Recent Thai court rulings that have held the so-called “collective leasehold” or “secured leasehold” 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.
Under current Thai law, the maximum lease term is a mere 30 years. Thus, it has become 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; it is 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 is not 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 shares in a Thai limited company that owns the land leased to buyers.
The idea is that eventually all of the buyers in the development “collectively” control the Thai land-owning and -leasing company (TLOC). Purportedly, this in turn ensures that the TLOC will renew all of the buyers’ leases for the two successive 30-year terms – “guaranteeing” or “securing” the buyers’ full 90 years.
But to widespread shock two Thai Trial Court judges and three Thai Appellate Court judges have held that the Collective Lease is legally “void” or invalid.
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.
Any alternative must avoid the issues that might be created, and that are not dealt with by the Collective Lease.
It must address three matters:
- The risk that the lease may not be renewed for a second or third 30-year term;
- The tax issues created by a lease renewal in light of the pre-payment for the commonly marketed 30+30+30 years lease; and
- Issues relating to the use of illegal Thai-national shareholding “nominees”.
The only structure that does all of this is the “Lease-Mortgage”.
As mentioned above, 30+30+30 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 previous 30-year term.
So the current landowner has merely promised he will give these additional terms to the lessees in the future, but he has already received money for them.
This is, legally speaking, a “loan”. Until money is paid for something that is actually provided, under the law it is 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, 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.
The simple and elegant Lease-Mortgage does exactly this and provides an accurate legal structure for what is already happening in practical terms (the lease for the first 30 years plus a loan for the next two 30-year terms).
It does this 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 the 30+30+30-year lease agreement with a loan and mortgage agreement.
Once the agreements are finalised, the first 30-year lease term is registered on the land and a mortgage securing the loan of the rent for the two 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 “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, it is no longer a loan but a rent payment – and the mortgage covering that part of the loan is also then automatically removed from the land.
The same would 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 investors will be able to foreclose on the property, have it sold, and recoup their investment.
Let’s return to our three points above.
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 buyer’s prepaid investment and interest is secured by a registered mortgage on the land deed.
Thus, the investor’s security, the mortgage, “remains with the title deed” regardless of who owns the land.
If the lease is not renewed as required, the buyer may have the land sold and receive from the sale price an amount to cover the original investment, with interest.
However, the more likely scenario would be that the new land owner would be willing to honor the renewal term and await its end, rather than lose the land through a forced sale.
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. The Lease-Mortgage reflects what is actually agreed upon between the parties: a total pre-payment 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 TLOC. The Thai tax regimen interprets full payment only for something actually provided, not something promised.
And, as we explained, only the first 30-year lease term can actually be provided. Failing any other legal explanation for the payment, all of it will be considered income for the TLOC for the first 30 years and it will all be taxed accordingly, in the first 30 years.
Thus, the TLOC will have all of its lease income taxed 30 to 60 years before it should have been.
Furthermore, the TLOC will not be able to account for income from the lease in the second and third 30-year terms, but 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. Lease renewal terms will then be unenforceable.
But none of this horror applies with the Lease-Mortgage.
The TLOC is not financially affected at all. It still receives the same amount as under the common pre-paid lease with two renewals.
But under the Lease-Mortgage, the payment will be booked 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 TLOC also benefits under the Lease-Mortgage structure by having the rental income properly taxed over the correct 90-year period and having the liquidity of the as-yet-untaxed loan cash available during the first and second 30-year terms.
Does the Lease-Mortgage address the issues relating to the use of illegal nominees?
Yes. A Thai limited-liability company may not own land and lease it if there are not at least two individual Thais owning shares in the company.
It is illegal for Thais to hold shares in a Thai company as “nominees” to benefit a foreigner.
Unlike the Collective Lease, however, the Lease-Mortgage does not require a buyer to risk using Thai nominees because he does not need to become part-owner of any company in order to secure his lease.
The Lease-Mortgage investor is, therefore, at no risk of losing his lease investment due to the use of Thai nominees.
Existing developments and their buyers may also benefit from the use of a mortgage as a security for the renewal of a lease. We will refer to this as a “Security-Mortgage”.
A Security-Mortgage can be implemented in an existing development to provide buyers with an additional layer of security.
It is quite easy to implement. The lessor and the lessee simply enter into a Security Agreement, which states that the lessor will be subject to a significant financial penalty in the event that the lease is not renewed as agreed.
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 Security-Mortgage also “travels with” the land title deed.
Regardless of whether the land is ever transferred to a new owner or not, if the lease is not renewed as required, the investor can have the land sold and recover his investment, with interest.
DUENSING KIPPEN is an international law firm specialising in business transaction and dispute resolution matters, with offices in Bangkok and Phuket, Thailand and affiliated offices in 45 other countries. Visit them at: duensingkippen.com