The financial collapse of the urban renewal entrepreneurial company “Derech HaTeena”, , has brought the Israeli Supreme Court to grant an interesting ruling a few weeks ago, which has created a great debate in the legal system and in the entire real-estate industry. In this article, we will summarize the main issues of the case, we will clarify the status of caveats (‘Hearat Azhara’) as a guarantee for real estate buyers and will clarify when a trustee or liquidator of an insolvent company can terminate an agreement by declaring the agreement as “onerous property”.
Derech Hateena case
In 2015, “Derech HaTeena” urban renewal company(“the Company”), engaged with the owners of a building in Ramat Gan for the execution of an urban renewal project by structural reinforcement and expanding the building (NOP 38/1).
The company used private investors to accompany the project, without issuing third party buyers a bank guarantees. In accordance with an appraisers report, the Company has expected to receive a permit for the construction of 12 new residential units and to complete the construction of the project within 15 months. Contrary to the Company’s expectations, the Company has received a permit to construct only 10 residential units while Ramat Gan municipality required the company to pay an additional sum of 1.2 million ILS for “parking ransom”.
Despite the limitations and delays the Company had encountered, it has succeeded in selling all 10 new residential units which were approved for lower prices than market prices, while registering caveats in favor of all third party buyers.
At the end of 2016, during the initial execution stages of the project, the Company couldn’t pay her debts, while the construction of the new residential units had not even begun.
In July 2018, the Tel Aviv District Court approved a legal motion submitted by the building original tenants, granting a liquidation warrant to the Company, and appointing a liquidator in order to locate financing sources required for the completion of construction.
Despite all of the liquidator attempts to heal the company by selling the project, new buyers rejected all his offers mostly due to the caveats registered in favor of the new residential units’ buyers.
The termination of the third party buyers’ agreements as they were considered an onerous property
The main part of the District Court’s ruling revolved around the legal motion which was submitted by the company trustee, stated that the sales agreement of those ten new apartments buyers should be considered as “”onerous property”, in accordance with the provision of Article 361 of the Companies Ordinance. After an in-depth discussion, the District Court judge has acceded to the motion and ruled that the agreements and the caveats which were registered in favor of the buyers must be revoked. Thus, the District Court has enabled the trustee to delete the caveats which were registered in their favor pursuant to the sales agreement, and thus enabling the trustee to promote the sale of the project to a new entrepreneur.
It shall be noted, that declaring an agreement as onerous property pursuant to Article 361 is an exception to the rule which binds the company to uphold its contracts. Pursuant to the article, a company in insolvency proceedings may ask the court to order the termination of agreements, if they are not executable, while taking into account damage-benefit considerations for the parties. In the Court’s rulings over the years, it was clarified under which conditions the court shall recognize an onerous property as onerous, and under which circumstances it will not recognize it as such. In this case it was ruled, that since it was not possible to locate a buyer for the project due to the caveats registered in favor of the buyers, declaring those agreements as onerous and deleting the caveats was the only way to promote the project.
The buyers of the new apartments have raised before the court several past rulings which anchor the status of the caveat as a proprietary security, and have argued that it should not be instructed to delete the caveats, since this is a first-degree encumbrance. Alternatively, they have argued, that if the sales agreements shall be recognized as an onerous asset, then the court must determine the status of the buyers as guaranteed creditors. This argument is based on the fact that the caveat was registered as a security for the buyers in accordance with Article 2(4) of the Sales Law (Apartments), and based on a Supreme Court ruling which has recognized the status of the caveat as an encumbrance and real estate buyers as guaranteed creditors in bankruptcy situations.
The arguments of the buyers regarding the status of the caveat as a quasi-proprietary security were denied, and it was ruled that the caveat was intended to guarantee the agreement and not the future real estate assets. Thus, the termination of the real estate purchase agreements has automatically resulted in the revocation of the caveat as well. It was further emphasized, that since the purpose of the caveat is to guarantee the base transaction, it does not guarantee any monetary compensation and restitution to the buyers (unlike a material security).
The Supreme Court, on its part, has ratified the decision of the District Court, and has ruled in addition, that the buyers should not be considered as guaranteed creditors.
The sales agreements as an onerous asset
In the court ruling, it was determined more than once, that examining the termination of onerous assets shall be done while verifying the good faith and fairness of the parties, while examining the extent of damage to the injured party, and only after it was determined that there is no other alternative under the circumstances. In the case before us, had the court not revoked the sales agreements as an onerous asset, the project would have remained as a stone which cannot be unturned. Therefore, it seems that the cost-benefit considerations and the fact that the termination of the agreements was the only alternative the liquidator had, justifies the court ruling despite the severe damage to the new units buyers and the damage accrued to the status of the caveat as a guaranteed security.
The significance of revoking the caveat and the status of the buyers
Major criticism was given to the court’s stance, whereas apparently, the significance of this ruling is that the buyers of apartments who buy them “on paper”, when a caveat was registered in their favor as a security in accordance with the provisions of the Sales Law (Apartments), are not guaranteed in cases of the collapse of the entrepreneurial company (or construction company), and it is possible that they will not even be recognized as guaranteed creditors.
Now is the time to state and clarify, that the Supreme Court has emphasized that its ruling on the matter which is the subject of this article, isn’t a binding ruling, and it should be considered as an unusual case which has required finding a creative solution.
Even though the court stated this is not a binding ruling, the ruling of the Supreme Court actually weakens the status of the caveat as a security (contractual or proprietary), so that it is therefore clear that there are situations where it will not be advised for property buyers to suffice a real estate deal by registering a caveat as the sole guarantee.
With regards to the refusal of the Supreme Court to determine the status of the new buyers as first-degree creditors, it was ruled that the role of the court is to determine whether the company’s debt toward the buyers is a claimable debt, and not the status of the buyers in the credit arrangements. Subsequently, the special liquidator or trustee shall be requested to determine the status of the apartment buyers in the credit arrangement (who have held a caveat which was deleted) after the buyers will submit to him individual debt claims.
The ruling of the Supreme Court in this case does not constitute a binding ruling, but one cannot remain indifferent to its consequences. Third-party buyers who buy assets from entrepreneurs and contractors in an urban renewal project must insist on their right to receive a security which is sufficiently strong, in the form of a bank guarantee in accordance with the provisions of Article 4 of the Sales Law (Apartment).