Lenders including banks will now need to work carefully on their cash flow, says RAJESH NARAIN GUPTA.
The rollout of the Real Estate (Regulation and Development) Act, 2016 (RERA) has been heralded as the most comprehensive reform for the real-estate sector since Independence. With developers sourcing funds from non-institutional sources and several issues compromising the interest of consumers on multiple fronts, policymakers were prompted to formulate RERA with a view to induce accountability and transparency in an industry that has been highly opaque and capital-intensive in its functioning.
A changed scenario
To date, commercial lenders have been extending funds to real-estate players against security interest and charges created on their assets inter alia on their receivable accounts. The money, collected by the developer as project funding, was under the charge of the lenders.
A key provision of RERA mandates that no charge or lien can be imposed on 70 per cent of the amount collected from a prospective homebuyer towards sale of property. The amount will have to be deposited in an account to be maintained in a scheduled bank. The funds can be specifically utilised to cover cost of land and construction cost for the specified project for which it is intended and will not be diverted to cover the expenditure of other projects of the developer. This is easier said than done, though, as banks would largely be concerned with how this bifurcation takes place and how the mechanism is put into place. As 70 per cent of the funds will be held in a separate no lien account, the funds will not be directly accessible to lenders.
The lenders' perspective
Lenders, including banks, will now need to work carefully on their cash flow component and the same will have to be carefully incorporated in their lending and security documents. Concerned about the implications, lenders are working to revise the format of these documents to ensure appropriate representations are obtained from developers and promoters. They are also taking care to ensure that loan and security documents are tightened wherever necessary to comply with rules and regulations from a RERA perspective. Upon the completion of the project, the excess money left in the no lien account after the funds have been utilised for project completion will belong to the developer. Hence, lenders have asked to be allowed to create and enforce the charge on such account once the project is completed as envisaged under the Act. This provision is largely within an ambiguous zone and is being dealt with on a contractual basis with existing rules being largely silent on the aspect.
A key point is that withdrawing money from the no lien account will be in tandem with the completion of the work on a specific project. Sanctioning withdrawal from this account is subject to the builder obtaining three certificates from an architect, an engineer and a chartered accountant, with an audit of the withdrawals to be undertaken every six months. Despite these regulations, if there are allegations of wrongdoings or malpractice against a developer or he is subjected to legal action with regard to the 70 per cent funds held in the no lien account, banks may be dragged into litigation as a necessary party or as witnesses (though they cannot be made liable for any such wrongdoing).
No override with RERA
Further, although RERA has been extolled as a landmark reform for the real-estate sector, it does not override other Acts which continue to exist.
The provisions of RERA have been formulated to exist in addition to provisions contained in other Acts. To protect the interest of consumers, the Act provides that a builder or developer cannot transfer his interest in the project without taking the permission in writing from 2/3rd of the allottees and the RERA authority. A serious issue to consider here is that where a lender takes recourse under SARFAESI for the sale or transfer of a project to a new developer or builder, would the lender be required to obtain the consent of the RERA authority and 2/3rd of the buyers or allottees who have invested in the project? This has been touted as a key area of concern by lenders and the rules are silent on this. It has been argued that logically under SARFAESI, this requirement does not hold any validity as the sale under SARFAESI is also being executed as per the provisions of an applicable statute. However, with a view to forestalling the smooth execution of security interest created in favour of the lender, the builder or developer may try to turn this into a contentious issue.
With the real-estate sector becoming RERA-compliant and developers bracing themselves to face the challenges of an overarching regulatory regime, the need to evolve an industry-friendly financial model assumes paramount significance. RERA has the potential to vastly improve the efficacies of the sector and root out fiscal indiscipline in an industry known for its use of unaccounted funds. Developers are re-jigging their systems and processes to ensure greater financial discipline conforming to RERA requirements.
A check-and-balance mechanism and monitoring of projects along every stage of the execution cycle by the RERA authority with the implementation of a due diligence system has made it easy for lending institutions to invest in realty projects.
Indeed, the implementation of RERA is a market-friendly, consumer-centric initiative that will bring about a paradigm change in the operation of the sector. Aiming to provide an organisational framework to a largely unorganised industry, RERA has the power to kick-start the investment cycle in the sector by making funds available to developers through a transparent lending process. Further, fly-by-night operators are likely to vanish. The consolidation of the sector and elimination of small builders who thrived in the unregulated market are imminent consequences.
If implemented in its true letter and spirit and if all the stakeholders in the real-estate supply chain contribute to its effective execution in a united manner, RERA has the potential to place the country's realty industry on a higher growth trajectory.
Removing the anomalies in allocating funds for construction projects and enabling a steady credit pipeline to the industry so that realty projects are not stalled for want of funds would make RERA a much-needed catalyst for the transformation of the sector. Now, it is critical that all safeguards and proactive steps are taken to ensure that the concerns of lenders are put to rest so that this sector does not suffer financial constraints.
About the author:
Rajesh Narain Gupta, Managing Partner, SNG & Partners, has vast experience in corporate and transactional matters. His areas of specialisation include almost all aspects of banking laws and practices, structured finance, micro finance, corporate and commercial laws, and real estate (including FDI in India).