Property Due Diligence

Property Due Diligence Introduction

Real estate is one of India’s fastest expanding industries, as indicated by a growth in real estate transactions such as buying, selling, leasing, and financing. We’ve seen large-scale land purchases from individuals in villages near metropolitan, industrial, and commercial centers, in addition to transactions in urban areas. Similarly, there has been an increase in commercial office space leasing (both short and long term).

Increased awareness of the risks associated with real estate transactions, combined with the increased engagement of the organized sector in real estate, has resulted in a need to ensure that the risks are identified and minimized in such transactions. The mode for achieving these aims is plainly ‘legal due diligence/ title search’ of real property (whether unoccupied tracts of land or developing residential/ commercial/ industrial properties).

DILIGENCE is defined as taking reasonable steps to avoid making a mistake or breaking the law.

Following a wide understanding of the commercials, a due diligence study is probably the most critical element of a real estate deal. This process has the potential to have an impact not just on the commercials, but also on the transaction’s practicality. While commercials frequently emphasize the need of completing a transaction quickly, it is vital in the players’ interests to devote sufficient time and attention to the thorough due diligence of the property in question. It’s crucial to understand how concerns like title, approved use, construction legality, encumbrances, and easements might affect the nature of the property and its suitability for the transaction’s economic demands.

Doctrine of Due Diligence

Black’s Law Dictionary defines Due diligence as the diligence reasonably expected from and ordinarily exercised by, a person who seeks to satisfy a legal requirement or to discharge an obligation. Further with respect to Corporations & securities the term is defined as a prospective buyer’s or broker’s investigation and analysis of a target company, a piece of property, or a newly issued security.

Due diligence is a legal responsibility imposed on a subject of law (Subjects of International Law). Normally, the responsible citizen or responsible government criterion is used to determine whether a subject has fulfilled that commitment (Governments). An inquiry, audit, or review is carried out to check the facts or details of an issue under examination. Due diligence in the financial industry is reviewing financial documents before entering into a proposed deal with another party.

Due diligence of property title:

It refers to an inquiry or legal audit to verify all material facts about the property’s history, title, encumbrances, covenants, liens, any restrictions contrary to the interests sought to be created, etc. It’s the process of gathering enough accurate information about a property to help identify any facts or conditions that could prevent a good, clear, and marketable title and know the rights and liabilities of all the interested parties over the same. It is an examination of all, or parts of, the legal issues connected to a property with the goal of revealing all legal dangers associated with obtaining the property and giving the buyer a thorough understanding of the property’s nature and the risk involved in purchasing it. It is an investigation of the title, legality, status, and/or user of the property before signing a contract in order to avoid mistakes, violations of the law, or even taking a property that is either unfit for the use or encumbered.

One can examine the risks involved in the property, he intends to purchase by completing due diligence. For that one needs to go over the documentation and make sure the property is free of legal encumbrances. It basically indicates that one should do his research before making a purchase. A property lawyer performs due diligence, but it is critical for the person intending to purchase the property to comprehend the basic terminology used in the report and what they mean in order to make an informed decision. Even the Securities Act,1933 of the United States, requires issuers of asset-backed securities, at a minimum, to disclose asset-level or loan-level data, if such data are necessary for investors to independently perform due diligence, including—

data having unique identifiers relating to loan brokers or originators;
the nature and extent of the compensation of the broker or originator of the assets backing the security; and
the amount of risk retention by the originator and the securitizer of such assets.

Even Section-55 of the Indian Transfer of Property Act,1882 imposes similar obligations on the seller to disclose to the buyer any material defect in the property [or in the seller’s title thereto] of which the seller is, and the buyer is not, aware, and which the buyer could not with ordinary care discover. The seller is also bound to disclose any relevant information which the buyer might ask for relating to the property. It is pertinent to mention here that the definition of the term property mentioned in the Indian Transfer of Property Act,1882 includes in its ambit both movable and immovable property.

