Real Estate 2021

Last Updated April 13, 2021

Russia

Law and Practice

Authors



Sirota & Partners is a boutique-style firm specialising in real estate and construction, including dispute resolution in this area. Since 2003, Sirota & Partners has focused on supporting international clients pursuing business opportunities in Russia, supporting their projects throughout their life cycle. For example, the firm has been handling Redpath Deilmann’s multimillion-dollar shaft sinking project with Uralkali, Russia’s major potash producer, since the tender in 2011, supporting the client in drafting the construction contract, handling arbitration on a complex dispute with Uralkali, and drafting a major settlement agreement between the parties. The firm was also entrusted with drafting and negotiating the contractual framework on the next stage of the project, namely surface buildings. Sirota & Partners also handled Zorlu Holding’s major investment into two power plants in Moscow, including construction consents, disputes with construction supervision authorities, investment contract prolongation and securing land use rights.

In Russia, real estate law is mostly an issue of federal legislation, meaning that real estate rules are similar in all regions (there are 85 regions in Russia). At the same time, territorial planning, zoning issues and taxation issues may be partly regulated at the regional or municipal levels.

The main sources of real estate law include codified statutes. The leading primary sources are the Land Code, the Civil Code, the Town-Planning Code and the Law on Registration of Real Estate Property. The Law on Mortgage also comes into play with regard to security interests over real estate.

Case law plays a significant role, especially Plenary Rulings and Case Law Guidelines of the Supreme Court. For example, Case Law Guidelines No 10/22 dated 29 April 2010 and No 51 dated 24 January 2000 contain a number of well-accepted principles for real estate and construction disputes.

General Overview

In Russia, commercial real estate continues to be one of the most attractive spheres for investment, incentivised by the Russian Central Bank's low key rates. In line with international trends, mixed-use developments and redevelopments of industrial zones are gaining popularity in Russia’s major cities (for instance, old factories and industrial facilities in Moscow are being redeveloped for housing and social infrastructure). In addition, housing renovation programmes are being implemented in major cities like Moscow, aimed at the demolition of old houses and the construction of new ones for the resettlement of local residents.

Real estate investment, however, is still affected by international sanctions. The risk of sanctions should always be considered with Russian projects. In particular, it should be borne in mind that secondary sanctions may apply in case of extensive dealings with sanctioned persons. Currency volatility must also be taken into consideration.

Impact of the COVID-19 Pandemic

Owing to the COVID-19 crisis and its impact on Russia’s economy, demand for real estate has declined, with the retail and industrial sectors experiencing the biggest upheaval in the first half of 2020. The warehouse sector initially showed a decrease, but attracted investor attention and achieved a record level (1.9 million sq m) in the second half of 2020. The office sector has been the leader in terms of volume of investment over the last 12 months.

In order to tackle the challenges caused by the COVID-19 pandemic, the Russian government has adopted a relief package, which, for instance, allows tenants of commercial real estate to apply for a deferral and rent reduction during the pandemic period.

However, the COVID-19 pandemic has also created incentives for the promotion of digitisation in the real estate and construction industry. The Russian government has adopted a programme of digitalisation, giving priority to Building Information Modelling. At present, the most important services in the sphere of real estate and construction can be obtained in an electronic form (including real estate title registration, obtaining construction and commissioning certificates, and approval of the design documentation). Major cities like Moscow maintain electronic databases of major real estate documents. These databases are accessible to the supervisory authorities and individuals and can be used for due diligence purposes.

Major Deals

In accordance with normal practice, most investment activities have taken place in Moscow, with Saint Petersburg reportedly claiming 11% of activity while significant investment activities in other regions remain minimal.

The most significant deals in 2020 include the following:

  • the purchase of land plots in Kolskaya Street and Kronstadt boulevard (approx. RUB6.5 billion) in Moscow by Capital Group, one of the biggest developers in Russia;
  • the acquisition of office space and parking spaces (27,736 sq m; approx. RUB5.5 billion) by Alfa Insurance;
  • the purchase of Tower business centre (29,420 sq m) in Moscow by Alrosa, a diamond mining company; and
  • the purchase of Beijing hotel (26,000 sq m) in Moscow by Zhemchuzhina Hotel Complex for RUB4.8 billion.

