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.
 

UPDATE | INSOLVENCY AND BANKRUPTCY CODE (AMENDMENT) ACT, 2019

On 6 August 2019 the Government promulgated the Insolvency and Bankruptcy Code (Amendment) Act, 2019 (Act) which seeks to make further changes to the Insolvency and Bankruptcy Code, 2016 (IBC). The most significant changes relate to extending the deadline for the completion of the insolvency resolution process and giving the Committee of Creditors greater say in the distribution of funds pursuant to a resolution plan. This amendment stems from the decision of the National Company Law Appellate Tribunal (NCLAT) in the Essar Steel case. This update summarises some of the changes in the Act.

Some of the proposed amendments are:

• Resolution Plan: The Act clarifies that mergers, demergers and amalgamations can form part of the resolution plan. While there was no bar on resolution plans including such provisions, the amendment explicitly makes such inclusions possible.
• Extended Deadline: The Corporate Insolvency Resolution Process (CIRP) presently has to be completed within a maximum of 270 days, failing which the corporate debtor is sent to liquidation. There was some confusion on whether this period was mandatory or directory and the impact of time spent on litigation on this timeline. The Act provides that the CIRP must mandatorily be completed within 330 days including time spent on litigation and the judicial process.
• Operational Creditors and the Power of Committee of Creditors: The NCLAT in the Essar Steel case had held that operational creditors must be treated in a fair and equitable manner when the proceeds of a resolution plan are distributed. NCLAT also held that the Committee of Creditors cannot determine the distribution of proceeds of a resolution plan which must be done by the resolution applicant. The Act reiterates that operational creditors must be treated in a fair and equitable manner. The Act further postulates that the manner of payment of debts of operational creditors would be determined by the Insolvency and Bankruptcy Board of India which shall not be less than the higher of the liquidation value of the company and the amount that the operational creditors would be entitled to if the company was liquidated and amounts paid to the various stakeholders in accordance with Section 53(1) of the Code. The Act now expressly empowers the Committee of Creditors to determine the distribution of proceeds of a resolution plan based on the principles enshrined in the Code.
• Voting by Authorised Representatives: The Act provides that authorised representatives of financial creditors on the Committee of Creditors must vote in accordance with the decision of 50% of the financial creditors represented by the authorised representative. Prior to the amendment, the authorised representative was required to vote based on the decision of each financial creditor represented by him.
• Makes Resolution Plan Binding: The Act further amended Section 31(1) of the Code clarifying that the resolution plan once approved by the National Company Law Tribunal would be binding on all the stakeholders including the Central Government, any State Government or local authority to whom a debt in respect of the payment of dues may be owed.
• Liquidation: The Act further adds clarity to Section 33(2) of the Code stating that the Committee of Creditors may with a 66% vote take a decision to liquidate the Corporate Debtor, any time after constitution of the Committee of Creditors and before preparation of the Information Memorandum.

MHCO Comment: The promulgation of the Act clearly indicates that the Code is a work in progress. The Government seems keen to ensure that the Code continues to be widely used to resolve the problems faced by struggling corporates. NCLAT decision in the Essar Steel case was seen by many commentators as a backward step, which the Act seeks to rectify. However, considering that NCLT has taken substantial time to admit the application, it is not clear on how these proceedings can be concluded within a period of 330 days as proposed in the Act.

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.com for any assistance.

LEGAL UPDATE | THE COMPANIES (AMENDMENT) ACT, 2019

On 31 July 2019, the Government promulgated the Companies (Amendment) Act, 2019 (Amendment) to amend the Companies Act, 2013 (Act). A significant portion of the Amendment rationalises the penalty provisions in the Act by reducing the quantum of penalty and substituting imprisonment of officers in default by a fine. That said, there are other significant amendments which are summarised in this update.

