Reverse CIRP: An Alien Concept to the IBC Regime

The article delves into the concept of Reverse CIRP recently introduced by the NCLAT.

The stigmatic law for economic defaulters, the Insolvency & Bankruptcy Code (“Code”) is controversy’s own child. The Code has undergone several amendments and has been subject to judicial scrutiny. The Code was recently in the limelight when the National Company Law Appellate Tribunal (“NCLAT”) introduced an alien concept under the Code i.e. ‘Reverse Corporate Insolvency Resolution Process’ (“Reverse CIRP”) in an appeal concerning a real estate company.

The recently amended Code inserted ‘home buyers’ under the category of financial creditors. In the concerned case before NCLAT, certain allottees being financial creditors had sought for CIRP of the defaulting real estate company, which was admitted.

Terming the Appeal ‘peculiar’, the NCLAT was posed with a strange question of law i.e. whether a corporate debtor can be put through the rigors of CIRP without a resolution applicant? Though such relief should not have seen the light of the day, instead, the NCLAT undertook an ‘experiment’ to introduce the alien concept of Reverse CIRP, which has no genesis under the Code.

The preamble to the Code, states to resolve the insolvency status of debtors in a time-bound manner and to ensure maximization of debtors assets to secure interests of all concerned stakeholders. Under the Code, defaulting promoters and management of the corporate debtor, once under the clutches of CIRP cease reign of the company, which is either liquidated or is resolved of its debts as per a successful resolution plan.

A logical finding has been passed in the order that, real estate allottees though declared as financial creditors, do not have the commercial wisdom to assume the same thinking as that of financial institution(s) having commercial expertise to understand viabilities of a resolution plan or the running of a corporate debtor under the Code. But, does this entail that the sacrosanct process under the Code can be bypassed to overcome such difficulties?

NCLAT felt so and held that CIRP of a real estate developer must be understood in a reverse manner as infrastructure is the ‘asset’ of the real estate corporate debtor company which under the Code would only meet the due of a secured creditor, whereas homebuyers would be unsecured creditors who at best, can seek allotments of flats to be made. It was also observed that in an ideal scenario financial institutions generally take a haircut on their debts to resolve debts, but homebuyers cannot take a haircut on flats/apartments.

In our opinion, the NCLAT erred in understanding the treatment of real estate allottees under the Code as financial creditors can only seek resolution of debts. Any other relief, such as allotments, would lie in alternate forums such as RERA or consumer forums. This is settled law in the decision of the Apex Court wherein it was held that allottees as financial creditors under the Code have remedies under RERA, which is in addition to the Code. However, it seems that the NCLAT erred in applying the true purport of the decision by considering allottees to take “haircut of flats/apartment”.

NCLAT seems to have self-certified the experiment taking a cue from the Supreme Court’s suggestions but it appears to have ventured into unchartered and forbidden territories of the Code.

Any experiment being undertaken needs to have a solid foundation to reach the desired outcome. The NCLAT erred here, by not referring to the definition of a resolution plan under the Code. This basic requirement ought to have been considered by the NCLAT, that whether a CIRP could be without a resolution applicant’s plan, which is a sine qua non under the Code? On first blush, it appears that NCLAT overlooked this aspect and hence the experiment took off on a faulty foundation.

Coming to the facts before the NCLAT, the appellate authority observed that the promoter of the corporate debtor ‘intended’ to be a lender but wished to stay outside the CIRP process. This lender/promoter, in turn, ensured that the allottees would be given possession of the flats during the ‘CIRP’ if there was no involvement of any third-party i.e. resolution applicant. Surprisingly, an NBFC being a financial creditor, agreed to such a scheme.

The next steps in the experiment are the perfect recipe for ‘operation successful, but, patient dead!’. Under the experiment of reaching Reverse CIRP, the NCLAT created new inventions under the Code i.e. an ‘Intended Lender’ and an ‘outsider financial creditor’ which find no basis under the Code. However, these inventions have probably created the perfect escape route to the bar of Section 29A under the Code i.e. persons barred under the Code to be a resolution applicant, specifically barring a promoter of the debtor company.

