Parliament of India enacted the Insolvency and Bankruptcy Code, 2016[1] (“the Code”) to consolidate laws relating to insolvency and bankruptcy in India and provide an effective legal framework for timely resolution of the companies. The Code provided Financial Creditors and Operational Creditors with the right to initiate the Corporate Insolvency Resolution Process (“CIRP”), against a Corporate Debtor under Sections 7 and 9 respectively.
I. Allottees as Financial Creditors – a step forward
The Insolvency and Bankruptcy Code (Second Amendment) Act, 2018[2] (“the IBC Amendment, 2018”) included the allottees of real estate projects as financial creditors under the Code. Hereafter, the allottees could apply to initiate the CIRP against the Corporate Debtors (“real estate developer”) alike other financial creditors i.e. banks and financial institutions. The Supreme Court of India in Pioneer Urban Land and Infrastructure Ltd. v. Union of India[3] (“Pioneer”) upheld the constitutional validity of the inclusion of allottees as financial creditors [“allottee(s)”] on 09.08.2019. The Court also categorically refused reading into any limitation like pre-requisite minimum threshold in terms of numbers or otherwise on the right of allottees to approach the Tribunal and trigger the resolution process.[4] Thus, an allottee of a real estate project was given a right to initiate the CIRP like other financial creditors “either by itself or jointly with other financial creditors” against a real estate developer on the occurrence of a default under Section 7 of the Code.
II. The legislative retraction – a limitation imposed
However, first, the President of India promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019[5] (“the Ordinance”) on 28.12.2019 as a stop-gap arrangement to limit the accessibility of individual allottees or to the Tribunal if a minimum threshold limit is not met. Section 3 of the Ordinance amended Section 7 of the Code by adding three provisos. The second proviso placed a condition on the allottees of at least being 100 or 10% of the total number of allottees, whichever is less, in the “same real estate project” to apply for initiation of the CIRP. Moreover, the third proviso directed the applicants of the pending applications which have yet not been admitted by the Tribunal shall be modified in conformity of the abovesaid minimum threshold within a period of one month i.e. by 28.01.2020, failing which such applications shall be automatically deemed as withdrawn.
The Ordinance was approved by Parliament on 13.03.2020 vide the enactment of the Insolvency and Bankruptcy Code (Amendment) Act, 2020[6] (“the IBC Amendment, 2020”) with identical provisions. Like the Ordinance, the IBC Amendment, 2020 has imposed pre-requisite minimum threshold for allottees of real estate project to approach the Tribunal under Section 7 of the Code vide an identical Section 3. In a writ petition titled Manish Kumar v. Union of India[7] , the provision has been challenged as violative of Article 14 of the Constitution of India. Primarily, the amendment has been challenged on the ground of being class legislation without any reasonable differentia and its retrospective application as manifestly arbitrary. The Court ordered status quo on 13.01.2020.[8]
With this background, the present article first, examines the wholesome effect of the condition imposed on allottee who was earlier given the right to apply for initiation of the CIRP individually, like other Financial Creditors. Second, the authors aver that the amendment in Section 7 vide the second and third provisos was uncalled for in light of the existing mechanism under the Code and the alternatives which were available with the legislature. Last, the authors suggest the possible middle way available now with the Court in pending writ petition.
III. Repairing effect of the second and third provisos to Section 3 of the IBC Amendment, 2020
The abovesaid limitation on the allottees of a real estate project is placed as a consequence of several apprehensions and after-effects of inclusion of allottees under Section 7 at par with other financial creditors. Their inclusion as financial creditor was followed with a surge in applications against the real estate developers before the Tribunal. Numerous independent applications were filed by allottees against the same real estate developers. Nearly, all the real estate companies[9] found themselves in hot water before the Tribunal as Corporate Debtors for defaults committed in timely completion of the projects and handover of timely possessions. This brought the real estate developers on their tenterhooks and they raised concerns of being entangled in malicious applications by multiple allottees which have severely affected their regular working. It was also argued that the Code has been used as a “debt recovery mechanism” instead of reviving such a corporate entity.
