The Treatment of Escrow Accounts under the New Real Estate Law
In this legal update, the fourth in our series on the new real estate law, Law Number 27 of 2017 (the New Law) we continue our discussion on the licensing requirements of developers and, in particular, focus on the treatment of escrow accounts.
Law Number 28 of 2014 (the Old Law) introduced into Bahrain the concept of establishing and maintaining escrow accounts for the duration of development projects. The rationale for doing so was the protection of end users. As anticipated, the New Law retained the obligation to establish an escrow account as part of a developer's licensing requirements. There are, however, noteworthy differences between the New Law and the Old Law in this context.
Land
Firstly, it appears that land is no longer permitted to be contributed to the balance of an escrow amount. At the time the Old Law was introduced this seemed like a useful and helpful measure for developers. In practice, however, it proved to be unworkable for many, as among other things, all amounts deposited in the escrow account (including title deeds) had to remain unencumbered.
This restricted the developer's ability to offer land as security in return for project funding. The New Law is noticeably silent on this topic. Unless the rules and procedures to follow from the Board of Directors of the Regulator (the Board) and the Central Bank of Bahrain (CBB) expressly allow it, it seems that it will no longer be possible to treat land as part of the sums held in escrow.
Bonds and Guarantees
Another key difference between the Old Law and the New Law is that the New Law seems to suggest that developers may be able to satisfy their escrow account obligations by putting in place a bond or bank guarantee. Article 19(5) states that part of the information to be placed in the Off-Plan Sales Register includes "particulars and details relating to the escrow account or any financial guarantees or funding methods relating to the off-plan sale project".
Further, Article 22 states that "the board of directors shall specify…after obtaining the opinion of the CBB, the methods of financing off-plan sale projects and the percentages of monetary deposits or bank guarantees as a percentage of the estimated value of the project". This being the case, this is a welcome addition to the law as it would allow developers to satisfy their escrow obligations in a more manageable way and without the need to lock up a large percentage of their cash flow.
As we have seen in other areas in the region such as Dubai, bonds and bank guarantees are commonly utilised by developers as an alternative to putting up hard cash. By introducing this method of financing escrow obligations, Bahrain keeps in line with other jurisdictions, who have tried and tested this already.
Escrow Amount
As to the amount to be held in escrow, the Old Law gave specific percentages. It stipulated that 20% of the construction value would need to be placed in an escrow account at the outset of a project and maintained throughout its duration. It also provided that 5% would need to be retained for a year after completion of the development. This detail is not yet known under the New Law. The percentage of the construction value of a project to be placed and retained in the escrow account will be specified by a resolution of the Board. It is clearly essential that a resolution on this is passed without delay.
Our experience is that the rules around escrow were one of the areas that caused most confusion and uncertainty for developers seeking to apply the Old Law. This confusion also extended to banks who were asked to act as escrow agents. Although the CBB in time issued rules and regulations to govern these accounts, they did not go far enough to alleviate the uncertainty and confusion in the market.
Both the Board and the CBB have a second chance to put in place clearer rules and procedures for escrow accounts under this New Law. Once these are issued we will provide further updates. In the meantime, our developer and financial institution clients should dust off their old escrow account agreements in preparation for a potential overhaul by the Board.
