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Frequent
Legal Issues for Contractors on XVII. Leasing Real Estate in Russia: Considerations for Lessees Presented by Rita Hoffmann, senior associate attorney and Director of the Yuzhno-Sakhalinsk branch office of Russin & Vecchi. Ms. Hoffmann's expertise in real estate leasing on Sakhalin Island is the result of her involvement as counsel in multiple leasing transactions over the past year. These include the restructuring of a commercial lease transaction involving an investment component, as well as the negotiation and drafting of preliminary agreements with respect to multiple residential properties. Ms. Hoffmann has also overseen due diligence reviews conducted by Yuzhno-Sakhalinsk attorneys for Russin & Vecchi with respect to land and real property ownership rights. Before joining Russin & Vecchi, Ms. Hoffmann practiced regulatory law in Alaska. She graduated in 1999 with honors from the Washington College of Law at American University. There are several issues that individuals and legal entities planning to lease real estate in Russia should consider prior to entering lease transactions in order to ensure that the terms of the transaction are as beneficial to them as possible. Lessees should:
Although the scope of all general provisions of lease agreements is too broad to cover in the context of this article, parties entering into a lease should be aware of the following, at a minimum. Lease agreements must be in writing and contained in a single document (195). They must also contain an adequate description of the property to be leased. If the term of the lease is not indicated in the agreement, it will be assumed to be a lease for an indefinite term, which is subject to three months notice of either party to terminate (196). A lease with a term of less than one year is not subject to state registration (197). Property must be used in accordance with both the particular use permitted by agreement and with its designated use under zoning provisions. Lessees should also be aware of the different preparatory actions necessary with respect to leasing complete and incomplete construction. Ownership rights in complete construction and any transactions involving the registered property must be registered with the Institution of Justice (198). As a result, ownership and/or any existing lease (199)rights to complete construction may be verified through a search of the state registry. When ownership rights in complete construction are properly registered (200), the parties may execute a lease agreement, as the right to lease right is immediately available. In the alternative, when preparing to lease incomplete construction, lessees should be aware that registration of ownership in the construction is a prerequisite to execution of an actual lease. Although registration of ownership rights in incomplete construction is possible, generally lessees are not interested in receiving the property for use until construction is complete. Once complete, the property must be accepted by the state before it may be registered. Due to these various contingencies, a commitment between lessor and lessee with regard to future lease of incomplete construction may only be secured through the execution of a preliminary lease agreement. A preliminary lease agreement obligates the parties to execute a lease at some point in the future (201). Such an agreement is used when the parties cannot legally execute a lease at the time when a commitment is needed. This could be in the case of incomplete construction or where construction is complete, but ownership rights are not yet registered. A preliminary lease should include, at a minimum: a determinable subject (an adequate property description), the essential terms of the principal lease, which include the property description and lease amount (202). Generally, the safest way to ensure the specific obligations of the parties is by attaching a draft lease to the preliminary lease agreement, which must be executed in identical form, once execution is permissible. Preliminary leases are enforceable by court order (203). Obligations under preliminary leases cease if the principal lease is not concluded within the time period established in the preliminary lease. (204) Lessees should conduct an adequate due diligence review before committing to lease property. Such a review, with regard to a lease for incomplete construction, should include an investigation into the land parcel upon which the building will be located, the corporate foundation documents (or other identifying documents) of the landowner, and any contractual relations between the landowner, developer, and future lessor. With regard to the land parcel, lessees should ensure that title and lease rights to the land are in order and have been properly registered. In addition, lessees should verify that all required legal norms were followed in land alienation procedures undertaken prior to the lease. Lessee should verify whether there are any recorded liens or encumbrances on the property, and if such encumbrances exist, determine whether it is willing to accept the property despite them. The land owner’s and future building owner’s foundation documents should be reviewed to ensure that there are no defects in corporate formation that would jeopardize the owners’ legal status, thereby jeopardizing the transaction. A review of contractual relations between the land owner, developer, and future lessor should include the general terms of any investment agreement between these parties, and assurances that all work to be performed on the property is properly authorized, and all intended uses of the property are consistent with its permitted use. Lessee should also confirm that all licenses and permits held by the developer are in order and valid for the duration of the construction, and that the developer has properly registered its design, construction, and building plans. The legal status of parties to a lease agreement as either Russian or foreign, as legal entities or individuals, will affect certain provisions of the lease agreement. The parties should be aware of how these distinctions affect currency control issues with regard to lease payments, profit tax withholding, the value added tax exemption for foreign accredited lessees, and the preferred venue for dispute resolution (jurisdiction of courts over individuals and entities). Where lessees are in a position to finance a lessor-developer’s construction costs through advance lease payments, these lessee-creditors should determine an appropriate legal mechanism to transfer funds in light of the fact that lease payments in advance of a duly registered lease are inappropriate. One alternative is to enter into an interest-free loan agreement with the lessor-developer, through which the lessor-developer’s obligation repay the loan is offset by the lessee’s obligation to pay lease payments as such obligations arise. Such loans may be secured through the use of a mortgage or other pledge. Ideally, a mortgage of already existing and registered property is available for security. Mortgage as a pledge of security is available for both incomplete and complete construction; however, the procedures for obtaining a mortgage and registering it are cumbersome and time consuming. Registration of ownership rights in the property to be mortgaged is a prerequisite. (205) Notarization and state registration of the mortgage agreement is required (206). There is a notary fee of 1.5% of the value of the property to consider (207), which can be a considerable expense. The parties should consider the 30-day term for the Institution of Justice to register both ownership rights in the property and a subsequent mortgage pledge of such property. As pledge rights arise from the moment of state registration of the mortgage (208), until this 60-day time period has lapsed (209), any loan agreement to be secured through the mortgage remains unsecured. Lessee-creditors who have obtained a mortgage pledge and who seek to foreclose on the property securing the pledge should also be aware of the particularities of mortgage foreclosure procedures under Russian law. Such procedures exist in both judicial and non-judicial variants. Non-judicial foreclosure allows the parties to avoid obtaining a court decision on foreclosure by mutual agreement. (210 )However, as the Civil Code prohibits entering such agreements in advance with respect to real estate (211), the parties may agree to this approach and conclude such an agreement before a notary only after the creditor’s right to foreclose has arisen. Jurisdiction over mortgage foreclosure proceedings otherwise is with the Russian Federation Arbitrazh Courts. Upon filing for foreclosure, a mortgagee does not become the owner of the mortgaged property by default. Sale of the property is mandatory, through either an open tender or auction procedure, depending on the circumstances. (212) The mortgagee is then compensated through the sale proceeds. (213) Although neither party to a real estate transaction likes to anticipate potential disputes, dispute resolution options must be considered at the outset of the transaction so that they are provided for in the preliminary and principal lease agreements. By default, Russian Arbitrazh courts have jurisdiction over disputes involving real property in Russia (214). Despite this requirement, some parties still opt, to resolve disputes through arbitration instead of immediately submitting to Arbitrazh Court jurisdiction. As Russia is a signatory to the New York Convention on Enforcement of Arbitral Awards, an arbitral award reached in another convention country should be enforceable by the court in Russia. If opting for arbitration, the parties should consider the efficiency and costs of foreign arbitration proceedings. Often Russian Arbitrazh courts may adjudicate issues faster and more cost effectively. Russian Arbitrazh courts also allow for injunctive relief, which may be a factor in determining the appropriate forum for dispute resolution. (195) Russian Civil
Code, Article 651(1).
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