The Shifting Boundary of Financial Debt in Real Estate
Introduction
There has been significant uncertainty under the Insolvency and Bankruptcy Code, 2016 (“IBC”), when it comes to the classification of real estate investors offering “assured returns” as a financial creditor defined under section 5(7). While Section 5(8) of the IBC, explicitly defines “financial debt” as a debt along with interest, if any, which is disbursed against the consideration for the time value of money. The core element of it being made against ‘consideration for the time value of money.’ It is this qualitative character of the transaction that distinguishes a financial debt from other liabilities. The pivotal distinction between a financial creditor and an operational creditor underlines the criticality of this classification.
This blog presents that the tribunal has gradually shifted from an objective test based on the commercial effect of borrowing to a subjective test where the intent of the purchaser to take such possession is examined. Since this subjective test approach lacks a clear statutory foundation, it often leads to uncertainty. The emphasis is on the economic substance of the transaction, as Section 5(8) deals with funds that are advanced with an obligation of repayment, along with a return that compensates for the passage of time. It is necessary to understand this distinction because only financial creditors can initiate Corporate Insolvency Resolution Process (“CIRP”) under Section 7 of the IBC. The distinction between a financial creditor and other stakeholders is essential in the IBC because it is not only concerned with the procedural aspects but it also directly affects the voting share in the resolution process and participation in the committee of creditors. Misclassification certainly has direct consequences for the allocation of control and value within insolvency proceedings.
This blog argues that the introduction of an intent-based “speculative investor” test is doctrinally inconsistent and uncertain and that classification must instead rest on objective indicators of financial debt, which include disbursement against the ‘consideration of time value of money’.
Judicial Expansion: Assured Returns as Financial Debt
In the landmark case of Nikhil Mehta and Sons (HUF) v. AMR Infrastructure Ltd., 2017, Hon’ble National Company Law Appellate Tribunal (“NCLAT”) observed that the allottees were considered as ‘financial creditors’ within the ambit of Section 5 (7) of the IBC when the commercial effect of borrowing existed in assured return schemes. The presence of committed returns, reflected as financial costs in the corporate debtor’s accounts, demonstrated the commercial effect of borrowing.
More importantly, in Anil Mahindroo and Ors. vs. Earth Iconic Infrastructure (P) Ltd., the NCLAT decided the merits of the case, addressing that advanced payments done for a property under a Memorandum of Understanding (“MOU”) with ‘a committed return plan’ would qualify as financial debt as per Section 5(8)(f) of the IBC.
The reasoning observed in the case of Pioneer Urban Land and Infrastructure Ltd. vs. Union of India is central to present analysis. The apex court clarified that under real estate agreements the amount paid by the homebuyers would qualify as financial debt under the ambit of Section 5(7) of the IBC when the transaction has the commercial effect of borrowing satisfying the requirement of ‘consideration for the time value of money’ as established by the courts. The Supreme Court noted that the developers often rely on such advances as a source of capital, thus satisfying the requirement of the time value of money. This case provides an objective framework against which later subjective intent approach can be critically assessed. Thus, this decision reinforces the doctrinal basis for assessing assured returns through objective indicators such as disbursement, time value of money.
Moving further National Company Law Tribunal (“NCLT”) Delhi in a notable case of Anubhuti Aggarwal Versus DPL Builders P. Ltd, reinforced this approach that when an agreement involves monetary transaction where the corporate debtor receives funds and agrees to repay the same with interest while considering ‘value for the consideration for the time value of money’ as per Section 5(8) of the IBC such agreement constitutes “financial debt.” In this case, the major conflict was that even though the agreement mentioned the transfer of the flat, the corporate debtor failed to repay the money. Hence, the transaction was not a purchase of an immovable property, but rather a financial transaction. Thus, any investment which is coupled with a promise of assured returns that satisfied certain conditions constituted a ‘financial debt.’ Consequently, the investor was a ‘financial creditor’ who could initiate the insolvency process against the corporate debtor on the occurrence of a default.
Similarly, in Neelam Singh Versus Mega Soft Infrastructure P. Ltd, NCLT Delhi held that such circumstances where a company receives money and promises assured returns in the form of periodic interest payments qualify as having the commercial effect of a borrowing. Hence, the debt is a "financial debt" under Section 5(8)(f) of the IBC, and the investor is a "financial creditor."
These decisions collectively establish that assured return arrangements operate as debt instruments in substance, thereby aligning real estate funding practices with the statutory conception of financial debt.
