The plot thickens

Despite its relative lack of history of real estate investment, the perception has recently formed that Russia is among the most attractive and promising countries for such projects. But before joining the rush to invest in Russian land or property, there are 
a few legal pitfalls that one should be aware of

The growing and receptive real estate markets of Moscow and St Petersburg are especially rich in possibilities for investment, although the regional markets of other large cities are also beginning to actively develop. Since there is practically no market for ready real estate projects in Russia today, the most sought after properties for investment are land plots and buildings suitable for reconstruction.

Due diligence review

Before any decision to enter into a transaction for acquiring a plot (as well as other properties), it is recommended that a comprehensive examination (due diligence) of the site is performed, which must include all the necessary legal, technical and environmental aspects.

Special attention should be given to verifying the functional designation of the plot (determined on the basis of the land category to which the plot is assigned and information on its permitted use) and the possibility/necessity of changing the designation for the purpose of the investment project, as well as to city-planning restrictions and other limitations on the site, which may result in restrictions over its use and development.

Special consideration should be given to identifying the possible restrictions of use on the plot not indicated in the land cadastre, or restrictions mentioned in the land cadastre but without a clear description of what they entail, making it necessary to carry out additional research into the nature of such restrictions and their influence on the implementation of the planned project. In our experience, relevant examples include: restrictions established by airports within the area of approach for aircraft; and the variety of zones of protection of engineering networks (they are included in the cadastre and the register of rights as registered limitations, however the particular restrictions related to these are not indicated). As a rule, when such restrictions exist, a construction project requires the additional approval of an authorized state body (organization), and so it is vital to identify the possible development restrictions in advance.

Obviously, the main purpose of legal due diligence is to verify the validity of the respective title and identify the risks and any losses that might ensue, as well as their assessment and minimization.

Acquiring the rights

When the Land Code came into force in 2002, a unified procedure for acquiring the rights to land was officially established at the legislative level in Russia. It should be noted that foreign and Russian investors have practically equal rights in the area of real estate investment. Effective legislation stipulates only a number of minor restrictions on the holding of ownership rights to land by foreigners: with respect to agricultural land and plots located in areas close to the Russian border. Such plots may be owned by foreigners only on the basis of lease right.

In practice, there are two main possibilities for acquiring rights to land: by means of purchase from a private owner or as a result of privatization, i.e. the acquisition of a state-owned plot.

Acquiring privately-owned land

In terms of implementing investment projects, one of the most common ways of acquiring the ownership rights to privately owned plots is through entering into an agreement on the sale and purchase of the land. Another popular way to acquire real estate (in particular, developed plots) is indirect purchase through the acquisition of ownership interest (shares) in the company holding the rights to the real estate (the so-called share deal).

As mentioned above, the main risk that should be identified and assessed prior to conducting a transaction is that of loss of title to the land plot. Unfortunately, in practice it often proves difficult to confirm the validity of title and the legality of its acquisition by the current owner. This is due to the fact that in the course of conducting a transaction for acquiring rights to land, the purchasers are often too concerned with quickly registering their title with the competent authorities and so do not properly prepare the documents. However, according to the statute book, the state registration of title only confirms its existence, but does not prevent it from being contested in court (in particular, due to errors made while conducting the transaction itself). Accordingly, it is of great importance to ensure that the transaction is conducted properly and is not contestable, so that all the documents are in order rather than to have a Certificate of State Registration of Title. There are many examples of when this rule is not observed. The following illustrates what can be revealed as a result of a legal due diligence:

For due diligence purposes, the title holder – Company N – has submitted a copy of the Certificate of State Registration of Title to a plot as well as the two agreements on whose basis the title was registered: (i) Agreement on Sale and Purchase of the Land Plot, and (ii) Agreement on Assignment by the purchaser of its rights under the Sale and Purchase Agreement to Company N. The representatives of Company N were certain that the company’s title was valid since the company had the Certificate. However, in the course of the due diligence it was established that the Agreement on Assignment of the rights under the Sale and Purchase Agreement to Company N was a void transaction, as in violation of the current civil legislation it was finalized after the Sale and Purchase Agreement had actually been agreed by the parties, and so any assignment of the rights was consequently impossible. The voidness of one of the agreements that served as the basis for the registration of Company N’s title to the land gave rise to the significant and unavoidable risk of the title being contested in court.

Acquiring state-owned plots

Considering that under the Soviet system the right of private ownership of land did not exist and that the process of land privatization only started in the 1990s, to date most plots have not yet been privatized and remain state-owned.`

The main difference between the procedure of privatization and that of a common sale and purchase is that state- and municipally-owned plots are disposed of on the basis of a resolution by an authorized body, and in this connection a number of administrative formalities must be performed prior to the transaction.

Rights to land (ownership right or lease right) may be granted at a tender (conducted in the form of an auction or a competition) or without holding a tender (only for lease rights) on condition of approval of the location of the building, i.e. the selection of the plot and approval of the main parameters of its development.

In the case of granting plots without preliminary approval of the location of the buildings, the relevant state body or local authorities themselves select the site for the intended development of a building and put it up for tender under certain conditions. The tender winner is the participant that has offered the highest purchase price or lease payment.

In practice, the selling of state- and municipally-owned land occurs significantly less frequently than the granting of lease rights to such plots. Therefore, the most common method for acquiring the rights to a state-owned plot for the purposes of implementing an investment project is that of being granted the leasehold to the land.

In this connection it is necessary to note that according to Russian legislation, the designation of a plot for construction purposes presupposes the possibility of finalizing a long-term land lease agreement for 49 years or the buyout of the plot after the completion of the construction work.

As in the case of acquiring the ownership rights, the procedure for acquiring the lease rights to a state- or municipally-owned plot involves the relevant authority adopting the respective resolution on granting the land plot for lease.

Local legislation may provide for additional obligations that must be performed by an investor within the framework of acquiring rights to a plot, including: the transfer of on-site structures and communications; the construction of engineering, transportation and social infrastructure; the improvement of common areas, etc. In many regions, the practice of finalizing so-called investment agreements has become common. An investment agreement is a combined agreement containing a complex of rights and obligations in connection with lease of the land, on one hand, and the investor’s obligations to fulfil the conditions for developing the plot, and on the other hand carrying out reconstruction work or completing the construction of a building.

The main legal issues that must be investigated for the purpose of assessing the risks in acquiring rights in this case are as follows:

Observance of the statutory procedure for acquiring rights to the land, for example the procedure for organizing and conducting the tender; the existence of grounds for granting rights to the plot without holding a tender; and the correct execution of all title documents with the authority of the body that concluded the sale and purchase or lease agreement with the investor.