News reports suggest that the panel constituted to review the Insolvency and Bankruptcy Code has submitted its report, and one of its key recommendations is that homebuyers should be allowed a place on the “committee of creditors”, i.e. the committee which decides on all major decisions concerning a company in insolvency. The committee of creditors is especially important as it is tasked with approving the “resolution plan” for the insolvent company, a kind of charter that lays down the terms on which the company is allowed to exit insolvency proceedings. The Code currently permits only “financial creditors” (banks and other creditors who gave loans to the company in return for interest) to be a part of the committee.
The proposed move is a worrying development, and marks the gormless culmination of a fruitless battle by the buyers of flats in the Jaypee Group’s Wish Town project. Wish Town is a mammoth 1,162 acre site situated 15 miles east of Delhi, and was to boast of about 32,000 flats. Today, half-finished residential towers mark the place.
After Jaypee Infratech defaulted on its loans, it found itself being a part of the so-called “Dirty Dozen”, the 12 companies that the RBI arbitrarily sent to the National Company Law Tribunal for insolvency resolution. This sent Jaypee’s homebuyers into a tizzy, a reasonable response, considering that a company in insolvency is freed from the baggage of having to fulfil its contractual obligations. They petitioned the Prime Minister and the Supreme Court to grant them relief. Worse was to follow, with the NCLAT, the Appellate Tribunal which hears appeals from Orders of the NCLT, ruling in another case that homebuyers were neither operational nor financial creditors under the Code. To make sure that home buyers could still lodge their claims during the insolvency proceedings, the Insolvency Board, which regulates the progress of the Code, came out with a special form, ‘Form F’, for creditors who were neither operational and financial creditors to submit their claims.
None of this seems to have actually helped the innocent homebuyers. And neither will the recent proposal to make them members of the committee of creditors. In fact, such a move will end up hurting the interests of other stakeholders and defeat the intention with which the Code was enacted. There are several reasons why I say so:
1. A resolution plan that keeps the company afoot *has* to be approved by the committee within 270 days, as per the Code. Failure to abide by that timeline triggers rules that provide for a garage sale of the company’s individual assets – a costly alternative, as such a sale generally yields less returns than the sale of the company as a business. It has proved hard enough to achieve any level of consensus with only genuine financial creditors (basically banks) being on the committee. With thousands of homebuyers getting on the committee, the required supermajority for a plan to be approved will prove even more elusive.
2. The voting share of an entity on the committee of creditors is proportional to its slice of the total financial debt owed by the company. If someone owes 90% of the company’s debt, they get a 90% voting share on the committee of creditors. Thus, members that have the largest voting shares have an enormous incentive to inform themselves about the company and carefully scrutinise plans received for it before choosing how to vote – they have the power to positively influence the company’s long term prospects, and in the process maximise their own returns. The addition of thousands of homebuyers would fragment voting shares on the committee, thereby making it less likely that anybody would want to devote significant resources towards analysing the future prospects of the company and hammering out a viable plan to resolve its insolvency.
3. The Bankruptcy Law Reforms Committee, which drafted the Code, warned against including operational creditors on the committee with financial creditors. Homebuyers are ultimately creditors who have arisen during the course of the company’s operation, and are therefore operational creditors. The draftsmen reasoned that operational creditors “are neither able to decide on matters regarding the insolvency of the entity, nor willing to take the risk of postponing payments for better future prospects for the entity.” Including them on the committee is a negation of the original intent behind such a committee.
4. If homebuyers are to be included on the committee of creditors, there is no logical reason why other operational creditors should not be. Further, there is no conceivable reason why homebuyers should be included on the committee of creditors and other stakeholders such as workmen should be excluded. The working of the committee will ultimately be paralysed.
The dogged spirit with which the homebuyers of Wish Town have conducted their campaign is laudable. However, the remedy proposed by the government’s panel is worse than the disease, and will cause more harm than good. The government ought to resist the temptation to accept this recommendation and must stand true to the principles that underpin the Code.
