Insolvency proceedings: Amend laws to recognise the concept of buyer's lien

Insolvency proceedings initiated against Jaypee Infratech and Amrapali Group companies only scratch the surface of the problems that lie in the underbelly of the Indian real estate sector. An estimated 1 million homebuyers may be stuck with ongoing housing projects, where either construction is stalled or moving at a snail's pace. In some cases, the corporate entity undertaking the project is on the brink of facing insolvency proceedings.
 
Despite being recent enactments, neither the Real Estate (Regulation and Development) Act (RERA) nor the Insolvency and Bankruptcy Code (IBC) sufficiently addresses the concerns of homebuyers as regards ongoing projects. The RERA might be able to protect the interests of homebuyers in projects launched in the new regulatory regime.

 
In the context of ongoing projects, both the RERA and IBC fail to expressly recognise that many real estate companies utilised the disbursements made by homebuyers as a cheap alternative to obtaining project finance from institutional lenders. Apart from this, neither recognises the concept of buyer’s lien, as is recognised in jurisdictions such as Canada.
 

The Sale of Goods Act of British Columbia (Canada) expressly recognises buyer’s lien in circumstances in which goods have been acquired primarily for personal, family or household use. The Canadian legislation provides for the priority of such lien over other security interests in the case of an insolvency or liquidation. The inclusion of a similar concept to safeguard the interests of retail customers (such as homebuyers) by either the government or the Indian legislature in the RERA and the Code is urgently required.

 
In an ideal situation, this should be addressed by enacting suitable legislation or amending the RERA and the IBC. However, given the urgency, the government may consider exercising its powers under Sections 18 and 36 of the IBC and issue notifications declaring real estate projects or housing units booked by homebuyers to be “assets held in trust by the corporate debtor for the benefit of homebuyers”. This step would address the primary fear of homebuyers of losing their properties to secured lenders of insolvent companies.
 
Next in line, the Insolvency and Bankruptcy Board of India (IBBI) may consider amending Regulation 38 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016. The amendment should stipulate that the resolution plan of a real estate company must provide for the amounts required for discharging liabilities towards homebuyers and constructing real estate projects. To have any impact, the amendment should specifically provide for discharging the liabilities of homebuyers as a matter of priority over all other creditors of the insolvent company. The amendment should clarify that the obligations under the RERA would continue to subsist and apply to any incoming or new promoter of a real estate company.

 
Lastly, the notification to be issued by the government under Section 36 (of the IBC) may also give priority to the amounts required for discharging liabilities towards homebuyers or constructing real estate projects over any payments to be made to secured creditors (whether part of the liquidation process or not) and other creditors of an insolvent company under Section 53 of the Code.
 
The approach outlined above of introducing the concept of buyer’s lien or treating the money paid by homebuyers as money paid in trust for the specific purpose of constructing their projects is likely to be more suitable than treating homebuyers as “secured creditors”, “financial creditors”, “operational creditors”, or “other creditors”. Treating homebuyers as “secured creditors” who are accorded priority in the liquidation waterfall under the IBC would not address their concerns as they would be able to receive only pro rata proceeds from disposing of secured assets. Treating homebuyers as “unsecured financial creditor”, “operational creditors”, or “other creditors” is undesirable because such a step may expose them to significant haircuts and may entail wiping off their lifelong saving as these classes of creditors would get any money only after payments to senior creditors. Sitesh Mukherjee is partner and Ramakant Rai counsel at Trilegal.

The views expressed are personal