Blockchain, decentralised finance, proptech and other technologies have not had a substantial impact on the real estate industry in Russia thus far. The main reason is that Russian law and court practice are normally quite conservative when it comes to the regulation of blockchain and similar technologies, and many legal issues remain controversial and unresolved. The recent introduction of a Law on Digital Assets has not changed this situation as the Law is quite boilerplate in nature.

At the same time, blockchain technology has notable perspectives in the area of the registration of real estate. Since 2018, the Russian authorities have been developing a pilot system of registration of residential real estate investment contracts using the blockchain technology.

The most prominent reform proposal involves a complete renovation of the Russian Civil Code with regard to property law. The respective bill, which was prepared after substantial academic debate, is now under consideration by the State Duma (the lower chamber of the Russian Parliament) in the second hearing.

The property law reform provides both for the introduction of new property rights, which are known in Europe but are not currently recognised in Russia, and for the codification of rules developed by the case law:

The draft bill provides for such new property rights as the right to build on a land plot owned by another person (superficies), perpetual lease (emphyteusis), the property right to use real estate (usufructus) and the property right to receive periodic income from land (charge on land). Currently, most of these property rights are in practice substituted by an ordinary lease agreement, which contains limited in rem protection for the tenant against third parties and the conditions of which may be modified by contract to the tenant’s detriment. For example, instead of superficies, developers in Russia are compelled to use the so-called “construction lease” to construct buildings on publicly owned land plots (which are normally not available for sale). This causes some practical problems, such as the risk that the lease may be terminated if the construction is not completed on time and therefore cannot serve as effective collateral to finance the project.

The draft bill provides for a gradual transition of Russian law to the German-style “unitary real estate object” system, where only land plots are deemed to be real estate while the buildings are merely a part of the underlying land plot. Currently, land and buildings are separate real estate objects subject to separate registration of title.

The draft bill introduces the so-called possessory claims, which allow an entity to reclaim possession of property without proving ownership title to the respective property, relying solely on the fact of previous possession. This is intended to expedite protection against an unauthorised takeover of property.

The following primary categories of property rights can be acquired with regard to real estate:

  • ownership, which is the fullest right to a real estate asset and is enjoyed for an indefinite time; and
  • lease, which is normally based on a contract with the owner. Leases are rather popular in Russia since many relevant land plots are often owned by the state or municipalities, so the primary option for the developer is to lease them under long-term lease agreements rather than purchase them.

Transfer of title is predominantly governed by the Russian Civil Code, which deals with general property law issues, and by the Law on the State Registration of Real Estate, which deals with registration of title transfer.

Several different laws apply to the transfer of specific types of real estate. For example, the transfer of land plots is additionally governed by the Land Code, while agricultural land plots are also subject to the 2002 Agricultural Land Plots Act.

There are also several laws that restrict the transfer of property with regard to select types of property. For example, the transfer of primary assets of strategic enterprises and a number of other entities may require prior approval from the Government Commission.

The Family Code also provides restrictions on the sale of real estate in a marriage, unless a marital contract concluded between the spouses excludes the statutory regime of joint ownership of real estate. Pursuant to the Family Code, the sale of real estate requires notarised consent of the spouse regardless of whether said spouse is officially registered as the owner of the real estate. Case law shows that this may be used to retrieve real estate from the purchaser even if the purchaser could not be expected to know that the seller was married. This is one of the major risks that should be taken into account in any real estate transaction in Russia.

Lawful and proper transfer of title is effected through state registration (EGRN or the Unified State Register of Real Estate) operated by the Federal Service for State Registration, Cadastre and Cartography (Rosreestr).

The Unified State Register of Real Estate contains data on both the real estate itself (formerly part of the Cadastre) and the transfers of title (formerly the Unified State Register of Real Estate Rights or EGRP). Such data with regard to a particular object can be obtained by the public for an insubstantial fee in an electronic form from the Rosreestr website or in hardcopy based on the address or the cadastral number of a given object.

A valid sales agreement is also a necessary prerequisite for the transfer of title. State registration does not guarantee lawfulness and propriety of title transfer, as a registration entity can be rebutted by various documents, such as a sales agreement. Furthermore, property rights that pre-date 1998 or are based on special grounds (such as inheritance) are valid without state registration and can be proven by any means. In practice, this means that a significant degree of due diligence is normally advised to verify the validity of title transfer.

Title insurance is available and is increasingly common.

Legal real estate due diligence typically includes the following.

