Insolvency of real estate firms to be limited to project, not across group: NCLAT

The National Company Law Appellate Tribunal (NCLAT) has held that any insolvency process initiated by a homebuyer or a financial institution would be limited to the project concerned and not impact other projects of developers.

While this may help real estate builders complete stuck projects faster, this order, say some legal experts, is contrary to the fundamental tenets of insolvency and secured transactions law. This may shortchange many creditors and lead to chaos, they believe.

“In CIRP against a real estate firm, if allottees or financial institutions, banks or operational creditors of one project initiated CIRP against the corporate debtor, it is confined to the particular project, it cannot affect any other projects of the same real estate company in other places where separate plans are approved by different authorities,” said a two-member NCLAT bench headed by chairman Justice SJ Mukhopadhaya.

Terming the process as “reverse corporate insolvency resolution process,” the bench said that once CIRP is initiated against a real estate firm, no homebuyer can approach the National Company Law Tribunal (NCLT) or the NCLAT to seek refunds for the project.

The bench was hearing the matter relating to Gurgaon-based real estate firm Umang Realtech, which was taken to NCLT by two flat buyers.

The Delhi-based Principal bench of the National Company Law Tribunal (NCLT) had on August 20, 2019 directed to initiate Corporate Insolvency Resolution Process’ against Umang Realtech. This was challenged before the NCLAT by a group of allottees – Flat Buyers Association Winter Hills-77, Gurgaon – contending that the project in question, will be completed by the end of Diwali in October, 2019.

The order also said that once the CIRP process has been initiated, homebuyers cannot approach NCLT or NCLAT for refund.

In case the flat owners of such projects wish to seek a refund for the particular project of the real estate company which is undergoing insolvency, they are open to sign an agreement, either with the interim resolution professional, or the promoter to find a new buyer and get the money back if and when that flat is sold, the NCLAT said.

Some insolvency experts have described the order as contrary to the fundamental tenets of insolvency and warned that this may lead to chaos.

“This judgment is contrary to the fundamental tenets of insolvency and secured transactions law. Invariably it is the assets and receivables of the enterprise that are secured with lenders and not individual projects. This judgment will shortchange many creditors and lead to chaos,” Sumant Batra, an insolvency lawyer of international repute, told Moneycontrol.

“Buyers of real estate will have to deal with an un-level playing field as resolution applicants will cherry pick projects. They will trash the commercially challenging projects and go for the attractive projects providing a raw deal to many allottees in the process,” he said.

Other experts are of the view that this would lead to faster completion of projects. It must be noted that most real estate firms float a special purpose vehicle for each project to ensure that liabilities of a project are limited to that particular project.

“The NCLAT order highlights a much larger issue. We have faced this dilemma while advising clients on several occasions and it appears to be a constant struggle. While some flat buyers want to initiate insolvency against the developer, others desire project completion. When a cash strapped developer is admitted into insolvency, all his projects tend to get adversely affected including projects that were near completion and could have been completed. This proved to be counterproductive as project completion is the ultimate challenge face by the industry,” says Yudhist Narain Singh, Senior Partner, heading the real estate practice with YNS & Associates based in New Delhi.

In a way NCLAT has adopted a practical and solution-oriented approach. However, it needs to deal with each of these cases carefully.

“In several cases developers did not incorporate a separate legal entity for each new project that they developed. Therefore, all the projects of the corporate debtor came under scrutiny during insolvency. While advising clients we have noted that most developers have adopted complex structures to protect their land bank, while one company would own the land, the other would merely deal with the construction of the project. In this manner, when the constructing company went into insolvency the land assets were safeguarded in the other entity. NCLAT must address these unique issues,” Singh said.

Venkat Rao of Intygrat Law Offices LLP says that this order would provide relief not only to builders but to a great extent to all those buyers who desired a home rather than a refund.

The order clearly states where resolution is proposed for the project, the buyer would have to wait for a refund till such a flat is sold.

“This would discourage those homebuyers who were misusing the forum for recovery of dues. Though practical implementation challenges will subsist but I believe this will encourage a more prudent and practical approach to resolution under the Code for real estate firms,” he said.