In the wake of the sharp downturn in the real estate sector in the aftermath of the global crisis, the U.A.E. economy has found itself exposed to unprecedented rates of mortgage default. While the actual figures of the magnitude of the default are unclear, the U.A.E. Central Bank has acknowledged that the country's banking sector has been ridden with a growing proportion of non-performing loans, reaching a record high at the end of 2011. The unprecedented nature and the magnitude of the default have inevitably lead to a series of legal and economic hurdles, exacerbated by the uncertainties in handling them. This is further complicated by the varying laws and practices of the individual emirates and their relationship with the federal laws.
In general, the U.A.E. federal mortgage laws are rather dated, going back to 1985, especially as applied in the context of today's reality, and are largely untested, While the emirate of Dubai has its own more current mortgage laws, issued in 2008, those laws too are scant in specifics necessary to deal with today's realities and equally untested. Moreover, neither body of laws seems to address the peculiarities of the Islamic or Sharia compliant mortgages.
Specifically, neither the U.A.E. laws nor Dubai laws provide adequate system to deal with mortgage default and resulting foreclosure. In sum, under both laws, foreclosure of real property requires a formal court action and a sale at a public auction. Under the federal laws, no separate mechanism exists to foreclose on real property outside of enforcement of contractual rights, which, in turn, can only be administered through regular court proceedings. In Dubai, there is a provision for specific execution proceedings in civil courts. Instead of going through a traditional court action, banks have the right to execute foreclosure through a simple hearing before a judge, after giving the debtor proper notification. The execution judge orders an attachment against the mortgaged property to be sold by public auction. In theory, such execution proceedings aim to be more expeditious and less costly than regular court proceedings. In practice, however, they are shrouded in mystery and are time consuming.
Significantly, neither law allows for voluntary foreclosure, whereby the debtor relinquishes his rights to the property, along with all of the payments made thus far, without the need for court action. Voluntary foreclosure has the advantage of avoiding costly and time consuming court proceedings and auction sales, while also giving banks the freedom to dispose of the property as they see fit.
Perhaps because of the complexities and novelty involved, the practice of foreclosure has been slow coming, across all of the U.A.E. Most banks in other emirates have yet to test it. Dubai has been the only emirate to have done so today. Even then, however, with its purported streamlined execution proceedings, foreclosure in Dubai is still in its infancy and is rather opaque. For example, the procedures and timelines involved in the actual court proceedings are ambiguous and inaccessible to the general public. From the few auctions taken place thus far, it appears that the typical timeframe between the court judgment and the auction sale is at least one year. The cause for the delay is uncertain. Similarly unclear are the banks' internal guidelines and factors governing their decision to foreclose or not to foreclose.
Same applies to the auction proceedings, which, in Dubai, are conducted by the Land Department. For example, as of the beginning of 2012, the Dubai Land Department has sold only eight foreclosed properties at an auction. This number pales in comparison to the reported several hundreds of properties currently under the foreclosure proceedings in Dubai courts. One of the reported reasons for such discrepancy has been the Land Department's difficulty in establishing values for the properties. The other reason has been the fear of over flooding the market with low-priced homes, at a time when prices are already fifty to seventy percent below their peak rates.
Aside from the delay in the administration of foreclosures in courts and at auctions, the banks themselves have been extremely reluctant to foreclose. While some banks have reported their preference for renegotiation of payment terms over a court action as the reason for their reluctance to foreclose, such reasoning is not entirely accurate. Banks' reluctance is rather attributable to factors stemming from the peculiarities of the U.A.E. legal and business landscape.
One factor, for example, is the banks' preference to use the threat of criminal prosecution to force borrowers to pay. This is made possible by the banks' practice of requiring guarantee cheques as security for the mortgage and the U.A.E. law of criminalizing dishonored cheques. Thus, upon borrower's default, banks prefer to exercise the option of cashing guarantee cheques, which, once bounced, become a criminal offense under the U.A.E. laws, punishable by jail sentence. Such tactic results in at least a temporary repayment of mortgage installments, thereby allowing banks to avoid calling default on mortgages and to begin writing them off.
The other reason for the banks' reluctance to foreclosure is the overwhelming number of defaulting mortgages, issued in the wake of the U.A.E.'s extraordinary property boom, characterized by sky high prices and demand. Many borrowers took out multiple mortgages for speculative reasons, relying on rental yields to pay off their monthly mortgage payments. With property prices dropping between fifty and seventy percent, monthly rental yields are no longer sufficient to cover mortgage payments. Similarly, the value of the mortgaged off-plan properties, delivery of most of which has been hugely delayed, has dropped by more than half. These changes in the economic conditions have dramatically reduced borrowers' ability to carry their mortgage obligations, resulting in significant defaults.
A further complication is that banks have thus far been reluctant to refinance mortgages, to make them more affordable, accounting for new economic conditions. This could be due to the absence of internal infrastructure or fear of having to realize their losses.
Another factor behind banks' reluctance to foreclose is the uncertainty of foreclosure on properties under Sharia compliant mortgages, where banks continue to own the property. To foreclose on such properties, in effect, means that banks must bring foreclosure cases against themselves. The existing laws or regulations do not address such issues.
Banks' reluctance to foreclose has lead to an exodus of many borrowers out of the U.A.E., to avoid criminal prosecution. The U.A.E.'s current laws criminalizing bankruptcy disallow debtors the opportunity to declare bankruptcy and to restructure their lives while remaining in the U.A.E.
Perhaps realizing these issues, the U.A.E. has begun to introduce measures to address them. A number of legislative initiatives are currently being considered, including the draft bankruptcy law, which may potentially decriminalize bankruptcy. Also, the U.A.E. Central Bank has represented that it would issue new rules to better regulate mortgage lending by the country's banks within the first quarter of 2012. This will include, among other things, more thorough scrutiny of the borrower's repayment ability, as well as a more stringent loan-to-value ratio. This, however, may be some time coming insofar as, at present, the U.A.E. does not yet have an effective credit rating system to be able to assess borrower's creditworthiness. The particularity of the U.A.E. demography, the majority of which are expatriates from other countries, is a further complication. It is more difficult to assess one's creditworthiness outside of the U.A.E.'s jurisdiction. Equally challenging is to cope with the expatriates' ease of escaping liability by simply leaving the U.A.E. for their home countries. While the challenges are clear, it is also clear that the country is determined to address them and has already done much in that regard, at least in the way of public discourse and a series of draft laws.
The views expressed in this article do not necessarily constitute the views of Zawya.
© HPL Yamalova & Plewka JLT 2012
