The Lease- Mort­gage

The bet­ter way to pro­tect in­vestors and pro­mote Thailand’s res­i­den­tial real es­tate mar­ket

Thai-American Business (T-AB) Magazine - - Property Trends - Writ­ten by: Olaf Duensing and Jer­rold Kip­pen

Re­cent Thai court rul­ings which have held the so- called “col­lec­tive lease­hold” or “se­cured lease­hold” (“Col­lec­tive Lease”) to be void, have cre­ated quite a stir among Thai real es­tate developers and in­vestors. This is be­cause many developers who sell to for­eign in­vestors have been marketing and sell­ing the Col­lec­tive Lease for sev­eral years now in Thailand. Thus, the im­pli­ca­tions of these rul­ings could af­fect a sig­nif­i­cant seg­ment of the real es­tate mar­ket in Thailand.

WHAT IS A COL­LEC­TIVE LEASE?

A long- term lease is a com­mon means for a for­eigner to in­vest in Thai real es­tate. This is due largely to the fact that Thai law, with some lim­ited ex­cep­tions, pro­hibits for­eign free­hold own­er­ship of real es­tate. How­ever, un­der cur­rent Thai law, the max­i­mum lease term is a mere 30 years. Thus, it has be­come rather com­mon for developers, who are marketing to for­eign­ers, to of­fer a long- term lease of 30 years with two ad­di­tional suc­ces­sive 30- year term re­newals.

Un­der Thai law, how­ever, any such ad­di­tional term is not an “ex­ten­sion” of the lease; rather it is merely a “re­newal” of the lease. This means that the new term is essen­tially a new con­tract. The re­sult is that if the owner of the prop­erty changes dur­ing the first lease term, the new owner will not be obliged to honor the re­newal of the lease, even if the lessee has al­ready pre- paid the orig­i­nal owner for the re­newal term.

In an ef­fort to ad­dress this in­se­cu­rity, many developers of­fer the Col­lec­tive Lease. They prom­ise not only a lease but also ac­qui­si­tion of shares in a Thai lim­ited com­pany that owns the land that will be leased to the in­vestor. Other in­vestors in that same de­vel­op­ment would then do the same– lease their land and also be­come one of the own- ers of the land own­ing and land leas­ing Thai lim­ited com­pany. The idea is that even­tu­ally all of the in­vestors in the de­vel­op­ment would “col­lec­tively” con­trol the land own­ing and land leas­ing Thai com­pany. Pur­port­edly, this would then in turn en­sure that the Thai com­pany would re­new all of the in­vestors’ leases for the two suc­ces­sive 30- year terms— “guar­an­tee­ing” or “se­cur­ing” the in­vestors’ full 90 years.

We have al­ready de­tailed in pre­vi­ous ar­ti­cles why the Col­lec­tive Lease does not achieve the se­cu­rity for the for­eign real es­tate in­vestors in Thailand that it ad­ver­tises. Now added to that, we have the hold­ings of two Thai Trial Court and three Thai Ap­pel­late Court judges who have held the Col­lec­tive Lease legally “void”, in other words, legally in­valid. We have also ex­plained those rul­ings in an­other ar­ti­cle. We wish to em­pha­size that this law firm does not agree with the le­gal hold­ings of these five judges. How­ever, given that the Col­lec­tive Lease fails to pro­vide any real se­cu­rity it is not sur­pris­ing that real es­tate developers and in­vestors in Thailand are look­ing for an al­ter­na­tive to truly se­cure real lease­hold in­vest­ments.

IN­TRO­DUC­ING LEASE- MORT­GAGE

Any al­ter­na­tive must avoid the is­sues that might be cre­ated and which are not dealt with by the Col­lec­tive Lease. It must ad­dress: ( 1) the risk that the lease may not be re­newed for a sec­ond or third 30- year term, ( 2) the tax is­sues cre­ated by a lease re­newal in light of the pre- pay­ment for the com­monly mar­keted 30+ 30+ 30 years lease; and ( 3) is­sues re­lat­ing to the use of il­le­gal Thai share­hold­ing “nom­i­nees”. The only al­ter­na­tive that does all of this is what we will re­fer to here as the “Lease- Mort­gage”. It is not only a sim­ple struc­ture; it re­flects what is al­ready ac­tu­ally hap­pen­ing in most of these com­mon 30+ 30+ 30 year lease agree­ments in Thailand. As al­luded to above, these lease agree­ments are almost al­ways “pre- paid” in full. How­ever, the two ad­di­tional 30- year re­newal terms can only be granted and ef­fected at the end of each prior 30- year term. Thus, the cur­rent landowner has merely promised he will give these ad­di­tional terms to the lessee in the fu­ture, yet he has al­ready re­ceived money for them. This is “money for noth­ing” in re­turn or, legally speak­ing, a “loan”. Un­til such money is paid for some­thing that is ac­tu­ally pro­vided, un­der the law it is merely a loan. Thus, in all of these com­mon struc­tures where a sin­gle lease pay­ment cov­ers all 90 years, two- thirds of the pay­ment is, from a le­gal stand­point, merely a loan. And what is the sim­plest and best way to se­cure loaned money? Do ex­actly what banks do — sub­ject the loan to in­ter­est and reg­is­ter a mort­gage against the land to se­cure the loan and ap­pli­ca­ble in­ter­est.

