Insolvency in Real Estate Sector: Issues and Challenges
Student of the Post Graduate Insolvency Programme at IICA
Overview of the Indian Real Estate Sector
- The Real Estate sector in India is an important pillar of economy, with significant forward and backward correlations. According to an estimate, close to 50% of India’s Gross Domestic Product (GDP) is linked with the domestic real estate sector.
- While the government has focused on promoting India as a global manufacturing hub, the contribution of the domestic real estate sector in employment creation, adding real economic value, and its spillover effect on different industries is generally not considered.
- According to conservative estimates, nearly 7 crore Indians are working in the real estate sector as of 2022, with the overall sector expected to cross the $1 trillion mark by 2030.
- With more than 270 allied industries being dependent on the real estate sector for business sustenance, this important sector has an important add-on effect along the entire supply chain. Examples of important ancillary service sectors include design, contracting, facility management, leasing, and property consultation. Key supply industries include steel, cement, timber, and construction materials.
Insolvency in Real Estate Sector
- The real estate industry has seen a lot of companies undergoing insolvency. According to the data provided by the IBBI, out of 2,298 CIRP cases, 518 cases pertain to real estate sector. It is of significance that only 78 out of 611 approved resolution plans belong to the real estate It is implied that the despite the fact that the allottees have not fared much better under the Code, real estate remains the second biggest sector in which CIRP has been initiated.
- Initially, the Insolvency and Bankruptcy Code, 2016 (“Code”) did not have any specific provision dealing with the rights of allottees of real estate projects. Subsequently, in pursuance of judicial pronouncements holding that advances made by allottees have the commercial effect of borrowing, Section 5(8)(f) of the Code was amended in 2018 to specifically include allottees as ‘financial creditors’.
- This entitled allottees to initiate Corporate Insolvency Resolution Process (“CIRP”) against a defaulting real estate developer as well as participate in the meetings of Committee of Creditors (“CoC”) of such developer. Thereafter, Section 7 of the Code was further amended in 2020 to specify a threshold for allottees to initiate CIRP to limit frivolous applications. Despite these legal provisions, a poor success rate has hindered the prompt and efficient resolution of stressed real estate projects.
- There is a lot of policy uncertainty in the legislation when it comes to insolvency in the real estate business. Despite multiple amendments, allottees have largely been on the margins in the CIRP of real estate companies.
- Pertinently, in some quarters, it is felt that the Code may not be the best mechanism to resolve manifold grievances of allottees, and authorities such as Real Estate Regulatory Authority (“RERA”) may be better suited for the purpose. The rights of allottees under RERA and the rights of creditors under the Code, however, may need to be balanced by the legislation.
Challenges in CIRP of a Real Estate Company
- The fact that Financial Creditors (“FCs”) contain several allottees and necessitate lengthy deliberations and consensus-building processes within the CoC is one of the factors contributing to the low success rate of insolvency resolution in the real estate industry.
- Information asymmetry is a further issue that creditors, particularly allottees, frequently deal with. The majority of allottees are unable to submit their claims on time because they are not aware of how the Code operates and how time-sensitive it is.
- Additionally, in the majority of the cases, allottees do not even reside in the area where the real estate project is being undertaken, therefore, they are not even aware of the status of the project. Since, only a newspaper with a wide distribution in the region where the CD’s (“Corporate Debtor”) registered office is located is used for the public announcement of the CD, Section 15 of the Code becomes redundant. Due to this, the allottees frequently approach the NCLT at a later stage to request the inclusion of their claims. This hinders the CIRP, undermines the “time bound” objective of the Code, and shoots up cost of CIRP.
- Allottees as a class of FCs are numerous and a heterogeneous group. Unlike other FCs whose aim is to maximize recovery, allottees are more interested in the completion of the project and possession of their property.
Project Wise Insolvency
- This approach does not address the complexities such as applicability of the moratorium at the entity level as opposed to project level and dealing with claims of entity-level creditors.
Split Judicial Opinions
- The NCLAT has made it abundantly clear in Umang Realtech’s  ibclaw.in 166 NCLAT  judgment in which the idea of “reverse CIRP” was pioneered that the moratorium is only applicable to the specific project undergoing CIRP and not to the other projects of the developer.
- This is contrary to the stance taken by the NCLAT in the insolvency of Supertech Limited (2022) ibclaw.in 455 NCLAT , wherein it was held that the moratorium is applicable to the CD as a whole.
Transfer of Property Act, 1881
- According to the Act, a buyer is entitled to a charge on the property to the extent of the purchase money paid by her along with interest. This statutory right provided to a buyer is subject to a contract to the contrary.
- Therefore, in the absence of a specific waiver by the buyer in the agreement for sale, the buyer would have a charge on the property. In general, such a specific waiver by the buyer is not included in builder-buyer agreements or the model form of agreement for sale recommended by the majority of RERAs, including in Maharashtra.
- This right of allottees does not appear to have been regarded by any judicial pronouncement and allottees are continue to be treated as unsecured creditors under the Code.
MCA Discussion Paper
- The amendments proposed by the MCA seek to provide a specialized resolution framework for real estate projects, where project wise resolution will be permitted. It is also proposed that the RP will be empowered to transfer ownership and possession of completed units to the allottees during the moratorium, with the consent of the CoC.
- It is not clear how the issues pertaining to applicability of moratorium at the entity level as opposed to project level and claims of entity-level creditors will be dealt with in the proposed amendments.
- Further, there is an apprehension that errant promoters can take advantage of these provisions by pushing projects which are commercially unviable for them into insolvency without impacting their other projects.
Way Forward & Suggestions
- One of the measures which may be considered under RERA to improve the outcome for allottees is adoption of a conciliation mechanism by all RERA authorities.
- RERA empowers the RERA authorities to take measures to facilitate amicable conciliation of disputes between the developers and the allottees. However, such conciliation forums have been set up only in a few states, such as Maharashtra and UP.
- Permitting allottees to initiate insolvency action and participate in the CoC is empowering but not necessarily effective for getting their homes or recovering their dues.
- The legislature must urgently enact substantive and procedural changes to address project-wise insolvency. To enable NCLTs to separate projects of the CD and admit only those projects that justify insolvency, while leaving other projects outside the scope of the Code, specific provisions/regulations should be introduced to the Code.
Information Asymmetry to be Addressed
- It should be made mandatory for the IRP/RP to take proactive measures to get in touch with allottees and inform them about the start of CIRP. In this regard, explicit rules should be introduced.
- Additionally, it is necessary to amend Section 15 of the Code read with Regulation 6 of the CIRP Regulations to ensure that the public announcement of the commencement of CIRP does not only include newspapers with large circulations but also other forms of mass media such as news channels.
Specialized NCLT Benches
- Administrative measures, such as establishing specialized NCLT Benches for real estate companies, will also go a long way toward ensuring quicker and more effective solutions.
- The Code’s performance may not be as optimistic as one would have expected it to be. However, it has fared significantly stronger than the previous attempts. The Code ushered in a cultural transformation, and cultural changes demand perseverance. It is still a work in progress in that regard. To achieve the best results from the process, all of the different parties, including the government, the regulator, the courts, the creditors, and the corporate debtors, must cooperate.
 How the Indian Real Estate Sector drives the Nation’s Economy, Published by Financial Express on 21.03.2023
 Quarterly Newsletter released by IBBI (Oct-Nov 2022)
 Section 55(6)
 Discussion Paper released by Ministry of Corporate Affairs on 18.01.2023 inviting comments on changes proposed to the Code.
 Section 15: Public announcement of CIRP
 Regulation 6: Public Announcement
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