Analysis of Judgment of the Supreme Court upholding the legality and constitutionality of Section 5(8)(f) of IBC, 2016

Finally, the Hon’ble Apex Court gave its green signal to the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 (Second Amendment Act) whereby the “Allottees” were deemed as “Financial Creditor” under Section 5(8)(f) of the Code. Thus, the judgment, which is titled as Pioneer Urban Land and Infrastructure Ltd. and Anr. v. Union of India and Ors. upholds the constitutional validity of Section 5(8)(f) of the Insolvency & Bankruptcy Code, 2016 (hereinafter as the ‘Code’). This judgment is seen as a major win for the homebuyers, who will now not only be allowed to invoke the Code but will also be a part of the committee of creditors with the same footing as banks and other financial institutions. This will certainly put an embargo which will act as a deterrent upon the fraudulent real estate companies and developer, who have failed in completing the projects despite taking huge chunks of money from the homebuyers.

What was under challenge?

More than 150 builders, developers, real estate companies challenged the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 (Second Amendment Act) which inserted two explanations in Clause (8) (f) of Section 5 of the Code. Pursuant to the first explanation, any amount raised from an ‘allottee’ of a ‘real estate project’ (i.e a homebuyer) shall be deemed to be an amount having the commercial effect of borrowing, and resultantly he is a financial creditor under the Section 7 of the IBC. (Which allows financial creditor(s) to file an application in NCLT for initiating the corporate insolvency resolution process against a defaulting company). The amendment had further allowed the homebuyers being financial creditors to have representation in the Committee of Creditors through an authorized representative and also have voting rights.

What was the challenge?

It was argued by the real estate companies that the classification of homebuyers as financial creditors is an unreasonable classification and is discriminatory in as much as it treats unequals equally, and equals unequally, thus having no intelligible differentia and thus the said amendment is violative of Article 14 of the Constitution. It was further pointed out that such an amendment was contrary to the objectives laid down under IBC and a handful of exasperated homebuyers may cause the entire housing project to stand still.

According to the learned senior counsel, Dr. Abhishek Manu Singhvi, leading the charge on behalf of the real estate developers, a perfectly good management which has several projects on its hands can be removed at the instance of one allottee and either replaced – in which case the massive funds infused by the developer himself would be set at naught – or worse still, lead to commercial death, in that, if there are no resolution plans or all resolution plans are rejected either by the Committee of Creditors or by the authorities under the Code, a perfectly solvent company would then be wound up, which would not be in the interest of anybody, least of all the bulk of allottees themselves, who would want possession of flats/apartments. According to him, therefore, these amendments are also violative of Article 19(1)(g) of the Constitution being manifestly arbitrary, being excessive, disproportionate, irrational and without determining principle.

The learned senior advocate further referred to the Apex Court’s judgment in Swiss Ribbons v. Union of India (2019) 4 SCC 17, in copious detail, in order to drive home the point that not a single one of several characteristics of financial creditors stated in that judgment would apply to allottees/home buyers. On the contrary, if at all they could be assimilated to anybody, it would be to operational creditors, in which event it would be enough to state that there is a pre-existing dispute between the parties, as a result of which the Code cannot get triggered. According to him, including allottees of real estate projects – a huge amorphous and disparate lot – as financial creditors, would not only be unworkable, as thousands of petitions would flood the NCLT.

However, the main leg of the contention of real estate companies was that the homebuyers already have a separate remedy under the RERA Act, 2016 and Consumer laws for the redressal of their grievance and their grievances need not be addressed under the Code as the same leads to duplication of proceedings. It was also put into contention that giving advance payment for the allotment of a flat cannot be termed as ‘Financial Lending’.

What Supreme Court held?

Supreme Court primarily noted that the constitutional validity of the amendment will be decided on the background of the fact that the legislature must be given free play in the joints when it comes to economic legislation. For clear understanding, the Apex Court then went ahead to examine the recommendations made by the Insolvency Committee Report wherein it was stated that the delay in completion of under-construction apartments has become a common phenomenonCommittee further agreed that amounts raised under home buyer contracts is a significant amount, which contributes to the financing of the construction of an asset in the future. Finally, the Committee concluded that the current definition of ‘financial debt’ is sufficient to include the amounts raised from home buyers/allottees under a real estate project, and hence, they are to be treated as financial creditors under the Code. Thus, the Court observed that the legislative judgment in economic choices must be given a certain degree of deference by the courts.

Court then examined the RERA Act and came to the conclusion that “even by a process of harmonious construction, RERA and the Code must be held to co-exist, and, in the event of a clash, RERA must give way to the Code. RERA, therefore, cannot be held to be a special statute which, in the case of a conflict, would override the general statute, viz. the Code.” Court further noted that “In similar circumstances, this Court in Swaraj Infrastructure Private Limited v. Kotak Mahindra Bank Limited (2019) 3 SCC 620 has held that Debt Recovery Tribunal proceedings under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and winding up proceedings under the Companies Act, 1956 can carry on in parallel streams.”

