Legal Effects of Unregistered Property Interests on Third Parties: What is the Position of Ethiopian Law?

If you have an interest on a property and this interest is registered, it will have legal effects on third parties. The idea is the third party knew or should have known of a prior interest registered before the acquisition of his own interest. The government enhances certainty and security of land transactions by providing a registry system. The purpose of this registry system is to register anyone who has prescribed interests (such as mortgage) on a land so that third parties can inspect the registry and decide whether to make another transaction. There is of course a practical question of as to whether the current registry system provides such service to inquirers. Leaving this aside, another question is what if the interest is not registered because the law does not require such interest to be registered in the first place or because of other reasons. Consider the following:

X owns a building part of which is rented to Y on the basis of a written but unregistered contract for a period of 15 years. Y has undertaken to pay the rent quarterly in advance. X developed a business idea and borrowed money from Easymoney Share Company by providing his building as collateral. The contract of mortgage is registered. Now that X defaulted in paying back the sum he borrowed, Easymoney plans to foreclose the building. The question is now as to whether Easymoney or any purchaser of the building will have the right to evict Y?

The above set of facts presents two competing interests. On the one hand, there is the property interest of the bank which did not know of the existence of this long-term contract of rent. On the other hand, you have the contractual interest of Y which has planned all his business on the understanding that he would have the right to the use of the building for the agreed period of time. It is true that this contract was not registered but it is also true that the law does not require such contracts to be registered. In a recent case, the Cassation Division of the Federal Supreme Court decided that Article 1723(1) does not include contracts of leases (Rental Houses Administration Agency v Sosina Asfaw [2005] File Number 15992). Article 1723(1) provides that "a contract creating or assigning rights in ownership or bare ownership on an immovable or an usufruct, servitude or mortgage of an immovable shall be in writing and registered with a court or notary". It should be noted that Article 1723 is concerned with the validity of the contract between the parties and not with its effect on third parties. Therefore, it can be argued that contracts of lease for whatever period of time could be made in any form and will still be valid. The question relates to the effect of contracts of lease on third parties. In this regard, Article 2899(1) provides that "leases for a period exceeding five years shall not affect third parties until they are entered in the registers of immovable property at the place where the immovable is situate". It follows therefore that even if oral or written but unregistered contracts of lease are binding on the parties, their effect on third parties depend on the period of time they are made and whether they are registered. If the lease is made for a period of time exceeding five years, it should be registered for it to have affect third parties. In the above example, the contract of lease is for a period of 15 years but not registered. In such cases, Article 2899(2) provides that the contract of lease affects third parties only for five years from the day when the the third party has registered his/her right on the immovable. It follows therefore that the contract of lease between X and Y affects Easymoney for a period of five years. If on the other hand, the period of time for which the contracts of lease is made is not certain and the contract of lease is not registered, Article 2933(1) and Article 2899(3) provide that this contract is deemed to have been made for indeterminate period of time. Assume in the above case the period of time for which the contract of lease is made is uncertain; in such cases, Easymoney can presume this contract to have been made for indeterminate period of time. The question is what will be the effect of that presumption? According to Article 2966, contracts of leases for an indeterminate periods of time can be terminated by giving default notice. To conclude, it can be said that contracts of lease is binding on the parties in whatever form and for however it is made. But is the effect on third parties depends on two factors:

(1) length of time for which the lease is made; and

(2) whether it is registered or not.

If the contract is for more than five years and it is registered, the contract of lease will also bind third parties who acquired property rights on the property. If it is not registered and the period of time it is made is more than five years, the contract of lease will bind the third party only for five years. If it is not registered and the period of time is uncertain, the contract of lease can be terminated by giving notice. If it is not registered and the period of time is less than five years, the contract binds the third party for that period of time. It is also important not to overlook the possibility that the lessor and the lessee may agree in the contract of lease that third party purchasers will have the right to terminate the contract.

What is the problem with this law? The problem is the possibility that a contract of lease unregistered will have the effect of binding a person with a properly registered property interest, even if it for a period of five years or less. What is the message? The message is purchasers of property or people who intend to acquire any right on a property need to examine not only registers of property to see if someone else has an interest in the property but also make some independent enquiries as to whether someone else has unregistered interest in the form of contract of lease. This adds up the costs of property transactions. In addition, it creates a room for collusive behaviour between the original owner of the property and another person to frustrate the interest of the third party. It is also a bit anomalous. If the law requires leases exceeding five years to be registered so that they effect third parties, the logical extension of this rule should have been: leases exceeding five years and not registered will not affect third parties or leases exceeding five years and not registered will not affect third parties in good faith.