In the facts before the NCLAT, the promoter has been given the invented term ‘intended lender’ who in effect would, under Reverse CIRP, present a plan giving economic support for the revival of the corporate debtor. Outside the Reverse CIRP, such a promoter intending to provide a resolution plan would be at the outset be barred under Section 29A of the Code. Thus, in our understanding, the NCLAT erred in failing to apply Section 29A of the Code and the intent of the Legislature to insert such a provision to oust defaulting promoters attempt to indirectly overtake their own debt-ridden company at pared-down debts, with all sins washed away.

Next in the experiment, NCLAT takes note of all development(s) in the real estate project concerning construction of flats, possessions taken by allottees, extension of timelines, etc. Further, the NCLAT also records a ‘strange’ request of the ‘outsider financial creditor’, the ‘intervenor’ in the proceedings, to stay all recovery proceedings against the corporate debtor pending before any court, consumer forum/ RERA till the completion of the real estate project to utilize the funds effectively. Interestingly, the NCLAT also recorded the undertaking of the corporate debtor, that during the development of the project it had cleared the debts of a few financial creditors through the funds received from the allottees and the remaining financial creditors would be cleared in intervals. A clear case of allowing priorities in payment to a creditor, which is expressly prohibited under the Code.

The NCLAT while reaching the magical potion of ‘Reverse CIRP’ held, without much discussion, that insolvency resolution process of a real estate company shall be limited to the concerned project in controversy which will not affect any other real estate projects of the company. While this comes as a huge relief for the debt-ridden real estate sector, however, in our opinion and for reasons below, the invention of Reverse CIRP may not hold good before the Apex Court for being perverse to the ethos of the Code.

Firstly, NCLAT erred by transgressing into forbidden territories of other forums such as RERA or consumer forums. The Code under no provision provides for the adjudicating or the appellate authority to delve into prohibited matters which fall in the domain of other forums. A case of exceeding jurisdiction?

Secondly, issuance of directions to the promoter of a corporate debtor to cooperate with the resolution professional and to disburse funds as an ‘outside lender’ but not as a ‘promoter’, seems to be an overreaching attempt of the NCLAT to resolve debts, which is specifically barred under the Code. On one hand, the legislature is plugging loopholes to oust defaulting promoters and on the other, the NCLAT seems to be further untying the loose ends.

Thirdly, allowing officials of the corporate debtor to jointly operate company accounts with the resolution professional falls foul with the provisions of the Code. Upon initiation of CIRP, there ought to be complete severance in activities involving the suspended management of the corporate debtor.

Fourthly, issuance of directions to the resolution professional to move an application before the adjudicating authority, after successful completion of the real estate project, seeking disposal of the application filed by the financial creditor(s) is beyond the provisions of the Code. Such disposal of a financial creditor application is not envisaged under the Code, as a financial creditors application is disposed of, either as allowed, leading to initiation of CIRP or is dismissed, unless withdrawn as provided statutorily. Thus, it cannot be deciphered as to under which provision of the Code can the appellate authority pass such directions to the resolution professional.

Lastly, directing the adjudicating authority, to step out of the Reverse CIRP and to initiate normal CIRP under the Code on the failure of the promoter to make requisite investments as an outside financial creditor, appears to be an overreaching direction passed by the NCLAT which finds no sanctity or basis under the Code.

Thus, in our considered opinion, the experiment may have had the right intent to ensure that real estate companies are not impacted in entirety due to one affected project. But, the execution in reaching the desired result appears to have faltered miserably.

In our suggestion, a better approach would have been to pass suggestions to the committee of creditors in real estate insolvency matters, to only resolve the insolvency of the concerned project and not move to other projects of the company, which may not be debt-laden, unless required.

It would be a matter of time that this decision is put to test before the Apex Court and it will be interesting to see whether the ‘Reverse CIRP’ experiment is certified as an invention or will the laboratory experiment be shut down?

The authors are Sanjeev Kumar, a Partner and Anshul Sehgal, a Managing Associate in the Litigation and Dispute Resolution Group at L&L Partners Law Offices, New Delhi, India who specialize in insolvency, bankruptcy and commercial matters. The views expressed are personal.

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