IBC and real estate: What home buyers should know

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For most Indians, buying a house is perceived as a tangible asset, which will always appreciate in value and protect them from an unanticipated financial crunch. However, it might not always be the case, especially when the construction of the house is stalled and you are oblivious about its completion. This blog covers how home buyers can make the best out of this situation using IBC proceedings.

Firstly, let’s briefly understand what gives rise to this situation i.e. stalled construction. Real estate projects are stalled due to a number of reasons – most common of them being regulatory hurdles and financial tumble. In this blog, we would be focusing on the latter, particularly, on situations when a financial crunch leads to insolvency of the developer.

An insolvent situation, in the context of real estate, arises when a developer is unable to deliver his/her project on time due to certain financial constraints and is unable to service his debt. Primary reasons for the same are improper financial management, planning and discipline. Market and sectorial trepidation may also lead to insolvency of the developer. Then, depending upon the decision of the financial creditors the project is officially declared insolvent.

Some basics of Insolvency and Bankruptcy Code

  • Section 6 of the Insolvency and Bankruptcy Code, 2016 empowers financial creditors to initiate bankruptcy resolution process in the event of a company committing a default.
  • A typical example of such a situation is when a developer defaults payment of interest or principal borrowed from banks or financial institutions.
  • Another context is when the sales agreement has to be terminated because either the developer or the homebuyer breaches the terms of agreement. Post termination, the developer is required to refund any payment made by the home buyer till the point, as directed by RERA. Failure to make this refund within stipulated time frame is also considered as a default.
  • Home buyers should be aware that a default of a minimum Rs. 100,000 is enough make the project fall under the ambit of IBC.
  • Insolvency cases in India are handled by National Company Law Tribunal (NCLT) which facilitate the resolution process.
  • As per the insolvency law, the entire resolution process is expected to be completed under 180 days, with an extension of 90 days.

At first, any average home buyer may find this situation serious and difficult to tackle. However, it should be noted that IBC has made various provisions for the convenience of the financial creditors, which include home buyers.

Some of these provisions and rights that home buyers are entitled to during the insolvency proceedings include:

  • Status of financial creditors – In 2018, it was decided to give the status of ‘financial creditor’ to home buyers. It was decided that money collected from them has a commercial impact similar to other borrowings. Thus, home buyers can form a Committee of Creditors (CoC), initiate the insolvency proceedings and have ‘voting rights’ during the resolution process.
  • Distribution of cash flow – In case of liquidation, there are various other financial creditors like operational creditors and secured creditors who may take precedence in cash flow positions over home buyers. It is however, not clear, as to where home buyers will be placed when it comes to liquidation.
  • Option of forensic audit – As per NCLT, 51% vote of CoC is sufficient to initiate forensic audit on the company under the insolvency net.

Points to keep in mind

  • Passing a resolution – In order to pass a resolution, a minimum threshold of voting by CoC is required. As mentioned in the previous point, home buyers might not be the only creditors in the committee, hence consensus from other creditors is crucial. The voting threshold is generally 51%. But certain imperative decisions like appointment of resolution professional, approving resolution plan, etc. requires a minimum threshold of 66%.
  • Implicit legal costs – The legal cost involved in the process of insolvency proceeding is something home buyers should not ignore. It includes application fees, fee payable to insolvency professional, liquidator, lawyer, preparation of legal documents, etc.
  • Time consuming and cumbersome – Certain cases might take longer (more than 270 days) to resolve. The legal proceedings and consensus among the creditors might require additional time to delve a little deeper, depending from case to case.

IBC will guide you home!

According to a news report, 235 companies in real estate sector have filed for insolvency, until December 2018. From these 235 companies, the proceedings of 87 companies have been completed. Insolvency and Bankruptcy Board of India (IBBI) has been continuously working towards improving the effectiveness of insolvency code. Allowing insolvent companies to borrow abroad (external commercial borrowing), implementing need for approval from the Competition Commission of India (CCI) before finalizing resolution plans and excluding time taken by litigations in the 270 days limits are some of those pro-active measures.

Furthermore, a memorandum of understanding (MoU) has been signed by the IBBI and Securities and Exchange Board of India (SEBI) to improve the implementation of insolvency code. Ministry of Housing and Urban Affairs has suggested Ministry of Finance to create a ‘special fund’ to provide financial assistance to stressed projects. This fund will have the potential to provide interim relief to thousands of home buyers and lenders.

The stressed real estate fund market is gaining a lot of traction in India. Many investors such as ASK, HDFC, etc. are planning special funds with a primary objective of investing in stressed real estate projects. National Buildings Construction Corporation (NBCC) is also taking part in the resolution process of real estate developers. Going forward, more such developers and investors are expected to enter this market providing relief to home buyers!

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