Developers desperately in need of capital are floating sister concerns and diverting money collected for one specific housing project to another. Often, funds dry up as some projects run into losses, leading to delay in delivery of apartments. This is why lawmakers need to act quickly on the proposed real estate regulation bill as it moots the setting up of escrow (depositing money for a project in one account and strictly monitoring its withdrawal) accounts for housing projects.
In a recent case, the Allahabad High Court issued a notice to the Noida Authority after 27 home owners alleged that money collected from them for a group housing project in Sector 100, Noida, had been diverted to associate and group companies which had again invested the money in other NCR properties.
In another case being investigated by the Economic Offence Wing (EOW) of the Delhi Police, a real estate developer allegedly collected hundreds of crores from investors and banks for his commercial project in Ludhiana and lent funds to his sister concerns as loans. Later, he wrote off all the loans due to which the company became a non-performing asset.
“This is just the tip of the iceberg. Many such cases are being reported because builders have started defaulting on projects and delaying them as funds collected for the same project have been diverted for other loss-making ventures leading to drying up of funds. Homebuyers are now aware of this. In fact, many developers have floated multiple companies just for fund diversion,” says an investigating officer from EOW.
Often, subsidiaries are floated to divert funds. “During our investigations, we have come across cases in which the director of a parent company floated other companies and appointed his wife and children as directors only with the intent to divert funds in other companies, risking the hard-earned money of the homebuyers,” the EOW official adds.
Experts say there are various ways in which the situation can be dealt with. In a majority of cases of funds diversion, it has been seen that the parent company has not filed its balance-sheet with the competent authority annually.
“A company’s audit report, done for the purpose of filing income tax, is basically the balance-sheet of the company which is filed with the registrar of companies and ministry of corporate affairs every year. The penalty for not filing income tax returns or the balance sheet is not very harsh in our country. The maximum fine that can be imposed on the company is `1 lakh and approximately 24% interest on taxes due to the department. On an average, 15% companies don’t file their income tax returns every year in a disciplined manner,” says Neeraj Singh, a charted accountant.
An escrow account, as proposed in the real estate regulation bill, can to some extent check the problem. According to section 4(2)(i)(D) of the proposed bill, 50% or higher (as notified by the appropriate government) of the amount realised for real estate project from allottees, from time to time, has to be deposited in a separate account to be maintained in a scheduled bank to cover the cost of construction. It has to be used only for a specific purpose.
“That will be a good practice which I think will discipline developers and ensure the project gets completed on time,” says SK Pal, a Supreme Court lawyer, who is appearing for homebuyers in a similar case in the Allahabad High Court.
Escrow accounts have not worked in Haryana housing
Though real estate experts feel the provision of escrow in the proposed real estate regulation bill will discipline developers and force them to use funds for a specific project and complete it on time, a similar provision in The Haryana Development and Regulation of Urban Areas Act, 1975, has not enabled timely delivery of apartments in Gurgaon and Faridabad.
Section 5 (1) of the said Act, which deals with ‘Cost of Development Works’, states, “The colonizer shall deposit thirty per centum of the amount released, from time to time, by him, from the plot-holders within a period of ten days of its realization in a separate account to be maintained in a scheduled bank. This amount shall only be utilised by him towards meeting the cost of internal development works in the colony. After the internal development works of the colony have been completed to the satisfaction of the director, the colonizer shall be at liberty to withdraw the balance amount. The remaining seventy per centum of the said amount shall be deemed to have been retained by the colonizer, inter-alia, to meet the cost of land and external development works.”
The Act has not been enforced properly. “Every developer gets an escrow account opened. And though he deposits 30% of the total money collected from homebuyers he can withdraw it without seeking permissions from anyone. However, the Act states that the director of department of town and country planning can inspect the developers’ account and scrutinise his expenses to make sure that withdrawal from the escrow account is for the purpose for which it was created. This is where the problem is as the government agencies are not doing a good job,” says SK Sayal, managing director, Bharti Realty.
According to section 6 (I) of the Act, which deals with ‘Auditing of accounts,’ the director, or any other officer authorised by him shall be competent to inspect the accounts maintained by the coloniser who shall produce before him all the relevant records required for this purpose.
“The colonizer shall get his accounts audited, after the close of every financial year, by a chartered accountant and shall produce a statement of accounts, duly certified and signed by such chartered accountant, in the manner prescribed,” section 6 (2) states.
Amit Jain, founder, Centre for Research and Analysis of Real Estate in India, an NGO working on real estate issues, wonders how the escrow account will be monitored. “If developers are allowed to withdraw money from the escrow account without anyone’s permission, then it’s very important to have in place measures for frequent and regular audits of the account. That’s why the Regulatory Bill proposes that that the amount from the separate account shall only be withdrawn by the promoter after it is certified by an engineer, an architect and a chartered accountant that the withdrawal is in compliance with the percentage of completion of the project.”
The bill also states that the promoter shall get his accounts audited within six months after the close of every financial year by a chartered accountant and publish on its website a statement of accounts duly certified and signed by the chartered accountant. It will also be verified during the audit that the amount collected for a particular project has been utilised for that project and the withdrawal has been in compliance with the percentage of completion of the project.
“If these provisions are not implemented strictly, the purpose of escrow accounts will be completely defeated,” says Jain.