– Bhanudey Kanwar, Hariani & Co., Advocates and Solicitors

Many of us have at some point in time pointing at new buildings said or heard someone say “this area (in a city or town) has changed so much from what it used to be”. How are such buildings being built? Who is building such buildings? Where are they getting the money to build such buildings?

A quick tour in any city or town in the country and  the number of buildings already completed/ under construction is evidence enough that the real estate sector in India is one of the fastest growing markets in India attributable to a growing economy, large population, rising income and rapid urbanization. The sector has been able to attract a lot of investors allowing real estate developers to expand rapidly. According to the Department of Industrial Policy and Promotion (DIPP) which is responsible for the overall industrial policy and facilitator of foreign direct investment (FDI) in India, the construction sector of India, including housing, townships, built-up infrastructure, commercial and industrial projects, has attracted an estimated US$ 22,000 million FDI from 2000 to 2013.

THE GROWING PHENOMENON- CAPITAL INTENSIVE SECTOR   

The real estate sector is the second largest employer after agriculture and is slated to grow at 30 (thirty) % over the next decade. With the growing demands for housing, commercial, hospitality and retail spaces the Indian real estate sector is expected to touch US$180 billion by 2020 and foreign direct investment is expected to increase to US$25 billion in the next 10 years, from the present US$ 4 billion. According to a recent report by the McKinsey Global Institute (MGI), India will require more than US$ 1.5 trillion to upgrade urban infrastructure and compete with the highly growing urbanization in next 25 years.

It goes without saying that the real estate is highly capital intensive sector and most companies engaged in the sector constantly require funds for various purposes such as expansion, retiring expensive debts or for making business expenses.  As a result companies engaged in real estate sector constantly look for various mechanisms to feed the ever rising demand and raise capital for its growing business.

STAGES AT WHICH FUNDING MAY BE NECESSARY- VARIOUS STAGES

So have you often wondered what the stages are and when does the funding happen? Since real estate is a capital intensive industry, funding and financing are required by developers at various stages of development of the project. Although the end result is to raise capital, the mode and manner of raising the same varies from one stage to another. Typically funds may be raised by developers during one or more of the following stages:

• Land acquisition stage
• Approval stage
• Post-approval stage
• Completion stage

NOT SO LONG AGO and CORPORATIZATION OF THE REAL ESTATE SECTOR

The real estate sector in the good old days was usually financed by bank borrowings and/or self accumulated wealth of the builders or borrowings from such other sundry creditors as the builder could woo. And in those days the sector was fairly unorganized, fragmented and mostly characterized by small players with local presence.  However, with the growing interest in the public to invest in the sector saw the need for more transparency and accountability and for the lack of a better word “corporatization” of the real estate sector.  Inter-alia the advent of reputed builders and international property consultants strengthened and led to a professional corporate image. The move by government to open up the real estate sector to FDI also led to the growth of the sector.  In India, the prevailing popular sentiment and good will towards investment in the real estate to be a safe option was also one of the driving factors for such corporatization.  As a result, today several ancillary industries including professional advisors are dependent on the simple build and sell outlook of the past.

BEHIND THE SCENES

With the growing awareness and need for transparency the real estate sector and the stakeholders are relying heavily on the expertise of their advisors viz. legal and financial. Today’s real estate financing transactions are structured to be tax efficient for the stakeholders. Although the financial advisors are engaged from the proposal stage, the lawyers are engaged by the developers and the investors at the time of drawing up the definitive and binding documents for the transaction in line with the applicable laws.  Sometimes the proposals/term sheet are finalized and at the stage of drafting the definitive agreements , the proposals may not be legally workable therefore forcing the parties to go back to the drawing board and resulting in delay.  It is always advisable to engage the lawyers from the moment “go” when structuring parties are negotiating the proposals/ term sheets etc are made so that the lawyers can ensure that the legal perspective is provided to the proposals/term sheet.  It is not only important to have commercially sound financing transaction (including the proposals/terms sheets for the same) but also legally sound ones. As the case with all lawyers goes, depending upon whether one is representing the developers or the investor the role of the lawyer is to protect his client’s best interest.

