Jaypee Infratech insolvency: To protect home buyers, SC must come up with a Vishaka-type initiative

The Supreme Court (SC) on Monday (4 September 2017) stayed the National Company Law Tribunal's (NCLT) insolvency proceedings against developer Jaypee Infratech. The decision came as a relief to over 30,000 home buyers as indeed to millions of others awaiting their booked flats across the country, whose position became tenuous after the 9 August 2017 NCLT order that kick started the proceedings. (IDBI Bank, the lender to the company, has moved the Supreme Court on Tuesday seeking a modification of the stay order.)



Home buyers are a distinct class of creditors. In Jaypee's case, the Noida buyers had paid 90 percent of the price when the company was referred to NCLT under the Insolvency and Bankruptcy Code 2015 (IBC). The buyers apprehended rightly that NCLT would perforce have to give a short shrift to their claims even though in all fairness to it, a relief was given to them in the form of ability to file their claims before the insolvency professional. The apprehension was not borne of the fear of prejudice on the part of NCLT but out of the skew in the law in favor of secured creditors -- the claims filed would not be worth the paper was written on because the liquidator would follow the letter of law.

A pat solution some of the market enthusiasts are offering for such situations is a built in mechanism to increase the floor-area ratio so that the beleaguered builder can build more number of flats. Suppose 100 flats were contemplated and approved by the authorities including municipality. On going bust, the project should be allowed to build say 150 flats is the pat solution. The extra money obtained from the Johnny-come-latelies would enable the completion of the project, gush the enthusiasts. Really? Wouldn’t that amount to throwing good money after bad? Would new-comers touch such projects with even a barge pole? Wouldn’t the additional money thus brought in be soaked up by the claims of secured creditors and workmen who have a pari passu claim on security obtaining for secured creditors?

The Supreme Court will be taking up the case for hearing in October 2017. It has a task cut out. It has to be a Vishaka-type initiative -- the one that breaks new ground and challenges shibboleths. The Vishaka guidelines coupled with the gruesome gang-rape followed by the murder of Nirbhaya resulted in Parliament making drastic changes to the IPC on the beastly crime of rape. One hopes something similar happens on the home buying front.

But then it won’t be easy. The SC will have to do some deft tightrope walking because while Vishaka guidelines were about sexual harassment at workplaces the revulsion against which is universal. Home buyers while vying for repayment have to vie for sympathy as well. It is not only the home buyers who are left in the lurch when the builder goes bust. Others equally hit are the small suppliers of bricks and cement and other construction materials.

Elevating home buyers to the ranks of workmen so that they compete for the preferential creditors space and cut into the otherwise cocooned security of the secured creditors is a compelling if hasty and ill-thought out solution. If everyone tries to clamber into the preferred creditors block, secured creditors’ security would get increasingly truncated and belittled. With the result and in the end everyone would become equal alright but secured creditors would be bearing the brunt of the sacrifice on rather nebulous and socialistic considerations.

In the event, the Apex Court may consider the following solutions:

1) Bank guarantee for home buyers to be provided by the builder.

2) SPV or standalone companies being floated for each project as the existing Escrow account mechanism -- under which a builder has to deposit 50 percent of the project amount in a separate bank account thus preventing diversion to that extent -- is not a solution when things go over the top because on liquidation, funds of the company seamlessly mix as a homogenous lot thus rendering the ESCROW mechanism useless.

3) Making home loan companies have more skin in the game. As it is, home loan companies merely go by the repaying capacity of the individual borrowers coupled with the valuation of the mortgaged property. They must be made to bear a part of the loss that befalls on the hapless individual borrower. This would bring due diligence into their appraisal of the home loan application and discipline the builder as well.

In the end, Parliament would have to bestir and make a law fashioned on SC guidelines.

Updated Date: Sep 05, 2017 14:16 PM

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