  • Title – at the very least, an excerpt from the public register of real estate should be obtained to confirm the owner of the asset. However, this excerpt is not sufficiently reliable, as legal defects may lead to the invalidity of a registered title (eg, due to the absence of spousal consent). Therefore, due diligence on the history of title is advisable. It is also necessary to analyse legal encumbrances, such as long-term leases and easements.
  • Regulatory and environmental matters – it is advisable to request information on the land category, permitted use, usage restrictions, territorial zoning and city planning documentation. Nearby land plots and facilities should also be checked to ensure that they will not disrupt the use of the purchased asset. For example, pipelines, electricity lines and hazardous production facilities may mean that nearby areas are placed in a safety zone, which may entail significant regulatory restrictions.
  • Construction matters – the construction history of the building (as evidenced by construction permits, commissioning certificates, etc) should be reviewed to reduce the risk that the asset may be demolished as an unauthorised construction.
  • Infrastructure – the availability of utilities and public roads (or the possibility of ensuring such availability) should also be verified. In Russia, connection to utilities and/or the establishment of road infrastructure in some areas may be extremely expensive and lead to substantial difficulties.

The COVID-19 pandemic has not had a significant impact on commercial due diligence, as a significant part of this process is performed digitally, thanks to the overall digitalisation of real estate data in Russia. However, in some areas, especially with regard to residential real estate, it became quite popular to purchase real estate after an online presentation only, without an in-person visit.

The seller is normally expected to provide a number of warranties and representations in the sale of real estate. Sellers' representations and warranties normally cover title to the real estate and its physical condition, and do not usually depend on the seller’s best knowledge but imply an assumption of risk. However, in some cases the parties may limit these warranties to the best knowledge of the seller.

In the absence of the parties’ agreement, the Russian Civil Code contains a number of default rules with regard to title and the physical condition of real estate. In particular, the seller impliedly warrants that it has full title to the real estate and that no civil encumbrances exist. The physical condition of the property must normally comply with the ordinary use of such property and the mandatory quality rules applicable in the sphere of construction (eg, certain types of construction materials are prohibited in civil construction, such as amphibole asbestos). However, these rules are at times quite inadequate for international projects (for example, there is no general prohibition on chrysotile asbestos in Russia), and therefore it is advisable to obtain contractual warranties that take the buyer’s specific needs into account.

Since 2015, the Russian Civil Code has included rules on warranties and indemnities, which are largely in line with international legal practice. These two concepts can be invoked by the buyer to provide additional protection against future losses (eg, such special issues as environmental claims of state authorities or subsequently revealed disputes with neighbouring landowners).

A breach of representations and warranties allows the buyer to claim damages or penalties (if provided by the sale contract) and in some cases to terminate the sale contract. Indemnities allow the buyer to reimburse the incurred losses.

The acquisition and use of some assets are restricted in Russia, so the relevant laws imposing these restrictions should be considered by potential investors. For instance, laws on agricultural land and on certain types of biological resources and laws establishing protection zones of industrial facilities, historical and architectural monuments and other territories should be taken into account.

Apart from restrictive measures, the Russian government has adopted several laws aimed at the promotion of investment in real estate. This includes, for example, laws on priority investment projects and the creation of special economic zones, which allow investors to receive tax and other benefits, as well as certain state support, including financial support.

Environmental regulations are spread out across various sources of law in Russia. The 2002 Environmental Protection Act can be singled out as a major regulation in this sphere. Select rules on environmental protection are covered by separate statutes (the Water Code, the Land Code, the 1992 Subsoil Act and the 1998 Production Waste Act). However, in recent years the environmental policy has received increased attention from the Russian government. For example, the government has been increasing environmental impact fees (the “polluter pays” principle), and environmental assessment is now a precondition for construction permits for major real estate projects.

Under Russian law, only the actual polluter or contaminator is responsible for the pollution or contamination. This responsibility does not normally “attach” to the property and therefore does not pass to the buyer in an asset deal, unless the breach is continuing.

All real estate objects including land plots and buildings have a pre-determined permitted use, which is normally indicated in the Unified State Register of Real Estate. The permitted use is established by authorities in the zoning and planning documents adopted on federal, regional and local levels (see 4 Planning and Zoning for more detail). If necessary, the permitted use can be amended by requesting changes to the zoning and planning documents.

