Corporate counsel from Kotak Investment Advisors, Larsen & Toubro and Jones Lang LaSalle shared their real estate concerns with India Business Law Journal. Six specialists analyse their problems and offer practical solutions, legal remedies and risk mitigation strategies.
Board resolutions and LLPs
Shagoofa Rashid Khan, senior vice-president & head of legal, Kotak Investment Advisors: The board of a developer-company typically consists of representatives of the promoters group and real estate fund. When the board consists of two nominees each from the promoter group and the real estate fund and if a real estate fund proposes to transfer its shares (in accordance with the investment agreement and the articles of association), would a resolution for transfer approved at a board meeting that is attended and voted upon only by the nominees of the real estate fund be regarded as invalid or could it be challenged through a petition filed under section 397-398 of the Companies Act, 1956? Would the answer be different if the developer-company is a public company?
Sumita Chauhan, partner, Mine & Young: As held by the Supreme Court in VB Rangaraj v VB Gopalkrishnan, the articles of a private company may contain provisions restricting the right to transfer of shares, but any restriction outside the articles (e.g. a private agreement between the shareholders) is inoperative and unenforceable unless the same has been specifically incorporated in the articles. A restriction that is not specified is not binding either on the company or on the shareholders. Thus, an agreement restricting the right to transfer, contrary to or inconsistent with the provisions in the articles, is not enforceable.
To answer the specific query – if the terms of the investment agreement stating that the transfer of shares has to be approved by at least one nominee each from the promoter group and the real estate fund, have not been incorporated in the articles of the company, the transfer of shares cannot be successfully challenged for violation of such restrictive provisions of the investment agreement or understanding under section 397/398 of the Companies Act.
The legal provision as obtained in the form of section 111A of the Companies Act deals with free transferability of shares of a public company and does not expressly restrict or take away the right of its shareholders to enter into a consensual agreement in respect of shares held by them.
Shagoofa Rashid Khan, Kotak Investment Advisors: Where a project is held in a limited liability partnership (LLP) with promoters and a real estate fund as partners, can an LLP agreement provide that only partners above a particular threshold can seek liquidation of the partnership (so as to avoid nuisance from a partner holding a nominal stake)?
Omar Vanjara, partner, Solomon & Co: An LLP agreement is a written agreement between partners of the LLP or between the LLP and its partners and is an agreement which determines and sets out the mutual rights and duties of the partners and their rights and duties in relation to that limited liability partnership.
The Limited Liability Partnership Act, 2008 provides that an LLP can be wound up either (i) voluntarily or (ii) by the order of the tribunal.
Upon the occurrence of an event of dissolution as defined under the act, the LLP shall cease to engage in any further business. When the LLP is wound up and liquidated, the assets and net proceeds shall be distributed according to the LLP agreement and in proportion of the share in the profits held by each partner or according to their rights and interest in the LLP.
In the absence of an LLP agreement, matters if any would be governed by the provisions of first schedule of the act.
Thus, in case of a dispute between the parties, the agreement would be interpreted by the tribunal in accordance with the law and therefore the agreement cannot be arbitrary and provide that only partners above a particular threshold can seek liquidation of the partnership.
Shagoofa Rashid Khan, Kotak Investment Advisors: Can a debenture trustee sell mortgaged property or part thereof if a default occurs? Is a notice of default mandatory? What precautions need to be built into the debenture trust deed and articles of association of a developer-company to ensure that such enforcement is not challenged as arbitrary by the developer-company?
ML Bhakta, senior partner, Kanga & Co: The debenture trustee holds the mortgaged property on behalf of issuer of security and for benefit of debenture holders. In the event of default by the issuer of security, the debenture trustee will have the power and authority to sell the mortgaged property and the proceeds of such sale shall be applied to redeem the debentures. This is one of the duties cast on the debenture trustee under the Securities and Exchange Board of India (Debenture Trustees) Regulations, 1993.
The debenture trustee can sell the mortgaged property by following the procedure laid down in section 69 of the Transfer of Property Act, 1882.
