Supreme Court Rules on Real Estate Insolvency: Key Takeaways

The tension between a real estate developer’s plea to save a project and a lender’s right to recover dues has been a recurring theme in Indian courts. On Thursday, the Supreme Court delivered a landmark judgment that has significant implications for the real estate sector. The verdict, given by a bench comprising Justices J B Pardiwala and R Mahadevan in Elegna Co-op. Housing and Commercial Society Ltd. v. Edelweiss Asset Reconstruction Company Ltd., clarifies two critical questions: Can a builder avoid insolvency by claiming the project is ‘substantially complete’? And can a housing society intervene at the outset to stop the insolvency process?

The dispute centered on a residential-cum-commercial project in Ahmedabad called “Takshashila Elegna,” developed by Takshashila Heights India Private Ltd. The developer had taken loans worth Rs 70 crore but defaulted on repayments, leading to the account being classified as a non-performing asset. The debt was eventually assigned to Edelweiss Asset Reconstruction Company. After a failed restructuring attempt, Edelweiss approached the National Company Law Tribunal (NCLT) to initiate the corporate insolvency resolution process under Section 7 of the Insolvency and Bankruptcy Code (IBC). Section 7 allows a financial creditor to initiate insolvency proceedings against a corporate debtor if a default occurs.

The NCLT initially dismissed Edelweiss’s plea on the basis that the project was ‘viable and substantially complete’ and that pushing the company into insolvency would only hurt the homebuyers. However, the National Company Law Appellate Tribunal (NCLAT) overturned this, ordering the insolvency process to begin. This led to appeals before the Supreme Court by the developer and the Elegna Co-operative Housing Society – whose plea for getting added as a party in the matter had been rejected by the NCLAT.

‘Viability’ Defence

The primary argument raised by the developer was that the insolvency petition was a pressure tactic for recovery rather than a genuine attempt at resolution. It argued that since the project was nearly finished and had enough unsold inventory to cover the debts, the court should use its discretion to deny insolvency. The developer relied on the Supreme Court’s 2022 judgment in Vidarbha Industries which had suggested that the NCLT has the discretion to keep a company out of insolvency if there are valid reasons, even if a debt exists.

However, the Supreme Court rejected this argument. The bench clarified that the Vidarbha Industries ruling was an exception based on specific facts and not a general rule. “The inquiry under Section 7(5)(a) is confined strictly to the determination of debt and default, leaving no scope for equitable or discretionary considerations,” Justice Mahadevan wrote in the judgment. The court held that once a debt and a default are established, admission into insolvency is mandatory. “Considerations such as ongoing operations, partial project completion, or anticipated receivables are extraneous to the statutory mandate,” it noted.

The court emphasized that assessing the financial health or business prospects of a company is not the job of the tribunal at the admission stage but that of the Committee of Creditors (CoC) – a body consisting of financial lenders who take control of the debtor company’s administration during the insolvency process. “The commercial wisdom of the Committee of Creditors is paramount and is not ordinarily amenable to judicial review,” the Court observed, adding that questions regarding feasibility “fall squarely within the domain of the CoC, and cannot be examined at the threshold stage.”

Can a Housing Society Intervene?

The second major issue that the court ruled on was regarding the role of the Elegna Co-operative Housing Society. The society argued that as a representative body of the homebuyers, it had a right to be heard before the insolvency process began as the outcome would directly affect its members. The apex court upheld the NCLAT’s decision to reject the society’s intervention, drawing a distinction between individual homebuyers and a maintenance society. Under the IBC, individual homebuyers are classified as “financial creditors,” but a housing society – usually formed for maintenance – is not.

“A society is a distinct juristic entity separate from its members,” the court held. “Unless it has itself advanced funds, executed allotment agreements, or received allotments, it cannot claim financial creditor status.” The court explained that the initial stage of filing an insolvency petition is a proceeding in personam – a private dispute between the creditor – Edelweiss – and the debtor – Takshashila. “Proceedings under Section 7 are essentially bipartite at the admission stage,” the court ruled. “Unrelated third parties including other creditors, have no independent right of audience at this stage…”

The court cautioned that allowing societies to intervene would create an “extra-statutory layer” of representation. “It would also enable errant corporate debtors to obstruct and delay insolvency proceedings under the guise of purported collective interests,” it noted.

Safeguards for Homebuyers

Along with strictly enforcing the insolvency code, the judgment acknowledged the vulnerability of homebuyers. The bench clarified that “the fundamental object of the IBC is resolution and revival, and not mere recovery.” To ensure homebuyers are not prejudiced by the decisions of big lenders, the court issued specific directions to the CoC to act with transparency.

“Any extraordinary or non-routine decision taken by the CoC must … be supported by cogent reasons duly recorded in writing,” the court directed. Specifically, if the CoC decides not to hand over possession of completed units to buyers or if it recommends liquidating the company, it must “record cogent and specific reasons” for doing so. The court also mandated that the information memorandum – a document containing key details about the corporate debtor for potential bidders during the insolvency process – must “mandatorily disclose comprehensive and complete details of all allottees.” This would ensure that even though a housing society cannot intervene at the start, the individual homebuyers are recognized and their interests recorded once the process begins.