Home Buyers – Secured or Unsecured Creditors?

Introduction

Home buyer is a person who is buying a house or apartment. The status of the home buyer is as an allottee which has been defined in the Real Estate ( Regulation and Development ) Act. Earlier, home buyers were treated like other creditors and they were not regarded as financial creditors or as operational creditors, which restricted their ability to initiate insolvency proceedings under IBC 2016 against a defaulting builder/ developer.

Amendments

According to the 2018 Amendment Act, if an allottee were to claim an amount against a developer pertaining to a real estate project then that amount will be considered to have an impact similar to the commercial impact of borrowing. Therefore amount paid by the home buyer to a builder was to be considered as financial debt and the home buyer considered as Financial creditors. This has enabled the home buyer to initiate insolvency proceedings against a defaulting builder company under the IBC and to be entitled to a representation on the committee of creditors.

The amendments made by the Ordinance inter alia brings IBC in closer sync with Section 18 of RERA which gives the allottees the right to demand i) refund of the entire amount paid by the allottees (together with interest at prescribed rates), and ii) interest to be claimed for any delayed possession.

Who are Financial Creditors under IBC?

The Insolvency and Bankruptcy code classifies two creditors under the following categories: Financial creditors – Section 5(7)

Operational creditors – Section 5(20)

The Financial creditors are basically entities (lenders like banks) that have provided funds to the corporate. Their relationship with the entity is a pure financial contract, such as a loan or debt security.

When a corporate defaulter is brought under the resolution process (Corporate Insolvency Resolution Process), There can be two types of creditors to whom the corporate should give back money-

1. The entities who gave loan or funds to the corporate
2. The entities from whom the corporate brought inputs and other

So, the financial creditor in simple terms is the institution that provided money to the corporate entity in the form of loans, bonds, etc.

Suppliers, customers, contractors, etc. are generally operational creditors and mostly Operational creditors are Unsecured. While banks and lenders are generally financial creditors and can be Secured Financial creditors or Unsecured Financial creditors.

Secured and Unsecured Creditors

A Secured Creditor is any creditor or lender who is associated with an investment in an asset or issuance of that asset, which is backed by collateral. If a borrower defaults, the secured creditors have a legal right to the asset used as collateral, which can be seized and sold to pay off the obligations.

On the other hand, an UNSECURED Creditor is an individual or institution that lends money without obtaining specified assets as collateral. This poses a risk to the creditor because it will have nothing to fall back on if the borrower defaults.

Secured Financial creditors Vs Unsecured Financial creditors

The difference between secured financial creditors and unsecured financial creditors mostly has an implication on the priority of payments upon liquidation of the company. One of the interpretations with regard to homebuyers being an unsecured creditor is that, while the homebuyers credit the money to the developer without obtaining collateral, their right on asset is only ensured when the asset is transferred to them by the developer. This makes them an unsecured creditor to the developer.

Home Buyer is a Secured or Unsecured Financial creditor?

Now the question arises whether the allottees(home buyer) can be treated as a secured creditor given the fact that they have similar rights under RERA and that their payments are now recognized as financial debt under IBC or will they be treated as an unsecured financial creditor who stands much below inline (as compared to secured financial creditors) when it comes to the distribution of the proceeds recovered upon liquidation of a company. For this examination of certain provisions of RERA is needed.

As per section 11 (4) (h) of RERA, a mortgage cannot be created over units in respect of which agreed to sell has been executed by the promoters/developers and even if such mortgage is created the same shall not affect the right and interest of the concerned allottee. Also, as per the second proviso of section 8 of RERA, in case of revocation of registration of a real estate project under RERA, the association of allottees have the first right of refusal for carrying out the remaining development work.

While the provisions of RERA as mentioned above read with the definition of ‘Security Interest’ under IBC is wide enough to ensure that allottees are treated as secured creditors.

Conclusion

Whether the home buyer is a secured creditor or an unsecured creditor has not been cleared in the provisions of law, it’s all upon the interpretation of such laws. It would also be interesting to note how the same is interpreted in different circumstances, i.e., depending on the stage of construction, whether an agreement to sell is executed or not, and if only allotment letters were given by the promoter/developer who would be a corporate debtor, whether an association of the allottees has been formed or not.

Additionally, in cases where a single larger project of the corporate debtor has various associations of persons for separate buildings or phases registered with RERA or if there if only one representative shall be allowed or different representatives shall be permitted for each phase registered under RERA, remains unclear.