Judicial Retreat: The Speculative Investor Doctrine
The subsequent jurisprudence represents a departure from the earlier substance-based approach but it was not a uniform development across all tribunals. NCLT decisions reflect its first instance application, but NCLAT decisions, as appellate authorities, carry greater weight in establishing the subsequent doctrinal shift. In the case of Mrs. Nidhi Rekhan Vs M/s. Samyak Projects Private Limited, Hon'ble NCLAT noted that the applicants were merely speculative investors who were interested in the recovery of assured returns and had no genuine allottees to buy the units for actual possession. Thus, they did not act as financial creditors, and CIRP cannot be initiated by them.
Moving further, NCLAT held in the case of Rajesh Alfred vs. Ketsaal Retail LLP that the reseller agreement was structured in a way where profit margins were contingent on business outcomes rather than loan repayments, so it did not qualify as financial debt. The case provided further clarity that assured returns would not qualify as financial debt if it lacks the element of ‘consideration for the time value of money’, reinforcing the NCLAT’s role in refining the doctrinal test.
Indian jurisprudence presents a list of contrasting authorities as well. In the case of Nikhil Khanna and Ors. vs. Spaze Towers Private, NCLT Chandigarh dismissed the application, and the Tribunal asserted that investors who are seeking ‘assured returns’ on commercial property without any genuine intent for possession will be considered speculative investors and not ‘financial creditors’.
Additionally, NCLT Chandigarh in the case of Ravi Luthra and Ors. vs. Vatika Limited, while dismissing the application, upheld the same principle that claimants who are seeking assured returns without any genuine interest in property would not be considered as financial creditors as per Section 5(8) of the IBC, but rather as speculative investors, and they cannot initiate the CIRP process.
These decisions mark a judicial retreat from the earlier substance-based approach by introducing the notion of the “speculative investor” as a category distinct from a financial creditor.
Doctrinal Inconsistency Observed
The jurisprudence reveals three tests distinguishing financial creditors from speculative investors, with NCLAT decisions reinforcing the doctrinal shift. Firstly, whether the return compensates for the passage of time. Secondly, the commercial effect of borrowing, meaning thereby whether the developer used the funds as finance. Thirdly, whether the investor intended to take possession. The third test lacks a statutory framework backing, and this intent-based inquiry has given rise to inconsistency. The distinction is necessary as a major concern exists that the IBC should not become a recovery forum.
The concern is legitimate because IBC is not intended to function as an ordinary debt recovery mechanism. A creditor cannot invoke the insolvency mechanism merely as a coercive means of recovering an investment when the underlying transaction does not qualify as financial debt or no default has occurred. So, the safeguard against misuse should lie in the objective test whether the transaction fulfils Section 5(8) of the IBC by disbursement against the ‘consideration of time value of money’, rather than introducing an additional inquiry to determine whether the investor intended to obtain possession. Assessing debt based on perceived intent not only departs from the statute but also excludes creditors whose claims are indistinguishable from other forms of financial lending.
Conclusion
The jurisprudence on assured return schemes in the real estate sector demonstrates that such arrangements cannot be dismissed as mere contractual obligations. Hence, in appropriate circumstances, it can be understood that in real estate, assured return arrangements qualify as financial debt under Section 5(8) of the IBC and the corporate insolvency resolution process could be initiated by the financial creditors. Early decisions, notably Nikhil Mehta v. AMR Infrastructure and subsequent cases, reflect a substance-oriented approach which is focused on the economic character of the transaction. Most importantly, the apex court in Pioneer Urban Land and Infrastructure Ltd. vs. Union of India provides the foundation by directing attention towards commercial effect of borrowing of the transaction. This supports an objective assessment to determine whether a transaction carries the characteristics of financial debt rather than assessment based primarily on the subjective intention of the allottee.
The courts and tribunals were concerned with recognising that the advances made to developers with a promise of a fixed return had the commercial effect of borrowing, thus satisfying the statutory requirement of ‘time value of money’. But the primary shift towards an intent-based speculative investor doctrine risks displacing the statutory focus on the time value of money and has led to uncertain and inconsistent outcomes which require careful scrutiny. By requiring proof of a genuine intent to take possession, tribunals have introduced a criterion that finds no statutory framework backing, which in turn leads to doctrinal inconsistency. The courts look beyond contractual frameworks to protect the interests of genuine investors.
The doctrinal distinction appears to be motivated by a legitimate policy concern that the IBC should not be reduced to a mere recovery mechanism for investors seeking to enforce assured returns, even though the code already contains structural safeguards against such misuse. Accordingly, preventing misuse of the IBC should not be achieved through a subjective inquiry into the investor’s intent to obtain possession but through rigorous application of the statutory requirements of financial debt and default.
*The author is a Fourth-year B.A., LL.B. student at Chanakya National Law University .
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