In a landmark judgement, the Supreme Court has stayed insolvency proceedings against Jaypee Infratech (the real estate arm of JP Associates).
While prima facie the move has been triggered by concerns to protect interest of homebuyers and hence is a welcome move, it raises questions about the sanctity of the insolvency process in India.
The country took a long time to arrive at a resolution platform and any sudden derailment would go against the interest of all stakeholders.
A brief background
Jaypee Infratech was one of the dozen companies where banks were asked to initiate an insolvency resolution process. The National Company Law Tribunal (NCLT) admitted lead banker IDBI’s plea for initiating insolvency proceedings against Jaypee Infratech on August 9, 2017.
The company has debt outstanding of close to Rs 7,700 crore and negative operating profit, thereby impairing its ability to service debt of this quantum.
Jaypee Infratech had sold close to 27 housing projects to homebuyers. This move had caused immense anxiety among the homebuyers whose number is said to be around 32,000. Angry homebuyers staged protests against the company and demanded that their money be returned first as they feared that if the company was declared insolvent, all their court cases would become ineffective and they would not be able to get possession of their flats and would lose their hard-earned money.
To protect the interest of the homebuyers, the Insolvency and Bankruptcy Board of India (‘IBBI’) amended the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 to introduce a new Form F for the homebuyers to file their claim under bankruptcy.
Why did IBBI introduce this new form?
The creditors of Jaypee were required to file their claims by August 24. The regulations prescribed different forms for different classes of creditors. The IBBI has regulations requiring financial creditors to file claim in Form C, operational creditors in Form B, and other creditors in Form F. Homebuyers were therefore asked to file their claim in Form F.
Why did homebuyers file a PIL (public interest litigation)?
If homebuyers file Form F instead of Form C, it would be a prima facie admission that they are unsecured creditors.
A financial creditor whose Form C is accepted will have the right to be part of the committee of creditors which decides the resolution plan. In addition, the claims of financial creditors whose Form C is accepted will take priority over operational creditors and other unsecured creditors.
If the resolution plan fails and Jaypee were to go for liquidation, there may be a scenario where the unsecured creditors (who filed Form F) may obtain only a fraction of their investment or may not get anything.
The PIL in this regard by homebuyers alleged that they had not received the flats and the insolvency proceedings initiated against the company would render them without any remedy.
The plea said that the homebuyers, being unsecured creditors, would get nothing out of the insolvency proceedings as the dues of financial institutions, which are secured creditors, would be cleared first.
What happens in the event of liquidation?
Should any company go for liquidation, of the amount received after providing for the insolvency cost, in the waterfall structure, financial creditors are paid first, followed by operational creditors.
Since homebuyers are unsecured creditors, their claim would be somewhere at the bottom. Moreover, should a company go for liquidation, the liquidation value is almost always less than the outstanding debt. Hence, there is seldom any chance of recovery by operational and other unsecured creditors.
What does the Supreme Court order mean?
Stalling insolvency is akin to again giving the company back to the promoters. The insolvency process had a well-defined timeline – 180 days with a maximum extension by another 90 days. The judgement takes away that timeline from the resolution process.
Regulations need to come up that protect the interest of the customers while not throwing the resolution process into jeopardy.
In the days to come, existing regulation could be modified that could tweak the waterfall structure. Either home buyers will be treated at par with financial creditors or they would receive a certain share.
In any case, this doesn’t augur well for the beleaguered banks. They have been asked to provide 50% provision upfront when an asset gets referred to NCLT.
If the bankruptcy proceeding is stalled, there is no hope for a time-bound resolution and if existing regulations are modified whereby financial creditors’ interests are compromised, the banks are staring at a further haircut.
The fortunes of the real-estate sector are changing for the better post the implementation of RERA (real estate regulation & development act). which is expected to bring in transparency. Recent equity deals in the sector to de-leverage balance sheets are also a welcome development.
However, real estate sector still remains highly indebted. The combined debt of the sector is close to Rs 1.2 lakh crore and interest coverage ratio stands at only 1.3.
Banks should be prepared to face such hiccups unless the regulation defines in clear terms the claim of each and every stakeholder. For now, Jaypee Infratech’s case is seen as one-off in the insolvency proceedings; hopefully it stays that way.