Challenges posed by insolvency in real estate sector

The status of a homebuyer has been alleviated to the status of the financial creditor and can bring proceedings against the alleged defaulter.

Published: 05th April 2022 01:22 AM  |   Last Updated: 05th April 2022 01:22 AM   |  A+A-

Real Estate

For representational purposes

Whenever a real estate project is stalled or the property developer is taken to court for default in payments, it is the homeowners—who have made deposits—who suffer. These cases have seen a sharp rise since the Insolvency and Bankruptcy Code has been rolled out, giving creditors, often the lead bank, a room for a proceeding against the real estate developer in the Tribunals. The status of a homebuyer has also been alleviated to the status of the financial creditor and can bring proceedings against the alleged defaulter. But for this, vide IBC (Amendment) Act 2020, there is a de minimis threshold that has been introduced. According to the amendment, 10% of the allottees have to come together to file a petition for insolvency against the property developer under the IBC. Other remedies such as under the Consumer Protection Act remain open.

Therefore, the rights given to allottees are not without limitations. The trials at court are long, tedious and costly. Starting a petition does not guarantee a proper or desired result, leaving the depositors disappointed or hanging.

Recently, the Union Bank of India petitioned against Supertech for a default in payments. It is clear that insolvency is not usually a direct result of default of payment due to illiquidity but can also be a consequence of violation of regulations that bind the real estate developer, such as this case. This is just one of many cases; a lot of developers are either under scrutiny by the banks or the allottees (or some of them) are soon going to be declared insolvent. The Covid-19 pandemic has just exaggerated the problem in many ways, putting financial pressure on both the allottees and builders.

So the policy question is that, if there is a requirement of separate procedures for real estate insolvencies for the benefit of the allottees, should there be adequate pre-insolvency measures? Or should the preference be for pre-packs or other alternative dispute resolution procedures?

Pre-insolvency procedures should be made effective and the resolution of a company in the twilight zone should start much earlier; we should not wait for it to fail. The possibility of introducing a depositors’ insurance can also be explored, which will give the depositors at least a reassurance for putting their money as an investment in real estate. Of course, the policy conditions will have to be watertight.

The problem has to be dealt with sufficient immediacy, so perhaps devising a new procedure is not possible in this area. But devising a new procedure of resolving debts should not be discarded for other fields such as insolvency of banks and financial institutions.

Coming to Alternative Dispute Resolution methods that can be used, mediation is already being considered as one of the best for such disputes, absent any arbitration clause. But there is always a power imbalance in case the allottee is the one bringing the petition and not the lender.

Still, this method should be religiously considered because this will not only save a lot of costs but also a lot of time; and narrowing of the issues that the parties have, the saved costs can lead to increase in value that may be distributable according to the priorities. Since depositors are treated as financial creditors, they will have rights equivalent to those such as banks.

Pre-packs will have a debtor-in-possession model in insolvency and there is always a risk of the related party misusing this method for deliberately causing losses to the company, only to let it be bought out by a related party at an undervalue. This can be overcome by procedures such as The Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2021 that have been introduced in the UK, which qualify a substantial disposal only when consent of the creditors has been taken or an independent evaluator sends a report for the same.

There can also be different permutations and combinations of reforms in this area, like RERA could keep a check on compliance by the developers through an annual filing system and depositors should get access to the same upon request.

This problem is not transitory and will have a wider economic impact because the big names in this area such as Jaypee and Supertech have failed/are failing. Therefore, steps are needed to protect the allottees and value of the company to tackle this problem while keeping the goals of IBC in mind.

That is not to say that IBC has failed in addressing the problems, but the procedure for the allottees is novel with restrictions and its efficacy is yet to be seen. While the system is tested against practical realities, the allottees who have deposited money should not be left with an outcome that is uncertain.

Kavya Lalchandani

Legal scholar based out of UK



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