Protecting Homebuyers: A Decisive Approach to Real Estate Insolvency

In a significant ruling, the Supreme Court has clarified that insolvency resolution in the real estate sector should focus on the completion of housing projects rather than liquidation. This decision, particularly highlighted in the Supertech case, is a beacon of hope for thousands of homebuyers who have been left stranded by insolvent developers. However, unless regulators, insolvency professionals, and disclosure rules align with this goal, the promise of relief may remain on paper.

The philosophical underpinnings of this judgment must now permeate the legislative and regulatory framework governing the real estate sector. Preventive and curative measures are essential to address the kinks that developers exploit for their misdeeds. The Supreme Court, in the Mansi Brar case, has directed the Insolvency and Bankruptcy Board of India (IBBI) to frame specific guidelines for real estate insolvencies. These guidelines should have legal force and establish a clear framework for the completion and handover of housing units to homebuyers.

A workable option is to appoint turnaround specialists of proven integrity and experience in executing real estate projects as Resolution Professionals (RPs). These RPs should have the legal authority to arrange working capital, recover stolen funds, complete projects within an agreed timeframe, and issue completion certificates. If necessary, they can hire financial and legal experts in addition to the existing management team under insolvency.

The role of the RP is crucial in the insolvency process, with a mandate to resolve a housing project. However, the current practice of institutional financial creditors proposing the appointment of RPs can create conflicts of interest, particularly if there is collusion with the corporate debtor. Therefore, the authority to appoint an RP should rest with the IBBI, which may also receive recommendations from financial creditors. Additionally, an RP should not handle more than two projects at a time to ensure effective management.

According to data from one state Real Estate Regulatory Authority (RERA), as of February 22, only four RPs were handling 66% of all projects under litigation at the National Company Law Tribunal. These RPs were managing 90, 41, 31, and 24 projects, respectively. This concentration raises concerns about the ability of a single RP to manage multiple projects effectively. The IBBI, which regulates RPs, should prevent such concentration and ensure that RPs can be removed from projects in cases of misconduct.

Currently, RPs remain in charge of a project even after their authorization is suspended, including in cases of misconduct. The IBBI should be empowered to initiate the removal of RPs from existing projects in such cases. Furthermore, since RPs discharge important public functions, insolvency regulations should designate them as public servants to promote accountability. Currently, their status is unclear, with the Madras High Court holding that an RP is a public servant, while the Delhi High Court has a contrary view.

Private real estate companies (RECs) should also be declared as ‘public interest entities’ (PIEs) under the Companies Act, given the significant public interest involved. RERA should track their disclosures to ensure transparency of their operations. Unlike shareholders, flat aspirants who fund the project do not receive an electronic copy of the builder’s financial statements, leaving them in the dark about the firm’s operational effectiveness until insolvency is declared.

The Supreme Court has underscored the importance of red flags as a preventive measure. Analysis of the MCA-21 database, which is a repository of corporate information maintained by the Ministry of Corporate Affairs, can raise red flags for preventive action. The data should be analyzed in real-time using advanced analytical tools and artificial intelligence. An institutional mechanism for identifying red flags can be an important measure to prevent corporate malfeasance and enable swift course correction.

Following a series of frauds and insolvencies, China adopted a Three Red Lines Policy in August 2020 to prevent excessive debt accumulation in the real estate sector and reduce financial risks. India should develop its own policy based on domestic and international experience, leveraging the MCA-21 database for identifying red flags.

The law applies strict ‘fit and proper’ criteria for the appointment of directors of deposit-taking institutions such as banks. Given that housing projects are akin to collective investment schemes, agencies like RERA should review the ‘fit and proper’ status of the boards of insolvent builders to determine their fitness to oversee public interest entities in the future.

The development of real estate, especially housing, is essential for a prospering society and contributes significantly to economic growth. This broad sector, including related industries, can contribute up to 20% to India’s GDP annually. Adequate housing stock is a crucial component of a developed nation, and protecting homebuyers is a step in the right direction.