Kunaal Shah and Samira Lalani
The current outbreak of the novel Coronavirus (COVID-19), a virus that has wreaked havoc globally, is the most crucial time witnessed by the world lately, in global history. As the clock struck midnight on 25 March 2020, India was officially ordered to be on a ‘complete national lockdown’.Impact of outbreak on real estate sector
In the already struggling real estate sector, COVID-19 has come as a killer blow, in turn, shaking not only the human health but also the economic health of the nation. COVID-19 has massively derailed the seamless functioning of developers, homebuyers and other concerned stakeholders of the real estate market. Some of the immediate adverse impacts on the Indian real estate sector include the following:Woes of developers
COVID-19 has aggravated the persisting liquidity crunch in the real estate sector. The various restrictions imposed by the Indian Government to curb the pandemic has left the developers stranded, consequently facing multiple issues, including stalling of construction work, shortage or non-availability of man-power and raw materials due to lock-downs across the nation coupled with uncertainty haunting potential commercial transactions and business operations.These hardships of the developers have a domino effect on the receivables derived from a project along with the contractual obligation of a developer to service the construction finance/loans procured for the project.
In view of the above, the developers have been asking to declare ‘COVID-19’ as a part of the definition of ‘force majeure’ under the Real Estate (Regulation and Development) Act, 2016 and other relevant applicable laws, to seek extension of timelines in relation to project completion and repayment of loans. Impact on homebuyers
The restrictions imposed by the Indian Government on lockdown and introduction of ‘work from home’ policy have essentially left homebuyers in a bubble of uncertainty and fear as they have no clarity on whether they would have sufficient, regular and timely cash flows to make payments to the developer or service their home loans, as the outbreak has brought their economic activities to a standstill. Homebuyers who are professionals or run independent businesses are more vulnerable.
The distressing uncertainty lingering around the outbreak of COVID-19 has a rippling effect on the homebuyers by weakening their purchasing power and their financial capacity to service home loans availed from financial institutions/banks and other payment obligations to the developer under the builder-buyer agreements. Such uncertainty, if not proactively tackled, would lead to a high rate of termination of under-construction bookings currently made by homebuyers, as well as defaults in servicing of home loan EMIs.Fall out on commercial leases
The uncertainty around the COVID-19 outbreak has had a direct impact on not just under-construction properties but also on the commercial lease arrangements (especially the ones executed by foreign entities in India, co-working spaces, brands/franchisees and other start-up entities in India). Parties to such commercial leases are battling with challenges to honour their contractual obligations under respective leases owing to decreased retail traffic due to ‘social distancing’ mandates.
This has led to low or almost negligible revenue generation. Consequently, the lessees of commercial lease arrangements are revisiting their lease documents and weighing the risk around invocation of the ‘force majeure’ clause to either suspend rent payments or exercise termination rights on account of force majeure, if permitted by the contract.Provision of force majeure and frustration of contract
‘Force Majeure’, as a concept, is applicable across all industries and sectors and as such, its applicability and ingredients remain unchanged for contracts governing the real estate sector. Through our analysis of a plethora of Indian judgments, the key ingredients for invoking a ‘force majeure’ provision, include the following:
Occurrence of an event which affects a party’s ability to perform a contract, either in entirety or in a timely manner;
Occurrence of event which is beyond reasonable control of parties;
Events which albeit may not render an act to be literally impossible but make an act impracticable and useless in terms of the object and purpose of the contract; and
Difficulty in performance of any obligation under a contract is not sufficient for invocation of a force majeure provision.
In light of the aforesaid ingredients, it can be concluded that upon occurrence of a ‘force majeure’ event, there are two possible remedies available with the parties to such contract, which could either be termination of the contract in its entirety owing to frustration of the same or temporary suspension of performance of the parties under such contract by seeking extension of timelines with appropriate and necessary relaxations to the affected party.Remedial measures to tackle the current COVID-19 outbreak
The two global events in the past which have come closest to a situation triggering crisis in an international context, similar to COVID-19 are the epidemic outbreaks of SARS and Ebola. Largely, courts in China, where SARS had the maximum impact have, at the outset, ruled that a force majeure event was adequately triggered by such outbreak. Similarly, in the case of outbreak of Ebola virus which had primarily affected the regions of West Africa, courts ruled that it is a force majeure event.
Considering the ingredients of a ‘force majeure’ event and the fact that COVID-19 has world-wide led to a situation which is far worse than SARS and Ebola, in our view it should be conclusively categorised as a ‘force majeure event’.Economic rescues and safeguards to curb the impact of COVID-19
Invocation of ‘force majeure’ and frustration of contract are ‘factually driven’ and lack of clarity vis-à-vis automatic suspension of contractual obligations under such contracts may open flood gates of disputes, litigations and termination of existing bookings by homebuyers.
In order to address such uncertainty and in light of the present situation of ‘crisis’ caused by COVID-19, in our opinion, the Indian Government should proactively weigh the actual as well as the probable damage of COVID-19 on the economic health of the nation and adopt requisite cues from the fiscal safety-nets devised by other nations of the world (like China and Italy) to revive the ongoing economic downturn.
While the Indian Government has set up an Economic Task Force and the Finance Minister has already announced certain procedural relaxations, the Indian Government should consider implementing the following additional steps and safeguards to rescue the real estate sector from bleeding any further:Recommendations vis-à-vis banks/financial institutions
Introduction of ‘anti COVID-19’ real estate rescue funds with a long-term horizon to aid banks and NBFCs which are already facing acute liquidity crunch owing to non-repayment of construction finance availed by developers along with other high NPA related issues. The contributors to such funds should include a broad spectrum of players in the real estate market such as governmental instrumentalities, sovereign funds, pension funds, insurance companies and other long-term investors.Recommendations vis-à-vis developers and homebuyers
Implementation of moratorium for servicing of debts for a minimum period of 3 (three) months by homebuyers and developers in relation to real estate projects (including EMIs on home loans availed by homebuyers from financial institutions and banks, finance availed by developers in relation to completion of real estate projects, etc.).
Providing automatic extension of timelines for payment of consideration by homebuyers under existing builder-buyer agreements.
Implementing automatic extensions and granting of grace period to developers for completion of all ongoing real estate projects.
Reduction in the tax brackets and statutory levies (such as income tax, GST, property tax, stamp duty) applicable to developers and homebuyers.
A complete tax deduction vis-à-vis the entire sum of EMI (principal plus interest) paid by the homebuyers such that the net taxable income is lowered.
Some of the aforesaid economic rescues are already in the process of being implemented in other countries affected by the pandemic such as Italy, China, Spain and India should leave no stone unturned to proactively implement robust and effective measures to tackle and save the Indian real estate sector from the current crisis.(The authors are partner and counsel respectively, Trilegal)