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SEBI Greenlights REIT Way: Approval for Fractional Ownership of RE

Leave a Comment / Capital Markets and Securities Law / CBCL

[By Shaswat Kashyap & Snigdha Dash] The authors are students at Gujarat National Law University and National Law University, Odisha respectively. Introduction In recent years, India has seen a rise in web platforms, such as WiseX and others, offering investors the chance to invest in real estate (RE) assets through fractional ownership. Recognizing the growing value of investments and the increasing number of investors, the Indian watchdog deemed it crucial to formalise the sector. In a move to safeguard the interest of investors, the Securities and Exchange Board of India (SEBI) in its 203rd board meeting dated 25 November 2023, took a crucial step by granting approval for the implementation of a regulatory mechanism governing fractional ownership of RE assets. This strategic move followed the issuance of a Consultation Paper (CP) on May 12, 2023, which proposed the inclusion of Fractional Ownership Platforms (FOPs) within the purview of SEBI (Real Estate Investment Trust) Regulations 2014 (The Regulations) through necessary amendments. In the CP, the regulatory watchdog proposed Real Estate Investment Trusts (REITs) type registration including listing, terming it as Micro, Small and Medium (MSM REITs). In common parlance, REITs are types of trusts or corporations that invest in real estate directly by purchasing properties or buying mortgages. The Board approved the amendments to the Regulations for SM REITs with an asset value of at least 50 crores as opposed to a threshold of 500 crores for existing REITs. SM REITs shall have the facility to formulate mechanisms for real estate asset ownership through Special Purpose Vehicles (SPVs) constituted as companies. This aims at providing investor protection measures that will thereby ensure the orderly development of the Real estate sector and the market. The move would be beneficial, especially for retail investors unfamiliar with such a structure. Understanding Fractional Investment A concept still at its nascent stage in India, Fractional Investment is an investment strategy wherein the acquisition cost is divided among various investors who invest in securities issued by SPV established by the FOP. Such investment serves investors with a limited appetite for real estate who desire focused investment in a specific location through multiple SPVs and helps one maintain a diversified portfolio when one has a low capital to invest. FOPs play a vital role by providing investment in pre-leased real estate by bringing a pool of investors on the same paradigm. Fractional Investment in real estate or property provides an alternative to engaging in the real estate sector via REITs and reduces the financial burden on single investors while allowing them to generate a steady stream of cash flow and long-term returns. Decoding the Rationale behind this Approval: Addressing the Challenges The regulatory oversight of FOPs is either ambiguous or absent. SEBI, with recent approval, is making efforts to address various other challenges that include: First, In most cases, the SPVs are constituted as private limited companies and are thus subjected to the regulations outlined in the Companies Act, 2013. However given how the FOPs obtain the interest of participation from members of the public, the SPV may have undertaken a Deemed Public Issue (DPI) without complying with issuing a prospectus and filing and registering with SEBI. It may further breach the maximum number of shareholders permitted for the private companies as per the Companies Act, i.e., 200. Second, even though the FOP provides fractional ownership to purchase real estate, it doesn’t necessitate any uniformity of disclosures regarding the valuation of RE and other disclosures. Such Fractional Investment mainly targets Non Institutional Investors (NII) but the investor has to depend on the FOP for the necessary information to aid diligence by potential investors Insufficient transparency and disclosure of essential information to an investor could result in financial losses for the investor. This may occur due to misrepresentation, the sale of real estate assets/securities from SPVs without accurate valuation awareness, and similar factors. Third, the mode and manner of completion of the purchase/ acquisition of RE is ambiguous and doesn’t have a mandatory independent review or assurance mechanism. The CP suggest that such an amendment will rescue the investors who fall prey to mis-selling and provide an end-to-end regulatory mechanism for grievance redressal. Further, the migration of current SPVs or other structures established by FOPs to the REIT may result in the treatment of such investment by investors as investment in Business Trusts under the Income Tax Act which provides certain tax benefits which are otherwise not granted to the SPV in the existing scenario. Therefore, the proposed amendment will also ensure to reduction of the complexity attached to the issuance through SPVs. Proposed Scope of Regulation: A Brief Overview 1. It facilitates a provision for registration and regulation of FOPs under REIT Regulations: Any person or legal entity including FOPs who facilitate fractional investment by any structure is required to register with SEBI to work as SM REIT in the manner specified by SEBI in its standard format. 2. It is optional to come under the ambit of REIT: The chairman of SEBI, Madhabi Puri Buch clarified that the existing fractional ownership has the option to either navigate to the ambit of REIT or stay under the company structure. The better explanation to register under REIT will reach a wider audience ensuring credibility and attracting overseas flows. 3. It ensures investor interest: There is an expectation that the FOPs will comply with the new framework and further upgrade their scale, the new framework is investor-friendly. While still trying to evolve from a nascent stage, the investors will get the right investment option and attract larger portfolios ensuring continued assets to meet the increasing demand. It will also make sure that investors are protected, common practices are disclosed and there is a robust redressal mechanism. 4. Another proposal suggests setting a minimum subscription of Rs. 10 lakh. Currently, most platforms maintain a minimum ticket size of Rs. 25 lakh. The regulator is considering further reductions as the market matures. Critical Analysis The NIIs apart from having limited

