By Rehan Khan. Published in The National www.thenational.ae on 21st January 2010. Last week, the people of Haiti suffered a terrible natural disaster. If I were buying or selling a new building there that had been turned to rubble, it would be classified by the lawyers as a force majeure event. Last week also saw a property developer inform its buyers in an off-plan project in Dubai that a force majeure event had taken place, right here in the UAE. In doing so it was relieving itself of all obligations under contract with the buyers and would not be continuing with the building works for which they had paid.
As you may know force majeure is French for “superior force” and is readily found in contracts freeing both parties from liability or obligation when an event beyond their control takes place and so prevents either party from completing their obligations under the contract. A force majeure event may be war, strike, riot, crime or what in legal parlance is termed an “act of God”, such as a natural disaster.
This particular UAE-based developer has blamed the global financial crisis as an event beyond its control and so invoked force majeure. In November 2008, Donald Trump tried the same strategy. He blamed the world financial crisis for the non-payment of a US$334.2 million (Dh$1.22 billion) construction loan to Deutsche Bank. The jury is still out on that one.
The developer in question has a project consisting of 5 million square feet of sellable area, of which 50 per cent has been sold at an original price of Dh2,000 per sq ft. It has collected 30 per cent from customers, or Dh1.5bn, in receivables. It is extremely unlikely that customers will see any of their money returned since the majority of it has been spent in infrastructure and sub-structure works. The developer by contract did what it was supposed to do: it used the funds for building the project. Unfortunately it is impossible for the developer to complete the project because further receivables from customers will not be forthcoming. Neither is bank financing available and, most critically of all, there is an oversupply of units in the market that will last for a long time to come.
Before you draw your daggers and make for the developer’s office, there is one thing I have not told you. This particular developer was a sub-developer within a master development owned by a master developer, and it is the latter that stopped all works and demobilised its contractors. So the sub-developer in question may have collected a massive amount from buyers and used it legitimately on the project, but it cannot continue because the master developer has effectively shut down the entire site.
By closing shop, the master developer is no longer building out the infrastructure – roads, pipes, electricity – or signing off design approvals from the sub-developer for the different stages of construction. The sub-developer’s hands are tied.
So surely the situation is something beyond the control of the sub-developer, but under the contract or the sales and purchase agreement (SPA) signed with the buyer, the sub-developer is directly obligated to the buyer. There is no fallback on the master developer. Yes, there may have been an unwritten convention in the market that the master developer will effectively underwrite all of the sub-developers, but that convention is not in writing and so offers no practical protection for buyers.
That, plus the fact that the master developer is in absentia with buyers, then leaves the sub-developer and the buyer in an extremely difficult position.
If we repeat the formula across hundreds of other projects where a sub-developer may go this route, you would need a scientific calculator just to read all of the zeros after the first couple of digits.
“What is permitted to be a force majeure event can be the source of much controversy in the negotiation of a contract,” says Rima Jameel, a partner at the Dubai-based legal firm Motei and Associates. “For a developer [defendant] to invoke force majeure, the event proposed as force majeure must pass three tests.
“First, externality; the defendant must have nothing to do with the event’s happening. Second, unpredictability; if the event could be foreseen, the defendant is obligated to have prepared for it. Being unprepared for a foreseeable event leaves the defendant culpable. This standard is very strictly applied. And finally, irresistibility; the consequences of the event must have been unpreventable.
“Although suspension by the master developer constitutes an extraordinary circumstance beyond the control of the sub-developer, if it does not fulfil the three aforementioned elements, it would not ascend to a force majeure event.”
Where force majeure is invoked, then the sub-developers’ obligation to build and the buyers’ obligation to pay ceases until force majeure is remedied. Once the matter is resolved, then the obligation on both parties continues again.
Most SPAs will outline what should happen in terms of the obligations under a force majeure event, and for how long an event can continue. A contract will normally allow for between six months and one year, but will depend on circumstance.
If the force majeure period delays completion beyond the completion plus overrun date, where does that leave the buyer? According to Ms Jameel, the SPA should clearly state the consequences and entitle either party to terminate, should the event continue for a specified period of time. Otherwise she refers to Article 273 of the UAE Civil Code (Federal Law No. 5 of 1985), which she says provides that if in a “mutual binding contract, an obligation is discharged because of impossibility of performance, all other counter obligations shall discharge and the contract shall then be automatically rescinded”.
But she says that this relates only to that part of the contract that is impossible to perform, and so the discharge of obligation also only relates to that part.
She adds: “These provisions also apply in continuing contracts to the temporary impossibility of performance. And the creditor [buyer] may in these cases rescind the contract after serving notice upon the debtor [seller]. In this case, pursuant to Article 274 of the UAE Civil Code, the creditor is to be put back in the position he was in prior to entering into the contract.”
Although one sub-developer has started down this track and others may follow, the law certainly appears to protect buyers. It is much more sensible for both seller and buyer to collaboratively work out a situation in which both parties can be discharged of their obligation towards one another in dead-end projects, without making it too onerous on either side.
There will definitely be some pain, but it should be limited through the use of the right surgical instruments available in the law.