Sarthak Law

Real Estate’s Unending Hardship – How COVID-19 is worsening the Crisis

– Mani Gupta & Santosh Pandey

The Indian real estate sector has been in crisis for sometime now. At this time, there are insolvency petitions pending against a large number of developers, and the case-load before the consumer courts and sectoral regulatory authorities is burgeoning. The present pandemic and the measures to curb the same are likely to worsen the hardship for this sector.

No part of this sector is going to remain unaffected – be it developers, flat-buyers, or ordinary individuals who already have agreements dealing with personal property as sellers or lessors or lessees. Following on from our earlier articles, which may be read here, here, here, and here, this piece takes a special look at the real estate sector and how it is affected by COVID-19.

Under Construction Projects
As most of us are aware, Indian real-estate sector relies heavily on migrant, unorganized labour. In light of the nation-wide lock-down imposed by the Central Government, there was an en masse movement of migrant workers who feared job security, salaries etc. Although not all migrants are engaged in real-estate sector, there is a sizeable chunk which is. With a view to alleviate the concerns of this sector, and to prevent the movement of labourers from one state to another, the Central Government has made it mandatory for employers to pay salaries. The overall consequence of these measures is that while these labourers are not able to work on site, the project developers’ cost during this duration (or extension thereof) remains constant. Apart from this, the time required for completion of the project would, naturally, elongate.

Under the Real Estate (Regulation and Development) Act, 2016 (“RERA Act”), the Real Estate Regulatory Authorities (“RERA”) established across states are empowered to extend the registration granted to promoters of real estate projects due to force majeure (“FM”). Force majeure has been defined under Section 6 to mean “a case of war, flood, drought, fire, cyclone, earthquake or any other calamity caused by nature affecting the regular development of the real estate project”. It can be argued that Covid-19 pandemic qualifies as a ‘calamity caused by nature’, and it would entitle the promoters to get the extension. Some RERAs, like Maharashtra, Karnataka have already extended the completion timelines by 3 months, for those projects whose completion dates were due after March 15, 2020. However, given the scale of disruption, it may not be sufficient, and further extensions may be required. It is likely that the promoters, in individual cases will move applications to relevant RERA for seeking such extensions.

Having said that, it is worthwhile to note that the extensions on registration under Section 6 do not suspend the interest and penalty obligations of the developers for projects that have already been delayed. Recoveries against developers have also not stopped, however, the real estate trade bodies are seeking state-wise RERA’s intervention to stop recoveries from promoters.

As between the allottees and the promoters of real estate projects, the agreements for sale may contain FM clauses, excusing the obligation of the promoter contractually during Covid-19. However, such agreements are unlikely to contain a clause entitling the buyers to suspend payments during a force majeure event. In days to come, RERAs may also have to deal with the situation of buyers requesting a suspension of their payment obligations, particularly where projects have been suspended. RERA may also have to step in to determine the date of commencement as well as the date of cessation of the FM events. In cases of prolonged suspension of projects, it is likely that the buyers may seek refund by terminating their agreements, which trigger the obligation on the promoters to refund the amounts received. This is likely to create practical difficulties where promoters do not have the funds to repay.

Effect on Leases and Licenses
Leases, except long term leases, and leaves and licenses, both commercial and residential, are not covered under RERA Act. It is important to note that a lease agreement is not merely a contract but also envisages and transfers an interest in the demised property by creating a right in favour of lessee in rem, whereas a leave and license agreement does not transfer any interest in favour of licensee in respect of the property.

A lessee contemplating deferment or suspension of rent will have to carefully examine the terms of its lease agreement for a FM clause, specifically a right to defer or suspend payment of rent in such cases. Normally lease agreements do not provide for suspension or deferment of payments on account of FM. In light of this, the order under the Disaster Management Act, if applicable, will come to the rescue of those lessees who are covered by it.

Further, since leases are governed by the Transfer of Property Act, 1882 (“TP Act”), it has been held by Supreme Court in Raja Dhruv Dev Chand v. Harmohinder Singh[1], that ordinary principles of frustration of contract under Section 56, Indian Contract Act do not apply to lease agreements. However, a provision exists in Section 108(e) of the TP Act, which entitles a lessee to declare the lease as void, ‘if by fire, tempest or flood, or violence of an army or of a mob, or other irresistible force, any material part of the property be wholly destroyed or rendered substantially and permanently unfit for the purposes for which it was let’. For a lessee to claim the benefit of Section 108 (e) of the TP Act, it may have to demonstrate that (a) Covid 19 and its consequences constitute an ‘irresistible force’, and (b) due to such irresistible force, the property has been rendered substantially and permanently unfit for the purposes for which it was let. While it may be possible to argue that Covid-19 and its consequences do constitute an ‘irresistible force’, however, the it may depend on facts if the circumstances do render the property in question unfit for occupation, substantially and permanently. A lockdown, at best, is a temporary phenomenon, and it may not have the character to make the property unfit for use permanently. Further, on determination of the lease, Section 108 (q) of the TP Act mandates that the lessee is bound to give the possession back to the lessor, and for such time that the lessee continues to remain in possession of the property, the lease continues, and so does the obligation to pay the rent.

Frustration of contracts, under Section 56 of the Contract Act entitles a party to declare a contract void if the performance becomes illegal or impossible. It is arguable that since leave and license agreements are in the nature of executed contracts (i.e. contracts that have been performed), the benefit of Section 56 would not be available for such agreements[2]. However, even if the courts were to reconsider the applicability of the defense of frustration under Section 56 of the Indian Contract Act, it may still not entitle the lessee or the licensee to suspend or defer payments of lease rentals. Even if the lease agreements are frustrated, the lessees will need to restore the advantages received under the said agreement or pay compensation for the same, by virtue of Section 65 of the Contract Act. Therefore, lease rental for the duration of the lease will still have to be paid. Similar view may be taken even for common area maintenance charges payable under common area maintenance agreements.

Real estate sector will be the most complicated piece of the puzzle for the Government and the policymakers. The Government and industry have already been in fire-fighting mode with the number of insolvency petitions pending against real estate developers. The current crisis will put further burden on this sector and it would have to be seen whether the contingency plan of the FM would be required for real estate and MSMEs. The government is already mulling a special plan but its contents are yet to be released. Further, in those cases where individual’s personal properties are involved – say residential leases – the government is required to walk a tight rope and balance all interests. This is particularly because any legal intervention has the effect of affecting a concluded bargain between private parties. In light of the prevalent conditions, there are a large number of white-collar employees also who are losing their jobs or facing substantial salary cuts. Therefore, would it be fair to also throw them out of homes? Unless the government provides some sort of alleviative remedy, this is the most likely outcome.

[1] Also followed by Delhi High Court in Hotel Leela Ventures Ltd v. Airports Authority of India, FAO (OS) (COMM) 64/ 2016.
[2] The courts also seem to be of the view the principles of frustration of contract in Section 56 apply to executory contracts (i.e. contracts yet to be executed), and not to executed contracts. Leases have been held to be executed contracts, and a similar view is likely for leave and license agreements too.