Commercial Wisdom of the Committee of Creditors Consisting of Homebuyers

Introduction

The principle of commercial wisdom is a recognised concept in Indian jurisprudence. It essentially emphasises that courts should not interfere with the business decisions of companies or their management unless those decisions are so unreasonable that no man with ordinary prudence would not have made them. Resultantly, this principle helps in minimising unnecessary judicial intervention in business matters.

In the context of Insolvency and Bankruptcy Code, 2016 (IBC)¹ the principle assumes importance, when the Committee of Creditors (CoC), typically composed of financial creditors, takes over as the decision-making authority from the company’s Board of Directors, once the corporate insolvency resolution process (CIRP) initiates. The CoC’s primary responsibility is to protect and advance the interests of creditors. This includes safeguarding their right to recover the amounts owed to them to the greatest extent possible. The CoC has the power to approve or reject the resolution plans submitted by prospective resolution applicants, determine the liquidation process, including appointing a liquidator, etc. These decisions are often guided by commercial considerations and can have significant implications not only for the debtor company but also for other stakeholders, such as operational creditors, employees, and shareholders.

Therefore, IBC aims to strike a balance between upholding commercial wisdom and ensuring fairness in the resolution process.

Status of homebuyers as financial creditors

Initially, the IBC did not recognise homebuyers as creditors, similar to other financial institutions. However, over time, the IBC underwent significant changes to accommodate the unique position of homebuyers in real estate projects. The IBC amendments, recognised homebuyers as financial creditors, acknowledging their substantial financial investments in real estate projects. This inclusion grants them certain rights and responsibilities in the insolvency resolution process.

Homebuyers were excluded from the ambit of CoC since they were understood to lack the financial expertise and commercial wisdom of traditional financial institutions like banks or non-banking financial companies (NBFCs). Unlike these institutions, homebuyers may not possess the specialised knowledge required to assess the viability and feasibility of a resolution plan for a distressed corporate debtor.

The objectives of Code are multipronged, one of it being the revival and continuance of corporate debtor as a going concern, in a manner that benefits all stakeholders. Hence, case laws such as Innoventive Industries Ltd. v. ICICI Bank², which have established the legal framework recognising homebuyers as financial creditors.

Balancing the interests of various stakeholders, including homebuyers, in insolvency proceedings is a complex challenge. It underscores the need to ensure that the resolution process respects the rights and interests of all parties involved, including those who may not possess the same level of financial expertise.

In Flat Buyers Assn. v. Umang Realtech (P) Ltd.³, a notable observation was made regarding the majority of financial creditors who were allottees in a real estate project. The observation acknowledges that allottees, as homebuyers, typically do not possess the same level of financial or business expertise as traditional financial institutions or banks. It often requires in-depth knowledge of the corporate debtor’s financials, market dynamics, and business operations. This observation raises legal and practical questions about the role of homebuyers or allottees in evaluating resolution plans. It highlights the challenge of expecting them to possess the same level of financial acumen as traditional financial creditors.

While recognising the limitations of allottees in terms of financial expertise, the legal framework aims to protect their interests as financial creditors by ensuring their participation in the decision-making process. Their inclusion in the CoC allows them to collectively make decisions and seek professional advice if necessary.⁴

Upon conducting an exhaustive examination of the pertinent definitions, the Supreme Court has made the observation that the contractual arrangement between a builder and a homebuyer, commonly referred to as a builder buyer agreement, possesses the characteristic of a “commercial effect” akin to a borrowing transaction. Having said that, the Supreme Court has cleared the dust from retrospective applicability of the Amendment Act by holding that homebuyers were included in the main provision i.e. Section 5(8)(f) of the IBC⁵ with effect from the inception of the IBC.

Judicial interpretation of commercial wisdom of CoC

The judicial understanding of the commercial judgment of the CoC has been developing since the implementation of the IBC in 2016. The courts typically exhibit deference towards the decisions of the CoC, recognising and respecting its autonomy and expertise in subjects pertaining to business and finance. The courts have abstained from intervening in the merits or practicability of a settlement plan, unless it contravenes any legal requirement or is capricious or unjust.

Nevertheless, the courts have acknowledged certain restrictions and exemptions to the business prudence of the Code of Conduct, particularly when it impacts the concerns of other parties involved, such as operational creditors, dissenting financial creditors, employees, or the public welfare. The courts have also interfered in cases when the Code of Conduct has demonstrated bad faith, collusion, or discrimination.

In Essar Steel India Ltd. (CoC) v. Satish Kumar Gupta⁶, the Supreme Court upheld the importance of the CoC in determining how the proceeds should be distributed among different groups of creditors in a resolution plan. However, it also stressed the need for the CoC to consider the interests of all parties involved and guarantee that operational creditors receive at least their liquidation value. The Supreme Court invalidated specific parts of Regulation 38 of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016⁷, which granted preference to secured financial creditors over unsecured financial creditors in the event of disagreement.⁸

Additionally, in K. Sashidhar v. Indian Overseas Bank⁹, the Supreme Court of India made a significant ruling regarding the authority of CoC in the approval of resolution plans under the IBC. The Court emphasised that if a decision made by the CoC is purely commercial or business-oriented, it falls outside the scope of justiciability. In other words, the Court cannot review or interfere with such commercial decisions.

