The Insolvency and Bankruptcy Code (IBC) 2016, was brought with an aim to simplify, streamline and speed up the process of insolvency process of ailing companies. However, due to tough economic conditions and poor real estate demand, more and more real estate developers have come under the scanner, hampering the overall buyer sentiment. examines the impact IBC on the real estate sector as a whole.

Real state of affairs

In last one year, the number of real estate developers caught in the bankruptcy proceedings has almost doubled. Till the first quarter of 2019, as many as 421 developers were under the proceedings of Corporate Insolvency Resolution Proceedings (CIRP). The number was 209 till September last year.

Of the total, 257 are ongoing cases while the remaining have been closed, withdrawn, or the firms have faced liquidation. (Source: Insolvency and Bankruptcy Board of India).

The number is the second-highest after the manufacturing sector.

Factors aiding slowdown in the real estate sector

It has been almost half a decade since the real estate sector is facing the brunt of a slowdown, fueled by a series of factors. Excess inventory, lack of buyer confidence in under-construction projects, demonetisation, implementation of Real Estate (Regulation and Development) Act (RERA), Goods and Services Tax (GST) regime, and finally the IL&FS crisis, which prevented Non-Banking Financial Companies (NBFCs) to lend to real estate developers, have all contributed towards the grim realty sector. Reserve Bank of India (RBI) also tightened the norms for lending by NBFCs post-IL&FS crisis.

In fact, most of the developers with ongoing insolvency proceedings have fallen into the situation due to their unsustainable functioning in the past. The fact that developers borrowed money to pay the interest has worsened the scenario over a period.

However, frequent liquidation has had a domino effect, further eroding the investor sentiment.

The effect of massive liquidation

Talking about how the insolvency proceedings of over 400 developers across the country are affecting the market sentiment, Mukesh Jain, Corporate Lawyer & Founder, Mukesh Jain & Associates says, “The situation is grim. Unlike other industries, advance from customers forms a significant source of funding for a real estate project. Resultantly, the flat buyers have a very significant stake in the financial health of the promoter.”

Nonetheless, until the advent of RERA, homebuyers had no control over the end use of their money by the developer. The funds were generally diverted towards the purchase of other land parcels, repayment of unrelated debts, completion of other pending projects, and still worse, siphoning off by the promoters. The forensic audit report presented before the apex court in case of Amrapali group proves this point. Today, even a small creditor can slap an insolvency petition on a developer. Even a single disgruntled home buyer may also proceed, putting the interest of all other home buyers in jeopardy. Suggestions have come that any action must have the support of creditors above a cutoff point, such as 10 percent of total creditors of that class or a claim beyond the net worth of the company so that the forum cannot be misused for oblique purposes. However, until then, it is an open mine-field.

The above situation has hit the real estate sentiment hard. The buyers have lost confidence in ongoing projects. If the prevailing situation continues, a time may come that home buyers shall buy only ready flats, thus drying up a critical source of working capital for the developers. No doubt, the developers themselves are responsible for the catastrophe.

Expressing his views on the long-term impact of the exercise, Jain says “It is indisputable that the present situation is the result of financial profligacy of the developers and a general slowdown of the economy. In the long run, a disciplined approach shall definitely make the sector more resilient and robust. The twin deterrents of RERA and IBC may cause the developers to adopt financial celibacy. Although in the longer run, the insolvency processes may help the real estate sector as a whole, in short to medium term, dark clouds are there to persist.”

The way ahead 

It has been long since the real estate sector is under strain. The government must consider a special package of concessions for the industry, thereby increasing demand and clearing the unsold inventory. Institutions like Insolvency and Bankruptcy Board of India (IBBI) and National Company Law Tribunal (NCLT) must act as a facilitator and a guide to the troubled real estate developers. A collaborative approach and a predictive and supportive policy regime will undoubtedly go a long way in the recovery of the real estate sector.