LEASE- MORT­GAGE AD­DRESSES REAL­ITY

The Lease- Mort­gage does ex­actly this and thereby sim­ply pro­vides the ac­cu­rate le­gal struc­ture for what is al­ready hap­pen­ing as a prac­ti­cal mat­ter ( the lease for the first 30 years plus a loan for the next two 30 year terms) by adding what should hap­pen in such cases ( in­ter­est on the loan and a mort­gage se­cur­ing the loan for the next two 30 year terms) through the com­bi­na­tion of: ( 1) the 30+ 30+ 30 year lease agree­ment with, ( 2) a loan and mort­gage agree­ment. Once the agree­ments are fi­nal­ized, the first 30- year lease term is reg­is­tered on the land and a mort­gage se­cur­ing the loan of the rent for the two ad­di­tional 30- year re­newal terms is also reg­is­tered on the same land.

If the lease is re­newed, for the sec­ond 30 years, that por­tion of the loan is, again in non- tech­ni­cal lan­guage, “for­given” be­cause the parties agree that it then be­comes rent for the sec­ond 30- year term. In other words, since the sec­ond

term is ac­tu­ally pro­vided at that time, it is no longer a loan but a rent pay­ment — and the mort­gage cov­er­ing that por­tion of the loan is also then au­to­mat­i­cally re­moved from the land. The same would then hold true for the loan of the rent for the third 30- year term and the mort­gage se­cur­ing it.

How­ever, if at the end of the first or sec­ond 30 years the lease is not re­newed for any rea­son, then the in­vestor will be able to im­me­di­ately fore­close on the prop­erty, have it sold, and re­coup his in­vest­ment.

Let’s re­turn to our points above.

( 1) Does the Lease- Mort­gage ad­dress the risk that the lease may not be re­newed for a sec­ond or third 30- year term?

Yes. As out­lined above, the in­vestor’s pre­paid in­vest­ment and in­ter­est is se­cured by a reg­is­tered mort­gage on the land ti­tle deed. Thus, the in­vestor’s se­cu­rity, the mort­gage, “re­mains with the ti­tle deed” re­gard­less of whether or not the land is ever trans­ferred to a new owner. If the lease is not re­newed as re­quired, the in­vestor may have the land sold and re­ceive the sale price to cover his orig­i­nal in­vest­ment and in­ter­est. How­ever, even if the land were trans­ferred, the more likely sce­nario would be that the new owner would be will­ing to honor the re­newal term and await its end, rather than lose the land by a forced sale.

( 2) Does the Lease- Mort­gage ad­dress the tax is­sues cre­ated by a lease re­newal in light of the pre- pay­ment for the com­monly mar­keted 30+ 30+ 30 year lease?

Yes. As ex­plained above, the Lease- Mort­gage re­flects what is ac­tu­ally agreed upon be­tween the parties: a to­tal pre­pay­ment for 90 years of lease, which shall be pay­ment for three suc­ces­sive 30- year terms.

Un­der the Col­lec­tive Lease, this is a ma­jor prob­lem for the land own­ing and leas­ing Thai com­pany. The Thai tax reg­i­men will in­ter­pret full pay­ment only for some­thing ac­tu­ally pro­vided. And as we ex­plained, only the first 30- year lease term can be ac­tu­ally pro­vided. Ab­sent any other le­gal ex­pla­na­tion for the pay­ment, all of it will be con­sid­ered in­come for that Thai land own­ing and leas­ing com­pany for the first 30 years and it will all be taxed ac­cord­ingly in the first 30 years. Thus, the Thai com­pany will un­for­tu­nately have all of its lease in­come taxed 30 to 60 years in ad­vance of when it should have been.

Fur­ther­more, the Thai land own­ing and leas­ing com­pany will not be able to ac­count for in­come from the lease in the sec­ond and third 30- year terms. The Rev­enue Depart­ment will ex­pect in­come for those later terms and may as­sess fac­tious rental in­come and tax it; if not paid, the land will be seized and sold to a new owner. In such case, any lease re­newal terms will be un­en­force­able.

