Contemplation of fractional ownership in India: A real estate regulatory perspective

Tuesday 18 October 2022

Sushant Shetty
Fox Mandal & Associates, Mumbai, Maharashtra

Clarissa D’Lima
Fox Mandal & Associates, Mumbai, Maharashtra

Fractional real estate has become fashionable among investors involved with India’s real estate market in recent years. While offering an opportunity to acquire an interest in commercial and high rent-yielding properties, holiday homes and major township projects to name but a few, fractional real estate ownership keeps problems in making bulk investment in fixed assets and maintaining property at bay. Given the increasing interest in this subject, this article outlines regulatory concerns relating to fractional real estate ownership in India.

Company in co-ownership

Fractional real estate ownership has been facilitating different uses of immovable property in different forms for decades. Examples range from the undivided holding of rural agricultural land by joint families, to pooled ownership of individual households in cooperative housing societies in urban areas. The model that is currently very much centre stage involves setting up special purpose vehicles (SPVs) in the form of companies or limited liability partnerships under applicable statutes, and distribution of the holding in the SPV, based on the nature and value of the property held in such an SPV.

The shareholders of the SPV, which, in this case, also refers to partners of a partnership firm, consequently become entitled to the property held by the SPV as ‘co-owners’. Co-ownership allows multiple shareholders to hold distinct rights in common property; as stated in Salmond on Jurisprudence, ‘the right is an undivided unity, which is vested at the same time in more than one person’. Shareholders as co-owners are therefore exposed to the benefits and liabilities encountered by the SPV and its assets. It is therefore important to take note of the regulatory trends which govern such set-ups.

Connecting applicable regulations

While there is currently no specific overarching framework regulating fractional real estate ownership in India, different SPV entities may be subject to different laws, such as the Companies Act 2013 or the Limited Liability Partnership Act 2008 depending on their nature of incorporation. Investors involved with such platforms will not be engaged in the direct day-to-day management of the property and their control is limited to liquidating their share in the asset.

It is anticipated that platforms which bring together shareholders into an SPV would fall under the definition of ‘real estate agents’ under the Real Estate (Regulation and Development) Act 2016 (RER Act). Real estate agents, as defined under section 2(zm) of the RER Act, include persons who act on behalf of another person in relation to the transfer of property in return for a remuneration/fee/charges for such services. Real estate agents are not allowed to facilitate transactions in relation to registered real estate projects or any part of such projects unless they are registered with the Real Estate Regulatory Authority of the state, according to section 9 of the RER Act and the corresponding rules by the respective state. The renewal of registration of real estate agents is to be according to the rules framed by the states. In Maharashtra, for example, rule 12(4) of the Maharashtra Real Estate (Regulation and Development) (Registration of real estate projects, Registration of real estate agents, rates of interest and disclosures on website) Rules 2017 prescribes that such registration is valid for a five-year period. It is also noteworthy that under the aforementioned rules to obtain such registration in Maharashtra, the applicant is required to submit income tax returns of the three preceding financial years, or a declaration of any exemption.

When it comes to shareholders of an SPV, the applicability of the RER Act relates to the classification of these shareholders as ‘promoters’ of a project, where such project is a registered project. This proposition is explored in the next part of this article, in light of a recent Maharashtra Real Estate Regulatory Authority (MahaRERA) order. The MahaRERA acts as an adjudicatory body for disputes relating to the RER Act.

Consideration from the real estate regulatory perspective

In June 2022, a division bench of MahaRERA ruled on the case of Rare Township Private Ltd v IIRF India Realty VIII Ltd, addressing the issue of ‘investors’ in the real estate sector. The complainant in the case was the developer of a project called Rising City. The respondent was a shareholder of the developer company, vide share subscription and shareholders agreement both dated 24 December 2008 (SSHA) together with deed of addendum dated 26 September 2012. The complainant had alleged that it was unable to access funding for its project due to the non-responsiveness of the respondent and further contended that the respondent would fall within the definition of a ‘promoter’ and would therefore be liable for the delay in completion of the complainant’s project.

Dealing with this contention, MahaRERA explored the terms of the SSHA together with the provisions of the RER Act to determine whether the respondent would qualify as a ‘promoter’ under the RER Act and further proceeded to remark on the associated liability.

Considering the following sub-section of section 2(zk) of the RER Act, MahaRERA analysed whether an entity that causes the construction of a project as mentioned thereunder would qualify as a promoter:

'(zk) ‘promoter’ means –

(i)   a person who constructs or causes to be constructed an independent building or a building consisting of apartments, or converts an existing building or a part thereof into apartments, for the purpose of selling all or some of the apartments to other persons and includes his assignees;' (emphasis added).

To ascertain the applicability of the above provision, MahaRERA further examined the SSHA and observed that according to its clause 12.11, no decision could be taken by the board or management of the complainant company on matters specified under Schedule 5 therein which also included matters relating to incurring project expenses in excess of the limits set, and change in the capital structure of the company as detailed therein. On a joint reading of section 2(zk)(i) of the RER Act and the above provisions of the SSHA, MahaRERA concluded that with an affirmative vote the respondent could cause the construction of the project and by abstaining from such vote could also prevent the completion of the project. On the basis that the aforementioned power of the respondent to facilitate decision making in relation to the project, MahaRERA held that the respondent would fall under the definition of ‘promoter’.

The MahaRERA observed that while investors have the right to protect their interests in their investments in real estate projects, the interests of the homebuyers also needs to be protected by the regulatory authority. Consequently, MahaRERA held that the complainant and respondent would both, in their capacity as ‘promoters’, distribute the liabilities of the promoter in case of a breach. An important word of caution was also sounded by MahaRERA in this order, stating that the determination of an investor as a promoter in this case was not to be applied to all real estate investors and that each investor agreement should be considered on an individual basis.

Given the role of the real estate regulatory authority under the Act, and the wide ambit of the term ‘promoter’, the classification of fractional owners as shareholders in an SPV may be an area which needs to be examined in cases where the property to be purchased by the fractional shareholders falls under the remit of RER Act. While fractional owners, become owners of the property on completion of the construction project, they may not be subject to compliances in relation to the timelines for completion of the project but they can incur the liability of the promoter for defects in the project, as the defect liability period under the RER Act is five years from the date of handing over of possession to the allottee. Henceforth, from the real estate regulatory perspective, fractional owners must be cautious as to the possibility of incurring any liabilities of a promoter.

The way forward

Given the joint nature of holding that fractional owners share in the property, as long as they choose to be affiliated to an SPV and draw returns on their holding, the compliance of the SPV with the incorporating statute as well as the applicability of the RER Act cannot be ignored. In the absence of a definitive framework legislation to protect fractional owners, adherence to these compliances will provide security to SPV shareholders.

The compliance with registration and disclosure requirements mandated under the RER Act helps monitor platforms which promote fraction real estate ownership and access to such information supplements the diligence of interested investors. At the same time, the applicability of the RER Act to investors themselves may not be as favourable, however, it is essential to realise the objectives of the RER Act. It is therefore important for interested investors to ensure that their role and liabilities are taken care of in the SPV shareholders’ agreement/partnership deed. Supplementing this with comprehensive due diligence of the property in which the investor aims to acquire a share is essential in mitigating the associated risk of fractional real estate ownership. Assessing the governance records of the SPV is also key to making a safe investment.