It is possible to obtain data on the permitted use and restrictions for a particular parcel of land from the land plot development plan (typically known as the GPZU). The GPZU is issued by the local state architect and can eliminate doubts (to a certain extent) regarding the permitted use of the land plot.

Real estate objects can be expropriated (taken) for public needs, such as the construction of social infrastructure. Generally, this requires a court order and is subject to fair compensation. However, in practice it is not easy to obtain a market price compensation.

Furthermore, in exceptional cases land may be taken if the owner fails to use the land plot in accordance with its designated purpose (eg, in case of a failure to cultivate agricultural land for some time).

There are also rules for the taking of construction facilities erected on a publicly owned land plot if they are not completed within the agreed timeframe. The proceeds of the sale are to be provided to the tenant. At the same time, it is possible to extend the timeframe of construction under certain conditions.

Sales of real estate generally trigger VAT at a rate of 20%. However, VAT does not normally apply to residential real estate, sales of land or, notably, share deals (unless the sole purpose of the share deal is to cover an asset deal).

When selling real estate, the seller must pay income tax on the proceeds of the transaction, subject to a number of exceptions. For example, the income tax is not charged if the seller is an individual who has owned the object for a certain period of time.

There are a number of restrictions on foreign investors acquiring real estate. For example, foreign investors cannot own borderline land plots. Agricultural land cannot be owned by foreigners (or Russian companies with more than 50% of foreign investment), and may only be leased instead.

In some cases, prior approval from the Russian authorities is required to transfer control over real estate to foreign persons. For instance, the transfer of strategic assets and natural monopolies may be subject to prior approval.

Acquisitions of commercial real estate are mostly financed by ordinary bank loans, subject to repayment out of the future revenues, or by issuing equity or bonds.

A mortgage on real estate is the most common security created by a commercial real estate investor in favour of the lender. Generally, in case of default, the mortgage is to be enforced through the court, which provides some protection for the borrower. However, in commercial relations outside bankruptcy proceedings, the parties may choose to agree on extrajudicial enforcement of the mortgage (if this method is used, the mortgage agreement should be notarised). A mortgage must be registered in the real estate register in order to be effective against third parties.

Russian lenders also often require suretyships as security. A suretyship is an undertaking of the person or entity other than a debtor to be liable for the obligations of the debtor upon its default. Suretyships are often granted by a borrower’s parent company or by a company within the same group. However, there is also a practice whereby a bank requests a suretyship directly from the borrower’s beneficiaries or even its CEO to motivate them to voluntarily repay the loan.

Other types of security, such as bank guarantees, pledges of receivables or pledges of other assets, may also be used.

There are generally no restrictions on granting security over real estate to foreign lenders. Even in cases where there are restrictions on the ownership of certain assets by foreign investors (see in 2.11 Legal Restrictions on Foreign Investors), this generally does not prejudice security over such property in favour of foreign lenders, as normally security interest does not allow the foreign lender to obtain the relevant assets into its direct ownership (eg, a mortgage is normally enforced through a public auction).

Registration fees paid on the granting and enforcement of security over real estate are not significant. For example, the fee for registering a mortgage of one object is RUB4,000 (approximately EUR45).

In addition, since as a general rule mortgages over real estate are to be enforced through court proceedings, the enforcement of security will entail court fees and legal costs.

Russian law requires prior shareholder or board approval of so-called "major transactions", which include transactions that may lead to the acquisition or alienation of assets exceeding 25% of the company’s asset value. While transactions exceeding this threshold may be claimed to be part of a company’s "ordinary business activities" and thus do not require approval, it is a common practice for the lenders to insist on shareholder approval in all cases where the asset value threshold is triggered.

Furthermore, interested-party transactions are subject to advance disclosure to the borrower’s shareholders and management bodies, which may request them to be approved by the shareholder meeting.

Additional grounds for corporate consents may be envisaged by the articles of association of a given entity.

There are no statutory formalities to be complied with before enforcing security. However, the enforcement of mortgages and/or pledges itself generally takes place via court, which orders a public auction to sell the collateral. Out-of-court enforcement through direct taking of the collateral (lex commissoria) or selling the collateral to a third party without an auction is possible in business relations if such is agreed in the relevant agreement (which often has to be notarised for this option to be effective) and only outside of bankruptcy cases.