The Preamble of the Ordinance, the recent Standing Committee Report[10], or the IBC Amendment, 2020 does not state any specific reason to amend Section 7 of the Code. However, considering the abovesaid circumstances, the amendment can be inferred to have been brought in principally to cure two ills. First, all the allottees of the same project can be clubbed before-hand for efficiency in the hearings before the Tribunal and resolution process. Second, the legislature intends to bar applications by individual allottees who with the provided liberty and access to the Tribunal, could single-handedly topple down the existence of the real estate developer maliciously, despite, the entity being a going-concern and in the hands of good management. This would consequentially revive and also keep the real estate industry alive to the market needs.
Thus, the legislature amended Section 7 to alleviate the anxiety and troubles of the real estate developers. The amendment attempts to alleviate the miseries of the real estate developers due to multiple applications and keep the real estate sector alive and responsive to their needs in the development of the country. The amendment has been welcomed by the real estate developers who had been brought before the Tribunal maliciously or on minor defaults with the sole purpose of refund, instead of a revival of the entity.
IV. Impairing effect of the second and third provisos to Section 3 of the Ordinance
In contrast to the above said, the amendment has, however, impaired the right of the allottees who will now be not able to approach the Tribunal individually and independently or jointly, unlike other financial creditors and operational creditors, if the required minimum threshold is not met. The legislature has imposed minimum thresholds of 100 or 10% with retrospective applicability on the allottees who were included as financial creditors seeing their contribution in the projects and their condition of suffering for years.
Apart from the objections to the constitutional validity, the amendment in Section 7 gives rise to several anomalies which will need redressal by the Court or legislature in future. The amendment also gives rise to several severe consequential hardships and inconvenience to the allottees, particularly due to its retrospective applicability. These can be noted as follows:
i. Anomalies due to the amendment
First, as aforesaid the pending applications had to be “modified” within a period of one month. If a party fails to comply with the second proviso to Section 3 of the IBC Amendment, 2020, the application will be deemed withdrawn. But the legislature has not explained what is meant by the term “modified”[11] used in the third proviso to Section 3 of the Ordinance and the IBC Amendment, 2020. Does it merely mean amending the application wherein a party avers to having the requisite numbers along with a list of such allottees or does it mean that all the allottees whose applications are pending before the Tribunal or allottees who intend to apply shall be consolidated under one umbrella application pending before the Tribunal and thereafter be proceeded collectively?
Second, the amendment does not state whether the required strength of 100 or 10% of the total number of allottees, whichever is less, is mandated to be required only at the stage of initiating the proceedings or whether the strength needs to be continued and maintained all through. What will be the consequence if one or some allottees settle with the real estate developer and the requisite numbers then fall short subsequently? The Courts while interpreting Section 241 of the Companies Act, 2013 which provides a similar threshold for initiation of the proceedings of operation and mismanagement has held that the validity of petitions must be judged as they were at the time of its presentation. The legislature could have clarified this under the Code right from the inception and avert any such anomalies. Moreover, this may also give rise to mischiefs by several developers who may settle out of court with one or more allottees to make the proceedings infructuous.
Third, it would be interesting to see, if the said 10% criteria can include an allottee who may have defaulted in making payments to the developer considering the delay and default on part of the developer, can form part of the 10% group or not. To draw a parallel with the shareholders of a company filing under Section 241 of the Companies Act, 2013, a member is disqualified to file whose calls are in arrears or whose shares are partly paid-up or who is a holder of a share warrant.
