Financing a project before it gets ready

The UAE Civil Transactions Code 1985, "the Civil Code", contains various provisions which deal with certain aspects of real estate ownership.

Article 1,405 of the Civil Code is an interesting one. It provides that "real property held in mortgage as real security must be available upon execution of mortgage".

This means that until construction on the property is completed, no mortgage may be created. This may create a serious issue when banks finance the purchase of properties in the development projects as such properties are in the process of construction and, therefore, pursuant to Article 1,405, not yet in a state where they may be mortgaged.

Irrespective of Article 1,405, in almost all the projects, banks and financial institutions are providing financing prior to completion of the project. As a consequence, the mortgages taken by the developers are possibly subject to the risk of being deemed invalid since the mortgaged property does not actually exist at the time the mortgage is executed.

One possible solution to the obstacle Article 1,405 poses may be found in Article 1,407 of the Civil Code, which provides that "a pledge by way of security shall include the appurtenances of the land by way of buildings, growing things, and things which have become part of the land of affixation, and any new buildings erected on the land after the contract was made".

Article 1,407 addresses construction, which may be built later, and includes it in the mortgage. Attempting to extend the mortgage, at the outset, to include the future construction may risk the entire mortgage being declared invalid.

This may not be possible, however, from a practical point of view. This is so because banks involved in financing the purchase of properties, in fact, finance the construction to be and take as a security a mortgage on the property and construction. Since the construction does not exist at the time of the finance, how can a mortgage be validly created in light of Article 1,405? This shows how complicated the issue may be.

Another complicationstems from the fact that banks and financial institutions are providing finance for individuals willing to purchase properties for residential purposes.

This casts doubt with regard to the enforceability of mortgages taken over residential properties. In this regard one has to examine Article 247(2) of the Civil Procedures Code, which provides "without prejudice to the provisions of any other law, the following assets may not be attached:

The place of residence of the debtor or judgement debtor, and whoever was living with him of his relatives, whom he is legally bound to support, in the event of his death.

Establishing rights

Thus, in accordance with Article 247(2), if the borrower can establish that he has obtained the finance to purchase a property which is used, at the time when the execution of the mortgage takes place, as a place of residence by either the debtor or his relatives after his death, then it is possible that the property mortgaged may not be attached or thereafter sold towards the recovery of a debt.

This is a serious issue which banks and financial institutions, involved in financing the purchase of residential units, have to take into consideration. Some argue that under Article 1,419 of the Civil Code the mortgagee can enforce his rights under the mortgage where the debtor fails to meet obligations.

Article 1,419 of the Civil Code provides "a mortgagee may satisfy his debt out of the land mortgaged upon the debt falling due in accordance with the rank which he holds after taking the steps laid down in the Civil Procedures Code and special laws".

However, I am of the opinion that Article 247 of the Civil Procedures Code, which is a special text relating specifically to which assets may be attached, would prevail over articles 1,419 and 1,479 of the Civil Code which are of a general nature.

A question which may be asked here is whether it is possible for the debtor to agree in advance to waive his rights under Article 247 and allow his mortgaged residence to be attached and auctioned.

Although it may be argued that Article 247 is directed to the benefit of the debtor and, hence, he has the right to waive his rights thereunder, it may not be possible as the terminology used in Article 247 is of a mandatory nature.

Moreover, the courts would most likely determine that to permit debtors to agree beforehand to waive the legal protection, which Article 247 provides them, would be an abuse by creditors and create a serious loophole which would undermine the objectives that the Article attempts to achieve.

To overcome this problem it is suggested that banks and financial institutions obtain a power of attorney enabling them to dispose of the property should the debtor fail to meet his obligations.

The method of using power of attorney has been commonly used in financing auto loans and, to a lesser degree, in financing real estate. However, its efficiency is not fully certain particularly when in respect of real estate financing.

Legal proceedings

Another point which has to be taken into account is that a mortgagee cannot enforce its rights under the mortgage deed directly. Rather, the mortgagee must go through legal proceedings to obtain a judgement allowing the enforcement of the mortgage. Any agreement, even a subsequent one, to the contrary is null and void. In this context, Article 1,420 of the Civil Code provides the following:

1. If it is stipulated in the deed of the security mortgage that the mortgagee shall obtain ownership of the mortgaged real property against his debt if it is not paid by the mortgagor in due time and if it is stipulated that it shall be sold without regard to legal proceedings, the mortgage shall be valid and the condition shall be void.

2. The condition shall also be void even if it is made by a subsequent agreement.

Financing real estate is not an impossible action nor is it full of risks to the extent that it should not be pursued. There are legal mechanisms, which have to be carefully tailored, to meet all these challenges. A task which may not be easy but similarly not impossible.
(Concluded)

LOOKING AHEAD

Application of inheritance law
An issue which is almost certain to arise in the future is inheritance. It is not yet clear how the inheritance law would apply to residential properties owned by foreigners. Will the UAE law apply or the law of the deceased's nationality? Will Sharia law apply or the law of the sect of the deceased?

What validity, if any, will the courts give to a will executed by the deceased? What will be the legal implications of the death of the debtor on the mortgage, particularly since the title of the property may pass to the deceased's heirs? Will the heirs in this case incur any liability? These are only a few of the questions which arise in this context and which require careful consideration.

Dr Habib Al Mulla is a lawyer and owner of the law firm, Habib Al Mulla & Co, as well as a member of the UAE Federal National Council.