HOME BUYERS ARE SECURED FINANCIAL CREDITORS UNDER IBC – AN ANALYSIS

A. EVENTS IN THE RECENT PAST

The position of home /flat buyers have been debated in the recent past at different forums including in some decisions of Adjudicating Authority under Insolvency and Bankruptcy Law, however there is no clarity so far and the worried home buyers are knocking doors here and there including Supreme Court of India in the cases of Jaypee Infra and Amrapali Group of Companies.

The Regulator i.e. IBBI also created a third category of creditors and introduced a new Form ‘F’, which was perceived as if this new form is prescribed for home /flat buyers without any such indication by IBBI in the regulations or otherwise.

Bankruptcy Law Reforms Committee (BLRC) had also envisaged only two categories of creditors i.e. financial creditors and operational creditors and therefore, for initiating insol-vency proceedings against any defaulters only these two kinds of applicants were perceived and empowered. There is no third category of creditor who is empowered to initiated insolvency of a defaulter.

In case we consider flat buyers as third category of creditors, then there are no matching provisions in the code for triggering insolvency of the defaulters by this category and also this c ategory has no place in COC or decision making to safe guard their own interest. As such, the third category can not be the intention of law makers.

B. DETAILED ANALYSIS OF THE PROVISIONS OF IBC, 2016

We can also not assume that the law makers have missed this category of the creditors from the ambit of insolvency and bankruptcy law.

Therefore, a detailed analysis of relevant provisions can be done as under.

I. Linkage between ‘Creditor’ to ‘Debt’ and then from ‘financial debt’ to ‘financial creditor’

The following definitions would provide us the linkage which is prescribed under Insolvency and Bankruptcy Code, 2016 between ‘Creditors’ and ‘Debt’ and then from ‘financial debt’ to ‘financial creditors’

Section 3(10) defines: "creditor" means any person to whom a debt is owed and includes a financial creditor, an operational creditor, a secured creditor, an unsecured creditor and a decree-holder

Section 3(11) defines: "debt" means a liability or obligation in respect of a claim which is due from any person and includes a financial debt and operational debt;

Section 5(7) defines: "financial creditor" means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to;

Section 5(8) defines: "financial debt" means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes—

(a)  money borrowed against the payment of interest;

(b)  any amount raised by acceptance under any acceptance credit facility or its de-materialised equivalent;

(c) any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument;

(d) the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed;

(e)  receivables sold or discounted other than any receivables sold on non-recourse basis;

(f)  any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing;

(g)  any derivative transaction entered into in connection with protection against or benefit from fluctuation in any rate or price and for calculating the value of any derivative transaction, only the market value of such transaction shall be taken into account;

(h)   any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or financial institution;

(i)  the amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub-clauses (a) to (h) of this clause;

Section 5(20) defines: "operational creditor" means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred;

Section 5(21) defines: "operational debt" means a claim in respect of the provision of goods or services including employment or a debt in respect of the repayment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority;

II.  Advance given for any forward (future) sale or purchase agreement

Section 5 (8) (f) is reproduced to invite focused reading:

Section 5(8) defines: "financial debt" means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes—

f)  any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing;

III.   Major requirements for a debt to be qualified as ‘financial debt’

1) It should be a ‘debt’: Any advance given to purchase any product or service or both is a debt as it is a claim and anyone who has taken an advance is under a liability and obligation to pay back or to deliver the goods. Such advances are very common for purchase of any capital goods, plant and machinery, made to order products and also include a flat or home

2)  Along with Interest, if any: The interest clause is not mandatory as it may or may not have an interest clause. The words used in the definition is “along with interest, if any”

3)   Disbursed: The amount of advance is disbursed to the person who is entering into any contract for sale in future. The evidence of disbursement of money would be required. In most cases of home buyers, the money is disbursed to builders against an agreement to purchase

4)  Time Value of Money: Any product or service purchased would have different pricing, one for advance payment of consideration and one for payment on delivery and another for payment after the delivery depending upon the period of credit. The costing of the seller also changes depending upon the cost of working capital during manufacturing / construction of the product. In case the cost of commercial borrowing is borne by the seller, it is added to the price of the product or service. The time value of money is always reckoned while making such advances or while entering into any future sale or purchase agreement.

