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01 March 2019
Overview of leasing laws
Key characteristics of lease agreements
Bankruptcy of lessor or sale of property
Settling disputes over lease agreements
Gross-up payment for rent
With an estimated economic growth of 5.1% to 5.2% for 2018,(1) economic activities in Indonesia are expected to show a strong improvement. One of the indications of strong economic activities is the growing need for office space for businesses. It is expected that office space in Jakarta will increase from 6 million square metres in 2017(2) to 7.5 million square metres between 2018 and 2020.(3)
Leasing an office space is an easy way for a business to acquire office space in a prime location, and to help the business to free up working capital. Thus, a carefully prepared lease agreement is invaluable for the lessee and lessor. As a number of issues may be encountered when leasing a building for office space it is important to consider these ahead of time. This article highlights five of the most common ones.
In Indonesia, commercial lease agreements between lessees and lessors are not covered by any specific law, unlike in several other countries, where, in some cases, standard format lease agreements are available. Agreements between lessees and lessors on leasing an object are generally regulated under the Indonesian Civil Code. Under the code, a lease is an agreement under which a party binds itself to provide an object to another party for a certain period against a fixed price to be paid by the latter party. This covers both moveable and immoveable goods. Under the code, lessors are obliged to:
On the other hand, lessees must:
Given the very generic scope of Indonesian Civil Code, there are numerous types of lease agreement for office leases.
Lease agreements for office or commercial space in Indonesia are often presented in a standard format prepared by the lessor or building owner (or in some cases, by the building management), which gives the lessee little room to negotiate. However, this is not the case if the lessee is an anchor or major tenant in the property being leased.
As an anchor or major tenant, it is common for the lessor to grant naming rights or advertising rights. In addition, the lessor may accommodate a request from the lessee for:
One of the lessee's concerns is the bankruptcy of the lessor (which is treated differently to the bankruptcy of the lessee) where the lessor retains the right to terminate the lease.
Under Articles 36 and 38 of the Bankruptcy and Debt Repayment Law (37/2004), if the lessor is declared bankrupt and the court appoints a curator, the curator cannot immediately terminate the lease if the lessee complies with all of its obligations. If the rent has been paid in advance, the lease agreement cannot be terminated early. In a recent Supreme Court decision, the court ruled that a curator cannot terminate a lease agreement early if the lessee has paid the rent in full for the relevant term.(4)
Another concern a lessee may have is the status of the lease agreement if the lessor decides to sell the leased property to a third party. In this case, the lessee's rights are protected under the code, which states that the sale of a leased object will not terminate the lease, unless this has been agreed to.
Another consideration is the method to be used to settle disputes. This must be considered carefully, especially if either party to the lease agreement is affiliated with a foreign corporation (eg, a foreign investment company).
As the lease agreement most likely involves a real property in Indonesia, judicial resolution outside Indonesia should not be considered as an option, as Indonesia is not party to any bilateral or multilateral treaties regarding the reciprocal enforcement of rulings. Therefore, if a foreign ruling calls for the payment of monetary damages, in order to obtain recovery in Indonesia, the creditor must file a new suit against the debtor in the relevant district court in Indonesia. This procedure effectively amounts to a retrial of the dispute, and while the foreign court decision can be used as evidence, the Indonesian court will not be bound by its findings.
Given the above, the most common dispute settlement methods provided for in Indonesian lease agreements are:
The litigation process in Indonesia is lengthy. Depending on the complexity of the case, it can take from six months to approximately one year to obtain a district court ruling, and the losing party can then file an appeal in the relevant high court. Litigation before the high court can take another six months, and the losing party can then appeal to the Supreme Court, which can take from one to five years before a final and binding ruling is handed down. All proceedings in the Indonesian courts are conducted in Indonesian, so all foreign language documents to be submitted to the court must be translated.
Despite recent improvements in the Indonesian court system, many parties remain reluctant to turn to the Indonesian courts unless the situation requires interim relief enforceable in Indonesia or for matters involving Indonesian statutory rights or claims that may not otherwise be arbitrable, thus making the Indonesian court system the best and possibly only viable option.
Under the Arbitration Law (30/1999), all awards handed down by a tribunal or individual arbitrator within Indonesia are treated as domestic awards, regardless of the international nature of the dispute or parties. Therefore, whenever parties choose the Arbitration Law as the lex arbitri (ie, the law of the place in which the arbitration is to take place), the resulting award is always treated as domestic under Indonesian law.
