On 23 May, 2018, the Union Cabinet approved the promulgation of an ordinance to amend the Insolvency and Bankruptcy Code (IBC). The ordinance proposes to classify homebuyers as “financial creditors” putting them at par with banks and other financial institutions, which have lent money to defaulting real estate companies.
What does this mean? Up until now, homebuyers who had handed over money to real estate companies in order to buy homes, were not treated as creditors under the IBC. The money handed over was an advance and not a loan, hence, there was almost no chance of recovering this money.
With the proposed change, the money that real estate buyers handed over to real estate companies for homes (which were not delivered) is to be treated as a loan. And given that there might be some chance of recovering the money that was handed over by homebuyers to real estate companies.
How will the proposed change impact the homebuyers? In order to understand this, we need to first understand how the Insolvency and Bankruptcy Code, works.
Here are the steps:
1) A creditor of a company which has defaulted on a loan of greater than Rs 1 lakh can apply to the National Company Law Tribunal (NCLT). Within 14 days, the NCLT needs to issue an order on whether the defaulting company can be admitted into the corporate insolvency resolution process or not
2) Once the NCLT decides to admit a company into the corporate insolvency resolution process, the board of directors of the company are suspended and an interim resolution professional takes over
3) The interim resolution professional needs to constitute the Committee of Creditors within 30 days of the admission of the company into the corporate insolvency resolution process (CIRP). The Committee of Creditors can then decide whether to continue with the same professional or to appoint a new one. This individual is referred to as the independent resolution professional.
4) A resolution plan needs to be approved within 180 days of the company being admitted into the corporate insolvency resolution process. This plan needs to be approved by creditors who hold at least three fourths of the defaulted debt. It can also be extended by another 90 days
So, how does the ordinance giving the status of a financial creditor to a homebuyer, make any difference? Homebuyers can now be a part of the Committee of Creditors which appoints the independent resolution professional and at the same time approves the resolution plan.
Let’s look at this in detail:
1) With homebuyers on the Committee of Creditors, they can make sure that their interests are taken care of. While this seems straightforward it is not.
2) The number of financial creditors in case of banks lending to a real estate company is fairly limited. The same cannot be said about homebuyers. Take the case of Jaypee Infratech, a company which has taken money from many homebuyers and not given them homes.
Media reports suggest that the company has nearly 27,000 buyers, who have paid anywhere between Rs 40 lakh to a crore, to the company.
The first question is, how will these buyers be represented on the Committee of Creditors? (How do you choose representatives from 27,000 people in case of Jaypee Infratech?) The second question is how many representatives will be allowed given the huge number of buyers?
3) The third question is, Will the homebuyers have a greater representation on the Committee of Creditors than other financial creditors (basically the banks)? As a newsreport in The Times of India points out: “For instance, Jaypee Infratech had raised around Rs 13,500 crore from homebuyers by way of booking amount and instalments, which is far higher than the Rs 9,800 crore raised from banks to construct the apartments, Taj Expressway and a hospital.”
So, who gets a greater representation? Banks or homebuyers?
4) Typically, the resolution plan might be of another company taking over the real estate company which has defaulted on its loans. In this, the financial creditors might have to take a haircut.
Take the recent deal of Tata Steel buying out Bhushan Steel, a big defaulter. Tata Steel decided to pay Rs 35,200 crore to the creditors, against the total outstanding loans of more than Rs 56,000 crore. The creditors (the banks) had to take a haircut of 37 percent.
What will happen in the case of homebuyers? Will the homebuyers be ready to accept a haircut on the money they handed over to the real estate companies? Also, when the resolution plan is put to vote, how does the homebuyers representative decide whether to vote for or against the plan? How does he figure out what do the numerous homebuyers whom he is representing want as a whole?
These are not straightforward questions.
5) If another buyer is not found for the real estate company which has been put under the insolvency process, it will have to be liquidated, i.e. its assets will have to be sold. In this scenario, the homebuyers may again have to take a haircut. How will that be handled?
6) How do you align the interest of banks and homebuyers? The banks will be interested in getting some of their defaulted loans back and hence, ready to sell the real estate company to another company. A section of the homebuyers may be interested in getting a home, given that prices have risen between the time they invested and now.
Long story short, recognising homebuyers as financial creditors is one step forward, but it’s not going to do much to solve the mess that prevails. More solutions will be needed in the days to come.
(The writer is the author of the Easy Money trilogy and tweets @kaul_vivek)
Updated Date: May 24, 2018 12:56 PM