Following our recent update on how start-ups should deal with COVID-19 and its impact on investment transactions[1],we have put together another update on the impact of COVID-19 on Indian real estate transactions.

While the spread of COVID-19 had been spreading at an alarming rate since its inception in Wuhan in China since the beginning of January 2020, the fact that the number of affected countries has tripled by March 2020 is a major cause for concern, especially for a developing economy like India. The World Health Organization (WHO) has been assessing the outbreak’s alarming levels of spread and severity but on March 11, 2020 the Director General of WHO characterized novel Coronavirus or COVID-19 as a pandemic[2].

This article aims to provide insight into the effect of COVID-19 on the transactions in real estate sector such as in housing, hospitality, retail and commercial and the legal recourse which may be exhausted by the affected Party.

Impact on Real Estate Transactions:

  1. Joint Development: In such a transaction, the business arrangement between the landowner and the developer is mainly on the understanding that the landowner contributes its land parcel and the developer in turn:
    • obtains requisite approvals for the development of the project; and
    • develops the housing or commercial project within the agreed timelines.

The imposition of travel restrictions and lockdown by the government owing to the rapid spread of COVID-19 has caused a major shortage of manpower and supply of goods on account of panic exodus of labourers and difficulty in movement of goods (especially iron and steel from China) across locations, resultantly causing difficulties in completion of the projects. While the real estate industry is typically prepared for exigencies’ such as shortage of goods and other supplies and such factors are usually built into the timelines (providing enough headroom to tackle shortfalls) for completion of the projects, situations like COVID-19 are an exception to this preparedness. Depending on the level of investment made in the project, the present state of the development and the prospective penalties, the developer may opt for extension of timelines, or an altogether termination of its contractual obligations on the ground of impossibility of performance of the contract.

  1. Commercial Leasing: A leasing transaction, whether it is in the retail, hospitality, commercial, or industrial sector, are governed by the commercial terms of the lease instrument. The rapid spread of COVID-19 has negatively impacted the supply chain and decreased retail traffic on account of the government’s lockdown and ‘social distancing’ mandate which include directives to shut offices, malls, restaurants, schools, and premises used for commercial purposes. A few ways in which affected parties could mitigate the effects of this situation on the commercial leasing transaction could be classified under three broad heads:
  • If the deal is at a negotiation stage, the parties could use the current situation to justify a postponement of, or freezing of the commercial negotiations.
  • In the event the lease agreement has been signed, the current situation could be used as a basis to invoke the ‘force majeure’ clause in the lease instrument, as a justifiable reason to defer the start of the lease agreement, and hence avoid commencing the monetary obligations thereunder.
  • In case the lease has commenced, based on how the force majeure clause has been drafted in the agreement, the lessee could try to terminate the agreement, which has been dealt with in detail in this article later.
  1. Purchase/Sale: The impact of COVID-19 outbreak in such transactions can be broken down into two parts:
  • First sale: The terminology ‘first sale’ usually references the purchase of a residential/commercial property directly from the developer. Delay on the part of the developer in completion of the project and timely handing over of the possession has delayed the timelines for ‘first sales’, substantially. In this scenario, the affected parties are both the developer as well as the buyer and in such cases the developer may attempt to invoke ‘force majeure’ clause to exempt themselves from paying a penalty to the buyer for delay in the project delivery. This would typically lead to an extension of time for completion of the project, where such extension is often equal to the duration of the force majeure event. However, this will be subject to the option of the buyer to terminate the agreement and opt for a refund of the sale consideration paid by the buyer, which may or may not be palatable to most developers. It is pertinent to note that Maharashtra and Karnataka RERA Authorities have already extended validity of Projects by three months.
  • Second sale/resale: A second sale usually denotes a subsequent sale by the first purchaser or other purchasers of the property. Second sales are usually based on the seller’s readiness and willingness to perform certain acts before the handing over of the premises. A few demands that buyers normally raise before the sellers are:
  1. Deep cleaning/disinfection of the entire premises before handing it over to the buyer.
  2. White-washing and providing other basic fixtures/repairs/improvements to make the premises habitable, which would be impossible to perform by the seller in the current times.

The current COVID-19 scenario and preventive measures surrounding the same, makes it challenging, if not nearly impossible, for the sellers to comply with such demands of the buyer and fulfill the terms of the agreement. Therefore, in these instances, the completion of the sale may mutually be pushed by the parties into the future, or the agreement may be terminated altogether.

  1. Foreign Direct Investments/Investment: As per the government policy 100% foreign direct investment is allowed in development or construction of the township projects, built-up infrastructure, which includes residential/commercial premises, hotels, resorts, hospitals etc. COVID-19 has had a negative impact on such transactions as well and is expected to eventually slow down the pace of foreign investments in India in this sector due to the reasons discussed above, including delays faced by the developers.

Legal Ramifications of COVID-19 Outbreak on the Sector:

All legal contracts in India are primarily governed by the Indian Contract Act, 1872 (the “Act”), under which it becomes essential to check:

  • whether the legal contract between the Parties exists or not; and
  • whether the contract is duly registered and adequately stamped, from the point of view of its enforceability before a court of law.

For details on the construct and definition of ‘force majeure’ and how it’s been interpreted by the courts, please see our earlier article in the same series. Having said that, some relevant questions and issues, which each stake holder in a real estate transaction should be aware of and address, from a legal perspective are:

  1. Whether there is an exemption under contractual ‘force majeure’ provisions or ‘doctrine of frustration’ for such pandemic causes?

