Home Buyers are Now Financial Creditors: What is the Difference?

The cabinet has put home buyers at par with financial creditors, such as banks, etc. after approving changes to the Insolvency and Bankruptcy Code or IBC 2016. This was enacted to shore up home buyers who are left stranded by real estate companies declaring bankruptcy.

Buying an apartment includes paying for a long list of costs, land and location, construction, affiliated memberships, assorted interior details along with a hefty tax charge and blended profit margins included by the builder. Have you ever thought how much of this amount can be recovered if the builder goes broke and invokes bankruptcy?

How It Started

This was the exact question that anguished home buyers to no end when Jaypee Infratech initiated the corporate insolvency resolution process or CRIP. More than 25,000 home buyers of various under-construction projects protested vehemently until an amendment was done to IBC on August 2017 asking home buyers under the said company to file their claims as creditors.

Until then, the IBC did not include any under-construction project’s buyers as creditors and even after the amendment of 2017, home buyers as financial creditors ranked lower than all other financial and operational creditors.

Moving ahead, the government formed a committee to review the IBC and in March 2018 recommended in a report the inclusion of home buyers as financial creditors. Following this report, the government approved an ordinance to amend the Act in May 2018. Thus, home buyers under the Real Estate Regulations and Development Act or RERA 2016 got the status of financial creditors under IBC.

You can read about the whole issue here.

What It Means for Home Buyers

It all boils down to the fact that home buyers can now as financial creditors initiate CRIP against a defaulting company or promoters. Furthermore, they will also be able to have an authorised representative in the committee of creditors. Thus, with the 2018 Ordinance, IBC is now in the same track as RERA Section 18 which allows home buyers either to demand,

1. Refund of the entire amount paid along with interest, or
2. Claim interest in case of delayed possession of the home.

However, a host of clarifications are needed to ascertain whether this step has really benefitted the home buyers. To begin with, home buyers need to be clearly placed in either among the secured financial creditors or the unsecured operational creditors. According to the January 2019 ruling by the Supreme Court, the latter does not have any parity with the former. Hence, banks and financial institutions retain the first claim over the money released through insolvency proceedings.

Possible Outcomes

In the event of a bankruptcy, there can be three possible follow-up situations:

1. The builder finds the money required and settles the issue,
2. The builder is bought by another firm, and
3. The builder goes for liquidation.

In case, the third option is availed, the home buyers stand to lose the most because,

1. All expenses related to the process of liquidation are adjusted first,
2. Previously inflated costs hamper the value received, as the valuation is based on present-day value,
3. Associated costs for premium view or apartment facing sides, internal decor, and fittings, etc. are not included.

Furthermore, if a home buyer’s deposit is treated as claims against a developer’s or promoter’s asset then banks may end up charging more for loans seeing as their recovery rates would be lower in case of insolvency.

The Opinions Are Divided

Home buyers are, through simple logic, financial creditors because with their advance deposits to the builders. They fund the project and receive a house in return. For a home buyer who has invested all the savings towards a new home, recognition as a financial creditor is indeed a bold and welcome move but most buyers are of the opinion that builders and promoters should not be given an easy opportunity for filing for insolvency.

Almost all the industry experts agree on the part that creditors are and will continue to be above buyers. According to many, financial creditors will have to come before operational creditors, otherwise, banks might refuse to give credit to projects.

According to Umakanth Varottil of the National University of Singapore, “…the efforts to rectify the prevalent anomaly that deprives homebuyers of benefits in insolvency are indeed beneficial. However, the proposed manner of addressing the concern simply by treating them as financial creditors is an inelegant solution. While it may help assuage the growing numbers of affected homebuyers, it is sure to inflict collateral damage on the philosophical framework of the Code.”

To Conclude

Home buyers may not be perceived as serious, secured financial creditors but they would make sensible participants in creditor committees because, at the end of the day, they have the strongest interest in timely resolution. As financial creditors, home buyers deserve the confidence and the power to return to the market and invest.