Real estate: IBC ordinance sweetens deal for homebuyers

In a welcome relief for homebuyers, the government of India has amended the Insolvency and Bankruptcy Code (IBC) 2016 to grant the status of a “financial creditor” to a homebuyer. The President of India has also granted his assent to the IBC (Amendment) Ordinance, earlier this month.

The IBC ordinance puts homebuyers on the same footing as any other stakeholder participating in a real estate project and grants them due representation in the committee of creditors. This IBC amendment has been made in cognisance of the fact that money is raised from homebuyers as a means to finance construction, and thus they should be treated as any other financial creditor.

Relief for the homebuyer

This move will be particularly helpful for borrowers facing hardships due to incomplete real estate projects. In India, 20-30% of projects face delay due to various reasons, most common of which is a debt trap that a developer finds himself in. A stalled project turns out to be a triple whammy for homebuyers as they invest a substantial portion of their savings to make a down payment for the property, pay an EMI on the loan and continue to pay rent in the current place of stay. 

This will, however, change with the new IBC amendment. After having attained the status of a financial creditor, homebuyers have now been granted the right to invoke Section 7 of the IBC against an errant developer. The Section allows them to file an application seeking resolution for insolvency under the corporate insolvency resolution process (CIRP). Homebuyers can also expect fast tracking of pending court cases against leading real estate groups, as a result of this amendment. 

Claiming proceeds after liquidation

Thus far, homebuyers were at a disadvantage even if the proceeds from the sale of a liquidated real estate asset were distributed among stakeholders. There were as many as eight levels in the order of distribution, and homebuyers couldn’t make a valid claim even after liquidation of a project as they were regarded as consumers. 

Proceeds from liquidation were claimed first by financial creditors such as banks and financial institutions, then by operational creditors such as employees and vendors. Then came unsecured financial creditors, government stakeholders and finally the equity shareholders.

While the new IBC ordinance benefits homebuyers, promoters will not really lose out. So long as the promoter is not a wilful defaulter, he will still be given a fair chance of resolution rather than liquidation under CIRP. To provide a shot in the arm to promoters grappling with insolvency, the government has reduced the threshold of voting for all major decision of the committee of creditors to 66% from the earlier 75%. This too will encourage speedy resolution of insolvencies, in genuine cases.

The industry is expected to be benefitted on the whole by bringing about greater transparency in dealings, and weeding out fly-by-night operators. Further, the IBC ordinance will boost sales velocity as reputed developers offering complete apartments or apartments nearing construction will now come to the fore.

Increase in borrowing rates

But lenders may take a step back as a result of this amendment as proceeds from recovery have another added layer of distribution that was not taken into consideration at the time of the origin of loan. This dilution in the rights of lenders on liquidation proceeds may result in increase in borrowing rates depending on the borrowers’ credit profile.

Despite increased borrowing costs, real estate pricing are unlikely to witness a rise, as institutional lending forms 20-30% of the total value while the remaining comes from construction-linked payments made by homebuyers. Further, a lending institution is expected to proceed with IBC only under extreme financial stress. Generally, most stressed real estate assets are taken over and refinanced by the sponsors. 

As is evident, the government intends to empower homebuyers by giving them greater rights to seek insolvency. After the Real Estate (Regulation and Development) Act (RERA) was implemented last year to protect the interests of homebuyers and bring in greater transparency in the system, the IBC sweetens the deal further with an extra layer of security for potential homebuyers by putting them on the same footing as financial creditors. 

Sharad Mittal is director and CEO, Motilal Real Estate Fund