10 May 2018

Issues for manufacturers to consider when buying a business which has a lease with the Dubai Real Estate Cooperation

Authored by: Hadef & Partners, Sector Groups

Background

The Dubai Real Estate Corporation (“DREC”) was established in June 2007 by his Highness Sheikh Mohammed Bin Rashid Al Maktoum, Vice-President and Prime Minister of the UAE and Ruler of Dubai. As detailed on DREC website, DREC owns a sizeable land bank which includes properties registered under the name of the Dubai Government. Its mandate extends to building, investing in and the utilisation of commercial and industrial lands and properties.

Given the large geographical land portfolio of DREC, which is distributed across Dubai’s main areas, including Al Quoz, Ras Al Khor, Al Qusais, Jebel Ali, Muhaisnah, Umm Ramool, Al Warsan and around Sheikh Zayed Road, many manufacturers choose DREC as their lessor. However, as detailed below, DREC only offer rolling one year lease arrangements.

In this article, we highlight the issues facing manufacturers who intend to buy a business which has a lease with DREC (“Buyer”) and propose some ways of mitigating those issues.

Issues

  1. Assigning or sub-letting

Under the terms of DREC’s prescribed lease agreement, if a lessee sub-lets or assigns the leased premises, DREC imposes a fee on the lessee equal to twenty per cent (20%) of the rent payable pursuant to that “sub-lease”.

If the lessee proposes to sell their business to the Buyer (the “Transaction”) and DREC leased premises is part of that sale, the lessee will likely be considered to be assigning or sub-leasing the premises, triggering the twenty per cent (20%) fee.

  1. One year lease term

Another issue is that, it is possible that DREC could terminate the lessee’s rolling one year lease arrangement at some point following the Transaction, meaning that the Buyer’s capital investment could be severely impacted.

Mitigation of Issues

We would recommend that Buyers propose one or both of the following two mechanisms (although neither will offer more than contractual protection) to sellers:

  1. Promissory Note

The Transaction documentation should contain a condition that the seller issues an undated promissory note to cover the total of the Buyer’s capital investment (“Promissory Note”). Please note that this Promissory Note will need to be notarised by the issuer (i.e. the seller), in order to avoid any challenge before the courts with respect to the signature.

In the event that DREC refuse to renew the lease (without adequate compensation to the Buyer) the parties would agree to define this as an event of default (“Event of Default”) in the Transaction document. The Buyer could then seek to enforce the Promissory Note against the seller or its shareholders to enable it to be put in a similar net financial position as if the Event of Default had not occurred.

  1. Guarantee

In addition, a condition to the Transaction could be that an individual or company connected with the seller with “deeper pockets” than the seller (“Guarantor”) guarantee the full amount of the investor’s capital investment on an Event of Default to be documented by a note of guarantee (“Note Guarantee”).

However, it is possible that UAE courts may not enforce the Note Guarantee where the primary obligations of the seller under the shareholders agreement were deemed to be invalid, illegal or unenforceable. Although the shareholders agreement and Note Guarantee could be drafted in such a manner so as to mitigate the risk of this occurring, there would remain a risk that the seller may contend that such primary obligations are invalid.

Furthermore, should the Note Guarantee be deemed to be a “civil guarantee”, the time bar in Article 1092 of the Civil Code would apply. Specifically, the provision provides that if a debt is due, the creditor must claim for it within six (6) months from the date on which it fell due, otherwise, the guarantee will be deemed to have been discharged.

Conclusion

If a manufacturer is buying a business, it is imperative that the above issues are considered where the target business has a lease with DREC. Failure to consider these issues and put in place appropriate mechanisms in the Transaction documentation to mitigate the issues could have a significant commercial and financial impact on the Buyer.

For more information, please contact us on sectors@hadefpartners.com.