VALIDITY OF THE LEASE AGREEMENT AND LEGAL RISKS IN RENTING OUT A FACTORY WITHOUT COMPLETED LEGAL DOCUMENTATION

Dang Ba Tung – Associate

Tran Le Cam – Paralegal

1.Background and Practical Issues

In the course of investment in and operation of industrial parks and industrial clusters, it is not uncommon for project developers or factory owners to enter into the factory lease or sub-lease contracts while the legal procedures relating to the relevant facilities have not yet been fully completed, such as obtaining of a construction permit, the completion of procedures for updating ownership of the construction on the Land Use Rights Certificate, or the acceptance and commissioning of the completed works for use.

This approach enables the lessor to accelerate asset exploitation and capital recovery, while at the same time meeting the lessee’s urgent demand for production premises. However, in event of a dispute, particularly where the lease contract is declared null due to non-compliance with mandatory legal conditions, the legal and financial risks for both parties may be significant.

A frequently debated issue is whether, in circumstances where the contract is declared invalid but the lessee has in fact used the factory premises, the lessee is required to pay rent, and what legal basis should be used to determine the amount to be reimbursed.

2.Precedences and the Courts holding at different levels

In a case adjudicated by the Superior People’s Court in Ho Chi Minh City, both the first – instance court and the appeal court adopted the same approach to this issue. In particular, in 2020, Company F and Company M entered into a factory lease contract in an industrial cluster, with a lease term of three (03) years and a rental rate of USD 114,000 per month. At the time of execution of the contract, both parties were fully aware that the factory premises had not been granted a construction permit and had not yet completed the acceptance procedures for commissioning into use.

During the performance of the contract, Company M breached its payment obligations. Company F initiated legal proceedings before the People’s Court of Binh Duong Province. The core argument advanced by Company M was that the lease contract was invalid, as the factory premises did not satisfy the statutory conditions for being put into commercial use as real estate under the Law on Real Estate Business. The Court accepted this argument and declared the lease contract invalid due to a violation of prohibitory provisions of law, with reference to the provisions on invalid civil transactions under the Civil Code.

The dispute does not end with the determination of the validity of the lease contract, but rather centers on its legal consequences, specifically, whether a lessee who has actually used the factory premises is required to pay rent at the agreed rate when the lease contract is declared invalid.

Regarding the relevant regulations, according to Article 131 of the Civil Code 2015[1], where a civil transaction is declared invalid, the parties are required to return to each other what they have received; where restitution in kind is not possible, restitution must be made in monetary value, unless otherwise provided by law. In principle, this mechanism aims at “restoring the parties to their original position”, thereby ensuring a balance of interests between them.

However, in the context of real estate that does not satisfy the statutory conditions for being put into commercial use, a further question arises as to whether the use value of an asset “lacking the required legal conditions” may be regarded as a quantifiable benefit subject to restitution.

At present, there is no uniform statutory guidance on this issue. Judicial practice demonstrates the existence of two different approaches in addressing this question:

• First approach: Where real estate does not satisfy the statutory conditions for being put into commercial use, such asset is considered to lack “lawful use value” and, therefore, cannot be converted into a monetary value for restitution purposes. Under this approach, the lessor may not be entitled to receive any payment for the period during which the lessee actually used the property[2].
• Second approach: Notwithstanding the invalidity of the lease contract, where one party has actually exploited, used, and derived benefits from the property, such party is required to return the value of the benefits received. In practice, such value is commonly determined based on the rental rate agreed under the invalid contract[3].

3.Assessment and Legal Implications

From the perspective of fairness and risk allocation, the approach requiring the party that has derived benefits to return the corresponding value is reasonable. This approach prevents situations in which one party enjoys actual economic benefits without making any payment, while at the same time upholding the principle that no party should be unjustly enriched as a result of an invalid transaction.

However, in the absence of uniform statutory guidance or interpretative resolutions at the legislative level, the outcome of disputes continues to depend to a significant extent on the approach adopted by individual Courts. This results in a substantial degree of legal uncertainty for enterprises, particularly in relation to factory leasing arrangements implemented before the completion of the required legal documentation.

4.Risks for enterprises

From a legal risk management perspective:

• For the lessor:

• The risk that the lease contract may be declared invalid, resulting in the possibility of failing to recover rental payments or having to incur significant time and litigation costs to prove the value of benefits already provided; and

• The risk of liability for damages if the leasing of property that does not satisfy the required legal conditions causes loss or damage to the lessee.

• For the lessee:

• The risk of premature termination of the right to use the property as a consequence of the lease contract being declared invalid;

• The risk of loss of investment costs, including expenses for machinery installation and factory refurbishment; and

• The possibility of still being required to pay for the value of use despite the invalidity of the lease contract, depending on the approach adopted by the Court.

5.Practical Recommendations for In-house Legal

Prior to entering into a factory lease contract, enterprises should pay close attention to the following legal issues:

a. Verification of legal conditions prior to contract execution: The lessor should ensure that the factory premises fully satisfy the statutory conditions for being put into commercial use under the laws on land, construction and real estate business, including the completion of construction permits, acceptance and commissioning procedures, and the registration of ownership of assets attached to land.

b. Assessment of contractual risks during transitional periods: Where it is necessary to execute a lease contract before the completion of all legal documentation, careful consideration should be given to the use of conditional effectiveness clauses, interim arrangements, or security mechanisms for contractual obligations in order to mitigate the risk of invalidity.

c. Early engagement of legal advisors: Conducting a legal review at the project preparation stage and properly structuring the transaction from the outset can significantly reduce the risk of disputes and future compliance costs.

The foregoing sets out our assessment of the legal risks and the approach adopted by Vietnamese courts in cases where a factory lease contract is declared invalid. Should you require legal advice on dispute resolution strategies, or on investment structures and the drafting of contracts relating to business operations, investment, transfer, acquisition, or leasing of factory premises, please visit  DIMAC Website and our News Category to stay informed of our latest legal insights and practical experience.