Cooking an Investor's Real Escape from Real Estate!
This sector has, in the past years, attracted significant private money, both debt and equity, from structured funds like the alternate investment funds (AIFs). Many business groups and asset management companies (AMCs) like the Piramal, Essel, DHFL, Sundaram, IDFC, Reliance Capital, ASK, ICICI, HDFC, Kotak and a few more whose names do not readily spring to mind, set up such funds to attract investments from the high net-worth individual (HNI) community.
These AIFs were positioned as an alternative asset class with the promise of a high yield that a typical debt instrument would not provide and often promoted as fully secured against the land and property which these funds financed.
Most of these funds came into being in the period around the years 2008-2015 when the financial markets were plagued with uncertainties after the financial crisis, and the bank lending contracted (not only to this sector) due to the accumulated non-performing assets (NPAs).
These funds, which promised to return the money within six or seven years, invariably took extensions, and finally many of them wound up with staggering losses to the investors.
Despite the woeful picture above, the fund managers sponged off their annual fees and fattened their pockets.
With practically every investment into real estate projects getting into default, ending up in litigation, with many going into the Insolvency and Bankruptcy Code (IBC) process, these AIFs significantly contributed to the prosperity of the lawyers at the expense of their investors!
The typical cases funded by these AIFs involved a partnership with a real estate promoter with a land bank. The acquisition of large tracts of land had its own nuances and the USP of the land sharks (promoters) lay in the same. The promoter would contribute the land into a special purpose vehicle (SPV) to undertake a residential construction.
The land, when brought into the SPV, would be valued at many multiples of the acquisition cost and often the value of the land was worked backwards from the potential sale price of the ultimate constructed property, being a flat, a villa or a developed plot.
The AIFs would enter the scene by investing in the SPV on the basis of the inflated land value. The promoter would have structured the SPV in such a way that a good part of the AIFs’ investment would be siphoned out towards the land cost and would still enjoy a significant equity to be encashed assuming the project saw the light of day!  
The AIF would structure its investment as a ‘Napu saka’; neither equity nor debt, or both, and only understandable to the lawyers! The internal rate of return (IRR) would be anything between 20% and 30% such that post all the costs and leakages, the ultimate investor can get their promised 15% to 18% return!
An associate private company of the AIF would take away a sizeable upfront fee from the real estate venture for arranging the funding, ensuring the prosperity of the sponsor of the AIF, being one of the respected names listed out earlier in this article!
These cases were no different than the infamous pyramid schemes that lay people often fell for, and got scoffed at! However, the investors in these AIFs were highly informed savvy persons who could teach a Harvard class on valuation!
In the first few years, these ventures provided hefty returns to the investors which were fully taxable. They were being paid out of their own capital, literally!
Once that phase ended, the quarterly updates by the AMCs would start listing out the reasons for the slow progress of the project, the delay in government and municipal approvals and the overall poor off take for the flats, etc.
Soon thereafter, the returns would stop and the next phase of updates would talk about legal options on the course of action to recover the dues; initiation of arbitration proceedings, legal cases under section 138 for check dishonour, filing of IBC petitions, invocation of the personal guarantees and the like.
When finally, the schemes were wound up, the investors had little clarity on when and how to adjust the losses in the tax returns and endured the dismay of having paid tax in the past years on the high-interest receipts which were actually their own contributions coming back!
Besides the investment by the AIF, many projects took loans from banks and non-banking financial companies (NBFCs) depending on the economics, and the appetite of such agencies to fund a real estate project. Another facet is where an NBFC would fund a real estate project initially and later set up an AIF that would take money from the HNIs, and use the AIF funding for the project to repay the NBFC loan!
In the light of the above narration of how the credit needs of the real estate sector were being historically met, the case of Ambojini Property Developers Limited that came under the purview of the IBC in CP/938/IB/2018 before the Chennai bench of the NCLT is discussed.
Real Value Promoters Private Limited, Chennai, set up an SPV (Ambojini Property Developers Limited) to carry out a residential real estate project at Taramani on the outskirts of the city sometime in 2012/2013. 
The project went into delay and dispute, and ASK secured an award, to exit the project, for Rs182.5 crore against the SPV/promoters in the arbitration proceeding that they initiated!
The case of Ambojini was taken to the IBC process by one of its creditors and all the claims became subject to the said process.
The picture, with regard to the principal claimants in the insolvency process, is on the left below. The table on the right shows the fair value of the project, the liquidation value and the value offered by the resolution applicant (Rs141.5 crore).
ICICI Bank was a dissenting creditor in the process as it was not offered the full value of its debt. As per the distribution recommended by the committee of creditors, it was entitled to only its proportionate share of 4.8% of the resolution value after paying off all the expenses which ranked higher in priority.
The share of the Bank came to Rs7.44 crore against its balance loan outstanding of Rs12.08 crore. The case of the Bank was that it had the full security of the assets mortgaged to it and was legally entitled to recover the entire loan assuming the company was liquidated and the assets were sold.
A similar issue had earlier come before the Supreme Court in Jaypee Kensington Boulevard Apartments Welfare Association and Others vs NBCC (India) Ltd and Others, decided on 24 March 2021.
In this case, the Court had held that the security interest of a creditor only gave priority in distribution but the quantum would only be as decided by the committee of credits (CoC). The Court—on an interpretation of the provisions of the statute and the repeated stand of the Court in the earlier cases upholding the supremacy of the CoC in all matters—declined to interfere.
If the CoC, in its wisdom, felt that a fair distribution among all the financial creditors would necessitate an equitable haircut for even the secured creditor(s), such cannot be protested by invoking the right to encash the security and realise the outstanding loan amount.
Few other decisions have followed this principle. The received wisdom, by reading books on commerce and accounting that a secured creditor would net the full loan amount as long as the value of the security exceeded the loan amount, is no longer good!
Banks and finance companies that premise their provisioning for bad loans need to factor in this development.
The other important learning from Ambojini CIRP is that the AIF was able to extract a higher amount than its original investment. ICICI Bank must be regretting its choice of lending against a full security that ultimately caused a haircut to be suffered, when a quasi-equity investment exited with a small profit to boot!   
Besides the lenders like ASK and the Bank, the other major stakeholders were the house-buyers. The total cost of the CIRP was Rs5.27 crore, a sizeable percentage of the realisable value of the asset. IBC comes out as an expensive process and time consuming as well.
To conclude, the real estate sector may present an opportunity for different kinds of funding and typically accommodate a higher rate of interest for the lenders.
But, caveat emptor!
The watchword for the investors, the lenders and the advisers/ lawyers who deal with this animal is to anticipate the implications should the project funded finally go to the bankruptcy process and how the courts would bring to bear their own queer logic in each case.
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