New areas of regulation

The new legislation, which has been designed to protect buyers of homes that are still under construction and which comes into force on April 29th 2012, has been drawn up in a rush, however. The Act is divided into four major areas: pre-contractual disclosure obligations on developers, namely, the necessity to prepare an information memorandum; the classification of a development contract as a defined category of contract and its substantial formalisation (a statutory definition of the scope of the contract and an obligation to execute it in the form of a notarial deed); an obligation to conduct settlements with buyers through open-ended or closed home buyers' escrow accounts; and the introduction of a separate procedure in the event of a developer's bankruptcy.

Separate bankruptcy estate
Under the Act, if a developer is declared bankrupt, the funds in a home buyers' escrow account for a project, the ownership right or perpetual usufruct right, as well as any additional payments made by the home buyers following the declaration of bankruptcy to finance the costs of the project's completion, make up a bankruptcy estate which is separate from the developer's other assets. If, at the moment of being declared bankrupt, the developer is working on a number of projects, a separate bankruptcy estate will be established for each of them. The remaining assets (if any) will make up the general bankruptcy estate, which will be used to satisfy the developer's remaining creditors (contractors, banks, utility suppliers, etc.).

Privileged status of home buyers
The separate bankruptcy estate is to be used to satisfy the claims of buyers of homes built as part of a given project. Home buyers are also given the opportunity to decide as a group about the course of the bankruptcy proceedings. The home buyers' assembly can decide to satisfy their claims out of the funds in the escrow account, or to continue the project and commit themselves to making the additional payments necessary to complete it, or to enter into composition on the general terms of bankruptcy law. If the first option is chosen, all the funds in the escrow account will be repaid to the buyers commensurately to the amount of the payments each of them has made. This seems simple enough, but it will only work if the balance of the escrow account at the time of declaring the bankruptcy is sufficient to fully satisfy all the buyers' claims. In practice, this is possible only in the case of closed escrow accounts. However, this type of account will probably not be very widely used, as it requires the development to be financed entirely out of the developer's own funds or through a bank loan. In the case of open-ended escrow accounts without additional bank or insurance guarantees, from which part of the money has already been paid to the developer, the balance of the account will not be sufficient to satisfy the buyers, and thus they will have to enforce their claims by selling the land on which the project was developed.

A headache for bankers
One implication of this solution is that, while it protects buyers, the Act transfers a significant part of the risk to the banks that fund the developers. In most cases a bank holds a collateral security in the form of a mortgage on the real estate it finances, which would seem the most secure form of guaranteeing the repayment of a loan. Up until now, newly built homes would be released from this mortgage only after the whole price had been paid by the buyer and its respective part had been used to repay the bank loan taken out by the developer. From now on the bank will be required to grant consent to establishing a separate ownership title to premises free and clear of any encumbrances and to transferring that title to the buyer once the buyer has paid the full price. Unfortunately, the legislator failed to specify to which account this payment is to be made. However, considering the structure of the Act and its purpose, we can expect that it is the home buyers' escrow account. If so, the bank will be under an obligation to release premises from the mortgage even before the developer has repaid its loan or a sale agreement has been executed. And, if the developer is declared bankrupt and the project is continued by the buyers, and the remaining part of the property is transferred to a separate bankruptcy estate, the bank may be deprived of the possibility of satisfying its claims. If a project is continued by the buyers, the bank can hardly count on the project generating any cash surplus, as would be the case if the project were continued by the developer. Thus, if the developer has no other assets, the bank will forfeit mortgage security and will only be able to enforce its claims under the general terms of bankruptcy law as a fourth-ranking creditor and only out of the general bankruptcy estate, which may be practically non-existent.

A headache for developers, too
While it might seem that questions connected with the consequences of bankruptcy are beyond the realm of developers' interests, problems arising out of the practical application of the new legislation may indirectly affect them. To avoid the risk described above, banks may require additional security, such as mortgages on other real estate on which projects are not being developed, or costly bank guarantees. Also, to ensure the buyers the maximum possibility of satisfying their claims in full out of the funds accumulated in the accounts, they may refuse to open open-ended home buyers' escrow accounts without additional security in the form of a guarantee. For developers, such solutions will entail additional costs for doing business and for obtaining bank funding, which may have a significant impact on the prices of the homes offered for sale. Therefore, the fundamental objective of the Act, which is to protect home buyers, may be attained only superficially. But, as the old Chinese proverb says, "no price is too high for a peaceful sleep". Therefore, maybe developers' customers will be willing to pay higher prices in exchange for the security they gain.

The Act requires amendment
The concerns presented above and a number of other issues related to the interpretation of the new legislation have led the banking community and developers to undertake intensive work on the interpretation of the unclear provisions of the Act and to propose potential amendments. This work has been underway for several months now. Given the short vacatio legis period and the large number of doubts, developers and their advisers will have a very busy time in the spring of 2012. Unfortunately, the chances of correcting the imprecise provisions before the Act comes into force are rather remote. It remains to be hoped that the new law will be interpreted reasonably and that all market stakeholders will work together to find a consensus.

Małgorzata Chruściak, partner and head of the banking and international finance department, and Magdalena Brzozowska-Bielska, senior associate in the banking and international finance department - CMS Cameron McKenna's Warsaw office