Clarifying the position of homebuyers as Financial Creditors and not Operational Creditors, the Court further observed in Para 40 of the judgment that “what is unique to real estate developers vis-à-vis operational debts, is the fact that, in operational debts generally 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/apartment is the debtor inasmuch as the home buyer/allottee funds his own apartment by paying amounts in advance to the developer for construction of the building in which his apartment is to be found. Another vital difference between operational debts and allottees of real estate projects is that an operational creditor has no interest in or stake in the corporate debtor, unlike the case of an allottee of a real estate project, who is vitally concerned with the financial health of the corporate debtor, for otherwise, the real estate project may not be brought to fruition. Also, in such event, no compensation, nor refund together with interest, which is the other option, will be recoverable from the corporate debtor. One other important distinction is that in an operational debt, there is no consideration for the time value of money – the consideration of the debt is the goods or services that are either sold or availed of from the operational creditor. Payments made in advance for goods and services are not made to fund the manufacture of such goods or provision of such services.” Court further added that “One other vital difference with operational debts is the fact that the documentary evidence for amounts being due and payable by the real estate developer is there in the form of the information provided by the real estate developer compulsorily under RERA. It is these fundamental differences between the real estate developer and the supplier of goods and services that the legislature has focused upon and included real estate developers as financial debtors. The Apex Court further made it clear that it is impossible to say that classifying the homebuyers is not founded upon an intelligible differentia, nor is it possible to say that such classification is palpably arbitrary having no rational relation to the objects of the Code.

Court went ahead and further observed in Para 41 of the judgment that “The object of dividing debts into two categories under the Code, namely, financial and operational debts, is broadly to sub-divide debts into those in which money is lent and those where debts are incurred on account of goods being sold or services being rendered. We have no doubt that real estate developers fall squarely within the object of the Code as originally enacted insofar as they are financial debtors and not operational debtors, as has been pointed out hereinabove. So far as unequals being treated as equals is concerned, home buyers/allottees can be assimilated with other individual financial creditors like debenture holders and fixed deposit holders, who have advanced certain amounts to the corporate debtor. For example, fixed deposit holders, though financial creditors, would be like real estate allottees in that they are unsecured creditors. Financial contracts in the case of these individuals need not involve large sums of money. Debenture holders and fixed deposit holders, unlike real estate holders, are involved in seeing that they recover the amounts that are lent and are thus not directly involved or interested in assessing the viability of the corporate debtors. Though not having the expertise information to be in a position to evaluate feasibility and viability of resolution plans, such individuals, by virtue of being financial creditors, have a right to be on the Committee of Creditors to safeguard their interest. Also, the question that is to be asked when a debenture holder or fixed deposit holder prefers a Section 7 application under the Code will be asked in the case of allottees of real estate developers – is a debt due in fact or in law? Thus, allottees, being individual financial creditors like debenture holders and fixed deposit holders and classified as such, show that they within the larger class of financial creditors, there being no infraction of Article 14 on this score.

Discussing the scope of arguments advanced by the real estate developers that amendments are violative of Article 19(1)(g) of the Constitution being manifestly arbitrary, the Court observed in Para 45 of the judgment that- “The Code is thus a beneficial legislation which can be triggered to put the corporate debtor back on its feet in the interest of unsecured creditors like allottees, 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/apartment as soon as possible and/or pay compensation in the event of late delivery, or non-delivery, or refund amounts advanced together with interest. Thus, applying the Shayara Bano v. Union of India (2017) 9 SCC 1 test, it cannot be said that a square peg has been forcibly fixed into a round hole so as to render Section 5(8)(f) manifestly arbitrary i.e. excessive, disproportionate or without adequate determining principle. For the same reason, it cannot be said that Article 19(1)(g) has been infracted and not saved by Article 19(6) as the Amendment Act is made in public interest, and it cannot be said to be an unreasonable restriction on the Petitioner’s fundamental right under Article 19(1)(g). Also, there is no infraction of Article 300-A as no person is deprived of its property without the authority of a constitutionally valid law.”

Further, interpreting the Explanation added to Section 5(8)(f) of the Code, the Court further held that allottees/home buyers were included in the main provision, i.e. Section 5(8)(f) with effect from the inception of the Code. The explanation which was added in 2018 merely clarifies the doubts that had arisen.

The Hon’ble Supreme Court concluded the judgment in the following terms:

  1. The Amendment Act to the Code does not infringe Articles 14, 19(1)(g) read with Article 19(6), or 300-A of the Constitution of India.
  2. The RERA is to be read harmoniously with the Code, as amended by the Amendment Act. It is only in the event of a conflict that the Code will prevail over the RERA. Remedies that are given to allottees of flats/apartments are therefore concurrent remedies, such allottees of flats/apartments being in a position to avail of remedies under the Consumer Protection Act, 1986, RERA as well as the triggering of the Code.

iii. Section 5(8)(f) as it originally appeared in the Code being a residuary provision, always subsumed within it allottees of flats/apartments. The explanation together with the deeming fiction added by the Amendment Act is only clarificatory of this position in law.

Therefore, after analyzing the above judgment it can be said that this landmark judgment will certainly prove to be a huge deterrent against the fraudulent/unscrupulous builders. The Constitutional Bench of the Supreme Court by upholding the constitutional validity of the amendment in the Insolvency and Bankruptcy Code, 2016 has given a huge sigh of relief to the aggrieved homebuyers who can now approach under the Code without any hassle. In view of this judgment, the proceedings which were stayed in NCLT and NCLAT will also resume and the homebuyers who have been denied their homes can now expect a speedier remedy.

Disclaimer:- The above brief is based on the available facts and published for general awareness. For more information, please contact us at support@centrik.in

 

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