Last, Section 245 of the Companies Act, 2013 or Section 12(1)(c) of the Consumer Protection Act, 1986 delineate the procedure and conditions for a class action. However, the Code or the amendment does not provide any contours for a class action before the Tribunal.
ii. Consequential hardship and inconvenience to allottees
First, it is pertinent to note that the remedies under the Code are concurrent[12] and does not bar remedies of different natures before different forums in different parts of the country. The legislature failed to appreciate the hardship in consolidating all or some of the allottees to meet the requisite threshold from different jurisdictions. For example, Section 11 of the Consumer Protection Act, 1986 provides for the institution of complaint in a district forum at a place of business of opposite party or where the cause of action wholly or in part arose. However, Section 60 of the Insolvency and Bankruptcy Code, 2016 mandates the proceedings to be initiated only at the place where the corporate person has its registered office. Thus, the proceedings against the same real estate developer for the same project may be pending in different forums at different stages and in different jurisdictions. In such cases, bona fide applicants will fail to consolidate all allottees under one umbrella application or provide the number of pending disputes against the same real estate developer.
Second, the above hardship in consolidation is further elevated due to non-existence of any public record along with particular details of the allottees who have availed different remedies against the same project. Along with the amendment, the legislature should have brought a law which mandated the real estate developers to maintain the list of allottees of a project on a public platform. Until the real estate developers had complied with this requirement or until the time to comply expired, the right of the allottees to apply for initiating the CIRP should not have been curtailed.
Last, the legislature failed to realise that deemed withdrawal of applications filed but not admitted by the Tribunal within a period of one month will deny the applicants fruits of their already incurred litigation costs i.e. court fee and advocate fee. It will further encumber the allottees with afresh litigation costs for initiating de novo proceedings before other available forums. In many cases, the parties will have to also go through the hassles of agreeing to a common lawyer. This will be setting the clock backwards. It is pertinent to note that the Code provides summary proceedings and averting undue delay and a timely resolution was one of the prime objectives behind the enactment of the Code. However, the wholesome effect of Section 3 of the Amendment Ordinance, 2019 is contrary to the said objects of the Code.
V. Whether the second and third provisos to Section 3 of the IBC Amendment, 2020 are uncalled for?
On equating the pros and cons of the amendment in Section 7 of the Code and subsequently discussed alternatives, the authors are of the view that the amendment was uncalled for and in particular, to the extent of its applicability to pending applications. The legislature might have intended to balance the interest of the allottees and real estate developers but, there did already exist sufficient mechanism under the Code and the legislature had more feasible alternatives to address the concerns of the real estate developers.
i. Sufficient mechanism in place to check malicious applications
First, it is pertinent to note that on the admission of an application the Tribunal makes a public announcement and declares a moratorium under Section 14 of the Code. Other creditors like allottees, banks, and financial institutions can submit their claim before the Interim Resolution Applicant (“IRP”) or Resolution Applicant (“RP”). Thus, the intended clubbing and collating automatically happens with the admission of one application. After verification of their claims by the IRP or IP, they all can be part of the Committee of Creditors.
Second, the Code already provides an efficient statutory mechanism to keep a check on the apprehended mala fide applications whereby an allottee is apprehended to single-handedly topple down of the management or existence of the real estate developer despite it being a going concern. One, Section 65 of the Code already provides penalties ranging from Rs. 1 lakh to Rs. 1 crore on fraudulent or malicious initiation of proceedings. The Tribunal always has the power to impose costs on such applicants [See Navin Raheja v. Shilpa Jain[13] (“Navin Raheja”)]. For example, in Ram Pal Suhag v. Sweta Estates Pvt. Ltd.[14] the Tribunal imposed a cost of Rs. 50,000 on the frivolous application filed to arm twist the real estate developer . Two, similarly, Section 75 of the Code provides for a penalty of Rs. 1 lakh to 1 crore if the applicant under Section 7 knowingly falsely states a material fact or omits to state any material fact in the application. Three, if a real estate developer fears cessation of the Company, there are already several stages for the parties can amicably settle[15] . Merely an attempt to settle the dispute cannot be imputed with allottee being a malicious applicant or that the applicant is using the Code as “debt recovery mechanism”.
Third, the Supreme Court specifically stated that “in a Section 7 application made by an allottee, the NCLT’s ‘satisfaction’ will be with both eyes open – the NCLT will not turn a Nelson’s eye to legitimate defences by a real estate developers”.[16] Thus, the Court will not sit merely as a mere rubber stamp to allow mala fide applications. The Tribunal can always dismiss an application if the real estate developer raises viable defences.
