THE PROPERTY DEVELOPER, THE LENDER AND THE ABSCONDER: A CAUTIONARY TALE
Authored by: Clare Raven
There is a case currently working its way through the Dubai Courts where a property developer may become liable for the purchaser’s mortgage. Alternatively, the Court’s decision may result in the bank losing its registered security and all because a purchaser defaulted on its payments under a SPA and absconded.
- A purchaser enters into a SPA with a developer for the off-plan purchase of a residential unit. The SPA provided for the purchase price to be paid by instalments correlating to the stage of development of the property.
- The purchaser requested the developer to provide a no objection certificate (NOC) to the purchaser’s bank so that the bank could register the loan in the interim register at the DLD. Without the NOC the bank could not register the loan against the title, and without the security the bank would not lend the money to the purchaser.
- The developer provided the NOC and the lender’s interest was recorded in the interim register at the DLD.
This is a very common transaction taking place every day in the UAE. So where did it go wrong?
The purchaser defaulted on the purchase price instalments and left the country. After sending remedy notices the developer decided to terminate the SPA. The developer was willing to return the purchase price paid to date in exchange for clear title at the DLD. However, the bank had allowed the purchaser to drawdown the full amount of the loan. This was not a matter which the developer had been aware of as it was not a party to the mortgage agreement. The bank was not willing to remove its interest from the property title without first receiving reimbursement of the full amount of the loan.
Two competing interests:
As a consequence there are two parties with competing rights to the property: a developer, who under the terms of the SPA is entitled to terminate the SPA and remove the purchaser’s interest from the property register, and a bank that is entitled under the terms of its mortgage to enforce its security.
In theory, the bank could apply to the Dubai Courts for foreclosure of the property, have the property sold and keep sufficient proceeds to settle the outstanding loan. In such a case the developer is left without the balance of the purchase price, without the property, and is simply left to pursue a claim against the purchaser (an uphill battle if the purchaser is no longer in the jurisdiction).
However, in this case, the developer claimed for the removal from the interim register of the bank’s mortgage. Among the submissions raised on behalf of the developer it was argued:
- First, that as the bank was lending against an SPA for an off-plan/as yet to be built property with staged purchase price payments the bank knew that the purchaser had not paid the full purchase price. Therefore, the bank had taken the risk that the purchaser may default in making payments which would entitle the developer to terminate the SPA and recover full ownership of the property. As such, the bank had not acted in good faith when entering into the mortgage.
- Second, the bank had taken the risk of the loan because the bank had paid the full amount of the money to the purchaser and not the developer direct.
- Third, as the developer was entitled to terminate the SPA with the purchaser, the developer was entitled to be put back in the position it was in before the SPA was entered into. As a consequence of the rescission of the SPA, the developer was entitled to clear and unencumbered title to the property including the removal of the bank’s interest in the interim register.
The bank responded that:
- the registration of the mortgage in the interim register had created security for the bank which, even if the property was returned to the developer, remained intact and conferred a preferential right upon the bank to be paid before all other creditors including the developer.
- the developer, by issuing a NOC to the mortgage being registered in the interim register, became a surety for the debt.
The Court of First Instance held that the SPA had been lawfully terminated. Further, that as the mortgage deed was properly executed and the requirements of the Mortgage Law had been followed, as the developer had provided its NOC to the registration of the mortgage on the interim register, and as the bank had not received repayment of the loan amount, the developer’s claim to have the bank’s mortgage deregistered from the interim register was dismissed.
However, the Court of Appeal took a different approach and overturned the lower Court’s decision. In its judgment the Court of Appeal made the following determinations:
- it is established that when a sale contract registered in the interim register is revoked the purchaser of the property forfeits its ownership with retrospective effect and the purchaser is treated as if he had never owned the property;
- therefore, any dispositions made by the purchaser, whether selling the property or securing a mortgage against the property, become null and void upon the revocation of the sale contract;
- consequently, the original owner/seller is not bound by such dispositions irrespective of whether the third party (i.e. second purchaser or lender) acted in good faith;
- the bank in the present case knew that the purchaser had not paid the full purchase price and, therefore, knew that the purchaser’s ownership of the property was under risk of becoming invalid. As such the bank had not acted in good faith;
- the developer’s no objection certificate does not make the developer a surety for the loan and it does not transfer the purchaser’s liability to the developer.
Significantly, the Court of Appeal reasoned that the mortgage deed is only binding upon the signatories thereto due to the principle of privity of contract. However, it appears that this reasoning is limited to the context of the bank’s argument that the developer had become a surety for the debt.
So the story goes on:
The matter is currently pending before the Court of Cassation and with one judicial decision going each way, the decision of the Court of Cassation is awaited. However, there will necessarily be a loser that feels aggrieved. Therefore, lenders and developers should ensure that their transaction documents properly address their respective interests in respect of such risks.
This article, including any advice, commentary or recommendation herein, is provided on a complimentary basis without consideration of any specific objectives, circumstances or facts. It reflects the views of the writer which may, in some cases, differ from those of the firm, especially in the developing jurisdiction of the UAE.