Real Estate’s Ride Through COVID-19 And Way Forward

The outbreak of the novel coronavirus referred to as COVID-19, has struck at the roots of some of the world’s largest countries. After WHO declared COVID-19 a Pandemic (the “Pandemic”), many countries announced measures to contain its spread. In what is considered as a timely step, Government of India on March 24, 2020, imposed a 21-day nationwide lockdown (“Lockdown”) under the provisions of Disaster Management Act, 2005 (“DMA”) (which is likely to get extended further), during which various establishments including malls, offices, etc., were directed to suspend their operations.

The Real Estate sector was already facing a severe crisis since the last three years, and the Lockdown will further adversely impact the industry. Prior to the outbreak of this Pandemic and imposition of the Lockdown, barring the residential sector, other sectors such as commercial leasing, logistic parks, co-working, and co-living had shown remarkable growth in terms of development and strategic investment. However, now these sectors have also come to a standstill and will remain so until the world recovers from this disaster. Further, with production in China taking a hit, the supply chain of the construction industry would get adversely affected. Moreover, the present Lockdown would result in further financial constraints to developers in servicing their project loans, as they are required not only to continue paying salaries to its employees despite the stoppage of work but also face delay in the timelines for completion of projects.

In the wake of the present crisis, the Government, Regulators, and Judiciary have acted swiftly to address the situation:

● Various ministries of the Central Government such as Finance, Renewable Energy and Shipping have recently issued directions to consider COVID-19 a natural calamity or a force majeure event and relaxing the delays caused on account of it.

● RBI has announced a three months moratorium on payment of installments in respect of certain loans. RBI has also reduced the Repo Rate and Cash Reserve Ratio requirement so that additional cash flow becomes available to banks to lend to various sectors.

● The Hon’ble Supreme Court of India has extended the limitation period in all proceedings, w.e.f March 15, 2020, till further orders/s.

● The monetary threshold of default in respect of MSMEs, for filing an application for initiation of corporate insolvency resolution process under IBC has been increased from INR 1,00,000/- to INR 1,00,00,000/-.

● NCLAT has announced that matters relating to an extension of time, approval of resolution plan and liquidation will not be construed as urgent matters. Further, NCLT has held that any interim order passed by it shall continue till the next hearing.

● MAHA RERA has also extended the period of validity of registration of projects by three months, where the validity of a project expires on or after March 15, 2020.

The Hon’ble High Court of Delhi has recently in Anant Raj Limited vs Yes Bank Limited (W.P. (C) URGENT 5 / 2020) observed that the RBI COVID-19 Relief Package is also applicable to loan accounts of developers classified as SMA-2 as on February 29, 2020 and that such SMA-2 cannot be classified as an NPA in case they fail to pay installments during the moratorium period (i.e. from March 1, 2020, to May 31, 2020).

Additionally, Countries such as Singapore and Germany have proactively proposed new bills aimed to mitigate consequences of COVID-19 by providing temporary respite to individuals and companies from the performance of their contractual obligations and to deal with conflicts arising in such a situation.

Despite the aforesaid measures, it remains a fact that the unforeseen rise of the Pandemic has already impacted the performance of contractual obligations of various stakeholders in the industry and therefore, the ‘Force Majeure’ clause in a contract has now gained unprecedented importance.

‘Force Majeure’ has not been specifically defined under any Indian law, but its principle has been incorporated in Section 32 and Section 56 of Indian Contract Act, 1872 (the “ICA”) (commonly known as the doctrine of frustration), which are mutually exclusive. Section 32 of ICA will include such a contract that contains impliedly or expressly certain events or contingency, upon the happening of which, it would stand discharged. However, when upon the happening of a subsequent event (not contemplated by the parties under the agreement), if the purpose or basis of the agreement is completely frustrated or rendered impossible or illegal, then the affected party can take recourse under Section 56 of ICA to terminate the contract.

In view of the Lockdown, stakeholders are frantically reviewing their existing commercial and leasing contracts to assess if the Lockdown or Pandemic can be treated as a ‘Force Majeure event’. In such a situation, one must take a multi-factored approach and consider the definition and scope of Force Majeure as agreed under the contract i.e. to determine if it’s an all-inclusive definition that indirectly covers the Lockdown or Pandemic, or if it exclusively envisages physical damage or if it covers business interruption.

The law relating to ‘doctrine of frustration’ has been laid down by the Hon’ble Supreme Court of India in the seminal decision of Satyabrata Ghose vs Mugneeram Bangur and Company and Ors (AIR 1954 SC 44) (“Satyabrata Case”). The Court has analyzed the concept of ‘impossible’ as embodied in Section 56. The Court has observed that unless an untoward event or change of circumstances totally upsets the very foundation upon which the parties rested their bargain, it cannot be said that the promisor finds it impossible to do the act which he promised to do.

The Hon’ble High Court of Gujarat in the matter of Gujarat Housing Board vs Vipul Corporation (AIR 2004 Guj 319) has held that to render a contract void under Section 56 of ICA, the subsequent event must be of fundamental or of a sweeping character which kills the contract itself and not merely of nature which leaves the contract alive and capable of being performed at a later date and whether a contract can be deemed to be frustrated under Section 56 of ICA, depends upon the facts of each case.

The Hon’ble Supreme Court of India in Energy Watchdog and Ors vs Central Electricity Regulatory Commission and Ors (2017 6 SCJ 398), held that Courts are not at liberty to absolve a party from liability to perform his part of the contract, merely because on account of an uncontemplated turn of events, the performance of the contract may become onerous.