Scope of Legal Due Diligence of Real Property:

Gathering information is the fundamental goal of due diligence. The purchaser’s scope and type of due diligence will be determined by the following factors:

the purchaser/ lessee’s intentions and objectives behind the purchase;
the nature of the property involved i.e. whether it is private property or government property etc;
the nature of the real estate transaction i.e. whether the subject property is sought for the purpose of absolute transfer like outright purchase, or whether it is only for a limited interest in the nature of long-term/short-term lease, mortgage, or financing of the real property, etc;
the time frame for the completion of the subject transaction;

A title search is conducted largely to answer three issues in the event of a potential transfer of property or for the purpose of real estate financing:

Whether the transferor who claims to be the right holder actually has adequate authority i.e. marketable or absolute title to engage in the transaction of the concerned property in question?
Whether the transferor has possession of the property?
Whether there are any burdens in the nature of liens, encumbrances, mortgages, charges, taxes due, etc on the property that need to be released before the deal may be completed?
Whether there are any constraints on how the property can be used i.e in the nature of restrictive covenants?

Types of Due Diligence:

Before one begins with the actual process of due diligence, it’s important to understand that there are two types of due-diligence reports namely;

Full search report: A thorough search due diligence report is often prepared for a title period of 30 years or more prior to the date on which the subject property is vested in the hands of the seller. This study covers a thorough investigation of all facets of a property’s history and the present such as the status of encumbrances on the property, the status of disputes over the property, the applicable regulations, and the state of compliance with those regulations pertaining to the property in issue. In the case of a transfer in the nature of the sale, resale, or long-term lease transaction, as well as transactions involving the acquisition of financing through mortgaging the property in issue, a complete search is normally conducted. It also includes a thorough investigation of all aspects of the property’s history,
Limited search report: When a property is leased for a short period of time, a limited search is often undertaken. In such cases, the due diligence over the previous owner of the property is normally limited to fifteen (15) years (or less) from the date on which the present owner acquired the property.

Unlike comprehensive searches, a limited search restricts the search to specific components of the property’s history, such as current title history, encumbrances on the property, property disputes, and so on.

Further, it is pertinent to mention one more important aspect while conducting a limited or comprehensive search. The Indian Limitation Act of 1963, vide entries 64,65 and 111 of its Schedule delineates that the rights over the property will be defeated by the possessor if he is in adverse possession for a period of more than 12 years in case of private land and for a period of more than 30 years in case of government land. This aspect must also be kept in mind while deciding to go for a limited search report or a comprehensive search report.

Things To Check in a Due-Diligence Report:

The following aspects must be evaluated diligently while preparing a due diligence report:

Legal capacity of the transferor of the property to conduct the subject transfer:-

This factor goes to the root of the validity of the transfer and hence it is mandatory to diligently check the legal capacity of the transferor. The transfer will be void if the transferor or any of his ancestors in the line of title are minors, persons of unsound mind. If the transferor of the property is a minor, it cannot be purchased or leased without the authorization of competent authorities as determined by the minor’s personal laws. In the case of a minor Hindu before the guardian of a minor can deal with the minor’s property in any way, authorization from the civil courts is required as per the provisions of the Hindu Minority and Guardianship Act, 1956. Further, when the transferor is of unsound mind, the transfer on his behalf could be done only by a guardian appointed by a competent court vide the Mental Health Act of 1987.

Further, in case the subject land belongs to a company it should be seen whether the individual who is transferring on behalf of the company is authorized by the Board of Directors to perform such transfer as applicable under section 293(1) (a) of the Companies Act, 1956.

The nature of the transferor’s right or interest over the property, and whether such right or interest is transferable:-

Another vital factor to determine the validity of the transfer is to ascertain the nature of the transferor’s right to the property and whether or not that right is transferable. Various sorts of property rights or interests that can be vested in an individual are:-

freehold or absolute ownership;

perpetual lease right;

tenancy right;

the land was given by the state or the federal government under several statutes;

life interest;

limited interest; etc

All of the aforementioned rights or interests are not equivalent to absolute ownership of the property and hence should be vetted diligently.

The source from where the transferor derived his right or title:-

If the transferor has derived his title in any of the ways mentioned below, then different kinds of vetting should be done depending on the nature of the source of his title.