5)  Amount raised under any other transaction: Any advance raised from any person under a transaction would qualify for section 5(8)(f) and the word ‘transaction’ has been defined under section 3(33) as under:

"transaction" includes an agreement or arrangement in writing for the transfer of assets, or funds, goods or services, from or to the corporate debtor;

Section 3(34) further defines the word ‘transfer’ as under: "transfer" as includes sale, purchase, exchange, mort-gage, pledge, gift, loan or any other form of transfer of right, title, possession or lien;

Section 3(35) further defines ‘transfer of property’ as under: "transfer of property" means transfer of any property and includes a transfer of any interest in the property and creation of any charge upon such property;

As such any amount raised under the transaction of property sale or purchase would be covered under section 5(8)(f)

6) Forward Sale or Purchase Agreement: This ‘forward’ may also be read as future sale or purchase. Any money raised in a transaction of future sale or purchase would qualify for financial debt as defined under 5(8)(f). The product may be a plant, machine or a flat or a home.

7) Having the Commercial effect of borrowing: All transactions of raising advance against the future sale or purchase is having the commercial effect of borrowing as it provides funds to seller for working capital. The seller may raise working capital loan from regular lenders or may raise advance from customers against sale of products or services including flats.

IV. Taking advance is a regular mode of borrowing for some industry segments:

There are some industry segments which are raising commercial borrowings from customers against future sale of products or services and such commercial borrowings constitute very large part. Some of the examples are:-

a) Land development agencies for housing, industrial use or commercial use;

b)   Builders (organised or grey market) who are constructing flats, villas, farm houses or row houses;

c) Capital Equipment Manufacturers such as Cement plants, Sugar plants, chemical plants, plant and machinery, etc.

d)   Contractors for infrastructure projects, where they seek advance for working capital

e) Design, Engineering, Supply, Installation, Testing and Commissioning services. Taking advance from customer is very regular way of raising borrowing for working capital.

f) Automobile Industry: Booking of vehicles against advance payment of deposits.

g) White Goods Industry: Booking of some kind of gadgets are done against advance from future customers and this transaction would also have an impact of commercial borrowing.

h)   Professionals: various professions also take the advance payment against future supply of services.

C. H O M E B U Y E R S A R E FINANCIAL CREDITORS:

The transaction of home buyers with the builders generally have following features which are matching with the definitions given under the IBC:

a)  The amount of advance given by a home buyer to a builder is a ‘debt’ for the builder as he is under obligation and liability to pay back or deliver the agreed product or service.

b)  It is not important if the payment of interest is mandated in the agreement or not

c)  The amount of advance is disbursed to builder by home buyer

d)  The consideration of giving such advance by home buyer to builder is time value of money as the price for ready home/flat would be much higher than the price in advance booking against advance payment.

e)  The builder has raised debt under a transaction of future sale of home /flat and the nature of transaction is covered in the definition of transfer as per section 3(34) & 3(35) of IBC, 2016

f) The transaction of taking advance against an agreement to sell in future is a transaction of future sale as defined under section 5(8)(f) of IBC, 2016

g) The transaction of taking advance against future sale of flat is a transaction having the commercial effect of borrowing for the builder.

In view of the above, the nature of transaction where a builder take advance from a home /flat buyer against future sale of home /flat matches with the provisions of IBC, 2016 and the debt of the builder is ‘Financial Debt’ and the home buyers are ‘Financial Creditors’

Hon’ble NCLT have already held in cases that flat buyers are not ‘Operational Creditors’ as they are not covered under the definition provided in IBC, 2016.