The following are several distinguishing features of the Arbitration Law:
As in many other jurisdictions, domestic arbitral awards in Indonesia are not subject to appeal of any kind to the courts. Since arbitral proceedings are confidential and district court opinions are not reported, little information is available on the enforcement of domestic arbitration awards. The abovementioned unusual features of the Arbitration Law increase the risk that a domestic award may be unenforced based on formalistic or arbitrary grounds, or that an award made in excess of the tribunal's jurisdiction may not be subject to annulment by the losing party. Further, the Arbitration Law offers no judicial assistance with the enforcement of interim measures imposed by arbitrators.
On the positive side, the costs of administered domestic arbitration in Indonesia are quite competitive, particularly for smaller claims. Therefore, for contractual matters involving straightforward factual and legal issues – and where interim relief is not a major concern – domestic arbitration may provide an efficient and cost-effective method of dispute resolution.
For foreign investors, international arbitration offers at least one important distinct advantage over both domestic arbitration and domestic courts: forum neutrality. In addition, in well-established regional venues such as Singapore and Hong Kong, arbitration enjoys the full support of a strong lex arbitri, backed by a reliable and independent court system.
However, parties should be aware that there are inherent limits to the usefulness of even the best lex arbitri. Therefore, in cases where provisional relief is urgently needed with respect to assets or persons located in Indonesia, the interim orders of a foreign court or arbitrator are unenforceable in Indonesia, and Indonesian courts may decline to exercise jurisdiction if the underlying dispute is subject to a binding arbitration agreement.
However, once a final award has been entered, its recognition and enforcement in Indonesia should generally be (but in practice is not always) simple and straightforward. Under the Arbitration Law, any award handed down by a tribunal or individual arbitrator outside Indonesia is treated as an international award for the purposes of recognition and enforcement under the New York Convention. At the same time, when Indonesia ratified the convention, it entered a reservation declaring that it would limit its application to disputes arising out of legal relationships that are considered 'commercial' under Indonesian law. Therefore, Article 5 of the Arbitration Law (which states that claims of only a commercial nature or involving rights within the full legal authority of the disputing parties may be subject to arbitration) applies equally to domestic and international awards. Thus, if enforcement in Indonesia is anticipated, care must be taken at the outset to ensure that the subject matter of the dispute will be deemed arbitrable under both the lex arbitri and Indonesian law.
Other conditions for the recognition and enforceability of an international award in Indonesia are that:
It is important to include in the appointment of the tribunal an undertaking that the arbitrators will register the award with the local court for enforcement, if requested by the winning party.
Unlike domestic awards, international awards are not subject to strict time limits for recognition and enforcement. Further, while a decision of the Central Jakarta District Court chair granting exequatur (ie, an enforcement order) of an international award is not subject to appeal, a decision refusing exequatur can be appealed to the Supreme Court, which should resolve the matter within 90 days.
The service charge in lease agreements usually includes:
Depending on the lessor, the agreement regarding service charges may vary, including when payment is due (eg, quarterly or semi-annually) and who charges the service tax. Normally, the lessee pays the service charge together with the rent to the lessor as part of the payment of the rent. However, in some cases, the lease agreement may require the lessee to pay the service charge separately from the rent to the lessor or the building management engaged by the lessor. These arrangements can have two different consequences from the tax standpoint. In the first case, the withholding tax is paid at the rate which applies to rent including the service charge. In the second case, the tax due on the rent is paid at the rate which applies to the rent, while the tax due on the service charge is paid at the rate which applies to management services charge. It is therefore common for the lessee to engage a qualified Indonesian tax consultant to review or finalise the arrangement regarding the rent and service charge, to make sure that the tax regulations are not infringed.
One of the most debated items in a lease agreement is the cost of the service charge. Previously, lessees would accept the service charge without question, but it now has become customary for the lessee and lessor to determine the service charge after comparing the average service charge in several similar buildings in the same location. This is a fairer way to decide on the service charge for both the lessee and lessor.
The Income Tax Law (7/1983) (as amended several times) obliges the lessee to withhold the income tax due on the rent paid to the lessor. Thus, the lessor receives less than the amount stated in the lease agreement and, in some cases (particularly in the case of the lease of a building owned by an individual owner or a more traditional lessor or building owner), the lessor insists on being paid the full amount of the rent stated in the lease agreement. Although lease agreements commonly contain a clause under which each party accepts responsibility for its respective tax obligations, some lessors still insist that the lessee grosses up the rent payment.