By Purchase: The registered sale deed/ conveyance deed, as well as the title documents of the property’s predecessors’ titleholders, must be examined in case the title was acquired by purchase.
By Inheritance: In case the title was derived by inheritance, whether the inheritance was by will or succession has to be determined. If it is through a will, then the grant of probate, letters of administration, etc should be looked into. Further, the mutation register/jamabhandi which is kept by the Revenue Office for each village or the municipal records and/or court orders has to be looked at to check whether the name of the present title holder is reflected in the record. And in case the property is devolved by succession and in the case of joint owners, NOC(No objection certificates) should be obtained from the interested parties.
By Partition: In case the property is obtained through the partition, the partition deed should be vetted to ascertain if there are any limitations or restrictions in the deed that could impair the enjoyment or transferability of the subject property.
By Gift: In case the title was obtained through a gift, the registered gift deed must be vetted to ascertain if any of the restrictive covenants exist, such as a reserve of life interest, limitations on alienation, maintenance payment, pre-emption, and so on.
By Perpetual Lease: In case the title was obtained through a perpetual lease, the deed of the lease must be vetted to ascertain whether the right can be transferred. The contours and limitations of the lessor’s rights should also be diligently investigated.
In the case of built-up property, the legality of the construction:-

The state governments and the local bodies lay down their own rules and regulations over civil construction that must be carried out in a particular area depending on whether the construction is situated in a rural, urban area, etc. The compliance with these rules should be vetted. Further, the occupancy certificate, the environment, and fire clearances should also be vetted.

Whether the property is a part of any land acquisition process initiated by the government;
The burden in the nature of encumbrances, charges, mortgages, taxes due, etc over the property;
Whether the transferor is in possession of the subject property;
The records of the subject property in the Registrar’s office, Revenue, and land survey office;
The nature of the land use authorized by the government with respect to the subject property i.e. agricultural, industrial, residential, etc.
Public notice should be published in any local newspaper before the transfer of property so that any rival claimants may come forward with objections to the transfer.

A Valid Title Certificate Has the Following Constituents According to the Views of The Hon’ble High Court of Bombay:

The due diligence report/title certificate is issued based on the information gathered by completing the steps aforementioned. The Bombay High Court has delineated the requirements needed for a legitimate title certificate under Indian law in the case of Ramniklal Kotak Tulsidas & Others Vs Varsha Builders & Others (AIR 1992 Bom 62). The Hon’ble Court held that:-

“19.…………..In such a case the certificate of title must disclose at least the following:–

(1) Nature of the title of the promoter;

(2) Nature of the title of the vendor or the promoter or of the person through whom the promoter claims;

(3) Encumbrances and claims on the land;

(4) Steps required to be taken by the promoter for completing title as absolute, clear, and marketable while conveying the property or causing the same to be conveyed to the organization of flat purchasers on the due date;

(5) Whether the agreement to sell the flat will bind the owner of the land?

(6) Whether the title of the promoter or his vendor or the person through whom the vendor claims are of doubtful nature in any manner? If so, the nature of doubt entertained.

(7) Whether the authorization granted in favor of the promoter by the owner, lessee, or the vendor irrevocable so as to bind the owner with the agreements for the sale of the flats? Whether an agreement to purchase the land by the promoter is revocable or irrevocable?”

All the aforementioned conditions must be mandatorily vetted by the purchaser while carrying out the due diligence report.

Consequences if Due Diligence is not Undertaken:

The consequences if the title search is not undertaken could be detrimental to the interests of the purchaser in certain circumstances. Further Section-52 of the Indian Transfer of Property Act has incorporated the doctrine of ‘lis pendens’ which means that during the pendency of any suit, any transfer effected would be bound by the outcome of such suit. Therefore if any transfer is made which is contrary to the final outcome then such transfer shall be void which in effect means that such transfer is deemed to have not taken in the first place and the title and the rights over such transfer would be vested in the prevailing party of the suit. Further, the Transfer of Property Act of India reverses the burden on the buyer of a property in certain circumstances i.e. when, but for wilful abstention from an inquiry or search which the buyer ought to have made, or gross negligence, he would have known it. Further, the Act imposes the burden on the buyer where any transaction relating to immovable property is required by law to be and has been affected by a registered instrument in accordance with the provisions of the Indian Registration Act, 1908.

Conclusion:

The demand for real estate will continue to rise in a country like India, which has a population of over one billion people and a substantial middle class. Because the amount of land available for real estate development is limited, prices are likely to rise in the long run. Due diligence becomes extremely important in order to avoid numerous difficulties, misunderstandings, and frauds. In reality, doing due diligence on the property before entering into any deal is a requirement. Every individual should pay close attention to the many legal concerns involved in real estate transactions and, if required, seek the advice of an Advocate for due diligence to ensure that his investment does not turn into a nightmare in the form of protracted litigation in a Court of Law.

Property Due Diligence