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Revisiting the Second Proviso to Section 7(1), IBC, 2016: In Re Manish Kumar Ruling

[By Pranav Karwa and Gaurav Karwa] Pranav is a student at the National Law University, Jodhpur and Gaurav is a student at the West Bengal National University of Juridical Sciences. Recently, in the case of Manish Kumar v Union of India (“Manish Kumar Ruling”), the Supreme Court upheld the constitutional validity of all the provisos added to Section 7(1) of the IBC, 2016 (“Code”) via the IBC Amendment Act, 2020 (“the Amendment”). The second proviso to Section 7(1) of the Code introduced a new threshold for filing an application to initiate CIRP by Home-Buyers. As per the proviso, the allottees under a real estate project can apply to initiate the CIRP process only if not less than 100 allottees file it under the same real estate project or one-tenth of the total number of allottees under the same real estate project, whichever is lower. Various writ petitions were filed by real-estate creditors challenging the constitutionality of the Amendment, including the provisos added to Section 7(1) of the Code. The primary allegation in these petitions was that the Second and Third proviso to Section 7(1) violates Article 14 and 19(1) (g) of the Constitution of India. It was also alleged that the impugned provisos are in clear violation of the Supreme Court verdict in Pioneer Urban Land and Infrastructure Ltd. and Anr v. Union of India as in that case, it was observed that Home-Buyers are deemed financial creditors without any restriction imposed on them for initiating CIRP. The authors highlight the key observations by the Supreme Court in Manish Kumar Ruling and in the backdrop of this decision, examine the utility of the Second Proviso to Section 7(1). The authors conclude by suggesting certain better alternatives which comprehensively address the mischief sought to be resolved by the Second Proviso to Section 7(1). Manish Kumar Ruling While setting aside the petitioners’ arguments in the Manish Kumar Ruling, the Supreme Court observed that there is no real discrimination against Home-Buyers. The Court opined that an intelligible differentia exists between Home-Buyers and other financial creditors as there is the heterogeneity, numerosity, and individuality in decision-making in the case of Home-Buyers. In the Court’s view, the Second Proviso to Section 7(1) of the Code acts as a deterrent for individual homebuyers filing frivolous claims before the NCLT. Thus, the Apex Court held that the Second Proviso to Section 7(1) of the Code is constitutionally valid and just because the proviso causes some inconvenience and difficulties to the Home-Buyers is not reason enough to strike it down. Overall, the Manish Kumar Ruling is a major setback for Home-Buyers who want to initiate a CIRP under Section 7(1) of the Code, individually or in small groups. However, on a positive note, the Court has clarified that not all the Home-Buyers, applying under Section 7(1), must have pending dues against real-estate project developers. It will be enough if the total dues satisfy the threshold limit of ₹1 crore. Examining the Utility of Second Proviso to Section 7(1) It is the view of the authors that the Second Proviso to Section 7(1) of the Code was not necessary in light of the already existing safeguards in the Code which prevent initiation of CIRP by frivolous claims Various concerns of the project developers could have been addressed by alternate mechanisms, which were not taken into account by the Court in the Manish Kumar Ruling. There are safeguard mechanisms already existent under the Code to ensure that there is a check on mala fide applications, where a single home buyer intends to change the real estate developer’s management. For instance, penalties ranging from ₹1 lakh to ₹1 crore on fraudulent or malicious initiation of proceedings are provided under Section 65 of the Code. Further, as held in Naveen Raheja v Shilpa Jain & Ors, the NCLT also reserves the power to impose additional costs on such mala fide applications. Moreover, Section 75 of the Code envisages a penalty ranging from ₹1 lakh to ₹1 crore in the scenario where the financial creditor under Section 7(1) omits to disclose any material fact in the application. Thus, merely the fact that a single real estate allottee is filing a complaint does not mean that the Code is being used as a debt recovery mechanism, as there already exist sufficient safeguards to ensure that the NCLT does not entertain the malicious application. Furthermore, an observation by the Supreme Court in Pioneer Urban gives more power and discretion to the NCLT to filter patently frivolous and malicious applications; the Court said that “when a home buyer makes an application, the NCLT’s satisfaction will be with both eyes open – the NCLT will not turn Nelson’s eye to genuine defenses raised by real estate developers.” Moreover, it was also observed by the Supreme Court that as soon as the tribunal admits an application, it becomes a proceeding in rem from a proceeding in persona. Therefore, after the initiation of the proceeding, the entire matter goes out of the individual allottees’ control and becomes a collective action. In this light, the fear that an individual Home-Buyer may use the Code to force the real estate developer’s liquidation is unfounded and without any backing. This is because, after the constitution of the Committee of Creditors, the issue of whether liquidation or corporate restructuring is to take place is decided collectively by voting in the Committee of Creditors. Lastly, the Second Proviso is not an unambiguous provision free of all anomalies. For instance, that the Amendment, introducing the Second Proviso to Section 7(1), does not clarify as to whether the prescribed limit of 100 or 10% of the total number of allottees, whichever is less, is to be satisfied only at the stage of initiation of CIRP or whether it must be maintained throughout the proceedings. The consequence of such ambiguity is that the real-estate developers will take advantage of the same and may strike an out-of-court settlement with one or more allottees, rendering the proceedings infructuous.