The Supreme Court in NOIDA v Anand Sonbhadra recently considered whether sums owed by real estate developers to New Okhla Industrial Development Authority (NOIDA) under long-term leases could be classified as financial debts and whether NOIDA would, therefore, be regarded as a financial creditor (FC) under the Insolvency and Bankruptcy Code, 2016 (code). Both the National Company Law Tribunal and the National Company Law Appellate Tribunal had previously held that NOIDA was an operational creditor (OC).
NOIDA had leased land to each developer for 90 years for an initial premium, followed by half yearly instalments with interest. NOIDA argued that, if a corporate insolvency resolution process (CIRP) were initiated against a lessee developer, it should be classified as an FC as the amounts owed to it under the lease were financial debts. It maintained that firstly, under section 5(8)(d) of the code, the relevant lease deed was a finance lease under the Indian Accounting Standards and that secondly, under section 5(8)(f), the transaction underlying the lease deed had the commercial effect of a borrowing.
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The court, however, rejected NOIDA’s contentions and held that NOIDA was not an FC, as the outstanding debts did not satisfy the requirements of financial debts under section 5(8) of the code. While acknowledging the existence of a debt under the relevant lease deed, the court held that there was no “debt … disbursed”. NOIDA, being the lessor, had not disbursed any funds to the relevant corporate debtor and all funds under the transaction were from the corporate debtor to NOIDA. The court held that, in the case of financial debt, the disbursement must be from the FC to the corporate debtor. The amounts paid by the corporate debtor to NOIDA could not, therefore, be regarded as disbursements.
Although the judgment correctly applies the provisions of the code, it does not necessarily fulfil the code’s objective of “[balancing] the interests of all the stakeholders”. The judgment offers considerable relief to a large number of homebuyers who have faced delays and uncertainty due to CIRPs being stalled by authorities such as NOIDA, who have insisted on their classification as FCs in insolvency proceedings. Such homebuyers can now hope for a smooth and expeditious conclusion of the CIRP in which their developer is involved.
However, the judgment has relegated lessors of real estate developers to whom large sums of money are owed to the back of the queue. As an OC, NOIDA does not have a seat on the committee of creditors. Further, in the event of liquidation, NOIDA, as an OC will not receive any monies until after all secured debts, financial debts, government dues and workmen’s dues are paid. While in other cases, an OC may terminate its arrangement with the corporate debtor after a CIRP, in the case of real estate projects, termination of long-term leases where the property has been developed, and units have been allotted, may not be possible. Such creditors are unlikely to be satisfied with a one-time payment of a minimal amount in the liquidation. It is, therefore, likely that such lessors will continue to litigate the issue prior to the approval of the resolution plan.
The CIRP regime does not, in the case of insolvency of real estate developers, appear to adequately balance and address the conflicting claims and interests of all stakeholders. To remedy the imbalance, such projects require a different treatment under the code. Interestingly, notwithstanding its application of the provisions of the code, the court appeared to recognise the imbalance. The frameworks under the code will need to be revisited, as the court accepted the possibility of future amendments to them.
The complexity of a corporate insolvency resolution of real estate projects cannot be successfully dealt with through a uniform insolvency mechanism. This may be remedied through legislative intervention to insert an exception to the existing framework of the code, as was previously done in 2018 when the code was amended to reclassify the status of allottees of a real estate project as FCs. Alternatively, a separate regulatory frame work for real estate projects could be introduced to address in an equitable way the interests of all stakeholders, in line with the aim of the code.
Shreya Sircar is a partner and Sneha Sanyal is an associate at Bharucha & Partners
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