The treatment of home buyers as financial creditors under the Insolvency and Bankruptcy Code (IBC) framework has increased the default risk for real estate developers, especially those having legacy projects that have been delayed for long periods, said ratings agency ICRA.
As the amounts paid by home buyers now constitute a financial debt, any delay in handover of the property as per the commitments in the sale agreement can be grounds for initiating the corporate insolvency resolution proceeding under the IBC.
If admitted, the management of the company will pass on to a resolution professional and can result in a standstill in debt servicing, even if liquidity is available for the same.
“In the recent months there have been various instances of aggrieved home buyers initiating corporate insolvency proceedings against developers who have delayed project execution. The time bound nature of the insolvency process provides a limited window for developers to reach settlements with the claimants, failing which the resolution professional takes over the management,” said Shubham Jain, Group Head and Vice President, Corporate Ratings at ICRA.
According to the rating agency, even a single buyer in a single project pursuing such a remedy could put the company at risk of defaulting on loan obligations, irrespective of the liquidity position of the company.
Managing such risks will be a challenge for developers, especially those who have legacy projects where completion has been affected by factors such as weak sales, declining prices or inadequate funds.
Initially home buyers were treated neither as financial nor operational creditors under the IBC. As a result, they were unable to initiate corporate insolvency proceedings or have a say in the committee of creditors; moreover, there was lack of clarity as to their relative standing vis-a-vis the financial and operational creditors.
To address the concerns of home buyers in light of the increasing instances of project delays, the IBC was amended in June 2018 to classify home buyers as financial creditors by treating the amounts paid by them under the sale agreements as financial debt.
With this amendment, home buyers can initiate insolvency proceedings against developers who have not completed projects within the dates specified in the sale agreements.
As per the information available on the website of the Insolvency and Bankruptcy Board of India, some of the companies against whom claims were admitted in recent months include Puri Construction, Pioneer Urban Land and Infrastructure Limited, Emaar MGF Land and Vardhman Buildtech.
In some of these cases, the company was subsequently able to reach settlements with the claimants resulting in closure of the insolvency proceeding.
In another case, the company was able to obtain a stay on the proceedings from the Supreme Court. However, if such remedies are not in place before the insolvency resolution professional takes over the management, the debt servicing could be at risk as the IRP may decide to enforce moratorium on any such payments while the resolution proceedings are ongoing.
According to ICRA, new projects launched after Real Estate Development and Regulation Act (RERA) implementation may not face similar issues, since developers are taking abundant caution in committing completion dates. However, the risk of insolvency proceedings will continue to be an overhang for developers having delayed projects launched before RERA implementation.
“Granting the status of financial creditors to home buyers for the insolvency process provides an additional forum for them who have been aggrieved by project delays. However, with the focus under IBC remaining on providing recoveries to financial creditors and its effectiveness in addressing the issue of timely completion of projects remains to be seen,” Jain added.
As a solution, industry players have suggested that real estate cases brought to the National Company Law Tribunal (NCLT) should first be referred to the relevant RERA authority, since RERA has the required mechanism and infrastructure to adjudicate the case, grant compensation, and aid project completion.
In case the RERA authority is unable to resolve the dispute within a certain period, insolvency proceedings may then be initiated against the company. Such an approach would provide much required relief to developers, while simultaneously addressing the concerns of home-buyers.
Source: Economic Times, February 20, 2019