In Sale and Tenancy Contracts, is the Deposit Paid Refundable or Non-refundable under the laws of the UAE?
Many contracts in the UAE require at least one of the contracting parties to provide a deposit. Many businesses, however, get confused as to whether or not the amount received is refundable or non-refundable and what is the classification of such money ‘received’.
Given that this arrangement is widely used in the Middle East market, this note briefly discusses what the businesses generally need to know in terms of sale and tenancy agreements.
The Classification of Deposits
Generally and practically speaking, the interpretation of deposits in the UAE fall under three categories. The first interpretation is that it is considered and construed as a first installment. The second is that the deposit is considered earnest money and the third and final interpretation is that the deposit is considered security.
General Useful Information Regarding First Installment and Earnest Money
To begin with, by way of comparison, both the UAE law and the Iraqi law follow the approaches of the Germanic laws, while the Egyptian Law and the Jordanian Law, follow the approach of the Latin Laws. Specifically:
1- Under both the UAE and the Iraqi Law, money paid upon entering into a contract is deemed a mark of the party’s intention to honour the contract rather than a forfeit. This means that the presumption is that a contract is concluded between the parties, and not the other way around.
2- In sharp contrast however, the Egyptian Law and the Jordanian Law consider that money paid upon entering a contract means that either party may resile (draw back) from the agreement.
This is of particular importance as the legal effect of each varies.
Deposit as a First Installment:
Regarding the UAE, a deposit paid when entering into a contract (without any reference in the contract to the contrary) means that the contract is properly concluded between the parties. This would generally mean that the seller is not only entitled to the deposit but also is entitled to the full amount of the contract. In return, the seller is obliged to fulfil their obligation towards the buyer (to handover the asset – the subject matter of the contract, as per the agreement).
The only exception to this is if there is an agreement to the contrary between the parties or a contrary customary practice. If an agreement, or customary practice, exists and the provisions thereof contradict with what is mentioned above, then it may be construed as earnest money (non-refundable) or security (see below).
The customary practice is that if the deposit paid when entering a contract, then the points below must be taken into consideration:
– In a lease contract, generally speaking, the deposit paid is deemed a mark of the party’s intention to honour the contract rather than a forfeit.
– In a sales contract, absence agreement to the contrary, the sale in preliminary agreements may be construed as the contracting parties has the right to draw back from the agreement. Cautious must be taken into consideration as each Emirates in the UAE may have different customary practise.
– As is the case for lease contracts, if the sale contract is considered final, then this means that the deposit paid is also deemed a mark of the party’s intention to honor the contract.
The Effect of Constructing the Deposit as a First Installment:
If the deposit is considered a first installment, then broadly speaking the seller cannot only forfeit this amount as a penalty or as liquidated damages. The reason is that under the UAE law, damages, if contested by the other party, may not be enforceable and the UAE Courts must reconsider whether this amount is reasonable.
Also, the contract is considered ‘concluded between the parties’ and this will entitle the seller to one of the following two options:
Option one: is to ask for specific performance, which means that the seller must ask the buyer to specifically perform its obligation. That is, to pay the remainder installment(s) and, in return, the seller must keep the asset (the subject matter of the contract) simply because the seller is asking for specific performance. This will apply to nonfungible items (cars, properties, lands …etc.).
From a business perspective, this will refrain the seller from selling the asset to 3rd parties and that, depending on the business and how easy it is to sell the asset, may not be practicable.
Option two: is to terminate the contract or, as the case may be, ask the court to terminate the contract. This will entitle the seller to claim damages (if any). The deposit amount is, however, not guaranteed to the seller if there is proof that no damages incurred as a result of the buyer’s failure to fulfil its obligations.
Also, the seller must prove to the court that it is has the capability to fulfil its obligations.
For example: if the subject matter of the contract is a sale of land, the seller must prove to the court that it can transfer that land. This means that the seller may not be capable of selling the land to a third party unless the court terminates or confirms the termination of the contract.
Failure by the seller to prove that it can fulfil its obligation means that the seller cannot ask for termination/revocation, and this will mean that the buyer may ask the court to claim for damages.
However, if the seller sold the land, then it may be construed that the seller revoked the agreement and is required to return the money to the buyer. The reason being is that under the UAE Law, if the seller wishes to revoke the agreement, absent a term to the contrary, he must prove to the court that it can fulfil its obligation. Revocation will in any case and broadly speaking mean that the seller must return the first installment to the buyer (with a few exceptions that are outside the scope of this article).
