Second proviso to IBC not needed

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Recently in Manish Kumar v Union of India, the Supreme Court upheld the constitutional validity of all the provisos added to section 7(1) of the Insolvency and Bankruptcy Code, 2016(IBC), via the Insolvency and Bankruptcy Code (Amendment) Act, 2020.

The second proviso to section 7(1) of the IBC introduced a new threshold for filing an application to initiate a corporate insolvency resolution procedure (CIRP) by homebuyers. As per the proviso, the allottees under a real estate project can apply to initiate the CIRP process only if it is filed by no fewer than 100 allottees or at least one-tenth of the total number of allottees. Various writ petitions were filed by real estate creditors challenging the constitutionality of the amendment, including the provisos added to section 7(1) of the IBC. The primary allegation in these petitions was that the second and third proviso to section 7(1) violates article 14 and 19(1) (g) of the Constitution of India.

On a combined hearing of all the petitions in the Manish Kumar ruling, the Supreme Court held that an intelligible difference exists between homebuyers and other financial creditors: there is heterogeneity, numerosity, and individuality in decision-making in the case of homebuyers. In the court’s view, the second proviso to section 7(1) of the IBC is constitutional as it acts as a deterrent for individual homebuyers from filing frivolous applications.

Examining utility of second proviso

It is the view of the authors that the second proviso to section 7(1) of the code was not necessary given the existing safeguards in the code. Various concerns of the project developers could have been addressed by an alternative mechanism, which were not taken into account by the court.

For instance, penalties ranging from ₹100,000 (US$1,377) to ₹10 million on fraudulent or malicious initiation of proceeding are provided under section 65 of the IBC. Further, as held in Naveen Raheja v Shilpa Jain & Ors, the National Company Law Tribunal (NCLT) also reserves the power to impose additional costs on such mala fide applications.

Moreover, section 75 of the IBC envisages a penalty ranging from ₹100,000 to ₹10 million in the scenario where the financial creditor under section 7(1) omits to disclose any material fact in the application. Thus, merely the fact that a single real estate allottee is filing a complaint does not mean that the code is being used as a debt recovery mechanism as there already exists sufficient safeguards to ensure that the NCLT does not entertain malicious applications.

Further, an observation by the Supreme Court, in the Pioneer Urban case, gives more power and discretion to the NCLT to filter patently frivolous and malicious applications. The court had said that “the NCLT will not turn Nelson’s eye to genuine defences raised by real estate developers.” Moreover, it was also observed by the Supreme Court that as soon as the tribunal admits an application, it becomes a proceeding in rem from a proceeding in personam. Therefore, after initiation of the proceeding, the entire matter goes out of the individual allottee’s control and becomes a collective action. Thus, the fear that an individual homebuyer may use the code to force the real estate developer’s liquidation is unfounded and without any backing. This is because, after the constitution of the committee of creditors, the issue of whether to pursue liquidation or corporate restructuring is decided collectively through a vote of the committee.

Concluding remarks

There was no legislative necessity for introducing the new threshold via the second proviso to section 7(1), in light of existing safeguards and ambiguities in the proviso. Moreover, the Manish Kumar ruling has curtailed the remedy available to the homebuyers. It has affected the case of individual and small groups of homebuyers who otherwise satisfy the ₹10 million threshold under the IBC. The IBC being a beneficial legislation, an individual homebuyer must be provided with the opportunity of initiating the CIRP as sufficient checks and balances are already present in the IBC as mentioned above, which should have been considered by the court.

Pranav Karwa
National Law University

Jodhpur

Gaurav Karwa
West Bengal National University of Juridical Sciences

Kolkata