How do other countries solve this problem? Let me discuss the position of English law on this point. Under the Law of Property Act 1925 a contract of lease of three years or more must be made by deed--in a written document signed in front of witnesses. This is a validity requirement. If it is not made this way, the contract is considered void. This makes Ethiopian law different in that it does not provide any validity requirement for however period of time it is made. With respect to third parties, English law provides some leases to be compulsorily registered to be binding on third parties. There are many exceptions to the rule but generally it can be said that a lease for a period of seven or more years ought to be registered to have any effect. If not registered, it will not affect third parties. Leases for a period less than seven years are not required to be registered. Such leases will not affect third parties in good faith. That means it affects only third parties who knew or should have known of the lease. Under English law, therefore, whether unregistered leases for a period less than seven years affect third parties depends on whether the third party is in good faith or not. Unregistered leases for a period more than seven years do not however affect third parties. In Ethiopia, unregistered lease for more than five years affects third parties (whether they are in good faith or not) at least for a period of five years. By doing that and considering the fact that the law does not prescribe validity form, it creates an opportunity for the lessor and the lessee to conspire against the third party.

Ethiopian law has however one advantage: certainty and thereby reduction of litigation; I said this because the law avoided the need to determine if the third party is in good faith or not--fact intensive determination and one that could overwhelm our courts and opens room for judicial corruption. The need to curb litigation at the expense of fairness may be understandable at the time when the law was enacted; considering the fact that there were few learned judges at the time, Rene David framed many of the provisions in the civil code in a way that minimises litigation. The need to have 'bright-line' rules (the current rules discussed above can be considered bright line rules, all-or-nothing rules) as opposed to what are often called 'standards' (e.g. a rule formulated in terms of the concept of good faith) in less-developed countries has been advocated for two principal reasons. First, it is argued that 'standards' (rules of reason) need to be interpreted and concretised on case by case basis. This would bring huge burden on the judiciary especially at the beginning when such rules are enacted. However, it is argued that less developed countries do not have sufficient human capital to do this job. Hence, the argument runs, bright-line rules (rules of decision) should be adopted even if these rules might result in unfair outcomes in certain cases; the saving in human capital justifies the cost of unfair outcomes that these rules might bring about. For a full account of such argument see, for example, Hand-Bernd Schafer, 'Rules versus Standards in Rich and Poor Countries: Precise Legal Norms as Substitutes for Human Capital in Low-Income Countries' (2006) 14 Supreme Court Economic Review 113. I believe that this argument might account many of the choices made by Rene David when drafting the Civil Code. Perhaps, I will return to this point in a separate note. The second argument is that standards give the courts huge discretion and it is argued that exercise of judicial discretion in an environment where there are no adequate safeguards against bias and corruption might defeat the very purpose of the law. The argument goes in less developed countries lacking adequate safeguards against judicial corruption the better option is to use bright-line rules. For a discussion of this argument in relation to Russia, see JR Hay and A Shleifer, 'Private Enforcement of Public Laws: A Theory of Legal Reform' (1998) 88 American Economic Review 398. Considering the two arguments, the question now is whether we should continue with the status quo or is it time to make some changes to the law.

I argue that it is time to make some changes. Lessons could be learned from other legal systems. In addition, the civil code has already authorized courts to determine if someone is in good faith in a number of instances. For example, in relation to invalidation and cancellation of contracts, it states that "acts done in the performance of contracts shall not be invalidated if doing so affects the interests of third parties in good faith". The rules on acquisition of property recognize the possibility of acquiring ownership of stolen property if the third party has acquired the property for consideration and in good faith". On an agent who made a contract in the name of the principal while his authority has already been terminated or revoked, the civil code provides that the agent shall not be liable if he acted in good faith not knowing the reason why his authority has come to an end. There are many more examples where courts have the authority to determine if someone is in good faith or not. Therefore, a logical structure of the law on unregistered contracts of leases should have been formulated in terms of good faith. A requirement of good faith would give an incentive to the third party (in my example Easymoney) to make sufficient independent inquiries as to whether someone else has a lease on the property and to the lessee (in my example Y) to act in a way that signals that he has an interest on the property. Such independent inquiry on the part of Easy money could include physically surveying the property to see who is living or doing business in the building and a sufficient signal on the part of Y could be to continue to use the property that he leased.

Before I end my discussion, let me raise one point. In the above set of facts, assume that Easymoney has done its best to determine if there is anyone who has an interest on the building but no one appears to have an interest. Assume further that X failed to disclose the fact that the property was leased to Y for a period of 15 years. Does Easymoney have any remedy (contract or tort) against X? Assume instead that Easymoney did not make any independent inquiries apart from inspecting the registry and assume further that X failed to disclose the lease, will Easymoney have any remedy? Assume that X lied to Easymoney regarding the existence or period of the lease, will Easymoney have any remedy against X?