Mansukhlal Hiralal and Company

LEGAL UPDATE | SUPREME COURT UPHOLDS CONSTITUTIONALITY OF IBC AMENDMENT INCLUDING HOME BUYERS AS FINANCIAL CREDITORS

A 3 Judge Bench of the Supreme Court in Pioneer Urban Land and Infrastructure Limited v. Union of India upheld the constitutionality of the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 (Amendment) which included home buyers within the purview of financial creditors in the Insolvency and Bankruptcy Code, 2016 (IBC) and provided for their representation on the Committee of Creditors through authorised representatives.

A number of grounds were raised by the petitioners to challenge the constitutional validity of the Amendment. The Supreme Court rejected each of these by holding as follows:

• Free Play to IBC: The legislature must be given free play when it comes to economic legislation like the IBC. Apart from the presumption of constitutionality which arises in such cases, the legislative judgment in economic choices must be given a certain degree of deference by the courts. It is in this background that the constitutional challenge to the Amendment must be decided.
• Rightful Place on Committee of Creditors: The Insolvency Law Committee found, as a matter of fact, that delay in completion of flats has become a common phenomenon, and that amounts raised from home buyers contributes significantly to the financing of the construction of such flats. This being the case, it was important, therefore, to clarify that home buyers are treated as financial creditors so that they can trigger the IBC under Section 7 and have their rightful place on the Committee of Creditors when it comes to making important decisions as to the future of the building construction company, which is the execution of the real estate project in which such home buyers are ultimately to be housed.
• RERA IBC to Co-Exist: The Real Estate (Regulation and Development Act, 2016) (RERA) in Section 88 provides that RERA is in addition to and not in derogation of any other laws. The remedies under RERA are not meant to be exclusive but additional remedies. There is no such provision in the IBC. RERA and IBC operate in completely different spheres. RERA and the IBC must co-exist and in the event of a clash, RERA must give way to the IBC.
• Distinctions between Home Buyers and Operational Creditors: The principle that economic legislation must be treated with far greater deference and the legislature given free play in the joints applies to this case. It is impossible to say that classifying real estate developers as financial creditors is not founded upon an intelligible differentia which distinguishes them from other operational creditors, nor is it possible to say that such classification is palpably arbitrary having no relation to the objects of the IBC. The Honble Court made the following distinctions between home buyers and operational creditors:
• In operational debts when a person supplies goods and services, such person is the creditor and the person who has to pay for such goods and services is the debtor. In the case of real estate developers, the developer who is the supplier of the flat is the debtor inasmuch as the home buyer funds his own apartment by paying amounts in advance to the developer for construction of the building in which his flat is found.
• The operational creditor has no interest in or stake in the corporate debtor, unlike the case of a home buyer who is vitally concerned with the financial health of the corporate debtor, for otherwise the real estate project may not be brought to fruition.
• For operational debt there is no consideration for the time value of money. In real estate projects money is raised from the home buyer against consideration of the time value of money. The total consideration agreed at a time when the flat is non-existent or incomplete is significantly less than the price the buyer would have to pay for a completed flat and therefore, the home buyer of an incomplete flat gains the time value of money. Likewise, the developer who benefits from the amounts disbursed also gains from the time value of money. The fact that the home buyer makes such payments in instalments which are co-terminus with the phases of completion of the real estate project makes such payments a means of finance for the real estate developer.

It is these fundamental differences between the real estate developer and the supplier of goods and services that the legislature has focussed upon and included real estate developers as financial debtors. This being the case, it is clear that there cannot be said to be any infraction of equal protection of the laws.

• Financial Creditors | No violation of Article 14: Home buyers are individual financial creditors like debenture holders and fixed deposit holder and being classified as such, show that they are within the larger class of financial creditors, there being no infraction of Article 14 of the Constitution of India (Constitution) on this score.
• IBC Beneficial Legislation: The IBC is a beneficial legislation which can be triggered to put the corporate debtor back on its feet in the interest of unsecured creditors like home buyers who are vitally interested in the financial health of the corporate debtor, so that a replaced management may then carry out the real estate project as originally envisaged and deliver the flat as soon as possible and / or pay compensation in the event of late delivery or non-delivery or refund amounts together with interest. Therefore, the inclusion of home buyers as financial creditors in Section 5(8)(f) of the IBC cannot be said to be fixing a square peg in a round hole or be characterised as arbitrary.
• Expression Borrow: Section 5(8)(f) of the IBC would subsume within it amounts raised under transaction which are not necessarily loan transactions, so long as they have the commercial effect of a borrowing. The expression borrow is wide enough to include an advance given by home buyers to a real estate developer for use in the construction of the project so long as it is intended by the agreement to give something equivalent to money back to the home buyers, which in these cases is the flat. Thus construed, there can be no difficulty in stating that the amounts raised from home buyers for real estate projects would, in fact, be subsumed within Section 5(8)(f) even without adverting to the explanation introduced by the Amendment. The deeming fiction introduced by the Amendment is merely clarificatory in nature.
• In conclusion:
• the Amendment does not violate Article 14, Article 19(1)(g) or Article 300-A of the Constitution;
• RERA is to be read harmoniously with the IBC, as amended by the Amendment. It is only in the event of a conflict that the IBC will prevail over RERA. Remedies that are given to home buyers are therefore, concurrent remedies, such home buyers being in a position to avail remedies under the Consumer Protection Act, 1986, RERA as well as triggering the IBC;
• Section 5(8)(f) as it originally appeared in the IBC being a residuary provision, always subsumed home buyers within it. The explanation together with the deeming fiction added by the Amendment are only clarificatory of this position of law.

MHCO Comment : As in the Swiss Ribbons case, the Supreme Court has shown a keenness to support the Government in its economic legislative initiatives. Upholding the inclusion of home buyers in the IBC seems to be another step in this regard. The one issue that seems to have escaped the Honble Courts attention is what constitutes a default under the IBC for payments made by home buyers. In cases where there is a delay in delivery of possession, how does such default amount to a default as defined in the IBC. It is in this regard that RERA is a complete code. 

The views expressed in this update are personal and should not be construed as any legal advice. Please contact us directly on +91 22 40565252 or legalupdates@mhcolaw.comfor any assistance.