The parties are free to agree on contractual formalities to be complied with prior to enforcing the security. These may include, for example, an obligation to provide advance notice on the intention to enforce the collateral and provide time to cure the breach.

Existing secured debt may be subordinated to newly created debt by a subordination agreement between lenders. It is advisable to include the borrower in this agreement.

Existing secured debt can also be subordinated to newly created security interests if the security is not registered in the real estate register (if registration is legally required). In this case, the later registered security (eg, mortgage) will prevail since its holder was unaware of the earlier security.

Under the case law, during bankruptcy proceedings, secured debt may also be forcibly subordinated to the claims of all other creditors in cases where the lender controls the borrower or is affiliated with its controlling persons and provided funding (including by way of failing to reclaim pre-existing overdue debt) during the borrower’s financial crisis.

Generally, only persons that actually harmed the environment are liable for environmental violations. As a result, the lender holding or enforcing security over real estate will not normally be liable if it did not cause any pollution of the real estate and the object remained in the debtor’s possession. If the lender becomes the owner of the object as a result of enforcing security over real estate, the lender will thenceforth be liable for environmental issues.

As a general rule, security interests are not made void solely because the borrower becomes insolvent. They may, however, be invalidated in cases where the court finds that the security interest was created in order to harm other creditors – for example, if the security interest is created with regard to a pre-existing debt on the verge of bankruptcy in order to offer preferential treatment to a given creditor, especially an affiliated one.

However, the insolvency of the borrower has a number of other effects for security interests held by lenders. For example, any agreement that the lender may enforce the security out-of-court (eg, by directly becoming the owner of an asset) becomes inoperable in bankruptcy proceedings, and any security may only be enforced by a court-mandated public auction. As another example, the lender may obtain only 70% (80% for loans issued by licensed banking or credit organisations) of the value of the security, while the remaining amounts are to be distributed among the unsecured creditors.

As the LIBOR index is not widely used in Russia, its expiry should not have a substantial effect on the Russian financial market. Parties that previously relied on LIBOR will have to use another basis for interest in their contracts, depending on the currency of the loan (eg, EURIBOR for EUR, etc), or agree on another procedure for adjusting the interest rate.

Russia uses a multilayered system of controls for planning and zoning. At the federal level, the Russian government approves zoning and planning documents on a general scale, establishing plans for the construction of the most important objects (such as federal railways and highways, airports, etc). The federal governmental also controls the Town-Planning Code, which sets out the fundamental planning and zoning principles.

The regional governments also participate in the planning of territories by adopting their own territorial layouts and rules for land use and development.

The most detailed zoning and planning documents are adopted at the local (municipal) level.

The design, appearance and method of construction of new buildings or the refurbishment of an existing building are governed by the Russian Town-Planning Code and a number of regulations and standards concerning particular matters (such as safety requirements, construction methods and materials).

The design documentation, which includes particular solutions on the design, appearance and method of construction, is subject to expert approval. The relevant approval is provided by state experts for select projects, usually hazardous projects. The design of other facilities can be approved by accredited expert organisations.

The following sources of law and public authorities are responsible for regulating the development and designated use of real estate.

  • Federal level – the Land Code provides for basic rules on land categories and types of permitted use of land. The Town-Planning Code establishes framework rules on the planning and zoning restrictions. The Russian government periodically approves zoning and planning documents applicable to the whole country, as well as federal plans for the development of the most important infrastructure (energy, transport, etc).
  • Regional level – the regional governments of all 85 Russian regions also regulate their territories by adopting general territorial layouts serving as a basis for urban development of the relevant region.
  • Local level – the municipal (local) authorities approve the detailed planning and zoning restrictions for the relevant municipality, namely the Master Plan and the Land Use and Development Rules. Major cities also adopt their own rules for land use and development, which include zoning maps where areas are designated for residential, commercial and industrial use and usage restrictions are recorded. The municipal authorities also approve prospective “development” plans reflecting planned future changes to the zoning maps.

However, since Russian real estate law is in a transitional phase, these documents have not yet been adopted, or are only prepared as drafts in respect of many territories. As a result, planning policies in some territories may be unpredictable.

Before Commencing Construction

At the commencement of a project, it is necessary to obtain the so-called GPZU document (land plot development plan) issued by the local state architect. This document will outline the particular planning requirements pertaining to the land plot. Afterwards, the developer can commence engineering surveys and begin the design stage.