For example, an application may be dismissed if a real estate developer proves the occurrence of force majeure, actions inactions and omissions on the part of the Government or Authority, or default in payment by the allottees, or allottee not taking possession to earn higher interest etc. Inter alia other decisions, the NCLAT in Parvesh Magoo v. IREO Grace Realtech Pvt. Ltd.[17] dismissed the application of the allottee noting the force majeure and the fact that the apartment of the allottee was ready for possession. Similarly, in Navin Raheja[18] the NCLAT allowed the appeal against the order of the Tribunal admitting Section 7 application. The Court held that if a delay is due to force majeure “it cannot be alleged that the corporate debtor defaulted in delivering the possession”.
Fourth, the Supreme Court has already held that once an application is admitted by the Tribunal “it is a proceeding in rem which, after being triggered, goes completely outside the control of the allottee who triggers it….Under the Code, he may never get a refund of the entire principal, let alone interest….[He is] always taking the risk that if no one were to come forward, corporate death must ensue and the allottee must then stand in line to receive whatever is given to him in winding up” .[19]
Thus, an allottee cannot singlehandedly liquidate a real estate developer for his refund. “If the intention of the allottees is only for the refund of money and not the possession of apartment/ flat/premises, then the ‘Corporate Debtor’ may bring it to the notice of the Adjudicating Authority”.[20] Liquidation is the last consequence where the prior steps of revival fail. Thus, an allottee cannot straightway liquidate a company to recover his debts.
Last, it must be noted that a reasonably high court fee of Rs. 25,000 also inadvertently keeps a check on the filing of bona fide applications.
ii. Alternatives
First, the legislature could have instead, increased the costs or penalty on the malicious and fraudulent applications under Section 65 of the Code to deter malicious applicants. The legislature could have harnessed exercise of the power of the Tribunal under Section 65 to contain malicious applications, if needed.
The legislature could have attempted to define malicious applications i.e. non-disclosure of material facts in the application or non-performance or non-compliance to the material terms of the agreement including but not limited to default in payment of instalments or taking of possession. Similarly, the legislature could have enlisted some defences available to the real estate developer i.e. as aforesaid, force majeure, or default on part of the applicant. To draw a parallel with the shareholders of a company filing under Section 241 of the Companies Act, 2013, a member is disqualified to file whose calls are in arrears or whose shares are partly paid up. Thus, such allottees in default could have been restricted as being applicants under Section 7 of the Code.
Second, it is pertinent to note that Section 4 of the Code already provides the Central Government power to increase the pre-requisite of default from Rs. 1 lakh to any amount till Rs 1 crore. Thus, the Central Government could have easily increased the minimum threshold of default amount for the allottees of real estate project to approach under Section 7 of the Code i.e. Rs 10 lakh or 20 lakh for individual allottees. It must be noted that on 24.03.2020 the Government has raised the amount of default to Rs. 1 crore for all the creditors under Section 4 of the Code in view of the outbreak of Covid-19 epidemic. Similar step by the legislature for the allottees could have averted all legislative hassles and the above-discussed anomalies and hardships, arising out of Section 3 of the IBC Amendment, 2020.
Thus, given this position of law and alternatives, there was no viable reason to disable an individual allottee from applying without requisite numbers. The Tribunal already had sufficient mechanism to check mala fide applications. Even if this pre-requisite is deemed essential to save a real estate developer from malicious applications, its retrospective application only adds to miseries of the allottees. A mere surge in applications and apprehensions of real estate developers cannot be a ground for curtailing the remedy of allottees. The legislature could have easily averted the hardships and anomalies had it adopted any of the above-suggested alternatives. Moreover, it is difficult to appreciate the mala fide intents of an allottee in an application for revival of the company wherein the applicant has invested his life savings to purchase an abode and the real estate developer has defaulted in handing over the possession. Thus, the amendment in Section 7 on the allottees of a real estate project was uncalled for, particularly with a retrospective effect.
