Healthy realty projects may escape pain from developer's bankruptcy

The development assumes significance given that real estate accounts for 22% of insolvency cases undergoing resolution in India, and is the second-biggest sector after manufacturing, which makes up for 36%.

New Delhi: Homebuyers in healthy real estate projects may soon be spared the fallout when their developer defaults on another project. The insolvency watchdog is set to tweak regulations to allow the committee of creditors (CoC) to recommend keeping solvent projects out of bankruptcy proceedings, even when the developer as a whole enters the Corporate Insolvency Resolution Process (CIRP), according to two people in the know.

The recommendation, however, must be backed by a 66% vote of the CoC and approved by the National Company Law Tribunal (NCLT) for it to take effect, the people told Mint.

The Insolvency and Bankruptcy Board of India (IBBI) had deliberated on the proposal at its last board meeting held late August, and the new regulations would be notified shortly, they said.

The development caps months of discussions over how a project-wise insolvency plan will be implemented.

Currently, once a builder is admitted into the CIRP, all its projects come under insolvency proceedings. This hurts the interests of buyers living in finished or solvent projects, who then face disruption in maintenance and uncertainties in registration because the same developer defaulted elsewhere.

The development assumes significance given that real estate accounts for 22% of insolvency cases undergoing resolution in India, and is the second-biggest sector after manufacturing, which makes up for 36%.

Several real estate firms—such as Raheja Developers, Supertech, Today Homes and Ajnara—or their arms are facing bankruptcy proceedings. However, it is not clear yet if the new regulations would apply to these ongoing cases as well or only to fresh ones. A decision on the issue will soon be taken and notified, the people said.

The Insolvency and Bankruptcy Code, as amended in April, also backs project-wise insolvency.

The IBBI has not estimated the number of projects and homebuyers likely to benefit from the regulation tweak, said the people cited above. The number of dwelling units in India's stalled real estate projects was pegged at 4,12,000 with a total value of ₹4.08 trillion, as per an Indian Banks' Association estimate, cited in a July 2023 report of an expert panel led by former G20 Sherpa Amitabh Kant. Of these, more than half were in the National Capital Region alone. These included assets of realtors facing insolvency resolution.

As per the new framework, once the CoC is formed after the bankruptcy application against a real estate developer is admitted, it will be able to conduct a project-wise analysis and suggest exclusion of projects that don't require insolvency intervention.

Queries emailed to the insolvency regulator and to the corporate affairs ministry on Wednesday remained unanswered until press time.

Project-wise insolvency in real estate has been debated at length in recent years, and the current proposal draws from a discussion paper that the IBBI had floated in late June.

“It will be a project-wise treatment after insolvency admission of the developer and formation of the CoC, so that the CoC can take an accurate and well-informed decision,” said one of the people cited above, requesting anonymity.

A second person in the know concurred. “Project exclusion is being left to the CoC’s wisdom, but ultimately it has to be approved by the NCLT,” thius person said.

Anoop Rawat, partner and national practice head (Insolvency & Restructuring) at Shardul Amarchand Mangaldas & Co, said: “This provision is necessary because it shifts the resolution approach from corporate debtor rescue to project rescue and homebuyer rescue, which is what the Supreme Court, in the Mansi Brar case, said was needed.”

In the Mansi Brar case last year, the apex court observed that real estate insolvency should, as a rule, proceed on a project-specific basis rather than against the entire corporate debtor, barring exceptional circumstances. It also directed the IBBI to frame guidelines for realty insolvency, in consultation with the Real Estate Regulatory Authority (Rera).

The implementation of this plan is, however, going to be watched closely.

“A developer-debtor is a single corporate entity and any credit facility provided to the developer does not get converted into a ‘project finance’, whereas a project-specific insolvency can operate in isolation by excluding the viable projects,” said Yogendra Aldak, executive partner at Lakshmikumaran and Sridharan Attorneys.

To implement the proposal effectively, the regulator, in its June discussion paper, suggested mechanisms, such as enhanced project-wise disclosures, ring-fencing of funds, project-specific books, measures to account for homebuyer preferences, coordination between the resolution professional and the Rera, Aldak said.

“The latest IBBI proposal addresses a genuine structural problem in real estate insolvency,” said Vishal Gehrana, partner-designate at legal services firm Karanjawala & Co.

At the same time, safeguards need to be carefully worked out for its effective implementation, he said. “The regulation should clearly address who manages an excluded project, how existing creditor and homebuyer interests are protected, what happens to the moratorium in relation to an excluded project, and how project assets, liabilities and funds are dealt with after exclusion,” Gehrana said.

Why the plan

For context, when a developer goes into the CIRP, it triggers moratorium under Section 14 of the insolvency law without exceptions. This freezes prior payments for healthy, near-complete projects where there is no default, stopping construction, causing labour and contractor exit, blocking home loan disbursements and delaying home registrations, said Rawat.

This traps innocent homebuyers for years without possession or refund, while the cost of project completion escalates.

Project-wise insolvency will help by ring-fencing the Section 14 moratorium and CIRP to only the defaulting projects, allowing construction, funding, possession and registration to continue unimpeded in all healthy projects, Rawat said.