Financing
Secured lending
Discuss the types of real estate security instruments available to lenders in your jurisdiction. Who are the typical providers of real estate financing in your country? Are there any restrictions on who may provide financing?
Customarily, a mortgage is the most common form of security interest created over immovable property. The Transfer of Property Act 1882 provides for different types of mortgage, such as the following:
- simple mortgage: where the property is mortgaged without any delivery of possession, and upon failure to repay the loan the sale proceeds of the property may be appropriated towards the mortgage sum;
- mortgage by conditional sale: where the mortgagor ostensibly sells the mortgaged property to the mortgagee with a covenant that the mortgage will become void pursuant to payment of the mortgage sum;
- usufructuary mortgage: where possession of the mortgaged property is delivered to the mortgagee, who is authorised to retain the mortgaged property and receive rents and profits accruing therefrom;
- English mortgage: where the property is transferred absolutely to the mortgagee who will retransfer the same to the mortgagor upon payment of the mortgage sum;
- mortgage by deposit of title deeds: where the mortgagor delivers the documents of title to immovable property to the creditor with the intent to create a security thereon (this is only prevalent in certain states); and
- anomalous mortgage: a mortgage that does not fall into one of the above categories.
Other security instruments are pledges or hypothecation of movables, which may form part of a real estate project, or escrow of project receivables, which is primarily wanted to ensure control over the cash flows of a project. In a self-liquidating project, cash flows are considered the best security, since the mortgage over the immovable property keeps diminishing as the allotment or sale of units to third-party customers occurs.
In the recent past, real estate developers have managed to make successful issuance of mortgaged-back securities to public and financial institutions.
Leasehold financing
Is financing available for ground (or head) leases in your jurisdiction? How does the financing differ from financing for land ownership transactions?
State government instrumentalities and municipal authorities usually grant ground leases in India. These leases usually allow the lessees to obtain financing through pre-identified banks and lenders subject to receipt of prior approval from the lessor. The lessee’s lender in such a case acquires no better rights than the lessee itself. If the borrower defaults in repayment of the secured debt, the lender bank only has the right to appropriate leasehold rights in the property to itself or its nominee if the borrower obtains the land under a ground lease. This is because the rights of the lender will not ordinarily override the lessor’s rights under the contractual documents executed. If, however, the borrower defaults in repayment in respect of funds secured against a charge over land owned by the borrower, the lender may appropriate the charged land and may sell or encumber it to recover the amount due from the borrower.
In addition, lease rental discounting can be obtained by the owners of leased properties. These financing arrangements are on the basis of the lease rentals, lease tenures and other covenants of leases on a property.
Under applicable laws, there is no minimum lease term for a lease being financed or a shorter maximum term for the financing depending on the business decision of the lenders.
The terms of a lease deed pursuant to which a ground lease has been granted should ordinarily permit the lessee to obtain financing, subject to the lessor’s consent, and enable the creation of security over the leased premises or receivables accruing therefrom, to the lender.
Form of security
What is the method of creating and perfecting a security interest in real estate?
The typical method of creating a security interest over an immovable property is by way of creation of a mortgage over the immovable property. The mortgage can be a simple mortgage, mortgage by condition sale, usufructuary mortgage, English mortgage, mortgage by way of deposit of the title deeds or an anomalous mortgage. Depending on the nature of the mortgage, the mortgage deed is prepared and registered with the sub-registrar within whose jurisdiction the immovable property is situated. In the case of a company, the company is required to file a charge creation form with the registrar of companies. Further, any creditor, including the secured creditor, is required to file particulars of transactions of creation, modification or satisfaction of any security interest with the Central Registry of Securitisation Asset Reconstruction and Security Interest of India.
Valuation
Are third-party real estate appraisals required by lenders for their underwriting of loans? Are there government or industry standards for appraisals? Must appraisers have specific qualifications or required government or industry certifications? Who is required to order the appraisal?
Valuation for the transfer of real estate usually revolves around the benchmark of circle rates of the properties notified by the government (though the market rates could be significantly higher in certain jurisdictions). Real estate appraisers and valuation firms are used for the valuation of properties in larger transactions where the value of the property is significantly higher than the circle rate therefor. These valuations can be on the basis of the net operating income from the property (if leased), the net present value of discounted free cash flow of potential development on a property, the replacement cost of the property or the locational advantage of a property and the like.