According to section 69 (2)(a) of the act, the power to sell the mortgaged property cannot be exercised unless a notice in writing requiring payment of the principal money has been served on the issuer of security and default has been made in the payment of the principal money or part thereof, for three months after it has been served.
In order to ensure that such enforcement of security is not challenged by the issuer of the security (i.e. the developer), adequate specific representations and undertakings to that effect may be taken from the developer in the debenture trust deed so as to estop the developer from reneging from its representations and undertaking at the time of enforcement of security.
Shagoofa Rashid Khan, Kotak Investment Advisors: In case of secured debenture holdings, the pledge agreement is signed by the promoter, but the shares lodged with a depository could turn out to be held in joint names along with a spouse or a relative. Should a real estate fund accept shares pledged in this manner? Can the joint holder object at a later stage when the pledge is invoked and shares are sold? Would it be advisable to obtain confirmation of terms of the pledge agreement from the joint holder?
Sanket Sethia, associate partner, Krishnamurthy & Co: Shares are one of the most common forms of movable property used in pledges. The reasons are obvious as shares of a substantial value can be pledged to lenders without great inconvenience. Hence, pledge of shares has always been an important form of commercial financing.
Through a pledge of shares the borrower provides a security to the lender In case of default by the borrower in repayment of any amounts due. The lender may enforce the pledge and sell the shares to recover its monies.
The right to sell the shares in an event of default is a fundamental component of any arrangement relating to pledge of shares. To realize a sale of pledged shares, the lender needs the ability to transfer the shares from the owner of such pledged shares. This authority is usually provided by means of a power of attorney in favour of the lender.
When the pledged shares are held by two or more joint holders, it is advisable for the lender to ensure that all the joint holders consent to the creation of the pledge on shares and are signatories to the pledge agreement and also execute a power of attorney in favour of the lender.
It is important to obtain confirmation of terms of the pledge agreement from the joint holders because it is necessary for all the joint shareholders to agree to a transfer of shares in the case of a default. A transfer of shares held jointly by two or more shareholders is invalid unless signed by all of the joint shareholders.
The instrument of transfer has to be executed by all the joint shareholders as transferors. Therefore, if all the joint holders of the shares do not consent to the creation of a pledge, it is possible that non-consenting joint holders will object to the transfer of the shares when the pledge is invoked.
Brokers and third party-claims
Jane Niven, regional general counsel, head of legal & compliance, Asia Pacific, Jones Lang LaSalle: As a number of developers have gone to the wall of late or are financially strapped, buyers are looking elsewhere to recover damages for units that do not meet the specifications stipulated by the developer. Unfortunately, their gaze often falls on the hapless broker. How can brokers protect against third-party claims?
Sanket Sethia, Krishnamurthy & Co: Typically, a broker is approached by the buyer to find properties for purchase or lease. The role of the broker is to act as an agent for the principal, in this case the buyer, and for this the broker earns a commission on the transaction between the buyer and the developer.
The only obligation of the broker is to identify a suitable property for the buyer in accordance with the buyer’s requirement. The specifications attached to a property are a matter of separate contract between the buyer and the developer in which the broker has no role to play. The final contract wherein representations and warranties are provided by the developer in respect of the specifications of the property is between the developer and the buyer in which the broker is not a party and the broker cannot be held responsible for breach of any representations made by the developer.
The arrangement between a real estate broker and the buyer is usually not documented and in absence of a contract, it is difficult for the buyer to claim damages from a broker for any default by the developer. It is hard to imagine a situation where a broker is held liable for acts or omissions of a developer.
Moreover, under common law the principle of caveat emptor (let the buyer beware) can be applied to the buyers to protect the broker from claims made by a buyer. In effect this means that the buyer must rely on their own judgment and independent advice while making the decision to purchase a property.
Concerns about title and stamp duty
Badrinath Durvasula, vice-president & head of legal, Larsen & Toubro: In 90% of cases, the title to a property is not clear and this is a serious concern. Every company faces this risk and in quite a few cases they walk into a trap despite the best due diligence. What is the best way to deal with this issue and what additional checks can be put in place?