VI. The middle way
In light of the abovesaid, it is also difficult to aver that the surge in applications has not severely affected the working of the real estate developers. The litigation costs and replies to multiple applications do severely affect the normal functioning of these companies. In such a situation where the legislature felt the existing mechanism as not sufficient to check the disruptions due to multiple applications it would have been reasonable to give the amendment a prospective application only i.e. application filed after 28.12.2019, provided it withstands the test of constitutionality under Article 14 of the Constitution of India.
Further, the legislature could state that a minimum threshold is required to be met at the time of the first hearing before the Tribunal. Moreover, the legislature needs to find a way out for an authentic public record for a list of allottees, which will avoid unnecessary protraction of this efficient and speedy resolution proceedings due to hearings on this preliminary issue of whether the application meets the minimum threshold. It must be remembered that the proceedings under the Code are summary proceedings.
VII. Concluding remarks
Apart from other objections not subject of discussion in the present article i.e. the Ordinance and the amendment to Section 7 being violative of Article 14 of the Constitution, pending before the Supreme Court, the legislature has overviewed the above-noted consequent anomalies and hardships which is causing and is likely to continue causing grave injustice and hardship to the allottees of real estate project. The legislature may have intended to balance the equities of real estate developers, allottees, and the real estate market, but the legislature missed to appreciate the abovesaid anomalies and hardships caused to the already oppressed allottees and the retrospective applicability of the amendment runs it excessive.
In view of the authors, such a retraction by the legislature after recognising a right of the individual applicant dissuades faith reposed by the applicants, in the purported “beneficial legislation” like the Code. Such flickering enactments by the legislature makes applicants or litigants dissuade from such remedies, created for their benefit. The legislature should have, if deemed necessary, applied the amendment to future applications only. Additionally, the legislature could have easily avoided consequent anomalies by use of terms like “impleadment” instead of “modified”; stating that the pre-requisite criterion as, “….whichever is less, at the time of filing of the application” in the third proviso. Such legislation could contain the faith of the already oppressed allottees in such purported beneficial legislations who filed for initiation of the CIRP being mindful of the decision of the Court in Pioneer[21].
[This article is authored by Mr. Parveen Kumar Aggarwal, Advocate and founder of the Litigating Hand. It was first published with SCC Online Blog.]
[1] The Insolvency and Bankruptcy Code, 2016
[2] The Insolvency and Bankruptcy Code (Second Amendment) Act, 2018
[4] Ibid, paras 56-57
[5] The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019
[6] The Insolvency and Bankruptcy Code (Amendment) Act, 2020
[8]Ibid.
[9] Business Today, “Real estate tops bankruptcy chart; construction, metals and textiles follow”, dated 19-2-2019
[10] Standing Committee On Finance (2019-2020), Sixth Report, The Insolvency and Bankruptcy (Second Amendment) Bill, 2019
[11] Pareekshit Bishnoi, “IBC Ordinance, 2019: Impleadment of Allottees in a Pending Application”, IndiaCorpLaw, dated 16-3-2020
[12] Pioneer Urban Land and Infrastructure Ltd. v. Union of India, (2019) 8 SCC 416, para 86(ii)
[13] 2020 SCC OnLine NCLAT 46, para 33
[14] IB-1637 (ND)/2019, order dated 24-09-2019 (NCLT, New Delhi Bench), paras 5-6
[15] Pioneer Urban Land and Infrastructure Ltd. v. Union of India, (2019) 8 SCC 416, para 14
[16]Pioneer Urban Land and Infrastructure Ltd. v. Union of India, (2019) 8 SCC 416, para 56
[17] 2020 SCC OnLine NCLAT 421, para 15
[18] 2020 SCC OnLine NCLAT 46, para 55
[19]Pioneer Urban Land and Infrastructure Ltd. v. Union of India, (2019) 8 SCC 416, para 39
[20] 2020 SCC OnLine NCLAT 46, paras 33-37, 45-47 and 53-55
[21]Pioneer Urban Land and Infrastructure Ltd. v. Union of India, (2019) 8 SCC 416