How­ever, none of this hor­ror story is the case with the Lease- Mort­gage.

The land own­ing and leas­ing com­pany, the de­vel­oper’s com­pany, is not fi­nan­cially af­fected at all. It still re­ceives the ex­act same amount as un­der the com­mon pre- paid lease with two re­newals. But un­der the Lease- Mort­gage, the pay­ment will be booked dif­fer­ently to ac­cu­rately re­flect the 1/ 3 rental in­come for the first 30- year term and the re­main­ing 2/ 3 bal­ance, as a loan. Loans are not taxed and, there­fore, the Thai land own­ing and leas­ing com­pany/ de­vel­oper thereby also ben­e­fits un­der the Lease- Mort­gage struc­ture by hav­ing ( 1) the rental in­come prop­erly taxed over the cor­rect 90- year pe­riod, as well as, ( 2) the liq­uid­ity of as yet un­taxed loan cash avail­able dur­ing the first and sec­ond 30- year terms.

( 3) Does the Lease- Mort­gage ad­dress the is­sues re­lat­ing to the use of il­le­gal Thai share­hold­ing “nom­i­nees”?

Yes. A Thai com­pany lim­ited can­not own land and lease it if there are not at least two in­di­vid­ual Thais who own shares di­rectly or in­di­rectly in that com­pany. How­ever, it is il­le­gal for Thais to hold shares in a Thai com­pany as “nom­i­nees” to ben­e­fit a for­eigner. Thais can­not law­fully hold such shares “in name only” with­out ac­tu­ally hav­ing in­vested in that com­pany. Un­like the Col­lec­tive Lease, the Lease- Mort­gage does not re­quire an in­vestor to risk us­ing such Thai nom­i­nees be­cause the Lease- Mort­gage in­vestor is not forced to be­come a part owner of any Thai com­pany in or­der to pur­port­edly se­cure his lease in Thailand. The Lease- Mort­gage in­vestor is, there­fore, at no risk of los­ing his lease in­vest­ment due to the use of any such Thai nom­i­nees.

Thus, the Lease- Mort­gage is a much bet­ter al­ter­na­tive to the Col­lec­tive Lease. Ob­vi­ously, it is at best im­ple­mented in the be­gin­ning of a de­vel­op­ment be­fore the first leases are en­tered into and that is the con­text in which we have dis­cussed and de­tailed the Lease- Mort­gage above.

PENALTY- MORT­GAGE

How­ever, it should be noted that ex­ist­ing de­vel­op­ments and their in­vestors may also ben­e­fit from the use of a mort­gage as a se­cu­rity for the re­newal of a lease. This is what we will re­fer to as a “Penalty- Mort­gage”.

A Penalty- Mort­gage can be im­ple­mented in an ex­ist­ing de­vel­op­ment to pro­vide its in­vestors with an ad­di­tional layer of se­cu­rity in re­la­tion to the re­newal of their leases. And it is quite easy to im­ple­ment. The lessor and the lessee sim­ply en­ter into a Penalty Agree­ment, which pro­vides that lessor will be sub­ject to a sig­nif­i­cant Thai Baht penalty in the event that the lease is not re­newed as re­quired un­der the lease agree­ment. That penalty is then se­cured with a reg­is­tered mort­gage on the leased land.

As with the Loan- Mort­gage, the se­cu­rity pro­vided to the in­vestor by the Penal­tyMort­gage also “trav­els with” the land ti­tle deed. Re­gard­less of whether or not the land is ever trans­ferred to a new owner, if the lease is not re­newed as re­quired, the in­vestor may have the land sold. The in­vestor is then en­ti­tled to re­ceive the sales price to cover his orig­i­nal in­vest­ment and in­ter­est as pro­vided un­der the Penalty Agree­ment. How­ever, even if the land were trans­ferred, the more likely sce­nario would be that the new owner would be will­ing to honor the re­newal term and await its end, rather than lose the land by a forced sale.

The sim­ple el­e­gance and ac­cu­racy of the Lease- Mort­gage and Penalty- Mort­gage pro­vide un­com­pli­cated se­cu­rity and en­hanced re­sale value for in­vestors, as well as greater mar­ketabil­ity and other fi­nan­cial ben­e­fits for developers.

Olaf Duensing and Jer­rold Kip­pen are Part­ners at Duensing Kip­pen, Ltd. They can be con­tacted at olaf@ duensingkip­pen. com and jer­rold@ duensingkip­pen. com

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