Ameet Hariani, managing partner, Hariani & Co: A state-certified title is obviously the best way ahead, but currently only presumptive titles are available.
A Land Titling Bill is soon to be introduced in parliament. However, there are several infrastructure issues that need to be addressed before state-certified titles are made available. It has also been suggested that state-certified titles should be introduced in different areas in stages. For example, a certified title could be made available in urban areas in the first instance and then extended to rural areas.
Obtaining title insurance would ensure credibility of title and would go a long way in mitigating risk. But such insurance is not as yet available in India.
Badrinath Durvasula, Larsen & Toubro: Stamp duty and registration charges are very high across India and this encourages cash transactions, undervaluation and generation and circulation of unaccounted money, which a company cannot handle. What processes can be put in place to minimize cash transactions, while still being compliant with government regulations?
Ameet Hariani, Hariani & Co: While it is true that stamp duty and registration charges in India are on the higher side as compared to other countries, they have been reduced substantially in the last decade. High stamp duty and registration charges by themselves are not the only factors that encourage cash transactions or undervaluation.
The real cause is that the real estate sector generates a lot of pressures that require developers to have unaccounted money even in the process of holding and developing property. This is a fact which cannot be wished away. Thus while rationalization of stamp duty and registration charges is desirable – it is only a minor cause for undervaluation and generation of unaccounted money.
India’s real estate sector is being transformed into an organized corporate sector from an unorganized sector. This is encouraging bank and private equity investments, which in turn have created the need for good corporate governance practices. The market realities for attracting such money are pushing for cash transactions to be eliminated.
Health and safety
Jane Niven, Jones Lang LaSalle: A continuing issue in the construction industry is health and safety. Very few construction sites in India get completed without a serious injury incident and many fatalities occur annually. How can a construction manager guard against this? Should construction contracts include mandatory training requirements to highlight health and safety issues?
Sumita Chauhan, Mine & Young: An appropriate legal framework, an effective inspectorate, training of workers and supervisors, restrictions on working hours and wide availability of occupational health services are required for mitigating accidents at construction sites.
As of now India does not have a comprehensive law that looks into health and safety of workers. We have the Factories Act, 1948, and the Mines Act, 1952, and the Workmen’s Compensation Act, 1923, but all these acts make only oblique references to health and safety issues.
The prime responsibility for managing activities and people on construction sites rests with the main contractor, who is responsible for monitoring and reporting the activities of subcontractors. However, most contracts make only vague and general reference to training of personnel employed at the site and also their health and safety-related issues.
It is possible to draw up more stringent contracts to ensure that a contractor is liable for accidents and damage of equipment on site and also takes all “reasonable precautions” to protect the health and safety of workers. At present, contracts may include only a general statement to this effect.
As effective laws are not in place, contract documents can be made to act as important mechanisms to remind the parties to the contract of their obligations.
Landlords and tenants
Jane Niven, Jones Lang LaSalle: For years Indian landlords have enjoyed upwards of 20% annual growth in rental incomes. With greater choice in the market, tenants are insisting on better terms including rent-free periods for fit-outs, capped renewal, etc., but landlords are still reluctant to bow to commercial realities. Do you see any change in attitudes or can you recommend any innovative ways of addressing these issues during negotiations?
ML Bhakta, Kanga & Co: The real estate industry, especially the rental market, has witnessed a lot of change from time to time driven by market forces. Given the present market scenario, renting premises is preferred over acquisitions. This has consequentially led to a change in attitude of the landlords, who are making constant attempts at marketing their premises on terms which are more favourable to the licensee or tenants.
It is now an accepted practice of the rental industry that fit-out periods are rent-free, so also rental agreements are renewed on similar terms and conditions as applicable to the existing arrangements (save and except for escalation in rent at an agreed rate which is independent of market forces at the time of such renewal).
