Opening of escrow account doesn't guarantee completion of a project

Opening of an escrow account does not guarantee completion of a project in Dubai and investors have the right to examine the account records, lawyers said.

Ashraf Sayed, Associate, Real Estate, Hadef & Partners, Shahram Safai, Partner, Afridi & Angell, Ludmila Yamalova, Partner Al Sayyah Advocates & Legal Consultants, and Mohammed Kamran, Associate, Property, Al Tamimi & Company, all said the opening of an escrow account pursuant to the Law No8 of 2007 does not guarantee the completion of the project by a developer.

The law was introduced to safeguard investors' money in respect to off-plan purchases. Unfortunately, buyers at times misunderstand the escrow law with the general belief being projects with escrow accounts will get completed.


Does the opening of an escrow account guarantee completion of a project by developer?

Sayed: Not necessarily. Dubai Law No8 for the year 2007 on escrow accounts for real estate development (the escrow law) was issued to regulate developers in an attempt to safeguard purchasers money in respect of off-plan purchases in Dubai. Unfortunately, off-plan property buyers sometimes misunderstand what this means and it does not guarantee the completion of the project. If a buyer chose to invest in a bad project that cannot be delivered due to the project's viability then it is possible the escrow law is unable to help him.

While a project may have an escrow account, if the number of defaulting buyers 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 and therefore construction may stop.

It is also worth noting that under the escrow law if conditions exist that prevent the completion of the property development, the relevant land authority can take steps to preserve the rights of the depositors in order to ensure completion of the relevant project. Naturally this may not be possible if the funds held in the escrow account have been disbursed, but it does serve to increase the protection offered to purchasers.

Safai: Opening of an escrow account does not guarantee the completion of the project by a developer. However, the escrow law in Article 17 (b) provides that a developer shall be cancelled from the register of developers (prepared by the Land Department) if a developer does not commence construction within six months of the date from which it was granted approval to sell the off-plan unit. Article 17 (b) does not apply where the developer has an "acceptable excuse". No occasion has been published in which a developer's name was cancelled from the register of developers due to not commencing construction within six months. It may be that no such cancellations have taken place; certainly the phrase "acceptable excuse" is capable of being very broadly defined.

Yamalova: No, opening an escrow account does not guarantee the completion of a project. The escrow account itself does not assure that there are sufficient funds to build the entire project. In most circumstances, investors deposited funds in installments.

In those cases where installments reached 70 per cent or so, there is more likelihood that there are enough funds to complete the project, provided, however, that the funds were managed in accordance with the law. But if investors deposited only 10 per cent, for example, it is unlikely that those funds are sufficient to complete the project, unless the developer is financing the development either through its own contributions or through the bank.

But in any case, the question of whether there is enough money in escrow depends on whether developers complied with the escrow law at all, and if they did, to what extent and at what point in time. For some time after the escrow law was passed, many developers did not know how to comply with it. Additionally, some key clarifications were needed about the scope of the law itself.

For example, it was not clear whether land payments could be made out of escrow funds and if so, in what proportions. Thus, for many months later, it was assumed that land payments were allowed. Land payments, however, often included a payment of the premium, which was always paid first and in full, with the difference paid towards the land installments to the master developer.

Therefore, in those cases, a larger percentage of the initial installments was spent on the land, leaving very little for construction. Another issue had to do with whether developers were required to deposit all funds collected before the escrow law came into effect and how that was going to be enforced. This was especially a serious issue insofar as, prior to escrow, many developers spent funds collected for one project on buying other projects. So, developers could comply only prospectively, but not retroactively.

Kamran: The opening of an escrow account is compulsory for all developers wishing to sell property off-plan in Dubai pursuant to Article 3 of Law No8 of 2007. The opening of the escrow account does not itself guarantee the completion of the project. Article 15 of Law No8 of 2007 states that in the event of a force majeure (which is not defined) then the account trustee for that project, after consultation with the Land Department of Dubai, shall take all the required actions to safeguard the depositors' rights to ensure the completion of the project or the refund of the depositors' money.

Do escrow accounts safeguard investors' interest? If so, how?

Sayed: If administered correctly, buyers monies should be secured to the extent these ought to have been placed in the escrow account and only be used for construction. These funds will be secured (generally for all purchasers) to the extent money remains in the escrow account. However, as soon as it is dispersed these purchasers become unsecured creditors of the developer.