In the judgment of Kalpraj Dharamshi v. Kotak Investment Advisors Ltd.¹⁰, the Court made note of the fact that the IBC itself stipulates a few grounds for contesting a resolution plan. These grounds, which are listed in Sections 30¹¹ and 61¹² of the IBC, cover things like contravention of the law, failing to adhere to the rules established by the Insolvency and Bankruptcy Board of India (IBBI), material irregularities in the resolution professional’s (RP) use of their authority, among other elements. It reaffirmed the primacy of the CoC in evaluating and approving resolution plans. The Court emphasised that the CoC, given its composition of financial creditors and its commercial expertise, is often best positioned to assess the feasibility and merits of a resolution plan.

The difference between CoC consisting solely of homebuyers and other CoC’s

A CoC is established in cases when the builder who has failed to fulfil its promises to deliver properties to homebuyers. The CoC is exclusively composed of individuals who have purchased homes from the developer and are now seeking resolution for the default. Homebuyers are acknowledged as financial creditors according to the IBC, granting them the authority to commence and actively engage in the bankruptcy resolution proceedings of the non-compliant builder.

A CoC is established when a corporate debtor, which may encompass many entities such as banks, financial institutions, and debenture holders, fails to meet its financial obligations to these creditors. The aforementioned creditors are acknowledged as financial creditors according to the IBC. As such, they possess the authority to commence and engage in the insolvency resolution proceedings of the non-compliant entity.

The primary distinction between these two categories of CoCs lies in the fact that the CoC comprised exclusively of homeowners assumes a dual position as both creditors and customers. The individuals in question must effectively manage their financial concerns as creditors seeking to recover outstanding debts from the corporate debtor, while also considering their consumer interests as homebuyers seeking to obtain possession of their homes from the builder. In addition, it is imperative for stakeholders to take into account the concerns of other creditors, including operational creditors and Government dues, who may possess a lower level of priority in terms of payment but yet contribute vital goods and services to the corporate debtor. Furthermore, it is imperative for decision-makers to consider the social and economic ramifications of their choices, including but not limited to effects on employment rates, availability of housing, market stability, and public welfare.¹³

The CoC, comprised of several financial creditors, assumes a singular function as creditors. In order to optimise their recuperation from the corporate debtor, it is vital for them to endorse a resolution strategy that presents the most substantial value for their claims. The absence of direct impact on their part relieves them from the obligation to take into account consumer interests or the social and economic consequences of their decisions.

Analysis: Commercial wisdom of CoC consisting solely of homebuyers

The concept of “commercial wisdom” pertains to the capacity to make prudent and logical choices that prioritise the welfare of the various parties engaged in a commercial transaction. The assessment of the Committee of Creditors’ commercial acumen plays a pivotal role in determining the outcome of insolvency and bankruptcy processes, specifically in relation to the corporate debtor and its assets. The CoC is an entity tasked with the representation of all financial creditors of the corporate debtor, who possess a legitimate claim on its debt or assets. The authority to grant or deny approval of a resolution plan, which entails a proposal for the revival or liquidation of the corporate debtor, lies with the CoC.

When the composition of the CoC exclusively comprises of homebuyers, it implies the absence of any other financial creditors, including banks, debenture-holders, or suppliers, who have extended loans or furnished products or services to the corporate debtor. This circumstance is characterised by its rarity and unlikelihood, as the majority of corporate debtors typically own various avenues of financing and corresponding liabilities. Nevertheless, in theoretical terms, such a scenario can occur when the corporate debtor pertains to a real estate developer who has accepted prepayments from individuals purchasing residential units, yet has been unable to fulfil their obligations due to financial difficulties or other factors. In this scenario, it is important to note that the individuals purchasing residential properties are classified as financial creditors according to Section 5(8)(f) of the IBC. Consequently, they possess the ability to establish a CoC in accordance with Section 21¹⁴ of the aforementioned law.

The commercial efficacy of the CoC comprising exclusively of homebuyers would be contingent upon several things, including:

(a) The project encompasses a wide range of homebuyers, both in terms of quantity and variety.

(b) The monetary sum and relative percentage of funds contributed by individual homebuyers to the corporate debtor.

(c) The current stage and level of progress in the construction and delivery of the residential units.

(d) The accessibility and viability of alternate strategies for resolving disputes or implementing liquidation measures.

(e) This paper examines the legal rights and remedies that are accessible to homebuyers in accordance with a range of laws and regulations.

(f) The anticipated desires and inclinations of prospective homeowners with regards to their demands and concerns.

The Committee comprised exclusively of homebuyers must assess these variables and choose whether to endorse or decline a resolution proposal made by a resolution applicant, who may be either the current promoter or a new investment. The resolution strategy must adhere to several criteria, including:

(a) The provision should prioritise the payment of bankruptcy resolution process costs, liquidation value, and operational creditors’ dues over financial creditors’ dues.

