Insolvency resolution is about the allocation of losses among different stakeholders in a situation where there isn’t enough left in the pot for everyone. So far, the stakeholders at the centre of the public discourse under the new and fast evolving Insolvency and Bankruptcy Code (IBC) have been banks, trade creditors, promoters, workmen, employees and minority shareholders. The Supreme Court’s order in the Chitra Sharma v. Union of India case earlier this month has brought attention to the rights of a new group of stakeholders — consumers who have made advances on goods or services that are yet to be delivered.

In this case, the petitioners, who are homebuyers, submitted that insolvency proceedings against the real estate developer, Jaypee Infratech, would put on hold their cases in consumer forums, while not providing them any remedy in the insolvency resolution process under the IBC. The Supreme Court has responded by allowing the insolvency proceedings to continue, but with conditions.

Among other things, it has asked Jaypee Associates, the parent company of Jaypee Infratech, to deposit Rs. 2,000 crore with the Court by October 27. It has ordered the IRP to present, within 45 days, a resolution plan that will protect the interests of both homebuyers and creditors. Further, it has appointed an amicus who will participate in creditors’ committee meetings on behalf of the homebuyers.

Onus on IRP

Despite the Court speaking at length on protecting the interests of homebuyers, its order provides little guidance on the specific relief they would get as it is silent on the priority to be accorded to homebuyer dues in relation to dues owed to other creditors. The Court has not acceded to the petitioners’ request to treat homebuyers at par with banks nor has it specified whether the Rs. 2,000 crore deposit will be used solely to meet homebuyer dues.

As things stand, the Court has entrusted the resolution professional with the task of protecting both “homebuyers’ and creditors’ interests,” but with little guidance on how to do so given the limited pool of assets available for distribution to all parties.

This case raises the broader policy question of how to deal with consumer prepayments of all kinds, not just in the context of real estate transactions, in the event of company insolvency. In most common law jurisdictions, this has been a subject of extensive deliberation. The U.K., Australia and Canada continue to treat consumer prepayments as general unsecured credit.

The one exception to this is the U.S., which accords consumer deposits a priority over taxes and other unsecured claims, but only up to an amount of $ 2,600.

However, in all these jurisdictions, while consumers get limited or no special protection under insolvency law, they are provided timely and effective remedies through well-enforced contracts and consumer protection legislation.

In India, by contrast, the civil and contract related remedies available to consumers suffer from delays and poor recoveries. For this reason, the IBC, which offers a time-bound resolution, may be considered as a mechanism to provide some relief to consumers. However, the pros and cons of the possible designs for doing so need to be considered.

First, the size of consumer prepayments varies greatly across industries, and according similar insolvency protection to all of them may not be feasible. For example, the quantum and nature of protection accorded to homebuyers may differ vastly from that accorded to buyers of pre-paid gift vouchers from retailers.

A possible design may be to accord preferential status, similar to workmen and secured creditors, to consumers in sectors where their prepayments form a large part of overall company indebtedness.

However, this will likely lead to a clamour from consumers in more and more sectors to bring themselves on to this list. Further, as the list of preferential creditors expands, other creditors’ recovery rates will suffer, and this may show up as lower credit allocation and higher interest rates to firms in these sectors.

A second design is to retain consumer prepayments in a specified trust to prevent misuse of funds, and make these bankruptcy remote. For example, the newly promulgated Real Estate Regulation and Development Act, 2016 (RERA) requires developers to place 70% of customer advances in a project-specific escrow account and refund any such advances, with interest, if the property is not delivered as per terms of the sale agreement. Perhaps, the way forward is to amend RERA and other sector-specific legislation to extend these consumer protection provisions to cover insolvency events.

Cost to firms, consumers

However, while this appears to be an ideal solution from the consumers’ point of view, for firms it reduces the availability of business capital and increases costs, which would ultimately be transferred to consumers.

A third possible design is to require firms or sectors with large values of consumer prepayments to get insurance cover for these. But, this will require the insurance market for such products to evolve organically, before it becomes a credible consumer remedy.

For the Court and policymakers charged with thinking about consumer rights, it is important to remember that making the IBC the primary mechanism for providing consumer relief will come at a cost. This cost will be in the form of lower recoveries for other creditors in the short run, and an impact on credit market development in the long term.

For this reason, rather than placing the entire burden on the IBC, improving the accessibility and effectiveness of civil and consumer protection remedies, which provide relief much before the commencement of insolvency, may be a more effective strategy.

(Aparna Ravi is counsel at Samvad Partners and Anjali Sharma is a researcher at the Finance Research Group at the Indira Gandhi Institute of Development Research. Views expressed here are personal.)

In other countries, consumers get effective remedies through consumer protection laws

UnsecuredCredit – BingNews