Under Article 15 of the escrow law, in circumstances where the developer cannot complete a project, the trustee of the escrow account can, after consulting with the Land Department, either replace the developer in order to complete the project or refund the amounts in the escrow account paid by depositors.

The mechanism of determining who gets the money and in what proportion is not clear especially where a project financer (ie bank) is involved. Furthermore, we are not aware of any projects officially cancelled by Real Estate Regulatory Agency (Rera) or an account trustee as of yet.

Safai: The escrow law provides for the following checks to prevent developers from misusing monies paid in to the escrow account. Under Article 9 of the escrow law, a developer is obliged to use the payments made into the escrow account exclusively for the project for which the payments were made.

Further, if a developer is involved in more than one real estate project, it is required to maintain a separate escrow account for each project.

Article 14 of the escrow law says the account trustee has to retain five per cent of the total amount paid into the escrow account after the developer obtains the completion certificate for the project.

That reserved amount may not be paid to the developer until one year after the units are registered in the names of purchasers. Similarly, Article 5.1.5 of the trust account regulations provides that the account trustee has to retain five per cent of cash received from purchasers.

That retained money may not be released to the developer prior to one year after the date of receipt by the developer of the completion certificate for the project. That retained money can be released only if the developer provides the account trustee with a bank guarantee for an equivalent amount.

Yamalova: The objective of an escrow account is to provide assurances that the funds raised will be spent properly. The implementation of it, however, depends on the interpretation of the law at relevant points in time and on developers' willingness to comply with the law.

But in general, the principle behind an escrow account is as follows: 

- The money collected for a particular project must be deposited directly into a separate escrow account set up for that particular project

- Every project must have its own escrow account

- No money can be deposited into a general company account; in other words no commingling of funds allowed

- That money can then be spent only gradually, in accordance with the construction progress

- An escrow trustee, usually an employee of the bank that holds the escrow account, is appointed to manage the account

- The bank also appoints a bank engineer to supervise the process. Bank engineer's decision supersedes that of the developer's project consultant

- The account is managed in accordance with the escrow agreement that is set up between the bank and the developer

- The escrow agreement follows the mandates of the escrow law and the subsequent regulations introduced to interpret that law

- The developer does not have a direct access to the funds. Only the escrow trustee is allowed to release them, which he does throughout construction, upon developer's requests

- The criteria used in releasing the funds are generally tied to the construction progress. Thus, the developer would submit its audited budget of its expenses for each stage of the construction

- The trustee would only release the funds upon satisfactory proof that they were going to be spent legitimately

Kamran: Pursuant to Article 7 of Law No8 of 2007 sums paid by buyers of off-plan units or paid by financing parties must be deposited into the escrow account of the specific real estate project. Article 9 of Law No8 of 2007 states that all proceeds of sale from the real estate project shall be used exclusively for the purposes of constructing the real estate project.

The developer's creditors cannot claim the money deposited in the escrow account. Where a developer has numerous projects a separate escrow account must be opened for each project. Failure by developers to manage the escrow account can lead to criminal penalties and a fine not less than Dh100,000 pursuant to Article 16 of Law No8 of 2007.

Do investors have the right to examine escrow account books?

Sayed: Yes. Under Article 12 of the escrow law, buyers, or whomever they delegate, may review the accounting records concerning them, and may request they be provided with copies of the same. Unfortunately, while the buyers had been able to access such information initially, we understand the escrow trustees are now unwilling to disclose this information without a NoC from Rera or a court order.

Safai: Pursuant to the Article 12 of the escrow law any purchaser making payments into the escrow account has the right to examine the account records and may also request copies of the account records. The escrow law does not indicate whether the copies are to be provided by the account trustee or the developer.

Yamalova: By law, investors have the right to examine escrow account books. Under the law, "the depositors or their representatives may examine their account records and request copies".

Thus, the law is clear. And it only makes logical sense, insofar as the very objective of the escrow is to safeguard developer's funds by ensuring that they are spend in accordance with the law.

Kamran: Pursuant to Article 12 of Law No8 of 2007, the depositors or their representatives may examine their account records and request a copy from the escrow account trustee. However, depositors are not entitled to obtain information on the status of the escrow account generally. Representatives of the official authorities may also examine escrow account records and obtain copies from the escrow account trustee pursuant to this article.

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