How to profit from an industry in decline

Once upon a time, when the banking sector was booming, Ukrainian developers learnt that arranging financing took time. As time meant money, they rarely bothered to arrange financing in the early stages of a project. Today, however, many of these same developers are eagerly searching for anyone willing to invest in projects, as construction budgets run out

Before getting involved in projects like these, an investor should be aware of some of the basic legal principles that govern Ukrainian real estate.

Buildings and Construction

In Ukraine, a building and the land underneath it are separate items of property. Often they even have different owners (a common example is where the land is only leased to a developer who owns the building). Therefore, acquiring title to land does not necessarily lead to the acquisition of the building located on it. The building must be transferred separately.

Unfortunately, under Ukrainian legislation, a building only becomes a building after its construction is completed and it is registered with the Bureau of Technical Inventory (the “BTI”). Only then can it be transferred or mortgaged. In theory, Ukrainian law allows for the registration of a building during its construction phase (commonly referred to as „unfinished construction”). However, there are a number of inconsistencies in the legislation and the practice of registration varies from region to region. For example, in Kyiv the BTI often refuses registration unless at least 75 pct of all construction is completed.

If the building is not registered in time for a proposed transfer, a share deal involving the acquisition of a development special purpose vehicle rather than an underlying asset may be the most practical option. This would also apply in circumstances where the land under development is owned by the State or a local municipality and is only leased to the developer, as such lease agreements are not transferable.

Needless to say, when a company is being transferred, it is crucial to ensure that the entity performing the project is, in fact, a special purpose vehicle and does not carry out any other activities. If other activities were carried out, then a lengthy corporate restructuring may be required.

If an investor prices the “unfinished construction” based on executed pre-leases, then it must ensure that the asset will be completed within one year from the date of execution. If the asset is not completed in this timeframe, then pre-leases may not be enforceable against the tenants as a matter of Ukrainian law.

Greenfield sites

Surprisingly, the acquisition of land prior to the commencement of construction is generally a much easier process. Obviously, this only applies to privately owned land. Lease rights to publicly owned land remain non-transferable other than by the sale of a special purpose vehicle as explained above.

With respect to the acquisition of land (as opposed to the acquisition of shares in a development company), a key question is whether any construction permits will also transfer with the land. In principle, if a permit for construction works has already been obtained then it can be transferred to the buyer through a fairly simple re-registration procedure. However, if the project did not reach that stage, the buyer should be prepared to go through the full design approval route itself. Obviously this considerably lengthens the timetable for the project.

The lack of a permit for construction works is usually an indication that the contribution to the public infrastructure has yet to be determined. Such a contribution must to be paid to local authorities in relation to almost every planned construction. This quasi-tax may be up to (i) 10 pct of the construction costs of engineering structures and non-residential premises and (ii) 5 pct of the construction cost of residential and recreational buildings as well as buildings for public use.

If entering into a project based on leasehold property, one should also take into account the fact that land lease agreements are usually more specific as to permitted construction parameters than ownership certificates, and changing those parameters may involve a rather complicated and time consuming procedure.

Finally, under the Ukrainian Land Code, a buyer only acquires ownership of land once the relevant State act has been issued. Although this is a purely technical procedure, it can take up to six months after completion of all relevant transfer documentation and its submission to the governmental authorities. During this period, a buyer may not transfer or mortgage its land or even formally apply for zoning and construction permits.

What if the developer is 
in real financial trouble?

When choosing between the acquisition of an asset or of shares in a special purpose vehicle, one should also consider the likelihood of bankruptcy of the seller (potential target). Under Ukrainian law, a court appointed manager may refuse to perform any contract with a term exceeding one year or that is likely to cause losses to the insolvent entity. If your contract provides for anything more than the immediate transfer of property, you may never get it.

Moreover, practically any contract between an insolvent entity and its affiliates or by which the insolvent entity grants one particular creditor a privileged position over other creditors (provided that the latter arrangement is executed during the six month period preceding bankruptcy) may be invalidated by the courts. ν

Tomasz Stasiak is leading the real estate practise of CliffordChance Kyiv, Gennadii Roschepii is an associate in the real estate practice of CliffordChance Kyiv