The Real Estate (Regulation And Development) Act, 2016 (“RERA”) is a welcome for all consumers as it is a piece of legislation which seeks to organise an unorganised real estate sector across the nation. The legislation is primarily for the benefit and interest of the consumers and in doing so, the developers have been put into a regimented structure under the RERA. Amidst all the debates on protection of interest of consumers vis-à-vis the rights of the developers, the voice of the financial sector also needs to be heard. On one hand, the majority of consumers buy their ‘home sweet home’ or commercial establishments by taking finance from banks and financial institutions and on the other hand, the developers obtain project finance for construction by mortgaging the project land. Therefore, funding by lenders can be categorized into two heads – project finance to the developer and consumer finance. The question remains as to how the lenders may be affected in the RERA era. For this the following provisions may be discussed.

Section 4(2)(l)(D) of the RERA provides that that 70% of the amounts realized for the real estate project from the allottees has to be deposited in a separate account to be maintained in a scheduled bank to cover the cost of construction and the land cost and shall be used only for that purpose. The proviso states that developer shall withdraw the amounts from this account to cover the cost of the project, in proportion to the percentage of completion of the project. The words ‘construction cost’ and ‘land cost’ or ‘cost of the project’ have not been elaborated.

Under Section 7, the state authority constituted under the RERA (hereinafter referred to as the ‘state authority’) has powers to revoke the registration of a project. The consequences of revocation would also include temporary freezing of bank account of the developer in which 70% of the receivables were being deposited. On revocation, under Section 8, the state authority may consult the State Government to either carry out of the remaining development works by a competent authority or by the association of allottees or in any other manner. However, the association of allottees will have the first right of refusal for finishing the development of the project, provided there is an association of allottees in the first place.

Insofar as keeping apart 70% of the project receivables are concerned, the question being raised by the lenders is whether ‘construction cost’ or ‘land cost’ or ‘cost of the project’ would also include repayment of principal or interest to the lenders and whether servicing of lenders’ debt can attain priority? So long, lenders have had the right to design their contracts in a fashion so as to ensure that the developer repays the loan from the receivables of the project on a priority. The developers also gave priority to repayment of project finance so as to pre-empt the lenders’ from enforcing their charge against the project which would result in its loss of business as well as loss of reputation. But now, it is open to interpretation whether a developer may repay its lender from the 70% receivables of a real estate project or will have to fall back upon the 30% balance funds. This is a matter of concern as the 30% receivable may not be sufficient to service the debt of the lenders periodically. The developers are also peeved because between the 70 – 30 division of funds, their chances of making immediate profits out of real estate projects gets stalled.

As far as the consequences of revocation of a project is concerned, the first and foremost consequence is a loss of control by the developer over the project and its receivables, the cascading effect of which will be default in repayment of lenders’ dues. In the event the state authority takes the responsibility of completion of the project through government companies or public sector undertakings with credentials in construction or appoints another entity to step into the shoes of the developer to complete the project, the lenders will have to be afforded an opportunity of hearing by the state authority so that their interest is protected. The state authorities, in their zeal to protect consumer interest, should not take a decision that may be to the detriment of the lenders.

It must be the prerogative of the state authorities to ensure that whoever replaces the developer – whether it is some other entity or the association of allottees or even a state controlled body – must continue to service the debt to the lenders. Even though the lenders may have the option of enforcing their rights against the project land and the project, such an attempt will definitely be resisted by the state authorities or the association of allottees, leading to the project being mired in litigation and no good will come out of it for any stake holder. Such situations of conflict can be addressed if the state authorities look out for the lenders as well, because in a situation where a developer’s project registration is revoked, the lenders may be as much as an aggrieved party as the consumers.

For lenders active in the domain of consumer finance, the fallout of a revoked project may be similar if the borrower-allottees defaults in repayment and the project is incomplete. In such a scenario, the secured asset against which the lender could have enforced its charge may not even be in existence. In case of project finance to developers, the lenders should additionally secure themselves by obtaining collateral apart from the project land and/or project units so as to curb any future losses. Such an option however may be difficult to exercise in case of individual borrowers. Also, obtaining additional collateral from the borrowers may be a possibility for fresh lending but for existing projects or apartments under finance, rounds of tough negotiations may be required to obtain additional security; unless the lenders’ contract provides for such an option already. For existing borrowers, additional declarations and undertakings may be obtained by the lenders, if not additional collaterals, so as to protect their interest.

Till date, most states as well as most of the Union Territories have notified the rules under RERA leaving only a handful of states notably West Bengal, Goa, Telangana, Tamil Nadu and the North Eastern States which are yet to notify the rules. By and large, the rules of most of the states are similar in nature – Maharashtra being an exception. A glance at the rules or draft rules of majority states would show that the concerns being voiced by the lenders are not directly addressed. The rules of majority states are quite succinct and where it was hoped that grey areas of the RERA would be addressed in the rules, the state rules do not take into account diverse scenarios that may arise out of enforcement of the law vis-à-vis the interest of all stakeholders concerned.

Maharashtra provides relief to the lenders by (a) expanding the definition of ‘cost of construction’ to include repayment of loans of lenders as a part of cost of construction, though only for purposes of project finance but not loan for purchase of land or obtaining development rights over the land – Explanation III of Rule 5 and (b) giving adequate opportunity to lenders and investors who have rights over the real estate project, either by way of debt or equity, to represent their case before the state authority before it decides on the issue of revocation of project registration – Explanation to Rule 8. This will ensure that for projects in Maharashtra at least, lenders and also investors can expect their interest to be protected while the state authority takes steps for continuing the construction of the project under Section 8 of the RERA. Rajasthan allows for interest on finance for purchase of land to be included in land cost under Rule 5(1). On the other hand, Uttar Pradesh and Karnataka have narrowed the definition of ‘construction cost’ to mean the on-site expenditure incurred for physical development of the project.

We can only hope that the states will liberally interpret and apply the RERA and the rules thereof so as to give relief to all stakeholders concerned – including the lenders. This will calm any unease in the banking and financial sector and provide a sense of protection to the lenders that their interest will remain secured in case of errant developers.

At the same time, the financial sector also needs to bring a change in its prevalent practice of financing projects or apartments in the RERA era. It is necessary to remodel and redraft the schemes of finance and overhaul the loan documentation so as to secure the money lent in the best possible manner keeping in mind the aforesaid scenarios.