However, as tax regulations require the lessee to withhold income tax from the rent paid to the lessor, the lessee should not pay the lessor the full amount of the rent stated in the lease agreement, as the tax authority will decide that the lessee is not complying with its obligation to withhold income tax from the rent paid to the lessor. Therefore, the lessee and lessor should come to an agreement that the rent stated in the lease agreement includes an additional amount corresponding to the withholding tax to be withheld, so that the lessor receives the full amount of the rent as originally intended. It is also common for the lease to be paid three months in advance.
Under the Indonesia Civil Code, the lessor must maintain the leased object and may ask for repairs to be made (except for repairs for which the lessor is responsible). The lessor should also be responsible for all defects in the leased object that prevent its use. On the other hand, the lessee should be responsible for damage caused to the leased object during the lease term (unless it can be established that the damage was not caused by the lessee). This should include any damage to the leased object or loss to the lessor caused by the lessee's roommates or transferee, and the lessee should be required to take down and remove everything installed or constructed within the premises (at the lessee's own cost) without damaging the leased object.
However, in Indonesia, it has become common practice for commercial office or building leases to state that any repair and maintenance work will be undertaken by the lessor (or, in some cases, by the building manager engaged by the lessor), especially if the lessor is also the owner of the building. This is because the lessor usually understands the construction of the property much better than the lessee or the contractors engaged by the lessee and, this way, any maintenance or repair work necessary can be performed without threatening the integrity of the construction of the building.
To this end, it is common for lease agreements in Indonesia to contain clauses under which the lessor (or the building management engaged by it) undertakes the maintenance and repair work, including clauses regarding:
Sometimes, a debate ensues over the proposal to establish a sinking fund during the negotiations over the lease agreement between the lessee and the lessor. Unfortunately, there is no specific regulation on office or property leases which defines or regulates sinking funds. Usually, a sinking fund is established to cover repairs and maintain the property, which are the basic obligations of the lessor. However, in some cases, the lessor will try to include a contribution to the sinking fund in the service charge which is not refundable, thereby making the lessee also responsible to a certain degree for the maintenance and repair of the property. However, the lessor can often be persuaded to contribute to the sinking fund charged to the lessee (often as part of the service charge) refundable on lease's expiry but no interest is usually payable on the accumulated contributions as if they were a deposit.
In strata title buildings (ie, multi-level apartment blocks and horizontal subdivisions with shared areas), the sinking fund paid to the tenants' association is not refundable, as the association uses it for the maintenance and repair of the strata title building. However, this is not the case in commercial building leases. As there is no specific regulation on this matter, it is unclear which practice is most appropriate and so whether the sinking fund contributions are refundable to the lessee upon the lease's expiry depends on the negotiations between the lessee and the lessor.
If the lessor insists on charging the lessee a non-refundable contribution to the sinking fund, the contribution should constitute additional income for the lessee under the Income Tax Law. Consequently, the contribution paid is subject to withholding tax at the prevailing rate, and the lessee must withhold the tax due on the contribution paid to the sinking fund. Lessees should consider this aspect when negotiating with a lessor.
On the other hand, if the contribution to the sinking fund will be refunded on the lease's expiry, it does not constitute additional income for the lessor and therefore the lessee not need withhold any income tax on it. Meanwhile, it is common practice in Indonesia to refund any deposit the lessee pays to the lessor during the lease term without any interest, and this also applies to the contribution to the sinking.
Given the various issues discussed above, in Indonesia, both the lessee and the lessor should prepare the lease agreement carefully to avoid any potential dispute arising during the lease term. In some cases, the lessee does not negotiate the lease agreement diligently and so may well accept lease provisions that would be unacceptable to other lessees, while at the other end of the spectrum, sometimes the lessee and the lessor get involved in multiple lengthy sessions when negotiating the lease agreement.
For further information on this topic please contact John Andre Pandapotan Panggabean at Makarim & Taira S by telephone (+62 21 252 1272) or email (email@example.com). The Makarim & Taira S website can be accessed at www.makarim.com.
(1) "Economic growth in 2018 will be driven by domestic demand" (in Indonesian).
(2) "Office space: Sudirman is still a mainstay" (in Indonesian).
(3) "Wriggling online business, office space rental increases" (in Indonesian).
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John Andre Pandapotan Panggabean