The challenges of complex retail leasing in Dubai

Real Estate Gazette 27 Middle East

Dubai is famous for its world class shopping centers which, in addition to retail offerings featuring the world’s leading brands and cutting edge local brands, also offer a multitude of leisure experiences including indoor skiing and cage diving with sharks. However, the legal framework for leases does not mirror this level of sophistication, particularly as the existing legislation does not differentiate between residential and retail premises, nor are there separate courts to deal with disputes arising from commercial leases.

The following details a number of areas which currently pose challenges when negotiating complex retail leases in Dubai and how these could be better dealt with if the law is amended.

Early termination of leases and lease renewals

Dubai Law Number 26 of 2007 (as amended) (referred to here as “L&T Law”) applies to all leases relating to real estate in Dubai, other than those for staff accommodation.

The L&T Law offers protection to tenants by limiting:

  1. The circumstances in which a landlord may terminate a lease prior to its expiry
  2. The circumstances where a landlord may reject renewal of a lease

The limited grounds for early termination of a lease by a landlord include a failure to pay rent within 30 days of notification by the landlord, unauthorized subletting, use of the premises for illegal or immoral purposes and the premises being left unoccupied for 30 consecutive days or 90 days in one year (amongst others). Therefore there is some debate regarding whether a break right for termination “without cause” could be challenged by the party not exercising it on the basis that it does not fall within the grounds for early termination permitted within the grounds set out in the L&T Law. However, clause 7 of the L&T Law allows for early termination upon mutual consent of the parties so, provided a break right is well drafted, it ought to be enforceable.

There are also narrow grounds for a landlord to reject a lease renewal. The grounds are that the landlord wishes to carry out renovations which are not possible if the tenant is in occupation, Dubai Municipality require renovations to be made, the landlord wishes to occupy the premises itself or that it wishes to sell the premises. Therefore, it is not possible for a landlord to refuse to renew a lease upon its expiry, for example, if it wishes to bring a different brand into the shopping center in order to change and refresh the tenant mix.

There are no grounds set out in the L&T Law allowing a tenant to terminate a lease prior to its expiry or allowing a landlord to terminate, other than in prescribed circumstances and therefore tenants’ break rights must be negotiated and documented in the lease.

In order for the law to better support common retail arrangements, it would be useful if an amendment to the law removed the obligation on a landlord to be obliged to renew a lease upon its expiry other than in the limited circumstances that currently exist in the L&T Law and expressly permitted break rights.

Rental increases on renewal

Decree Number 43 of 2013 controls rent increases upon renewal for leases in Dubai. The law provides that the rent under a lease may only be increased upon renewal by reference to how it compares to the rent set out in the index compiled by the Real Estate Regulatory Agency (RERA). Although the Decree applies to all leases in Dubai, including free zones, in practice a number of the free zone authorities do not apply it and this lack of implementation should be clarified to bring more certainty to tenants.

The Decree provides for the following increases in rent upon renewal:

Dubai Shopping Centers

This restriction on rent increases upon renewal seems to have been issued largely with the aim of protecting tenants of residential properties (which tend to be for one-year terms). It is not particularly suitable for renewal of retail units within a shopping center where, first, the RERA rental index does not cover specific shopping centers and, second, the revised rent can be negotiated between the two commercial parties. Therefore, it would be beneficial for this control on rental increases to specifically apply to leases of residential property only.

Calculation of lease value for registration of long leases

Law Number 7 of 2006 in Dubai requires leases for 10 years or longer, but less than 99 years, to be registered at the Dubai Land Department (DLD). The effect of registration at the DLD is to render the lease binding on third parties. Leases with terms of less than 10 years must be registered on the “ejari” system operated by RERA and such registration has no effect vis-à-vis third parties; it remains a personal contract between the landlord and tenant.

Landlord and anchor tenants alike, in Dubai’s shopping centers, will frequently want a lease of more than 10 years in order to recover high levels of capital expenditure for fitting out and to provide continuity and appeal in the shopping center for customers and other tenants. However, the registration fees associated with registration of a long lease at the DLD are 4 per cent of the total “rental value”. The total rental value can be very hard to calculate due to rent reviews and turnover rents providing variables and the law offers no firm rules to deal with how this figure is calculated. Anecdotally, it is understood that turnover rent may be considered a commercial payment rather than rent and can therefore be disregarded in these circumstances, but this will very much depend on the particular scenario and the fee is still likely to be substantial in the case of a long term retail lease.

Therefore, the L&T Law would benefit from further clarity on how to calculate this fee where the rent throughout the term of a long retail lease cannot be known from the outset and whether turnover rent is excluded from such calculation.

Rent deposits

Article 20 of the L&T Law provides that landlords may obtain a deposit from a tenant to guarantee the maintenance of the premises upon the expiry of the lease provided that the landlord undertakes to return the deposit or the part remaining to the tenant upon expiry of the lease.

A material issue which arises from this is the reference to guaranteeing the “maintenance” of the premises which therefore does not appear to permit the landlord to use the deposit in the event of nonpayment of rent. From the tenant’s perspective, there is no requirement for the landlord to hold the deposit in a separate account which is ring-fenced in the event of insolvency or an attachment order being successfully placed on the landlord’s bank accounts by an order of the Dubai courts.

Certain provisions of the UAE Civil Code also apply in relation to security deposits as the tenant depositing funds with the landlord creates a contract of bailment and a relationship of bailor and bailee exists. The provisions of the Civil Code impose certain obligations on the bailee (the landlord) including that it:

  • Is liable for any wrongful act in relation to the deposit or any default in the safekeeping thereof
  • Must take the care of a “reasonable man” in the safekeeping of the property bailed (ie the deposit)
  • Cannot use the property bailed without the consent of the bailor
  • Must return the property bailed on the terms of the contract

Whilst the Civil Code cannot be amended by a Dubai law, it would be helpful for any revisions to or replacements of the L&T Law to reflect these existing obligations from the Civil Code in order that more landlords and tenants are aware of these provisions. There is also a risk that a tenant aggrieved by a landlord using a rent deposit could make a criminal complaint to the police and prosecutors for breach of trust under UAE Penal Code, which can result in imprisonment.

In order to keep pace with growth in Dubai and the growing sophistication of how commercial property is operated and managed, it would be highly beneficial for the L&T Law to be updated specifically to deal with commercial leases differently to residential leases in certain respects. We are aware that the Government is considering a new landlord and tenant law which will provide for a distinction to be made between commercial and residential leases. This will allow for greater certainty that complex retail leases will be enforceable in full and therefore move the retail market towards the standards expected by institutional investors. This may in turn help to trigger greater investment, particularly from overseas investment funds.