Legal preparatory for real estate developers

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COVID-19 may be the last straw that broke the camel’s back. It came at a time when pundits had started predicting a beleaguered Gross Domestic Product (GDP) of 2.5 per cent. With a whopping 14 pc of the workforce being employed in real estate and construction sector, the recent Government directives against deduction or withholding of wages/salaries have pushed the industry into a corner. Add to this, a startling default of 65 per cent in installment payments by homebuyers as reported in the media. Commercial real estate too is tethering on the edge. In this background, a little legal homework is always helpful.

Obligations of a flat purchaser  

The essence of The Real Estate Regulation & Development Act, 2016 (RERA) is to usher in a healthy real estate sector. So far it has been viewed from a very narrow prism as to how errant developers can be brought to book. However, Rera is balanced enactment. The payment obligations of flat purchasers are most sacrosanct. Under Section 19 (6) of Rera, a flat purchaser is bound to pay the price as per the terms of the agreement for sale, municipal taxes, maintenance charges etc. etc. Failure to honour such monetary payments attracts interest under Sub-Section (7) of Section 19. It may be noted that the speedy dispute resolution machinery available to the flat purchasers, under Rera, is equally available to the developers.

Fools rush in where angels fear to tread. Often drastic measures have unintended consequences. The flat purchasers may harden their stand on timelines for possession notwithstanding force majeure.  Instead of invoking Sections 19 (6), and 19 (7), a more dynamic approach may be helpful. Developers may consider renegotiating the terms of the agreements for sale in view of the dramatically changed circumstances.  It may lead to a win -win situation for both.

The benefits of good drafting cannot be underestimated. Typically, agreements for sale of under construction properties have many in-built clauses for passing on cost-escalations beyond a certain threshold to the flat purchasers. In case the drafts have fallen short, Covid 19 may have been an expensive lesson. The rumblings are more acute in commercial real estate.

Commercial real estate :

Force Majeure is being cited for stoppage of rent by retailers across malls. Those tenants whose lock-in period has expired may immediately break the leave and license agreement or lease and seek refund of the security deposit. Moreover, in Maharashtra, should a mall owner seek eviction of the retailer/licensee on whatever grounds, he is bound to approach the Small Causes Court. The landmark judgment Carona Limited Vs Sumangal Holdings pronounced by the Bombay High Court on April 25, 2007 based on the apex court’s earlier judgment [Re: Natraj Studio (P) Ltd. v. Navrang Studio AIR 1981 SC 537] cemented the law on the matter of the correct forum. However, to compound the confusions, for refund of the Security Deposit retailers can invoke the arbitration clause that most leave and license agreements contain.

Nevertheless, the tenants that are presently locked-in, have made out a strong case for waiver of rent on the grounds of force majeure. A ground that others too may soon adopt.

No one-size fits-all

Simply put, force majeure is an event beyond the control of the parties to a contract: literally translated as an act of God. However, several misconceptions have cropped up in the wake of the panic created by COVID- 19. Given below are two such illustrations:

  • Not all obligations can be waived off upon the occurrence of a force majeure event. The affected party can seek exemption of only those obligations, performance of which is not possible on account of the force majeure event. Further, the indulgence sought by the affected party cannot be in the nature of a blank cheque. There should be some co-relation between the waiver sought and the hardship caused by the event.
  • Force majeure need not necessarily lead to a severance of contractual relations. It only means suspension of contractual obligations during the subsistence of the force majeure event.

For reasons aforesaid, all flat purchase agreements provide for extension of construction timelines in in case of cement shortages, riot, earthquakes etc. Covid-19 shall be construed as one such event.  Furthermore, no liquidated damages are payable by the affected party.

It is defaults in payment of installment price that is being witnessed currently with respect to the stage of construction that has been delivered. For the reasons explained above, non-payment of monetary commitments on the grounds of force majeure may not be legally tenable.

Ironically, the developers may be examining ways to adopt the defence of force majeure to alleviate their debt burden. Latest news has reported an exposure of the banking sector to commercial real estate alone to the tune of Rs 2.27 lakh crores. Needless to mention, with the crises after crises in the banking and NBFC ecosystem, it is highly unlikely that foreign direct investment will fill in the gap. Alternate sources of funding in the light of latest circular as discussed below may be examined.

Sources of Funding

With revenues of the developers down to a trickle and mounting costs, defaults in project finance availed is imminent. In a double whammy of sorts, share prices have also plunged. Lenders may, therefore, seek fresh securities from the developers to top up the depleted collateral shares offered as pledge.  Those who had floated Real Estate Investment Trusts (Reits) may be teensy weensy bit more relieved. On March 23, 2020, the Securities Exchange Board of India (SEBI) announced a slew of measures for creation of encumbrance on Reits’ units.

The industry is made a wish list of sops such as 0% stamp duty for six months, deferment of tax payment by a year, reduction in premia payable to the municipality by 50%. It may be difficult for the government to give into to these demands.

Though a cliché; preparedness carries the day. As Field Marshall Sam Manekshaw once told Prime Minister Indira Gandhi “I’m always ready, sweetie.”

(Divya Malcolm is a Partner at Kochhar & Co., Advocates and Legal Consultants.  The views expressed in this article are her own and not that of the firm.)