Real estate lenders should explore debt for asset swaps

By Amit Ronald Charan and Kanika Malhotra, SNG & Partners
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The real estate sector in India is slow and lately many real estate developers are defaulting in delivering their projects and servicing their project loans. Such defaults have increased the number of outstanding real estate loans in the books of the lenders and some of the loans are at the verge of becoming non-performing assets (NPAs).

Amit Ronald Charan, SNG & Partners
Amit Ronald Charan
Principal associate
SNG & Partners

Debt for asset swap (DAS) arrangements are an alternative for lenders in a scenario where the borrower is or may become unable to pay its debts. In a DAS, the borrower exchanges an asset (typically an immovable property) with the lender for the outstanding loan amount. Implementing a DAS may not be an easy option for a lender, but it is better to have a quality asset in its balance sheet than to have a NPA. Such arrangements can help lenders avoiding NPAs particularly on loans to real estate developers.

Whether an asset may be acquired by a bank is determined by section 6 of Banking Regulation Act, 1949. Usually an immovable property generating real estate value can be acquired by a bank if it meets the requirements under section 6.

When formulating a DAS arrangement with a real estate developer, the lender will have to assess from a commercial perspective the scope of development of and around the property; saleability, competitiveness and marketability of the property; present and expected valuation of the property; demand and supply factors in the area where the property is located; sanctioned plan and master plan of that area; egress and ingress available to the project/property; maintenance of the property (including ensuring no encroachment) upon acquisition by the lender, etc. In respect of land, the lender must also ascertain the floor space index sanctioned in respect of the land parcel, to assess the land’s development potential.

Kanika Malhotra Associate SNG & Partners
Kanika Malhotra
Associate
SNG & Partners

Further, the lender will have to ascertain whether the title to the property is clear and where the property is encumbered, whether it can be acquired free from encumbrances. Whether the property is freehold or leasehold is also important. Acquiring a leasehold property under a DAS arrangement is more challenging than acquiring a freehold property.

In certain instances, it may be commercially more beneficial for the lender to purchase the development rights (DR) pertaining to the project land as against purchasing the project land per se. However, it needs to be ensured from a legal perspective that this will not put the lender at a risk of being unable to exercise unfettered rights with respect to the DR upon acquisition.

Though, legally, transfer/purchase of DR pertaining to project land may not be an issue, it may put the lender at risk of being dependent on the landowner for exercising various rights, and the saleability/marketability of the DR to any other developer by the lender may be in question. The lender may also have to examine the purchase of DR from an accounting perspective.

Where, a consortium of lenders is involved, a DAS transaction may pose further challenges. It may be difficult for all of the lenders to arrive at a consensus on the portion of the project land which would be transferred into their individual name, as every lender involved would desire to acquire the best part of project land from the perspective of commercial and legal feasibility. Also, in certain cases sub-division of project land is not permissible in terms of the title document or as per the rules framed by the authorities concerned.

Lastly, it is of utmost importance that the lender is able to sell the property it acquires under a DAS arrangement. In order to ensure this, the lender may consider having an option, under the document recording the arrangement, pursuant to which the borrower/developer will be under an obligation to purchase the property from the lender upon exercise of the option by the lender, at a predetermined valuation or at a valuation to be determined on the date of exercise of option by the lender, whichever is higher.

DAS arrangements are not much in vogue, especially due to the legal and commercial challenges associated with the property proposed to be acquired and due to depressed market conditions. However, as the modalities and structures will evolve over time, we can expect such arrangements will become a robust tool for lenders to recover their dues from borrowers that are strong on assets but weak on liquidity.

SNG & Partners has offices in Delhi, Mumbai, Singapore and Doha. Amit Ronald Charan is a principal associate and Kanika Malhotra is an associate.

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