• Declaration by new companies: A company incorporated after the commencement of the Amendment and having a share capital cannot commence business or borrow funds unless (a) a declaration is filed by a director within a period of 180 days from the date of incorporation of the company in the prescribed form with the Registrar that every subscriber to the memorandum of the company has paid the value of the shares agreed to be taken by him on the date of making such declaration; (b) the company has filed with the Registrar a verification of its registered office as set out in Section 12 (2) of the Act. If the declaration is not filed within the prescribed period and the Registrar is of the view that the company is not carrying on any business, the Registrar can initiate action for removal of the name of the company from the register of companies.
• Dematerialisation of Shares: The Central Government may prescribe that shares of a private company can only be issued or transferred in dematerialised form.
• Period for registration of charges: After the commencement of the Amendment, the period of extension for registration of charges has been reduced to 60 days with a further extension of 60 days possible on payment of additional fees.
• Corporate Social Responsibility (CSR): The most significant changes brought about by the Amendment are the changes to the provisions on CSR. These provisions now apply to companies that have been carrying on business for less than 3 financial years. If a company fails to spend the prescribed amount in discharging its CSR, the consequence is no longer giving reasons for the same. Comply or explain approach has been done away with by the Amendment.
  
  The company is now required to transfer the unspent amount to a Fund specified in Schedule VII of the Act within a period of 6 months of the expiry of the financial year. If the ongoing project for which the funds have been allocated meets certain prescribed conditions, the company is required to transfer the unspent amount within a period of 30 days from the end of the financial year to a special account opened by the company with a scheduled bank to be called the Unspent CSR Account and such amount shall be spent by the company towards its CSR Policy within a period of 3 financial years from the date of such transfer failing which the company shall transfer the unspent amount to a Fund specified in Schedule VII of the Act within a period of 30 days from the date of completion of the third financial year.
  
  The Amendment now penalises the failure of a company to comply with the provisions dealing with CSR by imposing a fine of not less than INR 50,000 but which may extend to INR 25 lakhs on the company and providing for imprisonment of every officer of the company who is in default for a term which may extend to 3 years or with a fine as prescribed for the company or with both. Finally, the Central Government is empowered to issue directions to companies on CSR which must be complied with by such companies.
• Additional Disqualification of a Director: An additional disqualification of a director has been added whereby a director is disqualified if he fails to comply with the provisions of Section 165 of the Act on the maximum number of directorships that may be held by a person.
• Additional powers to Central Government: The Central Government has been given certain additional powers under Section 241 of the Act dealing with oppression and mismanagement. Where in the opinion of the Central Government there exist circumstances suggesting that (a) any person concerned in the conduct and management of the affairs of a company is or has been guilty of fraud, misfeasance, persistent negligence or default in carrying out his obligations and functions under the law or of breach of trust; (b) the business of the company is not or has not been conducted and managed by such person in accordance with sound business principles or prudent commercial practices; (c) a company is or has been conducted and managed by such person in a manner which is likely to cause or has caused serious injury or damage to the interest of the trade, industry or business to which such company pertains; or (d) the business of a company is or has been conducted and managed by such person with intent to defraud its creditors, members or any other person or otherwise for a fraudulent or unlawful purpose or in a manner prejudicial to public interest, the Central Government may initiate a case against such person and refer the same to the Tribunal with a request that the Tribunal may inquire into the case and record a decision as to whether or not such person is a fit and proper person to hold the office of director or any other office connected with the conduct and management of any company.

MHCO Comment: The most significant amendments of the Amendment are the changes to the provisions on CSR and the powers given to the Central Government to initiate an inquiry into the conduct of directors and key managerial personnel of companies.

• The provisions on CSR are now mandatory with penal consequences for non-compliance. In making these changes, the Government has moved away from the “comply or explain” approach. In a liberalised capitalist society that India now is these changes are difficult to understand. It is the responsibility of the Government to address social inequity. This responsibility cannot be transferred to the private sector. If the Government is concerned on distribution of wealth, it could impose an additional tax on hugely profitable companies and use the income to address social issues. The changes introduced by the Amendment are akin to such a tax with the responsibility of achieving social change now imposed on the private sector. This is a wholly undesirable result. In the event if this Amendments are gazetted and notified, it is hoped these provisions will be challenged in the courts of law to ensure that the private sector is allowed to operate for overall economic development without being dragged into effecting social change which is the responsibility of the Government.

• The powers given to the Central Government on initiating an inquiry into whether directors or key managerial personnel are fit and proper persons to manage a company seem justified given the number of cases of mismanagement in the corporate sector headlined by the IL&FS case. The Central Government can now initiate action before a crisis snowballs to prevent any fallout of mismanagement and diversion of funds.  

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.