Here's what you should know about issues arising from long-term leases in India

Yudhist Narain Singh

Acquiring real estate in India is an expensive proposition.  With the recent influx of cutting-edge IT companies, startups, co-working spaces, food chains, retail stores, looking to setup operations in India (and acquire homes for their top executives), long-term registered leases with secure lock-in provisions are proving to be the practicable option.

These long-term leases ensure that there is minimum capital outlay while establishing operations and the restrictions imposed on purchase of real estate in India under the FDI policy are easily avoided.

In our experience, we have observed a surge in the number of companies and individuals opting to enter into elaborate and meticulously drafted leases (after completing a thorough due diligence of the property). These leases are then executed and registered as per law after paying the requisite stamp duty.

In this manner, both the lessor and the lessee derive a substantial amount of comfort from the secure leasing arrangement in place whereby the lessee enjoys an unfettered leasehold right in the property while the lessor enjoys a secure income from a well-established entity.

Typically, a 'lock-in' provision in these leases ensures that the lessee shall enjoy uninterrupted occupation of the property for a fixed duration (as detailed in the lease) without any interference by the lessor (who retains the option to terminate the lease only under exceptional and pre-established circumstances).

However, it is important to note that there are a few situations under which the leasehold right of the lessee may be adversely affected, irrespective of the agreed terms and conditions of the registered lease.

Here are some issues you should look out for prior to entering into such a leasing arrangement:

TITLE – It is crucial to ascertain the legitimacy of title of an immovable property prior to entering into a lease. A clear understanding of the devolution of title (chain of title) through registered deeds, understanding the nature of the title holder, i.e. partnership, HUF, incorporated entity and verification of mutation entries of the current title holder in the relevant tax records plays an important role in gauging the possible risks involved under a leasing arrangement for that property.

ENCUMBRANCE CHECK – Verification of the original title deeds and conducting an encumbrance search (both web-based as well as physical searches) helps establish whether a charge (mortgage) has been created on the property. In several instances, we have observed that potential lessors avoid disclosing charges created on their properties in order to increase the marketability of these properties.

With the significant rise in the number of real estate companies declaring bankruptcy or facing insolvency proceedings, an encumbrance search should be a mandatory requirement prior to entering into a long-term lease agreement.

PERMITTED LAND USE – Verifying the permissibility of land use is becoming increasingly important in leasing transactions. It ensures that the property being taken on lease is suitable and legally permitted for the intended use of the lessee.

For instance, an increasing number of buildings are being developed exclusively for use as information technology centres. These spaces are often conveniently located in affluent and well-developed areas. In the event that a multi-national company would like to open a commercial showroom in such a building, this would not be permitted.

Similarly, several properties are being developed pan-India as institutional properties with stringent end-use restrictions. Further, where commercial or industrial property has been developed in agricultural areas, the conversion of land use certificate must be verified to ensure that the land use has been changed via the certificate after following the due procedure established by law.

COMPLIANCE – Every building and industrial unit has to be developed in compliance with certain building bye-laws and as per the approved sanction plans. Typically, upon completion of these buildings, an occupancy or completion certificate (depending on the location of the property) is obtained from the concerned authorities.

A deviation from the sanctioned plan or violation of these mandatory compliances may have serious consequences in the ownership as well as the leasehold interest of the lessee. For example, in a recent transaction while advising a client during the due diligence of a property for a proposed long-term lease, we found that the developer (who was also the lessor and maintenance company in the project) had not registered the project under the Real Estate (Regulation and Development) Act, 2016.

As the developer was selling over 40 developed units in the project, this was a mandatory requirement and due to this failure in compliance, the entire project was brought under scrutiny. Further, developed spaces must obtain separate mandatory permissions for using lifts, generators, utility connections, height clearance. These permits need to be checked thoroughly prior to entering into a definitive leasing arrangement.

LITIGATION AND/OR DISPUTES – Certain checks must be carried out in order to determine whether the property to be taken on lease is the subject of any existing litigation or dispute.

For example, recently, an international renewable energy company obtained certain factory space in Uttar Pradesh for its assembly plant via a long-term lease. After commencing its operations on the property, the local farmers blocked the entry into the plant citing that they had long disputed the manner in which the land for the factory had been obtained and that this dispute was currently sub-judice in the local court. Needless to say, this proved to be disastrous for the operations of the company and may have been avoided in the event that a proper litigation search had been conducted.

ATTORNMENT – Ordinarily, a lease deed with a lock-in period is a long-term lease with the option for further renewal terms. Under these leases, a lessee incurs significant fit-out and development costs. An attornment clause in the lease deed ensures that in the event the owner (lessor) of the property transfers, sells or alienates his/her rights in the property which has been leased, the new owner or the transferee shall 'attorn and adhere to' the terms and conditions of the existing lease deed, effecting a smooth transfer of the leasing arrangement in the name of the new lessor. This ensures that the existing leasehold rights of the lessee are not adversely affected in the event of such a transfer.

TAXES AND COSTS – Under long term leases, property ownership taxes, maintenance costs, fit-out costs, power back-up charges, etc, may have significant financial implications. The lessee should seek clarity on these costs and charges prior to entering into the lease. Thereafter, these details must be recorded clearly under the terms and conditions of the lease in order to prevent a dispute arising at a later date.

DRAFTING OF THE LEASE AGREEMENT – The lease agreement shall be the definitive legal contract on the basis of which the lessor and the lessee shall be entering into a long-term leasing arrangement. Therefore, it is imperative that the lease agreement should be meticulously drafted after taking into consideration the findings of the due diligence of the property in order to safeguard the rights of the lessee during the term of the lease.

(The author is a senior partner heading the real estate practice with YNS & Associates based in New Delhi.)