Legal requirements
What would be the ramifications of a lender from another jurisdiction making a loan secured by collateral in your jurisdiction? What is the form of lien documents in your jurisdiction? What other issues would you note for your clients?
Lenders from foreign jurisdictions are subject to the Reserve Bank of India’s (RBI) Master Direction on External Commercial Borrowings, Trade Credits and Structured Obligations, dated 26 March 2019, bearing FED Master Direction No. 5/2018-19 (ECB Framework), as updated from time to time. This master direction provides for certain conditions that must be satisfied by borrowers and lenders in cases where the loan falls under the automatic route or the approval route.
Another route that foreign lenders and investors use is through subscription to secured non-convertible debentures of Indian companies, in accordance with the Securities and Exchange Board of India (SEBI) (Issue and Listing of Debt Securities) Regulations, 2008, which may or may not be listed on a stock exchange in India. The security interest is created in favour of a debenture trustee, who is responsible for holding the security on behalf of the non-resident and overseeing compliance by the borrower. The non-resident subscriber must be registered with SEBI as a foreign portfolio investor.
Loan interest rates
How are interest rates on commercial and high-value property loans commonly set (with reference to LIBOR, central bank rates, etc)? What rate of interest is legally impermissible in your jurisdiction and what are the consequences if a loan exceeds the legally permissible rate?
Interest rates are set on the basis of the interest rates set by the RBI. Interest rates are higher in India since it is still a developing country and there is a high level of inflation. Consequently, the interest rates for any loans or financing are high. While Indian banks usually do not lend money for the acquisition of land, they do lend for the construction of real estate projects. Loans are easily available for homebuyers as well. The fees and lender costs are generally excluded from the interest and are charged separately.
Additionally, the interest chargeable in relation to loans that qualify as external commercial borrowing will be subject to the conditions prescribed under the ECB Framework and may vary accordingly. For example, eligible borrowers can avail themselves of external commercial borrowing from eligible lenders at interest rates not exceeding 450 basis points (4.5 per cent) above the applicable benchmark.
Loan default and enforcement
How are remedies against a debtor in default enforced in your jurisdiction? Is one action sufficient to realise all types of collateral? What is the time frame for foreclosure and in what circ*mstances can a lender bring a foreclosure proceeding? Are there restrictions on the types of legal actions that may be brought by lenders?
After a mortgage payment has become overdue, a mortgagee can institute proceedings to obtain a decree debarring the mortgagor from redeeming the mortgaged property or for the sale of the property. Similarly, in the case of a mortgage by way of conditional sale, default in payment of a loan will make a conditional sale absolute. If a loan is secured by a security interest as defined in the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SARFAESI Act), a secured creditor will have the option to enforce its security interest according to the procedure laid down in the SARFAESI Act, which is more expeditious than the usual civil court process. Upon receipt of notice from the secured creditor, the borrower is required to discharge its liability within the stipulated time frame, failing which the secured creditor will have the right to take possession of the secured assets of the borrower.
Additionally, in accordance with the Insolvency and Bankruptcy Code 2016, a financial or operational creditor can initiate an insolvency resolution process upon the occurrence of a default on a debt owed by a corporate debtor to such financial or operational creditor. This remedy is becoming increasingly popular among creditors since the insolvency resolution process is professionally managed and must be completed within 180 days from the commencement of the insolvency resolution process.
Loan deficiency claims
Are lenders entitled to recover a money judgment against the borrower or guarantor for any deficiency between the outstanding loan balance and the amount recovered in the foreclosure? Are there time limits on a lender seeking a deficiency judgment? Are there any limitations on the amount or method of calculation of the deficiency?
There are no limitations. Indian law does not allow remote or indirect damages awards.
Protection of collateral
What actions can a lender take to protect its collateral until it has possession of the property?
Lenders usually seek interim orders to protect the status quo of the property. Lenders also seek rent deposits or other income or revenue from the property to be deposited with a court-appointed receiver or escrow agent or in a separate bank account.