D. H O M E B U Y E R S A R E S E C U R E D F I N A N C I A L CREDITORS:

The following definitions provided in the IBC, 2016 needs careful reading before the issue of secured or unsecured is deliberated:

Section 3 (30) defines: "secured creditor" means a creditor in favour of whom security interest is created;

Section 3(31) defines: "security interest" means right, title or interest or a claim to property, created in favour of, or provided for a secured creditor by a transaction which secures payment or performance of an obligation and includes mortgage, charge, hypothecation, assignment and encumbrance or any other agreement or arrangement securing payment or performance of any obligation of any person:

Provided that security interest shall not include a performance guarantee;

Section 3 (33) defines: "transaction" includes an agreement or arrangement in writing for the transfer of assets, or funds, goods or services, from or to the corporate debtor;

Section 3 (34) defines: "transfer" includes sale, purchase, exchange, mortgage, pledge, gift, loan or any other form of transfer of right, title, possession or lien;

Section 3(35) defines: "transfer of property" means transfer of any property and includes a transfer of any interest in the property and creation of any charge upon such property;

E. SALIENT FEATURES OF TRANSACTION BETWEEN A HOME BUYER AND BUILDER IN VIEW OF THE TRANSFER OF PROPERTY ACT.

a)The builder has an unfettered right to sell a property for future delivery

b)   The builder enters into an agreement with the home buyer for the sale of specific identifiable property /asset /flat /home.

c)  The consideration is being paid in instalments by the home buyers to builder against that agreement to sell and receipts are issued against that agreement to sell

d)  ‘Contract for Sale’ is defined under section 54 of the Transfer of Property act, 1882 as under:

“a contract for sale of immoveable property is a contract that a sale of such property shall take place on terms settled between the parties. It does not, of itself, create any interest in or charge on such property”

e)  The buyer in a contract for sale obtains a right to get the sale deed executed in his favour.

f)  Section 55(6)(b) of the Transfer of Property Act, 1882 deals with the rights of buyers of property under an Agreement to Sell. Some of the relevant part of the provisions are reproduced hereunder for ready reference:

“The buyer is entitled to a charge on the property, as against the seller and all persons claiming under him, to the extent of the seller’s interest in the property, for the amount of any purchase-money properly paid by the buyer in anticipation of the delivery and for interest on such amount and to compel specific performance of the contract or to obtain a decree for its rescission.”

g)  Section 55(6)(b) provides that an agreement to sell creates following rights of buyer on the property: -

? It creates a charge on the property

? To compel specific performance of the contract; or

? To obtain a decree for its rescission

h)  Any transaction which secures payment or performance of an obligation is considered a ‘security interest’ as defined under section 3(31) of IBC, 2016

F. CONCLUSION

The analysis done above leads to following conclusion: -

a) The amount of advance given by home buyer to builder is a debt in the books of builder and the home buyer is a creditor for builder as per definition of debt u/s 3(11) and definition of creditor u/s 3(10);

b)  The home buyer is a financial creditor as per section 5(7) as the amount of advance given by home buyer to builder is a financial debt as per section 5(8)(f);

c) The home buyers are secured creditor as defined

u/s 3 (30) as home buyers are having a security interest as defined u/s 3(31) on the property developed by builder, which is specifically identified.

G. CHALLENGE

The only challenge to the entire concept is regulation 21 of The Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016, which reads as under: -

“Proving security interest.: - The existence of a security interest may be proved by a secured creditor on the basis of: -

(a)  the records available in an information utility, if any;

(b)  certificate of registration of charge issued by the Registrar of Companies; or

(c)  proof of registration of charge with the Central Registry of Securitisation Asset Reconstruction and Security Interest of India.

It would be difficult for a home buyer to prove its security interest as per regulation 21(supra). However, regulations are subordinate to Code and all other provisions are available in the code, which overrides the regulations. May be an amendment is needed in the liquidation regulations for proving security interest, which is otherwise also a challenge for most car loans as they are not able to prove their security interest.

By:-

CA. Anil Goel, Chartered Accountant & Insolvency Professional Founder and Chairman of AAA Insolvency Professionals LLP.