In light of the present scenario there can be two possible situations which would suggest that whether the said force majeure clause covers a pandemic or not:

  • If the contractual definition of a force majeure event expressly includes a pandemic situation.
  • If the force majeure clause does not expressly cover epidemic/pandemic situation, however it broadens the applicability to an unexpected eventuality which is beyond the reasonable control of the parties.

In both of these kind of clauses, force majeure can be invoked. Therefore, whether a party can be excused from a contract due to COVID-19 being declared a pandemic would be a very fact specific determination and will depend completely on the nature of the party’s obligation and specific terms of the contract.

However, in contracts where the force majeure clause does not cover situations like pandemic or unforeseen eventualities or the force majeure clause is absent, an affected party may attempt to claim relief on the grounds of ‘frustration’ under Section 56 of the Act. It is relevant to highlight that the Supreme Court has said that the word ‘impossible’ has not been used in the section in the sense of physical or literal impossibility. Hence, though the performance of an act may not be literally impossible, but it may be impracticable and useless from the point of view of the object and purpose of the parties[3]. The applicability of the doctrine of frustration would not apply to lease of land, however, if the lease property is destroyed by fire, tempest, flood or violence, then the tenant has the option to declare the agreement void under section 108 of the Transfer of Property Act, 1882, has specifically been held by the Supreme Court in its judgements[4]. Therefore, in a situation where the lessee/tenant are unable to occupy the premises due to a pandemic situation, the object of the contract could be considered lost and the performance of the contract could be deemed to be frustrated.

  1. Whether ‘continuous operation’ clauses can be enforced in case of exceptional circumstances?

‘Continuous operations’ clauses are covenants commonly found in commercial leases that compel the lessee/tenant to operate efficiently and profitably by requiring them to conduct regular business at all times during the lease term. Due to COVID-19 the lessee/tenant will have to review their leases for any ‘continuous operation’ clauses. In order to comply with health and safety direction issued by the government, the closing down of the premises by the lessee/tenant would be considered a breach of the covenant. Considering such complexities, compliance with the law should take precedence over contractual ‘continuous operation’ clause.

  1. Whether losses incurred due to government or quasi-government (Civil Authorities) directed closures/shutdowns due to COVID-19 can be covered by insurance?

The current scenario of pandemic is highly unlikely to be covered by insurance in case of business suspension. However, since the Government of India has declared COVID-19 as a “notified disaster”, business suspension would be covered by many insurance policies provided the insured party fulfills all of their formal requirements. In order to formulate the overall strategy and course of action, careful examination should be made of the insurance policies to determine if certain losses can be mitigated under the same.

  1. Addressing other aspects such as mitigating the challenges and enhanced cleaning of the premises by lessor/landlords.

Issues relating to suspension, extension of time, cost escalation, and damages to the affected party needs to be closely evaluated and plan for suspension of work, including payment of mobilisation / demobilisation costs and any impact that may be caused due to extended force majeure should be borne in mind. Particularly, large infrastructure contracts have various stakeholders and it is important for a developer to ensure that sub-contracts have adequate back to back arrangements to mitigate such risks.

Further, other issues such as enhanced cleaning of the commercial premises, which is responsibility of the lessor/landlord, and which will increase the financial burden on the lessor/landlord should be examined and duly discussed, along with the sharing of costs, etc. with the lessees/tenants.

Challenges to be Addressed in the Upcoming Days

  • Businesses and parties should be mindful of developments to protect their arrangements from a possible global-economic slowdown.
  • Careful review of the leases and other real estate contracts by both lessor/landlords and lessee/tenants should be undertaken in order to mitigate their risk of suffering negative impacts from the pandemic.
  • Extra care to be taken while cleansing the premises to provide a safe working/living environment when the pandemic ends and to prevent any liability.
  • Going forward the lessor/landlords and the lessee/tenants should work in conjunction to agree on a clause for epidemics covering specific grounds for frustration in all real estate contracts.

Conclusion

The real estate risk business has always been based on defined and established risk parameters, however the economic skepticism created by the current pandemic is going to be one of the major nemesis of the real estate development. Judicial interpretation of contracts in disputes involving unforeseen events with diverse and nuanced approaches are highly dependent on the nature of the contract and the language of the terms. It is therefore prudent for real estate contracting parties to seek legal advice and conduct a thorough legal analysis of their contracts to protect themselves on either side of performance, allocate risk properly, formulate a strategy for renegotiation if required, and save the sanctity of contract.

[1] https://algolegal.in/covid-19-and-how-should-start-ups-navigate-these-troubled-waters/

Part-2: Impact Of Covid-19 On Investment Transactions

[2] https://www.who.int/dg/speeches/detail/who-director-general-s-opening-remarks-at-the-media-briefing-on-covid-19—11-march-2020

[3] Energy Watchdog v. Central Electricity Regulatory Commission & Ors [(2017) 14 SCC 80]

[4] Dhruv Dev Chand v. Harmohinder Singh [A.I.R. 1968 S.C. 1024].

 

This material and the information contained herein prepared by Algo Legal is intended to provide general information on a subject or subjects and is not an exhaustive treatment of such subject(s). Algo Legal is not, by means of this material, rendering professional advice or services. The information is not intended to be relied upon as the sole basis for any decision. Algo Legal shall not be responsible for any loss whatsoever sustained by any person who relies on this material.