Also, the lender may consider obtaining a usufructuary mortgage in its favour, wherein possession of the mortgaged property is delivered to the mortgagee, who is authorised to retain the mortgaged property and receive rents and profits accruing therefrom.
Further, the Transfer of Property Act 1882 prescribes certain liabilities that the mortgagee in possession must bear, such as:
- to manage the property as a person of ordinary prudence would manage it;
- to make best endeavours to collect rent and profits;
- to make repairs; and
- not to undertake any destructive activity, etc.
In the event of failure of a mortgagee in possession to comply with its responsibilities, when an account is made pursuant to a decree of a court, the mortgagee must be debited with the loss, if any, occasioned by such failure.
Recourse
May security documents provide for recourse to all of the assets of the borrower? Is recourse typically limited to the collateral and does that have significance in a bankruptcy or insolvency filing? Is personal recourse to guarantors limited to actions such as bankruptcy filing, sale of the mortgaged or hypothecated property or additional financing encumbering the mortgaged or hypothecated property or ownership interests in the borrower?
Recourse is first available to the collateral. However, in winding up, insolvency or other recovery proceedings initiated by a lender, the court can award recourse to all other assets of the borrower.
Cash management and reserves
Is it typical to require a cash management system and do lenders typically take reserves? For what purposes are reserves usually required?
The lender typically takes charge over all cash flows of the borrower (or as agreed for security and collateral). These are created through the hypothecation of the receivables along with escrow account agreements. It is not customary in India to maintain reserves for expenses, but in most cases, the lenders require appropriate debt service cover reserves to be maintained in lending agreements.
Credit enhancements
What other types of credit enhancements are common? What about forms of guarantee?
Guarantees, including personal guarantees of promoters, are very common in India. In fact, lenders rely more on personal guarantees from promoters or key shareholders rather than a security offered by the borrower company, since promoters make every effort to ensure that lenders are paid if the project does not perform. Depending on the negotiations, suitable covenants can be built into guarantee documents to protect the lenders in the event that the borrower creates any mischief.
Loan covenants
What covenants are commonly required by the lender in loan documents?
Usually, there are negative, affirmative and information covenants in loan documents. Furthermore, with respect to the freehold and leasehold financing, among other things, one important covenant is in relation to maintaining the ownership of the property. In the freehold asset class, ownership is already in favour of the borrower or owner, so a covenant to maintain the ownership and to not create any third party rights in the property is obtained, whereas with leasehold assets, a covenant with the effect of maintaining the ownership of leasehold rights and not to create any third-party rights over such leasehold rights is obtained.
Financial covenants
What are typical financial covenants required by lenders?
The most typical are security cover and the asset value, where periodic appraisals are conducted to keep the security enhanced if the value diminishes, and special rights requiring the permission of the lender for any major actions of the borrower or its shareholders. Further, the lender also emphasises on periodic submission of information related to the cash flows and periodic updates regarding the fulfilment of the purpose for which the loans have been granted.
Most of these covenants are required to be complied with by the borrowers through the tenure of the loan and are periodical in nature.
Secured movable (personal) property
What are the requirements for creation and perfection of a security interest in movable (personal) property? Is a ‘control’ agreement necessary to perfect a security interest and, if so, what is required?
A security interest over a movable property is generally by way of a pledge (in the case of the actual delivery of the property, such as shares of the companies or partnership interest in the LLP) or by way of hypothecation of the movables, such as plant and machinery, goodwill, equipment, inventories and receivables. Further, the lender typically controls the cash flows pertaining to a project by way of escrow accounts. Generally, a deed of pledge is executed along with a power of attorney in the case of a pledge of the movable property, and a deed of hypothecation for the hypothecation of the movable property. In the case of a company, the company hypothecating goods is required to file a charge creation form with the registrar of companies and also make filings with the Central Registry of Securitisation Asset Reconstruction and Security Interest of India.
Single purpose entity (SPE)
Do lenders require that each borrower be an SPE? What are the requirements to create and maintain an SPE? Is there a concept of an independent director of SPEs and, if so, what is the purpose? If the independent director is in place to prevent a bankruptcy or insolvency filing, has the concept been upheld?
This varies on a case-by-case basis.