The Agreement to Draw Back and the Effect thereof:
If there are proper terms in the agreement, and where it is construed as an agreement to forfeit money in case the party withdraws from the agreement, then the following must be taken into consideration:
1- The foregoing will generally mean that the parties did not enter into a full contract as of yet (unlike the first instalment construction, whereby it is assumed that the parties actually entered into an agreement), and either party may withdraw from the contract before it becomes binding.
2- If the buyer is the one who withdraw from the contract, then the seller may forfeit the earnest money/deposit paid, and this will not be considered as damages. As previously stated, liquidated damages may not be enforceable under the UAE laws in this manner and the forfeiture amount is not considered as ‘damages’ and, therefore, is enforceable.
3- If the seller is the one who resiles from the contract, then they must return to the buyer twice the amount. For example, if the deposit amount received by the seller is AED100,000, then the amount the seller must pay to the buyer is AED200,000.
Although it may sound severe, it is in fact not, as the seller put the relevant asset on hold, thus refraining him from the opportunity to sell that asset. Likewise, failure by the seller to adhere to the ‘preliminary agreement’ means generally that it had another opportunity. Thus, paying twice the amount is considered fair.
If the seller has proper policies in place to mitigate any risk in failure to enter a binding contract, then this option will be suitable for businesses, given that the seller can freely forfeit the money and retain their right to dispose of the asset to 3rd parties quickly, especially when the market is rapid.
That is why it is of particular importance for businesses to clearly agree with the buyer on the timeframe, should the latter decide to enter a binding contract.
In any case, proper drafting of the terms of the agreement and the conduct thereafter is of particular importance.
For instance: a buyer and a seller entered a contract. The contract did explicitly refer to earnest money (as nonrefundable) and all the terms were drafted to refer to earnest money as nonrefundable. The buyer, after paying the deposit, made tranches of the second agreed installment and the seller did not object but rather, kept silent.
This may mean, by conduct, that the buyer suggested that the contract is not preliminary anymore but rather, binding. The seller’s silence may be construed as acceptance and, thus, the earnest money (as nonrefundable) becomes a first installment, given that the parties considered that they did enter a binding agreement. Any remedies entitled to the buyer will be as mentioned in section one above (specific performance or revocation).
Therefore, it is advisable to consider, when drafting the terms of the contract, to:
1- ensure at all times that the forfeiture will occur before entering a final and binding agreement (therefore the skeleton of the agreement must be clear);
2- use the term earnest money as nonrefundable (as opposed to only deposit);
3- refer to article 148/2 of the UAE Civil Code (and its parallel in Jordan);
4- mention clearly the earnest money paid is considered liquidated damages for the purchaser’s decision to resile from fulfilling its obligation;
5- ensure that the seller silence in relation to any positive conduct is considered a negative act;
6- ensure to mention a timeframe / specific date for the buyer to enter the contract (e.g., making the full and final payment in due date); and
7- any other matter that well-defines this specific matter to mitigate any further risk.
Deposit as Security:
If the deposit is taken and stated to be returned after the buyer fulfils their obligation(s), then the deposit amount may be construed as a security.
If this is the case, then this means that there is a final and binding agreement reached between the parties and the seller shall return this security in due date. If, however, the buyer did not claim this amount, then the prescription period (the right to claim this money back) will vary starting from 3 years and up to 15 years.
The element in calculating the prescription period is the date the seller ‘knew’ that this deposit is due and refundable. In practice, the courts will construe any conduct between the parties to stretch the prescription period to the maximum limited permissible under the applicable law.
To minimise the prescription period, it is advisable to define when the ‘knowledge’ of the opposing party occurs, so that the chances are higher for the prescription period to be 3 years rather than 10 or (as the case may be) 15 years.
Note: Assuming the prescription period is 3 years, and the counterparty claimed this amount after the lapse of the prescription period, then they are still entitled to this money. However, it is considered a natural right, rather than a legal right which means that if you decided to pay this money back to the counterparty, then this means that you did actually fulfil the obligation and it will not be considered an enrichment.
In contrast, if the counterparty claimed this amount after the lapse of the prescription period, then the seller/ the landlord, can still decide to retain this money, as there is no legal right for the counterparty to claim this deposit from the court.
For more information in the UAE and Iraq, please contact Ahmad H. Haddad email@example.com.
For Jordan, please contact Mr Ayham A. Othman firstname.lastname@example.org.
For Turkey, please contact Professor Murat C. Pehlivanoğlu email@example.com.