The unexamined aspects of treating homebuyers as financial creditors under the IBC

The unexamined aspects of treating homebuyers as financial creditors under the IBC

Vardaan Bajaj

In the recent past, there were delays in giving possessions to home buyers who had booked flats/homes in real estate projects. There were also instances of Developers/Builders borrowing money from homebuyers in one project and investing them into another project, or even siphoning funds, and then becoming incapable of completing projects in which homebuyers had invested their hard earned savings. Homebuyers who had taken loans ended up paying EMI’s for flats whose possession they never actually got. Cases like Jaypee Infratech Case, Supertech Case, Amrapali Case, etc had projected Homebuyers as the worst sufferers. All of these factors propelled the government to bring in an amendment to the Insolvency and Bankruptcy Code, 2016 and recognise homebuyers as financial creditors.

The resultant amendment is as follows: Section 3 of the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 (second amendment Act) has 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 corporate insolvency resolution process against a defaulting company). The amendment has further allowed the homebuyers being financial creditors to have representation in the Committee of Creditors through an authorised representative and also have voting rights.

Many have categorised this amendment as a panacea for the homebuyers, however, there are few aspects to this amendment which are a cause of concern and are discussed as follows:

Dilemma about the ‘default’?

Though the amendment has classified the homebuyer as a financial creditor, the definition of the term ‘default’ vis-à-vis a homebuyer has not been amended. When is the ‘default’ said to have been committed by the developer and when ‘debt’ becomes due remains a grey area.

As per Section 6 of the Code, financial creditors can initiate the insolvency proceedings against a corporate debtor upon the corporate debtor ‘committing a default’. The default referred to is default in payment of monies by the corporate debtor to the financial creditor. Generally, terms of allotment letters and agreements for purchase of under construction flats provide for repayment of the monies by the developer only upon termination of the allotment. But in the cases of delay, builders don’t actually terminate the allotment agreements.

Relying on the definition of ‘default’ [Section 3 (12)], only once the refund is demanded by the homebuyer, it can be said that the amount of debt has become due. However, in the situations of delay in the delivery of possession which is largely the substratum of the dispute between the homebuyer and the developer, in the absence of termination of the agreement, there remains lack of clarity as to when the ‘debt’ has become due and the ‘default’ has been committed.

Disputed debt

The Amendment is based on a premise that the developer/builder is always a defaulter and presupposes a situation in which the projects are not completed on time. However, that is not really the situation in all the cases. At times, the default can also be committed by the flat buyers due to delay in paying the instalments or final consideration amount. This amendment has actually conferred such status to the homebuyers that they are entitled to sustain their claim irrespective of a disputed debt. It is pertinent to note that Insolvency application under section 7 will be admitted notwithstanding whether debt is disputed or not, as long as it is ‘due’ [M/s Innoventive Industries Ltd. vs. ICICI Bank].

The question that arise is whether the insolvency forum being a forum of summary adjudication is an apt forum to adjudicate upon a disputed debt which involves a mixed question of fact and law.

Whilst it true that the avid of IBC has resultant into an enormous pressure being created on the developers for the timely delivery of flats but at the same time if the developer/builder is not at default and the claim is disputed, IBC proceedings turn into an abuse of process of law.

For instance, in a matter before the Principal bench NCLT New Delhi, there was no delay in the grant of possession by the builder, however, the allottee defaulted in paying the instalments on time. After asking for the remaining consideration from the buyer several times, the builder eventually terminated the agreement, the flat buyer approached the NCLT under section 7. Before the arguments on the insolvency application could be completed, the builder entered into a hefty settlement with the flat-buyer in order to save his financially solvent company from the insolvency resolution process.

It is argued that the resolution which is a process to rescue a failing business can also become recovery tool and merely an instance of dispute with one out of hundreds of allottees could result into driving a financially solvent and healthy real estate developer/business into insolvency.

Many builders have asserted that homebuyers have an apt remedy to claim before the Consumer fora and RERA, and IBC amendment has only resultant into an additional encumbrance upon them. 

Homebuyers Secured or Unsecured

The amendment raises ambiguity about the priority in which homebuyers would be repaid their loans. Under IBC, the difference between secured financial creditors and unsecured financial creditors mostly has an implication on the priority of payments upon liquidation.

The amended law grants homebuyers the status of financial creditors but stops short of stating whether they are secured or unsecured creditors. The homebuyer will have to prove which category of creditor he is qualified to be as per the agreement with the real estate company.

If the developer company gets into liquidation, and the homebuyer is an unsecured creditor as per the agreement, he is actually even worse off. A plea by Jaypee Infratech homebuyers seeking secured financial creditors status is pending before the Supreme Court.

Third Party Interests:

Many homebuyers have booked flats by taking loans from the banks. The general practice these banks follow while giving loans is that they enter into a tripartite agreement with both the homebuyer and the developer.

By entering into such loan -cum -tripartite agreements with the banks, the homebuyers are actually creating third party interests in favour of the banks and are actually subrogating his rights in favour of the banks. In one such case with similar situation, NCLT Allahabad [Ajay Walia V. M/s. Sunworld Residency Private Limited, CP (IB) 11/ALD/2018] held that the homebuyers who has subrogated his rights in favour of banks cannot be treated as a financial creditor.

The homebuyers need to be wary of the fact that if they will enter into such tripartite loan agreements while booking a flat, they no longer will be treated as financial creditors and it would adversely affect their rights to initiate a corporate insolvency process against the developer.

Many homebuyers are continuing to pay EMIs for the loans they took from the bank for their flat. This aspect of creating third-party interests in favour of the bank and continuing to pay EMI’s for the flats whose possession they have not really gotten requires a further scrutiny in the Courts of law in the background of the amended Code.

Furthermore, it has yet to be seen how effective the participation of the homebuyers in the committee of creditors would be and their contribution in assessing and approving resolution plans.

Key Observations and Suggestions:

The Hon’ble Supreme Court [In Swiss ribbons Pvt. Ltd. & Anr. v. UOI] has held that the Insolvency and Bankruptcy Code is constitutional in entirety. However, Justice Nariman has also sought response from the ministries of corporate affairs, law and justice and housing, and others on a petition by (PULIL), which challenged the constitutional validity of the Homebuyers amendment.

IBC might have empowered homebuyers but its extent is still questionable. Furthermore, the homebuyer amendment also has the ingredients of being used as a tool to recover money from the developer/builder who hasn’t actually committed any default.

The author is of the view that more clarity is required with respect to the amendment by clearly defining when is the ‘default’ said to have been committed with respect to homebuyer-developer disputes. The legislature should also treat homebuyers as secured financial creditors to make this amendment more meaningful.

Vardaan Bajaj graduated from Gujarat National Law University, Gandhinagar and currently practises as an advocate in New Delhi. He deals with Commercial/Insolvency disputes and can be reached at

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