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Explainer | FM’s ‘no fresh insolvency’ offer comforts builders, but what about homebuyers?

Measure does little to boost housing sales and may curtail remedies available to homebuyers, say legal experts

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Representative Image

In a bid to grant relief to companies defaulting on loans due to the COVID-19 stress, Finance Minister Nirmala Sitharaman said on May 17 that no fresh insolvency would be initiated for one year under the Insolvency and Bankruptcy Code (IBC) and that coronavirus-related debt would be excluded from definition of default. While these measures seek to offer a breathing space to real estate companies to recover, they may curtail remedies available to homebuyers, say experts.

These measures were announced by Sitharaman as part of the fifth and final tranche of the Rs 20-lakh crore stimulus package unveiled to boost the economy ravaged by the pandemic and subsequent lockdown. The FM also said that an ordinance would be promulgated to bring this change in IBC.

Under the IBC that provides for a time-bound and market-linked resolution of stressed assets, an entity can seek insolvency proceedings against a company even if the default is only for a day. In March, the government raised the threshold default amount for invoking insolvency proceedings under IBC to Rs 1 crore from Rs 1 lakh in order to prevent triggering of such proceedings against small and medium enterprises.


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These measures announced by the FM mean that the developer cannot be dragged into insolvency by financial and operational creditors such as banks, homebuyers or contractors.

It could mean that Sections 7, 9 and 10 of the IBC would be suspended for six months and the suspension time can be extended up to one year. Section 7 and 9 pertain to initiation of corporate insolvency proceedings by a financial creditor and an operational creditor, respectively. Section 10 relates to filing an application for insolvency resolution by a corporate.

Most real estate developers have been facing liquidity issues and struggling with issues relating to demand. Sales during the COVID-19 phase have also been impacted. Housing sales dropped 26 percent and new launches were down 51 percent in nine major Indian cities in the March quarter of the financial year 2020 when compared to the same period last year, says a report by online property brokerage firm

A report by Anarock has said that residential sales had witnessed around 42 percent YoY drop in the first quarter of 2020 in the top-7 cities and a similar drop seen in the number of new launches.

Therefore, real estate companies that perhaps do not have enough balance sheet strength or the ability to maintain solvency during the Covid-19 period would be severely challenged if this step had not been taken. Having said that, most will continue to struggle with generating sales and demand from consumers.

Daizy Chawla, Senior Partner, Singh & Associates says that the government by declaring that no I&B proceedings can be filed for next one year (though a formal notification is still to come) will give real estate companies relief not only from financial creditors but also operational creditors.

This measure will come to the rescue of real estate companies that are facing demand issues during the lockdown and those firms that would have to deal with mounting costs to service debt going forward.

“This would help builders who are likely to be on the verge of defaulting because of sales and revenues drying up. Delays are likely, especially for projects that are stuck in early stages or those that are mid-way,” said Arvind Nandan, Managing Director Research & Consulting at Savills India.


Real estate developers welcome the move

The move that no fresh insolvency will be initiated for one year will lead to realtors focusing on survival and recovery during the one-year period, especially those impacted by funding crunch and low sales, say real estate promoters.

“The announcements of no insolvency cases for one year and exclusion of debts related to COVID-19 from defaults under IBC, are positive,” said R K Arora, president, NAREDCO-UP and chairman of Supertech Group.

Prashant Thakur, director and head – Research, ANAROCK Property Consultants said that this would help smaller local developers to tide through the unprecedented coronavirus crisis to some extent, and give them some time to get their business on track.

This measure, along with previously announced sops such as the three-year extension of loan moratoriums and extension of RERA deadlines by six plus three months can come to the rescue of smaller local developers who are particularly impacted by the funding crunch and low sales, he said.

Gaurav Gupta, president, CREDAI-Ghaziabad is of the opinion that this would ensure continuity of real estate businesses, completion of projects and unwarranted litigations clogging the National Company Law Tribunal (NCLT).

“Having said that, the biggest challenge that the sector currently faces is to do with a massive exodus of labourers which has in turn caused major disruptions on construction sites. This is likely to delay completion of projects at least by a year,” he says.

Vivek Kohli, senior partner and founder, Zeus Law agrees. “This is a welcome move but the biggest challenge developers face going forward is to do with pressure on supplies and lack of sales. Delay in delivery timelines is imminent.”


Measure provides temporary relief; unlikely to boost demand

Real estate experts say that this measure only provides temporary reprieve to the real estate sector as it does little to boost demand or induce homebuyers to invest in homes.

“While it does provide breathing space to realtors, it does not address the main issue of demand. Last year, Goldman Sachs Group had said that the cash crunch has raised questions around solvency of real estate companies, and threatens to push 70 per cent of them out of business in the next two years. This stress would touch 90 percent post Covid-19,” says Anckur Srivasttava of GenReal Advisers.

The reprieve does not come without additional costs. “Bankers/financial institutions would continue charging interest on the debt taken by the builder for a year and it would definitely show up in their balance sheets," he says.

There is also a possibility of some real estate projects becoming unviable after a year. Several networth positive projects are likely to become negative after a one year period due to massive cost overruns.

“Considering that the cost of debt for a developer is anything between 13 percent to 14 percent, this one-year extension could lead to increase in financing costs with social distancing norms and labourers to be maintained on construction sites. The construction costs could go up by 10 percent to 15 percent making some projects unviable after a year,” he says, adding if this happens, some projects may not be eligible for even stressed asset funding.

This may, therefore, prompt some developers who will take on this as an opportunity to resolve their current financial distress and utilize proceeds from external capital or distress funds to complete the projects instead of bearing the brunt of debt piling up after a year, he says.


Remedies available to homebuyers curtailed

All measures announced this month, be it the one-year extension granted to builders under IBC, the extension of completion deadlines for projects up to six months plus three months in the face of the COVID-19, treating the pandemic as a ‘Force Majeure’ event under the Real Estate Regulatory Act (RERA) 2016, may have come in as a relief to developers but they do not seem to safeguard the interests of homebuyers, say legal experts.

“Through these measures the builders have been provided immunity on all fronts. There will not be any remedies available to homebuyers for at least a year. Contractors and banks too will not be able to take the builders to task,” says Vaibhav Gaggar, managing partner, Gaggar & Partners.

Legally speaking builders have been provided a breather, the existential threat has been warded off for a limited period but at the ground level they will continue to struggle and there will be delays because they won’t have the capital or the liquidity to recommission projects or the able to make timely payments to ensure continuity of work.

The hardest hit in the process would be the homebuyers. “In this case even if the project construction does not take place for a year, buyers will not have the right to take the builder to NCLT. Even relief before the National Consumer Disputes Redressal Commission (NCDRC) has been stunted due to huge delays and pendency before the consumer courts and the state commissioners, despite they having the mandate to decide disputes within six months," he says.

“NCDRC is no longer an efficacious remedy as it takes a long to decide matters. Relief from RERA too has been extended automatically for six months. Therefore, for the next six months to a year, consumers may have theoretical remedies available before the NCDRC, RERA and even NCLT but all these have been curtailed on ground for now,” he adds.
Vandana Ramnani
first published: May 19, 2020 07:55 am
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