Jaypee Infratech insolvency case: Supreme Court is walking a tight rope as home buyers enter the fray

On 4 September, a Supreme Court bench comprising Chief Justice Dipak Misra and Justices Khanwilkar and Chandrachud granted an interim stay on the order of National Company Law Tribunal’s (NCLT) bench at Allahabad in the insolvency case against Jaypee Infratech, an infrastructure and real estate company. The NCLT had ordered the proceeding under the Insolvency and Bankruptcy Code to be initiated against Jaypee Infra. It is pertinent to highlight that the Reserve Bank of India (RBI) had asked the banks to initiate insolvency proceedings against top 12 defaulters, who account for a combined 25 percent of all the bad loans of the banking sector. Jaypee Infratech was one among the 12.

The order of NCLT has put many who have bought homes in the company's projects in jeopardy. Any order of insolvency resolution is usually seen as a welcome step for anyone who is interested in the distressed company. Once the insolvency proceedings are initiated under the code, the company’s position may either be recovered as a profit-making enterprise by substantial restructuring or it may be liquidated. The probability of liquidation is often high if the company is in a really bad financial shape. Liquidation results in selling off the assets of that company, also known as neelami in local parlance. The money realised is then distributed among the creditors and others.

Under the scheme of Section 53 of the Insolvency and Bankruptcy Code (IBC), there is an order of priority in which the money realised by such selling of assets is redistributed. In that list of priority, secured creditors figure two ranks above unsecured creditors. Banks or financial lending institutions are usually secured creditors, because they offer loan to anyone on the basis of some security. On the other hand, home-buyers in case of a real estate company are treated as unsecured creditors because they have paid the company in return of a promise of delivery of some real estate, therefore they have no security as such. Hence, they are unsecured creditors.

 Jaypee Infratech insolvency case: Supreme Court is walking a tight rope as home buyers enter the fray


The above is a bone of contention for obvious reasons. If, for instance, Jaypee Infra undergoes liquidation in furtherance to the result of an insolvency proceeding, then its wealth will be redistributed as per the priority envisaged under Section 53. The banks, as secured creditors, have obviously lent a lot more amount to such a real estate company than the amount given to it by the home buyers. Therefore, there is little possibility for home buyers to receive any substantial amount of money in case of liquidation.

The home buyers have given their hard-earned money to Jaypee Infra which in certain cases is their entire life savings. Their priority, however, falls below banks, who technically also deserve their money back. It is sometimes the bank’s money with the help of which a company might have started its business in the first place. In this case, however, the loan was taken by the company after it became distressed and after it had taken the money from the home buyers. This results in a complex scenario, which probably the framers of the code wouldn’t have imagined for the simple reason that the Code doesn’t serve only real estate sector and is relevant for companies in all sectors. This problem is only specific to companies operating in the real estate sector.

The home buyers also claim the aid of another legislation which comes to their rescue in such a situation which is the Real Estate (Regulation and Development) Act, 2016 (RERA). This legislation protects their rights. It even has provisions for return of money with interest, if the flat is not delivered on the promised date. However, this legislation too doesn’t envisage a situation where the court is dealing with the rights and entitlements of home buyers dealing with a distressed company which is facing liquidation.

The situation now becomes even more complicated in light of the decision of the Supreme Court in Innoventive Industries vs ICICI Bank. In this case, the apex court has held that the code will prevail whenever there is a conflict between the code and any other legislation. The decision was with respect to a state law. So, there can be an argument of its applicability when there is a conflict with another central legislation, being RERA in this case. However, the Supreme Court has declared the code to be an exhaustive law in the case of Innoventive. This means that it should overrule any other law which might not even be in direct conflict with it, and can include another Central Law too. The order on Innoventive is a very comprehensive one and it is difficult to find an exemption to the same.

Given that the Jaypee case is still sub-judice and the apex court has come out with only an interim order, there is still scope for bringing in more clarity on this point. Ideally, real estate companies should be treated as an exemption to Section 53 of the code and home buyers should be given some higher priority in repayments. Still, such an argument rests more on an emotional point of view rather than a legal one. The argument is that home buyers have invested their hard-earned money. For that matter, people with limited sources of income often invest their hard earned money in stock markets too. As per the scheme under Section 53, the priority of equity shareholders is last, which makes sense because they are part-owners of the company and their company failed. But going by the above logic, the same argument can be applied to such a situation of stockholders too.

Anyone investing in a company makes a conscious choice and ideally should be aware of the financial position of the company. Of course, there are cases when people are duped and defrauded of their hard-earned money. Therefore, in such a setting, it is desirable that the apex court takes a pragmatic view of the problem and resolves the issue on a case-to-case basis rather than laying down comprehensive law, making an exception to Section 53 itself. Such an exception, if created, might even render the whole scheme of Insolvency under the Code pointless, because banks wouldn’t be able to recover their due amount.

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Updated Date: Sep 06, 2017 11:02:20 IST