Issues in Real Estate Pre-Sale Agreements in Ethiopia

Continuing our series on real estate, DABLO tackles a growing concern: problems with pre-sale agreements. As you may recall, our previous article explored the key players in the sector. This time, we will focus on the real estate Pre-Sale Agreements. While high housing demand has fueled rapid development, pre-sale agreements – where developers rely on upfront unit sales to finance projects before construction – have become a hotbed of legal disputes. This short article identifies some basic issues arising from such agreements and explores their legal implications.

1. Lack of Specific Regulation and Regulator

A critical shortcoming of the Ethiopian real estate sector lies in the lack of a single, comprehensive law or dedicated regulatory body. This absence of a well-defined legal framework creates a reliance on contractual agreements between developers and property buyers to govern their interactions.

2. Ambiguities on the nature of the Pre-sale Agreements

The agreement basically involves two parties, the Real Estate developer, an entity responsible for constructing and developing the real estate project and the unit Property buyer (apartments, shops, or townhouses within a larger development). The core question revolves around whether such agreements constitute a typical sale contract or a construction agreement subject to the Ethiopian Civil Code's provisions governing Contracts Relating to sale of Immovables

This ambiguity arises from Article 2876 of the Civil Code, which falls under the title "Contracts Relating to Immovables" and the chapter on "Sale of Immovables." The article states:

"Work and labor relating to immovables and sale. A contract whereby one party undertakes to deliver to the other party a house, a flat, or another building that does not yet exist is a contract of work and labor relating to immovables, and not a contract of sale."

This provision suggests that a pre-sale agreement for a unit under construction between a unit buyer and a real estate developer is not a sale agreement, but rather a construction agreement, as per the Civil Code's provisions on "Contracts of Work and Labor Relating to Immovables." Consequently, the legal relationship between the unit buyer and the real estate developer would be akin to that of a client and a contractor.

The contract's classification significantly impacts the rights and obligations of both developers and buyers.A "sale" contract positions the developer as a seller, while a unit buyer as a buyer. A "Construction" contract positions the developer as a contractor, while the unit buyer as a client. Each role carries distinct legal implications.

A Counterargument to Article 2876 of the Civil Code

However, some argue that the pre-sale agreements occur on a plot land in any way possessed by the developer, and the unit buyer has no initial ownership rights. Given this context, they question how a genuine client-contractor relationship can be established, especially since the developer already possesses a legal interest in the land.

3. Types of payment Modalities

Real estate Pre-sales contracts typically employ two main methods for structuring payments: -

• Fixed-Term Payments: This approach schedules payments at predetermined intervals, typically at specific dates throughout the project timeline. These payments are not directly tied to the physical progress of construction.
• Progress-Based Payments: This method links payments to the achievement of designated construction milestones. Payments are released only after the developer has demonstrably completed specific stages of construction, as outlined in the agreement.

The selection of the payment modality has a significant bearing on the nature of potential disputes arising from non-performance by either party. The chosen structure will determine the available legal remedies for such situations.

4. Time of Completion

While most real estate contracts in Ethiopia establish timeframes for project completion, delays are a frequent occurrence. These contracts typically include clauses addressing force majeure events that could legitimately cause delays.  However, a significant gap exists, as these agreements often lack provisions to address unforeseen delays that fall short of constituting force majeure.  The following sections will discuss the remedies available to unit buyers in the event of such delays.

5. Currency of Payment

To hedge against inflation and fluctuating costs of imported materials, many contracts stipulate payment in US dollars, which contradicts National Bank of Ethiopia regulations. While the legal validity of such contracts remains untested, potential consequences like contract nullification cannot be entirely disregarded.

6. Remedies for Unit Buyers in Case of Delayed Construction or Non-Performance:

Different real estate agreements devise remedies for such scenarios,

• Penalties: Financial penalties imposed on the developer for exceeding the agreed-upon completion timeframe.
• Interest on Payments: Compensation to the unit buyer in the form of interest calculated on the total amount of the contract.
• Rental Fees: In some cases, contracts may stipulate that the developer is responsible for providing rental fees to the unit buyer to compensate for the inability to occupy the unit due to the delay.
• Contract Termination: If the developer is unlikely to finish the project unit buyers are entitled to terminate the contract.
• Contract Termination: If the developer demonstrates a clear inability to complete the project, unit buyers may have the right to terminate the contract and seek a full refund of their payments penalties or interests.

7. Remedies for Real Estate Developers in Case of Delayed Payment or Non-Performance by Unit Buyer

Developers also have recourse in the event of non-performance by unit buyers. Potential remedies may include:

• Penalties and Interest: Contracts may specify penalties or interest charges that the unit buyer must pay for late or missed payments.
• Contract Termination: Under the current practice, developers often prioritize contract termination over penalties or interest. This is because pre-sale funds often finance construction. Delays caused by a defaulting buyer can create financial strain. Therefore, developers may find it quicker and more advantageous to terminate the agreement and resell the unit to a new buyer to mitigate potential financial difficulties.

8. Quality of Construction and Adherence to Specifications

The pre-sale agreement is crucial as it binds the developer to deliver a housing unit that meets the specified quality and design. Concerns include ensuring the unit matches the design plans and maintaining structural integrity and finishing standards. If defects arise, buyers may have warranty coverage for structural issues or need to seek contractual remedies for design and finishing discrepancies.

Builders and Contractors typically provide a one-year warranty for structural defects. For design deviations and finishing issues, buyers might negotiate or pursue contractual remedies against the developer.

9. Assignment of Contractual Rights

A significant question regarding pre-sale agreements in Ethiopian real estate is whether unit buyers can assign their contractual rights (rights and obligations under the contract) to a third party during the construction phase. The prevailing Practice handle this situation inconsistently. Some contracts explicitly prohibit unit buyers from selling their rights to a third party. Others remain silent on the matter, creating uncertainty for both buyers and potential assignees (the third party who would acquire the rights). However, certain developers include a clause that permits the assignment or transfer of the buyer’s contractual rights, provided that the buyer has paid a substantial portion of the property’s purchase price, typically 50% or more.

Developers raise significant concerns about the potential tax complications associated with allowing unit buyers to assign their contractual rights. These concerns center on managing income and sales tax implications in the context of Tax Refunds and Declarations for Original Buyers. Developers fear difficulties in obtaining refunds and ensuring proper declaration of income and sales taxes for the original unit buyer when the contract is terminated. This arises because the original sale agreement is no longer valid. In such a scenario, a new sales contract would need to be established between the developer and the third-party buyer. This creates a situation where the actual transfer of the unit occurs between different parties than those originally envisaged in the initial tax calculations.

10. Dispute Resolution Forum

In the absence of a designated arbitration forum (institutional or ad hoc) within the contract, disputes typically end up in courts of Law. However, if the contract includes an arbitration clause, the matter will be settled through arbitration. This method is often preferred for its customized approach and getting the chance to be adjudication by experts in the field.

11. Conclusion

The lack of a robust legal framework governing Ethiopian real estate contracts creates fertile ground for disputes. By addressing the issues outlined above, developers and unit buyers can draft more comprehensive and legally sound contracts, fostering a more secure and predictable real estate market in Ethiopia.

Disclaimer: This analysis is for informational purposes only and does not constitute a legal advice.