwilkar and Justice DY Chandrachud allowed Jaypee Orchard Resident Welfare Society to withdraw its petition seeking relief from the company and intervene in the main matter.
In Innoventive Industries Ltd V ICICI Bank and Anr the Supreme Court extensively interpreted the IBC with a message, “We thought it necessary to deliver a detailed judgment so that all courts and tribunals may take notice of a paradigm shift in the law. Entrenched managements are no longer allowed to continue in management if they cannot pay their debts.”
It summed up the IBC: “The scheme of the code, therefore, is to make an attempt, by divesting the erstwhile management of its powers and vesting it in a professional agency, to continue the business of the corporate body as a going concern until a resolution plan is drawn up, in which event the management is handed over under the plan so that the corporate body is able to pay back its debts and get back on its feet. All this is to be done within a period of six months with a maximum extension of another 90 days or else the chopper comes down and the liquidation process begins.”
The NCLAT created an exception in the case of Nikhil Mehta v AMR Infrastructure and held that the concerned flat buyers were financial creditors due to an exceptional clause in their agreement with the developer. The developer had contractually agreed to pay a monthly amount to the buyers until the property was delivered to them. However, this is not a principle of general applicability and hence all flat buyers are consumers, but not necessarily financial creditors as well.
A toothless regime for home buyers
Under the IBC, flat buyers do not fall under the category of secured creditors like banks and they get back their money only if something is left after repaying the secured and operational creditors. The home buyers in the Jaypee case had sought a direction to the government and others that the IBC “shall not curtail the legal, statutory and vested rights of the flat owners/buyers as consumers”, defined under Consumer Protection Act.
With increase in the number of insolvency proceedings, it is clear that the IBC has immensely impacted the real estate sector. On one hand it enables the home buyers to initiate insolvency proceedings against defaulting developers; on the other, the home buyers will not get appropriate relief as they are not recognized as secured creditors by IBC.
There is certainly a need for clarification addressing the position of home buyers being recognised as creditors for the purpose of insolvency proceedings.
Before the IBC
Individual bankruptcy and insolvency was legislated under two acts: the Presidency Towns Insolvency Act, 1909, and the Provincial Insolvency Act, 1920. High courts had jurisdiction over insolvency-related matters in the erstwhile presidency towns of Chennai, Kolkata and Mumbai. Subordinate courts heard cases of individual insolvency in all other areas, with the district court being the court of appeal.
Corporate bankruptcy and insolvency was covered in a complex of multiple laws, some for collective action and some for debt recovery. The Companies Act, 2013, provided for collective insolvency resolution by way of restructuring, rehabilitation, or reorganisation of entities registered under the act. Adjudication was under the NCLT. The Companies Act, 1956 dealt with winding up of companies. It had separate provisions for restructuring except through M&A and voluntary compromise. Adjudication was under the jurisdiction of the high court. The Sick Industrial Companies (Special Provisions) Act, 1985 (SICA), dealt with restructuring of distressed “industrial” firms. Under this act, the Board of Industrial and Financial Reconstruction (BIFR) assessed the viability of the industrial company, and referred an unviable company to the high court for liquidation. SICA was repealed on 1 December 2016 by enactment of section 4(b) of the Sick Industrial Companies (Special Provisions) Repeal Act, 2003.
Recent developments
- In November 2017, a committee was set up to review the IBC and to identify issues in its implementation.
- An ordinance was promulgated on 23 November 2017 to prohibit certain persons from submitting resolution plans to resolve defaulting companies.
- The IBC (Amendment) Act, 2017, replaces the above ordinance and prohibits (i) wilful defaulters, (ii) promoters or management of the company having outstanding non-performing debt for over a year, and (iii) disqualified directors, from submitting a resolution plan in case of defaults.
- The objects and reasons of the act states that in the absence of restrictions on submitting resolution plans or sale of assets during liquidation, certain undesirable persons may misuse IBC provisions.
- Rationale of the act: In case of liquidation, the bill prohibits the liquidator from selling the assets of the company to ineligible persons to submit a resolution plan. Unlike a resolution, the company ceases to exist after liquidation. Therefore, the background of the person bidding for its assets may not be relevant. It is argued that excluding some prospective bidders from the liquidation process would lead to lower recovery. On the other hand, it could also be argued that certain promoters may deliberately run down the company to buy its assets at a lower price, and therefore there may be reason to exclude them from the liquidation process.
[/ihc-hide-content]
Tushar Chawla is the India general counsel, Alpana Srivastava is assistant general counsel (India) and Ishani Nayyar is assistant manager for legal at Jones Lang LaSalle. Ambika Kalsi and Kelissa D’Souza are trainees with the legal department who assisted with the article’s research.
https://law.asia/rera-matters-lenders/