Jane Niven, regional general counsel, head of legal & compliance, Asia Pacific, Jones Lang LaSalle: In recent years we have seen that clients are very reluctant to accept (or pay for) valuations that have been prepared during economically volatile periods. They challenge the assumptions used and demand revisions which are not based on actuals. This is a significant concern where a valuation is being used in a prospectus or in a dispute. When it comes to payment, clients refusing and cost of recovery (both financially and in time) often outweighs the fees. What would lawyers suggest is the best way to manage expectations and seek the recovery of fees?
Omar Vanjara, Solomon & Co: As rightly stated, clients are often reluctant to make payments during economically volatile periods. Therefore in our view it is imperative and essential for lawyers to structure the fee proposal for assignments in a way that ensures payments are made.
This could be achieved by putting together a fee schedule which contains either payment milestones or a structure which could contain fees linked to the outcome or a certain percentage of amounts recovered whichever is higher. In the case of litigation, the payment schedule could be linked to various stages of litigation.
Development plans and building codes
Badrinath Durvasula, Larsen & Toubro: Some projects lack proper development plans, whereby clarity is not attained on zoning, usage, restrictions, road development. Companies can face serious hardships, when the project is underway. Can we not freeze a development plan for a sustainable period through a directive, say for 20-year framework or so?
Manish Desai, founder, Vidhii Partners: Development plans in the present regulatory regime are framed city-wise by the respective planning authorities which are often the state government or the concerned municipal corporation for the respective cities. The development plans not only provide for different types of users but also create distinctions between different zones. The development plans also identify and demarcate heritage and slum areas.
In Mumbai, the development plan is prepared by the Urban Development Department of the state of Maharashtra in exercise of its powers under section 21 of the Maharashtra Regional Town Planning Act, 1966, and the same is revised from time to time as per the requirements of the city. Further, development control regulations, framed as part of the development plan, are also modified from time to time as necessary.
India as a country is still at a growing and developmental stage, particularly as far as infrastructure and global living standards are concerned. Therefore in order to match the constant growth and development changes, there is a need for flexible policies that can take care of the country’s growing requirements. Therefore, in my opinion a development plan will need to have a shelf life which is about five to seven years and will have to be looked at again by the relevant regulatory authority from time to time.
Such changes in the development plan should not adversely affect companies and developers as such changes in development policies have a prospective effect and do not affect existing projects.
Badrinath Durvasula, Larsen & Toubro: Each city has a different set of building codes, standards and permissions and builders don’t appear to adhere to them. Could an authority not be constituted to deal with all such regulations or define parameters accessible to the public?
Manish Desai, Vidhii Partners: Each city has its own set of building codes, standards and permissions which are regulated by respective planning authorities and sometimes the respective state government. Often contracts for infrastructure and real estate development by public private partnership are governed by the respective agreements or participation agreements which often have enforceable penal clauses.
A central regulatory authority that controls and supervises the entire development relating to real estate and infrastructure in various towns and cities may resolve the problem of multiple sanctions.
However, creating an additional authority to act as a grievance redressal mechanism will not resolve the issues relating to corruption, violation of norms and other teething issues.
The Real Estate (Regulation & Development) Bill, which has been pending since 2007, proposed by the Union Ministry of Housing and Urban Poverty Alleviation, seeks to establish a real estate regulator. Closer to home, the state of Maharashtra introduced the Maharashtra Housing (Regulation and Promotion of Construction, Sale, Management and Transfer) Bill, 2011, which has also broached upon the subject of a real estate regulator.
Both these bills may serve a limited purpose of transforming the protective umbrella that is available to flat purchasers under the existing laws, such as the Maharashtra Ownership Flats (Regulation of Promotion of Construction, Sale, Management and Transfer) Act, 1963.
However, with its restrictive purview and area of operation, it does not resolve the overall problems associated with real estate and infrastructure development. In addition, the role of the regulator has been limited to an authority responsible for regulating developer activities and for resolving disputes between developer and purchaser.
Rather than a central authority, the need of the hour is the introduction of a single window clearance mechanism, under which clearances required from separate government departments under central and local laws can be simultaneously obtained. This would not only cut delays in obtaining permissions, but also introduce clarity on the various approvals required to commence construction.