It’s now commonly acknowledged that India is firmly in the throes of a slowdown with many distinguished economists such as the former Governor of the Reserve Bank of India, Dr. Raghuram Rajan describing the economic situation as ‘recession’. Critical sectors of the economy such as real estate, infrastructure, automobiles and banking are going through a period of crisis in confidence. The need of the hour is to revive these sectors as these are important engines on which the economy needs to fire.
The real estate sector is a case in point. Once a net job generator, the sector is going through a lean patch with job losses, unfinished projects and litigation being the order of the day. Unable to raise adequate funding from either banks or NBFCs or others such as private equity investors, the sector is today saddled with unfinished projects worth $14 bn.
Apex Court directive queered the pitch for real estate projects
Experts believe that a key reason for this is an August 2019 Supreme Court directive which placed individual homebuyers on par with financial creditors. The Supreme Court in August 2019 dismissed 180 petitions filed by various real estate developers and upheld that homebuyers have the right to take legal recourse against developers under three key laws, that is, RERA, Consumer Protection Act and the Insolvency and Bankruptcy Code (IBC). The Supreme Court relied upon the recommendations made by the Insolvency Law Committee Report and emphasised the fact that the amounts raised from home buyers contribute significantly to financing the cost of construction of flats or apartments. The Court observed that the sale agreement between the developer and the home buyer would have the ‘commercial effect’ of a borrowing, which means that money is paid in advance for temporary use so that a flat/apartment is given back to the homebuyer. The apex court concluded that the amounts borrowed from homebuyers do qualify as ‘financial debt’ under the IBC.
In effect, this was an elevation of the status of the homebuyer from a consumer to a ‘financial creditor’ with its attendant benefits including a seat at the lenders’ table. From a corporate exposure point of view, this meant that now the financial rights of a homebuyer ranked alongside (pari passu) that of a financial creditor like a bank. The genesis of this principle stems from the legal interpretation of homebuyers as financial providers to real estate developers who in a sense have ‘borrowed’ from the home buyers.
The reason given for this change was to protect the interest of homebuyers who need to be compensated for the amount they have already paid towards the real estate project when insolvency proceedings are initiated by banks/financial institutions. A homebuyer can now initiate insolvency proceedings against a defaulting real estate developer company even if it is not before NCLT and be a part of the approval process of resolution plans or compel a liquidation of a company.
Negative for financing/lending to the sector
As a result of this important change in the legal landscape of the real estate sector, often it was found that banks had to take a haircut in terms of its recoveries from a corporate debtor as the recoverable amount from a project already in the NCLT had now also to be shared with the homebuyers. This, in turn, resulted in further financial and NBFC credit drying up for this sector as banks under strict regulatory supervision had to double down on provisioning, eroding profitability.
This also resulted in certain unintended consequences for homebuyers themselves. With individual homebuyers dragging developers to the NCLT, even solvent projects started to go sick thanks to long-winded litigation and no exit route for developers and investors who have already sunk in funds. This was mirrored in the fact that out of all the cases that arrived at the NCLT over a period of time, only 6 per cent led to a successful resolution.
One reason for this is the quality of expertise available at the level of the ‘Resolution Professional’ popularly referred to as the RP. The RP is often a designated authority with little or no practical experience in resolving stalled real estate projects. The admission of homebuyers as creditors on the high table has further queered the pitch.
RERA should be accessed to address homebuyer issues
Ironically, this is also the reason why the IBC framework may not be the right platform if the revival of a stalled project is the objective. The minuscule rate of the revival of such projects tells its own story.
Anurag Singh Thakur, Minister of State for Corporate Affairs, informed the parliament in November 2019 that since June 2018 (after getting the financial creditor status), a total 1,821 cases have been filed by homebuyers against builders under the IBC. The legal option that homebuyers now have indirectly approached the NCLT has only resulted in clogging the already stretched NCLT resulting in a humongous pipeline of piled up cases.
In certain cases, the misuse of the IBC mechanism by homebuyers is causing a delay in the construction and delivery of projects. According to CARE Ratings, a credit rating company, a total of 2,542 cases were admitted into Corporate Insolvency Resolution Process (CIRP) till the end of September 2019. In fact, several references to NCLT by single homebuyers confirm that they have sometimes used reference under the IBC as a coercive tactic.
As a platform, experts say, the RERA has enough teeth to solve the problems of the real estate sector through financing woes are beyond its remit. That said, there is enough in the legal architecture of RERA to safeguard homebuyer interest but this is not always widely appreciated.
In other words, as it stands today, by approaching the NCLT, an aggrieved homebuyer may be hastening the pace of liquidation of an otherwise solvent project as the IBC framework has its own legalities which come into play and resolution of litigation is anyway time-consuming. Rather, for aggrieved homebuyers, the RERA should be the first port of call.
The sad reality is that today, as per an estimate by Business Today, there is an unsold inventory of over 1.3 million houses in the country worth $14 bn which is more than the GSDP of Kerala, Haryana, Madhya Pradesh and Andhra Pradesh put together. That’s a slump which has already had a debilitating effect on the economy which is now in the 5percent growth orbit, down from the once lofty 7percent plus growth projections that were officially bandied about just a few quarters ago. Not surprisingly, this slump has washed away thousands of jobs with it as the construction and real estate sector once accounted for about 40 per cent of all incremental job growth in the country.
NCLT should be approached only as a class action suit with high threshold
The right given to an individual homebuyer to initiate insolvency process under IBC is, therefore, a retrograde step and impinges on the rights of lenders, suppliers, and even other homebuyers.
A homebuyer should be entitled to be considered as a financial creditor only when the real estate developer has been brought to the NCLT by its creditors (banks/financial institutions). Alternatively, the insolvency process could be allowed to be initiated by homebuyers only if agreed to by more than 75% of homebuyers of a stalled project who have not been able to resolve their differences after mediation with the company and its lending banks and financial institutions.
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