[Karan Latayan is a Professor of Law and Kavya Lalchandani an Assistant Professor of Law, both at Jindal Global Law School]
The Insolvency and Bankruptcy Code, 2016 (“IBC”) was introduced almost a decade back with an intent to revive and aid the sick businesses by resolving their financial distress. The design and purpose of the IBC was not to give a tool for misusing its provisions by filing premature suits for recovery of money, but to breathe life back into the companies that could be revived by such an intervention. Accordingly, it made a distinction between a financial creditor and an operational creditor and outlined different processes that need to be followed by each of these creditors. Financial creditors under the IBC, by default, have a stronger position, especially by virtue of constitution of the committee of creditors (it is understood that their wisdom during the entire resolution process is given primacy).
Homebuyers, as a disgruntled class of creditors (previous posts covering the issue of homebuyers under the IBC can be found here and here), were afforded a special and distinct protection under the IBC because of the nature of the debt that becomes due to them. In Pioneer Urban Land and Infrastructure Ltd. v. Union of India, a significant leap was taken by the Supreme Court in clarifying that homebuyers would be treated as financial creditors under section 5(8)(f) as the nature of the transaction entered into by them has a commercial effect of borrowing and thus gives rise to a financial debt. Consequently, homebuyers could then initiate insolvency process under section 7, IBC. One of the primary reasons was also the typical nature of real estate in India. However, this clarification resulted into an inadvertent consequence that anyone who has ever invested into a home could effectively raise a claim against the builders as soon as they would meet the requisite threshold under the IBC, which again was clarified subsequently.
The Judgement in Mansi Brar Fernandez
Recently, the Supreme Court of India passed a judgement in Mansi Brar Fernandez v. Subha Sharma, clarifying and reiterating their stance on the intelligible differentia that exists between a genuine home buyer and a speculative investor, focusing on the residential real estate sector. The Court clarified that a speculative investor will not be able to misuse the framework in IBC to their advantage when the IBC was actually envisioned as a reviving mechanism for the financially troubled companies rather than a debt recovery mechanism in the hands of the speculative investors. The 2019 amendments to the IBC introduced the threshold requirements for filing a Section 7 application by the allottees.
In the abovementioned case, among other things, there was an Memorandum of Understanding (“MoU”) that was signed by the parties which contained a clause per which the corporate debtor was under obligation to buy-back the apartment and refund any amounts, including premium. This gave rise to the contention that the buyer was actually a speculative investor rather than a genuine homebuyer. It is pertinent to note in this regard that that the MoU had been extended twice, there was no payment made by the corporate debtor, and the post-dated cheques that were issued, were dishonoured. However, the appellant had shown no intention of getting possession of the house. The only thing that the MoU assured was a financial gain to the appellant.
The National Company Law Appellate Tribunal (“NCLAT”) rejected the claim made by the buyer as it held that the terms mentioned in the MoU would qualify the buyer as a speculative investor, rather than a genuine home buyer.
On appeal, the Supreme Court dealt with the issue of whether the buyer was a speculative buyer or not. More importantly, it also delved into the contours for classification of any homebuyer as a speculative investor, thereby depriving them of the right to file a section 7 application before the National Company Law Tribunal (“NCLT”).
Speculative Investors: A Double-Edged Sword
On the one hand, speculative investors enable the developers of a particular housing project to inflate prices of the property because they create false demands which may look like a selling point for the genuine homebuyers. In fact, a speculative investor could buy and stock up units of a particular housing project to create unwarranted scarcity and thereby falsely increase the prices of the housing units. On the other hand, if these investors were treated as genuine homebuyers, it would defeat the purpose of the 2019 amendment to the IBC.
In fact in Pioneer Urban, it was noted in Paragraph 50, that the real estate developer could avoid the insolvency proceedings if they could provide evidence to the effect that the “insolvency resolution process under the Code has been invoked fraudulently, with malicious intent, or for any purpose other than the resolution of insolvency”. This included the fact that the actual buyer was a speculative investor.
The Court ultimately concluded as follows:
“where there is an actual chain of delivery ending with possession by a genuine buyer, the transaction is not speculative. Conversely, in the present context, where there is no intention to take possession, the onus to find another buyer and effect resale is cast on the developer. Delivery in such cases is more in the nature of a lien or an option.”
This, in the Court’s opinion could further be demonstrated by “terms of the agreement, the allotment letter, the payment terms, and the overall conduct of the allottee.”
Having regard to these factors, the Court concluded that the NCLAT was correct in categorising the appellants as the speculative investors and thereby, the Court restricted its differentiation only for the purpose of initiation of the Corporate Insolvency Resolution Process but refused to follow this distinction for any other remedies that the speculative investor might have before any other fora, such as the Real Estate Regulatory Authority.
A Balancing Act by Courts and Tribunals
Over the last half a decade, the Supreme Court, the NCLATs and NCLTs have had to strike a balance have consistently looked to balance two conflicting interests, viz. rights of homebuyers as financial creditors and unreasonable exposure and risk of the developers of real estate projects to be pushed into insolvency. Mansi Brar Fernandez v. Subha Sharma clearly forms part of this endeavour.
– Karan Latayan & Kavya Lalchandani