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The Insolvency and Bankruptcy Code (IBC) was enacted in the year 2016, in response to the growing number of non-performing loans. Its objective was to create a comprehensive structure for resolving insolvency issues of corporations, partnership firms, and individuals within a set timeframe. The IBC acknowledges two types of creditors: financial creditors and operational creditors.

Financial Creditor:

Section 5(7) of the IBC states "financial creditor means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred to."

Under Section 5(8) of the IBC, a financial debt is defined as: 

"financial debt means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes-

(a) money borrowed against the payment of interest;

(b) any amount raised by acceptance under any acceptance credit facility or its de-materialised equivalent;

(c) any amount raised pursuant to any note purchase facility or the issue of bonds, notes, debentures, loan stock or any similar instrument;

(d) the amount of any liability in respect of any lease or hire purchase contract which is deemed as a finance or capital lease under the Indian Accounting Standards or such other accounting standards as may be prescribed;

(e) receivables sold or discounted other than any receivables sold on non-recourse basis; 

(f) any amount raised under any other transaction, including any forward sale or purchase agreement, having the commercial effect of a borrowing;

(g) any derivative transaction entered into in connection with protection against or benefit from fluctuation in any rate or price and for calculating the value of any derivative transaction, only the market value of such transaction shall be taken into account;

(h) any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or financial institution;

(i) the amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub-clauses (a) to (h) of this clause;"

Operational Creditor:

Section 5(20) of the IBC states "operational creditor means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred;"

Under Section 5(21) of the IBC, "operational debt means a claim in respect of the provision of goods or services including employment or a debt in respect of the payment of dues arising under any law for the time being in force and payable to the Central Government, any State Government or any local authority;"

Rights of operational creditors and financial creditors in insolvency proceedings:

Voting Rights: The outcome of an insolvency case is significantly influenced by the Committee of Creditors (COC). The COC wields substantial authority throughout the Corporate Insolvency Resolution Process (CIRP), as they are responsible for selecting a Resolution Professional and endorsing a bid proposal. The COC consists solely of financial creditors, and not operational creditors. This particular aspect of the Code has been the subject of numerous criticisms from experts and stakeholders, primarily because operational creditors do not have representation within the COC.

Priority in the Waterfall Mechanism: The Waterfall Mechanism is the priority list of asset distribution during liquidation proceedings. The Code specifies the following priority list for distributing assets during liquidation:

• Cost of liquidation;

• Secured creditors and workmen payments;

• Pending wages of employees;

• Unsecured creditors;

• Dues to the government and unpaid amount to secured creditors;

• Operational creditors and unpaid amount to unsecured creditors;

• Preference shareholder; and

• Equity Shareholders or Partners.

This mechanism clearly demonstrates that operational creditors are near the bottom of the payment priority list. In most insolvency cases, very few assets remain by the time it reaches the stage of payment to operational creditors. 

Rights of Property Buyer under IBC:

The Insolvency and Bankruptcy Code (IBC) Act has undergone multiple amendments over the years, including the second amendment in 2018. This amendment introduced an explanation to Section 5(8)(f) of the IBC, which states that:

“(i) any amount raised from an allottee under a real estate project shall be deemed to be an amount having the commercial effect of a borrowing; and

(ii) the expressions, “allottee” and “real estate project” shall have the meanings respectively assigned to them in clauses (d) and (zn) of section 2 of the Real Estate (Regulation and Development) Act, 2016”

This means that real estate buyers who are now being treated as Financial Creditors have the right to attend meetings of the Committee of Creditors (CoC).

In the case of Pioneer Urban Land and Infrastructure Ltd. v. Union of India, 2019 SCC OnLine SC 1005, the Supreme Court confirmed the constitutional validity of the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, which provided for inclusion of ‘Real estate allottees’ within the meaning of ‘Financial creditors’ under Section 5(8)(f) of the Insolvency and Bankruptcy Code.

However, the Government of India, passed Insolvency and Bankruptcy (Amendment) Act, 2020 on March 13, 2020. Section 3 of the Amending Act, 2020 added the following provisos to Section 7 of the Code:

“Provided further that for financial creditors who are allottees under a real estate project, an application for initiating corporate insolvency resolution process against the corporate debtor shall be filed jointly by not less than one hundred of such allottees under the same real estate project or not less than ten per cent of the total number of such allottees under the same real estate project, whichever is less:

 “Provided also that where an application for initiating the corporate insolvency resolution process against a corporate debtor has been filed by a financial creditor referred to in the first and second provisos and has not been admitted by the Adjudicating Authority before the commencement of the Insolvency and Bankruptcy Code (Amendment) Act, 2020, such application shall be modified to comply with the requirements of the first or second proviso within thirty days of the commencement of the said Act, failing which the application shall be deemed to be withdrawn before its admission.”.

Prerequisites for initiating CIRP by home buyers

• The application must be filed jointly by one hundred allottees or one-tenth of the total number of allottees in the same real estate project, whichever is less. The NCLT will not consider individual claims.

• The total amount of default by the corporate debtor shall be more than Rs 1 crore; the Rs 1 crore threshold refers to the total default of the corporate debtor to any financial creditor, not just to the applicant allottees.

What to do if the builder becomes insolvent?

Buyers have the option to submit their claims using Form F, issued by the Insolvency and Bankruptcy Board of India (IBBI), which can encompass seeking reimbursement for the sum they had invested in the builder's project, compensation for any damages endured due to the non-fulfillment of their purchase agreement, or for gaining possession of the property they had paid for. However, in case of liquidation of the builder's assets, primary creditors such as banks are likely to be prioritized for payments. This may result in insufficient funds being available to reimburse the buyers adequately. Additionally, the home buyers have the option to approach the Real Estate Regulatory Authority (RERA) to seek possession or refund, as applicable.

References:

https://ibclaw.in/distinction-in-treatment-of-financial-creditors-vs-operational-creditors-by-vidushi-puri/

https://www.indiafilings.com/learn/operational-creditors-benefits-and-disadvantages-under-ibc-2016/

https://ibclaw.in/homebuyers-ibc-amendment-act-2020-four-years-two-amendments-and-journey-still-continues-advocate-jatin-rajput/

https://www.99acres.com/articles/what-if-your-builder-is-declared-insolvent.html