Real estate developers face a dilemma—whether to launch new projects under a SPV (Special Purpose Vehicle) or under the flagship entity. This decision is often influenced by various factors like stamp duty, GST, availability of resources, Real Estate (Regulation and Development) Act (RERA) and the Insolvency and Bankruptcy Code. 

While organisational structure and tax framework would favour launching a project in the flagship entity, RERA and IBC tilt the scales in favour of the SPV route. This is because the need to ring-fence the flagship entity from risks far outweighs operational inefficiencies of having project development and operations at the various SPV levels. 

Historically, SPVs were primarily used to make the process of land acquisition efficient. Hence, all developers typically had several SPVs in the form of land-owning companies (LOCs) which did not have any operations and only one or just a few operating entities (DevCos) in the group engaged in actual development work. The arrangement between LOCs and DevCos were typically transfer of development rights, until the advent of stamp duty on such transactions. 

More recently, variety of arrangements such a JDA, development management contract, underwriting/marketing contracts have taken over, depending upon whether the development work is being undertaken by LOC/SPV itself or separate Dev Cos. Such contracts define the roles and responsibility of each party and consequentially risk borne by each. 

NCLT order–a jolt from the blue 

The NCLT recently, in the case of Yadubir Singh Sajwan & Ors vs Som Resorts has admitted CIRP proceedings against a real estate developer by lifting the corporate veil and contending that the marketing agency (that was accepting payments for the project) and Som Resorts were under common management. While doing so, the NCLT has rejected the established doctrine of “separate legal entity”. 

Som Resorts (‘corporate debtor’) launched a residential project named ‘Casa Italia’ at Ghaziabad in 2012. It appointed Cosmic Structures (CSL) as its marketing agency. The home buyers (petitioners) had booked space in the project and were to be handed possession of flats in 36 months as per the Builder Buyer Agreement. The Delhi High Court, in 2017, ordered liquidation of CSL, and the official liquidator sealed the Casa Italia project, considering it to be the property of CSL. 

Since the corporate debtor failed to honour its obligations, a Memorandum of Settlement (MoS) was entered into between the home buyers, Som Resorts and CSL, whereby Som Resorts undertook to complete the project within 18 months (of de-sealing of the property). Further, all the payments made to CSL were deemed to be made to Som Resorts. 

However, Som Resorts failed to deliver the property even after 18 months of de-sealing of the property. Accordingly, the petitioner submitted a petition under Section 5(8)(f) of the IBC for a refund (along with interest). 

Som Resorts submitted that it had given marketing rights to CSL for a year only. Further, the marketing agreement did not permit CSL to receive payment in its name. It was also argued that several material acts were also not performed by petitioners such as providing proof of allotment, etc. 

The petitioners replied with reasons for the non-performance. They also said that as per the MoS, Som Resorts had undertaken to accept all allotment letters issued by CSL. 

NCLT’s verdict 

The NCLT noted that the relationship between the corporate debtor and CSL was one of ‘agency’. 

Relying on the decision of Calcutta High Court in the case of Charnock Collieries Co vs Bholanath Dharwhere, the NCLT held that the petitioners were justified in assuming that CSL was authorised to accept money on behalf of Som Resorts. In this regard, the NCLT also discussed the concept of ‘doctrine of indoor management’. The NCLT lifted the corporate veil and found that Som Resorts and CSL are indirectly controlled by the same person. Accordingly, the NCLT ordered the commencement of CIRP proceedings against Som Resorts. 

NCLT order–centre piece of the puzzle 

In recent times, the government/creditor etc. have increasingly been using forensic audits to help uncover frauds. Further, Section 43/44 of the IBC seeks to invalidate any preferential (or deemed preferential) transaction entered with related parties within two years prior to the commencement of insolvency. 

While forensic audit is event-based, evaluation of a preferential transaction happens only once the CIRP has commenced and only transactions entered within the preceding two years can be invalidated. In the absence of a smoking gun regarding the existence of fraud (or collusion or siphoning of funds), forensic audit and/or Section 43/44 of IBC has had mixed results. Due to inherent limitation, both the above means have not been able to comprehensively trace squandered money, especially in real estate transactions. 

Pathbreaking judgement

The NCLT ruling now gives overarching right to a home buyer where a home buyer can seek to initiate CIRP proceedings directly against the flagship entity, where the stakes are much higher for the developer. This judgement is pathbreaking as it opens the gates for bringing in the ‘real’ real estate developer into insolvency proceedings, even if defaults occur in a SPV—reducing the advantage of using SPVs. 

One may take the view that the ruling should not cover genuine cases where the delay in construction or possession is due to reasons not in the control of the developer. 

In any case, the ruling has necessitated real estate developers to holistically evaluate risk mitigation strategies that should be adopted in all their existing as well future projects to ensure that the flagship entity can be ring-fenced adequately. On the other hand, home buyers have another tool to seek justice, where it is due. 

(The authors are Partner and Manager, respectively with Nangia Andersen LLP, a business advisory firm)