Further, the NCLT, Mumbai Bench judgment, in Indiabulls Real Estate Company Private Limited vs Crest Steel & Power Private Limited (CP No. 1664/IBC/NCLT/MB/MAH/2017), suggests that “orders of governmental or statutory authorities” which results in a change in law and which makes it impossible for parties to perform their obligations could be considered as a force majeure event.

In view of the above, it is likely that the assets occupiers may find it challenging to contend that the present Lockdown or Pandemic is covered under the doctrine of frustration, since, it will be viewed as an event creating a temporary impossibility or partial suspension in performance of their contractual obligations.

Another important aspect to bear in mind is that the Hon’ble Supreme Court of India has in the matter of HV Rajan v CN Gopal (AIR 1975 SC 261) observed that the doctrine of frustration provided under Section 56 of ICA, can only apply to executory contracts and not to executed contracts such as conveyance or lease, where the interest in the property has been transferred to the other party. In cases of concluded leases, Section 108(B)(e) of Transfer of Property Act, 1882 (“TOPA”) would apply, which entitles a lessee to terminate a lease if a material part of the property is destroyed, or the property is rendered substantially and permanently unfit for use on account of natural calamity, war or any other irresistible force. The asset occupiers may also find it challenging to take recourse to Section 108(B)(e) to terminate their lease, as the present Lockdown or Pandemic may be viewed as temporary in nature, not resulting in the destruction of the property or rendering it permanently unfit. Thus, in such cases, the force majeure clauses agreed under the lease deed, would acquire immense significance for assessing any claims regarding the suspension of contractual obligations of the parties.

As regards leave and license agreements, Section 62(d) of the Indian Easement Act, 1882 (“Easement Act”) provides that a license is deemed to be revoked where the property is destroyed or by superior force so permanently altered that the licensee can no longer exercise his right. One would observe that this provision is similar to the provision set out in Section 108(B)(e) of TOPA, the common ingredient being ‘the property should be destroyed or permanently altered or rendered unfit’. Thus, even a licensee may find it challenging to take recourse to Section 62(d) of the Easement Act, as the present Lockdown or Pandemic would not result in the destruction or permanent alteration of the property. Further, if the force majeure clauses in leave and license agreements do not contemplate Government directions such as relating to the present Lockdown or Pandemic itself, then the licensees may find it challenging to claim suspension of their obligations. Licensees may also face challenges to take recourse to Section 56 of ICA, as the present impossibility caused through the Lockdown or Pandemic is not of a permanent nature. Further, even if the force majeure clause includes Acts of God or natural calamity then, it needs to be tested if the courts would consider the Pandemic as an Act of God / natural calamity and allow lessees/licensees to suspend their obligations. While interpreting the contracts, the courts are free to take a view based on equity and exercise their inherent powers, as the law which has evolved through various judgments, including the judgments mentioned herein, have never dealt with an unprecedented situation, similar to the present Lockdown or Pandemic.

Way forward

Various stakeholders such as cinema and hotel operators, occupants of retail and office space are claiming Pandemic as Act of God / natural calamity and are seeking suspension of their contractual obligations to pay rent/license fee, which in various instances has been accepted by the asset owners, but is likely to be contested by few of them. It will be interesting to note when these matters reach the courts, how they will interpret the contracts and whether it would allow suspension of contractual obligations treating various Government direction regarding Lockdown and Pandemic as a force majeure event including as an Act of God / natural calamity.

Even after the Lockdown is relaxed, the real estate industry will continue to face challenges as business may not be as seamless as it was earlier due to various factors, including social distancing, shortage in the supply chain of essentials or non-essential commodities and goods, non-availability of construction raw materials or migrant workers. Further, there is a high possibility that different Courts in India may view the impact of the Pandemic on contractual obligations of parties differently, thereby creating further conflicts and adversities.

Considering the above, the Central Government should consider modifying the DMA, to address the conflict which may arise on account of the parties' inability to perform their obligations because of the P and balancing the interest of all stakeholders. The Government may also consider appointing a special authority to assess if non-performance of a contract by a party was directly or indirectly linked to the Pandemic.

The industry is expecting a reasonable relaxation and extension of time in regulatory compliances, including a fast track approval process to reduce project costs. Developers are hopeful that the government would reduce the statutory / development charges, premiums, GST and stamp duty and also provide input tax credit benefit to the sector for at least one year to tide over the existing cash crunch. The three months moratorium to be provided by banks to developers and apartment purchasers as well as extension provided by RERA to developers beyond three months is being sought to be further extended for a reasonable period. The industry expects that their long-pending demands of granting ‘infrastructure’ status to the entire sector will be accepted. Deployment of stress asset fund of INR. 25000 Crores should be prioritized. Banks and financial institutions should take advantage of the surplus cash to be available with them due to a reduction in repo rate and cash reserve ratio which will be utilized for the sector to address liquidity crisis. The industry is also seeking a one-time rollover/restructuring of existing loans for more than one year, on a case to case basis. The government could also consider industries' demand of re-introducing subvention schemes with necessary safeguards.

An unprecedented crisis like the one presented by COVID-19 calls for unprecedented and proactive measures and coordination amongst regulatory and enforcement authorities, the real estate industry and the public.

This article was originally published by Cyril Amarchand Mangaldas.