HAS DUBAI'S ESCROW LAW SUCCEEDED IN SECURING PURCHASERS' MONEY?
Authored by: Ashraf Sayed
Dubai Law No.(8) of 2007 On the Matter of Escrow Accounts for Real Estate Development (the Escrow Law) was issued to regulate developers and safeguard purchasers’ money in respect of off-plan property purchases in Dubai. However, recently there have been cases where purchasers have been left without recourse to claim return of payments made where the project they invested in failed to complete. Ashraf Sayed examines the protections the Escrow Law offers to purchasers and whether the Escrow Law has succeeded in its objectives.
- The Escrow Law does not guarantee the completion of a project or the full security of a purchaser’s money placed in escrow.
- If a project faces completion difficulty, the relevant authorities have the power to preserve the rights of the purchasers, but have until now taken limited action against non-escrow compliant developers.
- Penalties are set out under the Escrow Law allowing the relevant authorities to levy fines and/or seek imprisonment of those who breach the Escrow Law.
The real estate boom in the UAE commenced in 2003, however, the Dubai Escrow Law was implemented in May 2007 and required developers to be in compliance by early 2008. There was therefore a period of four years where developers were essentially unregulated in relation to funds received from purchasers.
Generally, the Escrow Law:
- applies to all projects currently under construction and to all future projects where funds are to be collected for off-plan sales
- requires one escrow account for each project
- restricts developers from utilising purchasers’ funds for purposes other than the project
- contains provisions to control and limit “start up developers”
- provides penalties for non-compliant developers, which include criminal liability and de-registration.
Despite the Escrow Law being in force for over two years, some confusion remains within the market as to its practical application. So where do purchasers and developers stand?
Does the Escrow Law guarantee project completion?
The Escrow Law does not guarantee project completion. There are a number of reasons for this:
1. If a purchaser invested in a project that could not be delivered due to the project’s viability or the reputation or financial credibility of the developer, then the Escrow Law may be of limited assistance to the purchaser.
2. Prior to the enactment of the Escrow Law, matters between real estate developers and purchasers were addressed in contracts and prevailing law. More often than not, the contract did not specify that the monies would be held in escrow to be used only for the construction of the project or that a particular stage of construction must be reached before the next payment was due, although it is arguable that this is implied within the contract. It was therefore possible, in such a self regulated environment, for developers to use purchasers’ funds for uses other than the construction of the project.
3. Under the Escrow Law, developers had to submit a number of documents to the Real Estate Regulatory Authority (RERA) prior to opening an Escrow account and thereafter the developer had to meet certain criteria before being allowed by the Escrow trustee (a bank approved by RERA) to withdraw monies from the Escrow account. It is still unclear whether this process had been properly undertaken and was being fully enforced and also what mechanisms were put in place to properly test the viability and feasibility of the project before money was allowed to be extracted from the Escrow account. A related concern was that some Escrow trustees may have permitted release of certain funds without appropriate supporting documents. In the initial stages post-Escrow Law, and most certainly during the property boom, it could be argued there was a relaxed attitude towards the withdrawal of funds from escrow accounts by developers with limited sanctions imposed by RERA and the Escrow trustee. Some projects have run out of liquidity as monies in Escrow had been depleted either on non-project related expenditure or where released payments were greater than actual expenses.
4. Even where a project has an Escrow account, if the number of defaulting purchasers is high and the developer has no other source of financing, the project may not be completed as periodic liquidity requirements may not allow contractors to be paid, leading to a halt in construction. This is typical of projects where sales were made to bulk purchasers who were often real estate agents or speculators wishing to make profits from quick re-sale.
It is worth noting that, under the Escrow Law, if conditions exist which prevent the completion of the project, the relevant authorities can take steps to preserve the rights of the purchasers in order to ensure completion of the project. Clearly this might not be possible if the funds in the Escrow account have been depleted through questionable disbursements, but it can be utilised to increase the protection offered to purchasers.
Do Escrow accounts safeguard investors’ interests?
If Escrow accounts are administered correctly, purchasers’ funds should be secured to the extent they should only to be used for the development of the project to which they relate. These funds are secured generally to the extent that the money remains in the Escrow account, however, as soon as the funds are depleted, purchasers may become unsecured creditors to the developer.
In circumstances where the developer cannot complete a project, the Escrow trustee can, after consulting with the Dubai Land Department, either replace the developer in order to complete the project or refund the amount in the Escrow account paid by depositors. The mechanism of determining who gets access to the funds and in what priority is not clear especially where a project financer (ie bank) is also involved. Furthermore, it is not clear whether there have been any projects officially cancelled by RERA or an Escrow trustee due to the inability of the developer to continue with the project or due to non-compliance with the Escrow Law.
At the current time, any premium monies paid to a previous purchaser in a secondary market transfer will be paid direct to the previous purchaser and will not go into the Escrow account. Should a project fail, it is highly unlikely that any premium paid to initial purchasers will be recoverable by subsequent purchasers.
Misuse of funds and penalties
The Escrow Law clearly states that the Escrow account is to be used solely for the purpose of developing the relevant real estate project and the deposited funds may not be attached for the benefit of the creditors of the developer. Article (9)2 of the Escrow Law specifies that should the developer carry on more than one project, a separate Escrow account must be opened for each project.
The Escrow Law is also subject to the provisions of the Trust Account Regulations for Law (8) of 2007 (Regulations). One of the basic concepts of the Regulations is that money may only be released from an Escrow account in accordance with the provisions of the Regulations. The Regulations set out a range of expenses for which funds in Escrow can be used for and which generally relate to development costs, and other related expenses such as marketing for the project.
In addition, Article (404) of Federal law No.3 of 1987 (Penal Code) makes it a criminal offence for a party who has been given funds on trust for a specific purpose to use those funds for another purpose, which is essentially a breach of trust and could be fraudulent. There are a range of criminal penalties for breaching the Penal Code.
With reference to the Escrow Law, penalties are set out that allow the respective competent authorities to levy fines and/or seek an order for terms of imprisonment against those who breach these laws. If there has been a violation by any party of the Escrow account laws then, without prejudice to any punishments stipulated by other legislation (for example the Civil Code or the Penal Code), fines and/or imprisonment may be imposed. Such breaches cover a wide range of issues, including embezzlement or use without justification of funds collected for the construction of real estate projects.
Regulation of accounts
The Escrow trustee is obliged to provide RERA with periodic statements of revenues and payments from the Escrow account and RERA may request the Escrow trustee to provide information or documentation which it deems necessary for review. Furthermore, RERA may appoint auditors to review this documentation.
The relationship between RERA is also subject to the terms and conditions contained in the contract. This includes how often the Escrow trustee provides financial information to RERA.
If RERA finds that the Escrow trustee has committed a violation of the Escrow Law or its implementing by-laws, it shall serve a notice to the Escrow trustee and provide a grace period for the rectification of such violations. In severe cases, fines and/or imprisonment may be imposed.
A number of property related laws have been enacted in Dubai over the past four years to not only protect purchasers and developers, but to encourage development within the Emirate. As speculation about market recovery grows, and purchasers return to the market, discussion of applicable measures to protect investments naturally emerges. The Escrow Law is only effective if it is adhered to by developers and appropriately regulated by authorities. A number of recent cases have shown the potential abuses and penalties associated with misuse of Escrow funds. But recent improvements such as RERA’s policy of 100% payment for land prior to the launch of a new project and construction based payment schedules are sensible and necessary. There are likely to be further improvements in the future.