TYPICAL DOCUMENTS

Depending upon the understanding between the Parties, the following binding documents may be executed by the stake holders:

• Term Sheet/MOU: which inter-alia records the basic/ prima facie intention of the parties to enter into a financing transaction and the manner in which such transaction shall be carried out
• Share purchase or subscription agreement: which inter-alia records the purchase of shares (equity or preference from existing shareholders or subscription to fresh shares issued by a real estate development company
• Shareholders’ Agreement: which inter-alia records the mutual rights and obligations of the Parties who are shareholders of the real estate development company
• Debenture Subscription Agreement : which inter-alia records the subscription to the debentures and the rights of the debenture holders vis.-a-vis. the Company
• Loan Agreement : which simply records the terms and conditions on which the facility of loan is available to the real estate development company
• Ancillary security documents: in the case the dentures are secured or the loan is a secured loan the Parties shall enter into such documents to facilitate that the loan/ debenture (as the case may be) is adequately secured and lay down the mechanism for enforcing the security in the event of a default.

It is at the time of drafting and finalizing the definitive agreements that the real negotiations take place between the various stake holders, their lawyers and if need be their respective financial advisors.

FUND RAISING GALORE

There is no fixed standard for the raising finances in the real estate sector, there are several options (including with respect to the documentation thereof) depending upon the commercials of the developers and the nature and stage of funding.  Funds can be raised in various forms and different instruments are available to builders and developers for raising such funds. The nature of the instrument and the form in which such funds are raised depends, among other things, on the quantum of funds sought to be raised, the purpose of such funding, the nature of the Investor and on such other commercial factors as builders and developers may deem necessary.

However, the primary instruments used for raising funds are equity shares, preference shares and/or debentures. These instruments are issued with different rights, terms and conditions (viz., voting, convertibility and redemption) as the case may be, and are issued to either domestic or foreign entities by way of private placement, preferential allotment, rights issue, etc. Sometimes some of the bigger builders and developers may raise huge funds by issuing shares to public at large by way of an initial public offering (IPO) and incase  the company is already listed on the stock exchange by way of a second round of public offering .

Recently, SEBI has notified regulations governing a novel and relatively new vehicle for investment in real estate especially in India in respect of Real Estate Investment Trusts, popularly known as REITs. REITs as an investment vehicle will invest in rent yielding completed real estate properties. Owing to certain tax hurdles and amendment in laws relating to foreign investment REITs are yet to take off. However, for the corporate real estate practice area drafting the documents and advising for setting it up is something to look forward to.

REGULATIONS, PROCEDURE AND REGULATORY COMPLIANCES

The fundamental law applicable to real estate companies intending to raise funds is the Companies Act, 2013 and the rules, circulars and notifications made there under whether it is by issue of instruments or by raising a loan. When any instruments are issued to any foreign entity then apart from the provisions of Companies Act 2013 and the rules, circulars and notifications made there under, the relevant provisions of the foreign exchange regulations and guidelines and circulars issued by the Reserve Bank of India from time to time, are also required to be complied. Thus, depending upon nature of instrument and the type of investor different regulations, procedure and regulatory compliances are required to be complied.

After tackling with the compliance issue under the Companies Act, 2013 and other applicable law, in case the investors are foreigners the provision under the Foreign Exchange Management Act, 1999 and the regulations made thereunder including the provisions of the extant FDI Policy need to be complied with.

A five part lecture series on Real Estate Laws including on the relevant laws and factors that must be considered in a real estate corporatized transaction is being offered by Hariani & Co., Advocates and Solicitors. The lecture series, organized with the support of iPleaders and Government Law College, Mumbai, will be held at the Indian Merchants’ Chamber, Mumbai, from the 3^rd to the 7^th of August 2015. With 25 years of expertise and knowledge on real estate laws, the lectures promise to give an insider view and provide valuable and practical information to anyone who is a part of or interested in joining the legal profession.

For more details on the lecture series, click here.