(b) The provision should encompass the administration and oversight of the corporate debtor throughout the duration of the implementation phase.

(c) The proposed project must exhibit feasibility, viability, and compliance with all requisite authorisations from pertinent regulatory bodies.

(d) The system must adhere to all relevant legal statutes and regulatory requirements.

The Committee comprising exclusively of homebuyers must employ their business acumen to assess and cast their vote on the resolution plan, taking into consideration their own welfare as well as the welfare of other stakeholders, including employees, customers, suppliers, government agencies, and so forth. The CoC is required to conduct themselves in a manner consistent with the principles of good faith, free from any conflicts of interest or undue influence. The CoC must also take into account the potential ramifications of declining a resolution plan, as this could result in the liquidation of the corporate debtor and the subsequent depreciation of value for all stakeholders.

Rights and suggestion for individual homebuyers

The financial creditors have the right to challenge the decision of the RP to accept the claims of another financial creditor. They can do this by approaching the adjudicating authority under Section 60(5)(c) of the IBC¹⁵. However, in Jaypee Kensington Boulevard Apartments Welfare Assn. v. NBCC (India) Ltd.¹⁶, the Supreme Court examined the legislative background and determined that the homebuyers, albeit being financial debtors, did not possess individual rights. Homebuyers were eligible to engage in the IBC process solely as a category of financial creditors.

In its order dated 1-6-2022, the National Company Law Appellate Tribunal (NCLAT) reversed the order of the National Company Law Tribunal (NCLT) in Aashray Social Welfare Society v. Saha Infratech (P) Ltd.¹⁷ The NCLAT ruled that individual homebuyers have the right to participate in applications filed by other financial creditors, where they challenge the rejection of their claims by the RP. Hence, it gave opposing judgment to Jaypee Kensington Boulevard Apartments Welfare Assn. v. NBCC (India) Ltd.¹⁸

Individual homebuyers have the right to submit individual claims to the RP and receive the sums owed to them based on the resolution plan or the liquidation procedure. Individual homebuyers have the right to participate in and cast votes at meetings of homebuyers that are organised by their representatives. Individual homebuyers have no more individual rights beyond these.

Here are some recommendations for individual homebuyers in the CoC to enhance their representation:

(a) Individuals should establish clubs or groups according to their shared interests and preferences, such as the specific project or tower in which they have invested, the current state of development of their project, the desired amount of return, and so on. This would enable them to strengthen their assertions and articulate their worries with greater efficacy.

(b) An authorised representative (AR) should be appointed to work on their behalf and safeguard their interests in the CoC. The assistant resolution should possess a comprehensive understanding of the insolvency legislation and process, and should demonstrate proficient communication skills while interacting with the homebuyers. The augmented reality (AR) should also collaborate with other ARs from other groups of homebuyers and strive to achieve an agreement on the resolution strategy.

(c) It is advisable for individuals to authenticate their assertions by consulting either the interim resolution professional or the RP. Additionally, they should provide all pertinent documentation and evidence to substantiate their allegations. Additionally, it is advisable for individuals to monitor the progress of their claims and address any concerns or inquiries as necessary.

(d) It is important for individuals to actively engage in the CoC meetings, either through their authorised representative or in person, and make wise decisions when exercising their voting rights. Additionally, it is imperative for them to collaborate with the RP and other parties involved in the settlement process.

(e) The resolution proposals submitted by the prospective resolution applicants should be evaluated to determine their feasibility, viability, and benefits. In addition, it is important for them to take into account the concerns of other creditors and stakeholders, and cast their vote in favour of the most optimal resolution plan that maximises the value of Jaypee Infratech Limited (JIL’s) assets and guarantees the timely completion of their projects.

Conclusion

The presence of a CoC comprised exclusively of homebuyers represents a distinctive and complex occurrence within the context of insolvency procedures governed by the IBC. Homebuyers must employ their commercial wisdom when making decisions that impact not only their personal interests, but also the interests of other creditors, stakeholders, and the broader economy.

The use of commercial wisdom within the context of a CoC can yield substantial advantages for all stakeholders, as well as for broader society and the promotion of public welfare. The resolution applicant can provide improved recovery of dues, expedited delivery of homes, and enhanced construction quality and amenities to the homebuyers. In addition, individuals have the potential to circumvent the process of liquidation, thereby mitigating the risk of forfeiting their residential properties or receiving a diminished financial settlement relative to the proposed resolution strategy.

Hence, it is crucial for homebuyers to possess knowledge regarding their rights and responsibilities as stipulated in the IBC. Additionally, it is essential for them to be appropriately represented and organised within the CoC. Furthermore, they should have access to adequate information and expertise to assess the resolution plans, engage in fair and transparent negotiations with resolution applicants and other creditors, make well-timed and informed decisions in compliance with legal provisions, and effectively communicate their decisions to relevant authorities. By engaging in such actions, individuals can effectively secure their rightful claims as creditors, obtain their desired properties as customers, and receive fair treatment in the legal system as citizens.