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Real Estate

Partner disputes and resolution mechanism in the Indian real estate industry

September 13, 2021
Introduction

In a post-COVID world, disputes are often being considered with caution. Cost and time are playing as important factors for investors, lenders and borrowers in structuring the agreements with lawyers to avoid potential disputes and enhancing chances of better recovery of loan amounts being provided. The following key points of discussion are on issues concerning the reason behind disputes, how it impacts and what is the resolution mechanism.

1. Overall dispute resolution framework for the Indian real estate sector

  • The types of disputes usually occurring in the real estate sector are regarding: (i) disagreements amongst the parties to a joint venture; (ii) default on payment of assured returns; (iii) disagreement on inter se shareholders’ rights; (iv) oppression and mismanagement; (v) stressed assets based potential IBC proceedings; (vi) fall outs between developers and homebuyers under the RERA regime, etc.
  • The preferred mode of dispute resolution for equity investors is usually arbitration while debt investments prefer to take the IBC route. The application of SARFAESI vis-à-vis IBC continues to be in debate. While IBC offers a recovery solution for nearly all kinds of creditors, SARFAESI forbids the ability to foreclose the underlying asset in certain situations (like where the debentures issued are unlisted). However, SARFAESI provides faster and better asset value realisation at times when compared to the haircuts undertaken in the IBC regime. Resolution applicants continue to express their favour for IBC as it extinguishes all past liabilities, including third party liabilities over the assets of the corporate debtor; and all classes of creditors, including homebuyers, tax authorities, government authorities like NOIDA and MMRDA, etc. are considered in the present insolvency regime under IBC vis-à-vis SARFAESI.
  • The RBI’s prudential framework for resolution of stressed assets is available only to scheduled commercial banks, small finance banks, All India Term Financial Institutions (NABARD, NHB, EXIM Bank, and SIDBI) and NBFCs. Therefore, though this framework is not applicable to private equity investors, it has provided sufficient comfort through the inter-creditor arrangements as a pre-IBC measure for creditors.

2. Arbitration process & award mechanism

  • It is very common for the losing party to challenge the award before the High Court and then the Supreme Court. Pro-arbitration amendments have been made to the Arbitration and Conciliation Act in the last few years. For instance, Sections 34 and 48 have been amended to narrow down the scope of challenge to the arbitral award and Section 36 has been amended to do away with the automatic stay merely on filing of a court proceeding challenging the arbitral award. Of late, the instances of interference by the courts in arbitral awards are on the decline. The courts have increasingly been taking interpretations which support lesser court interference.
  • Lately, in PASL Wind Solutions vs. GE Power (April 2021), the Supreme Court of India has clarified that two Indian parties may elect a foreign seat of arbitration. Therefore, we might soon start seeing instances where domestic parties will agree to a foreign seated arbitration.
  • Cost and timing should be considered as significant factors while drafting the dispute resolution clause in agreements between lenders and borrowers. An economic foresight in the future should encourage dispute resolution clauses to appoint sole arbitrators as opposed to multiple arbitrators.

3. Lessons learnt and the future of minimising JV disputes

  • Clarity and simplicity in drafting multi-party agreements could play a major factor in avoiding interpretation-related disputes. Accordingly, process oriented agreements like joint development agreements need to have unambiguous drafting of the commercial terms and provisions in order to evade a dispute at a later stage.
  • Land leasing authorities like NOIDA, MMRDA, etc., should be included in the resolution plan with lesser haircuts as developers would often be required to obtain permissions from such authorities.
  • The provisions of IBC relating to bankruptcy of individuals were notified and made applicable to personal guarantors to corporate debtors, with effect from 1 December 2019. Thereafter, the Supreme Court decided a challenge to the newly notified provisions in Lalit Kumar Jain vs. Union of India (May 2021), wherein it held that: “…a resolution plan does not ipso facto discharge a personal guarantor (of a corporate debtor) of her or his liabilities under the contract of guarantee…The release or discharge of a principal borrower from the debt owed by it to its creditor, by an involuntary process, i.e., by operation of law, or due to liquidation or insolvency proceeding, does not absolve the surety/guarantor of his or her liability, which arises out of an independent contract.” Therefore, bankruptcy proceedings can now be initiated against the personal guarantors separately even while proceedings against the corporate debtor are pending or concluded.

Key tax issues / considerations

4. Arbitration awards and settlements

The outcome of an arbitration process depends on how the case has been presented before the Courts and what sort of demands have been raised – whether the resolution is by way of the transaction going through its original construct or settlement of disputes by way of an award or liquidated damages.

An arbitration award is in the form of a liquidated damage and is not a pay out in relation to the securities involved. In cross border situations, under the Tax treaty such payments have not been specifically envisaged and hence such cases fall under the residual category which is generally taxable at 40% and the obligation to discharge the tax liability is on the payer, thus complicating the situation further. In addition to income-tax, there could also be a GST exposure of additional 18% on such settlements. The high tax leakage can be mitigated by having a mindful approach while going into the arbitration – where preferably the settlement should be as per the original construct instead of an award. In case where the settlement is by way of the original construct of the commercial agreement going through instead of liquidated damages, the tax outflow could be restricted to the tax on capital gains on sale of securities, which in most cases is likely to be 10% as compared to the higher tax cut of 40%.

The arbitration award if on shares, under Indian Exchange Control regulations the transfer of shares is required to be at fair market value. Thus, if the asset / security value does not support the arbitration award, there could be a challenge in implementing the award from an Indian Exchange Control perspective. In such cases, a common valuation needs to be arrived at – sometimes by appointing multiple valuers and arriving at an average, to avoid disagreements on valuation between the various parties involved.

5. JDA arrangements

A JDA arrangement could be structured through a separate legal entity (like LLP) instead of through an agreement. This structure is more like an equity joint venture and the dispute resolution mechanism will be under the arbitration process as there is no debtor-creditor relations. While this structure is outside the ambit of GST law, there could be other challenges in this structure from an income-tax perspective, including GAAR implications.

Another famous vexed issue under the JDA arrangement is the additional GST cost on the land owner. Under GST law, the developer bears GST on reverse charge mechanism. The most efficient way to manage this is to factor the GST component in the overall pricing. Diluted language in the documents / agreements or keeping things open ended would only lead to more disputes at a later stage.

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