Furthermore, any major construction or refurbishment requires a construction permit. The time limit for the public authorities to issue a construction permit does not generally exceed 30 days. However, preparation of the supporting documentation in order to apply for it is generally time-consuming.

In some cases, public hearings are necessary before a given project can be approved (eg, if the project requires amendment of zoning and planning documents). However, in many cases public hearings are quite formal in nature and do not have a meaningful impact on the procedure.

During Construction

Normally, only construction contractors with membership in a so-called self-regulating organisation (SRO) can be engaged to perform construction works. In some cases, additional licences and permits may be necessary to perform hazardous works and handle particular equipment.

It is possible to appeal an authority’s refusal to grant permission for development in court. However, in practice, successful appeals are rare because the courts usually only review procedural grounds to annul the authority’s decision without going to the merits of their assessment. Furthermore, the courts tend to agree that the authorities acted unlawfully only when they required the developer to provide a document that is not foreseen by the law.

It is also possible to challenge territorial planning and zoning documents. If the developer wishes to use a parcel of land for purposes other than those envisaged in the planning documents, it is possible to apply to the relevant authority to change the planning documents. This may require public hearings. In exceptional cases, where the authority’s refusal violates the balance of public and private interests and the economic circumstances, said refusal may be successfully annulled in court.

It is common practice to enter into agreements with local or governmental authorities to facilitate a development project (but this is not a requirement). For example, it is possible to implement a project based on investment contracts with public authorities. Under an investment contract, the developer is normally expected to transfer title to select parts of the object to the relevant authorities in exchange for governmental assistance in construction or obtaining commercially relevant tariffs for operation of the facility, securing certain demand for its products, etc.

It is also possible to enter into the so-called public-private agreements (PPP) or concession agreements to set the parameters of the future construction project in advance and secure the government assistance and support in the course of construction.

It is normally necessary for the developer to enter into a number of utility agreements with utility suppliers (heat, energy, gas, etc). This usually includes obtaining the so-called "technical conditions", which often require the developer to build certain infrastructure to enable connection to the grid. Since the relevant utility grids are also regulated by certain planning documents, at times the developers have to request amendments thereto before they can begin a development process.

Failure to comply with the requirement to obtain planning consents (such as a construction permit) may lead to harsh consequences. The building may be demolished, and administrative fines may be imposed.

A number of steps can be taken to redress violations of the permitted use of a land plot. In particular, the owner of the land plot used in violation of the permitted use may be subject to administrative fines. The land plot may also be taken in the case of a substantial failure to comply with its permitted use (although this consequence is rare). If the land plot is leased and not owned, the public authorities may terminate the lease, including a construction lease (which may lead to the taking of the constructed building subject to compensation, the amount of which in practice is often insufficient and not market-based).

Real estate assets are often held by special purpose vehicles, which allows for the smoother operation and sale of real estate as a going concern through share deals.

There are no special requirements to set up an entity that is to be used for investment in real estate. Normally, real estate is held through either an LLC (Limited Liability Company) or a JSC (Joint-Stock Company). Both are corporate entities that have independent legal personality from their shareholders, and shareholders are not normally responsible for their debts (even though there are increasing grounds to hold shareholders secondarily liable for corporate debts – for example, where the shareholder is deemed to have caused the company’s bankruptcy).

The main difference between an LLC and a JSC is the flexibility offered by the LLC structure. Many issues in an LLC can be freely regulated by the articles of association, and the law contains fewer mandatory provisions. While a non-publicly held JSC also has a degree of flexibility, it is more limited in a number of aspects. A significant advantage of a JSC, however, is that the register of shareholders is not publicly available.

The minimum capital to set up an LLC or a non-public JSC is only RUB10,000 (approximately USD135).

There are no specific governance requirements with regard to real estate investment. Both LLCs and JSCs allow the use of both the two-tier governance structure (CEO and shareholder meeting) and the three-tier governance structure (CEO, board of directors, shareholder meetings). In some cases, the three-tier structure is mandatory. It is also possible to have several directors (instead of one CEO), who may act either severally or jointly (similar to the “two keys” or “four eyes” principle). The several or joint powers arrangement must be reflected in the trade register in order to be effective against third parties.

The annual entity maintenance and accounting compliance costs vary significantly depending on the type and size of the business. There are no mandatory annual fees paid by companies.

As limited property rights in Russia are quite underdeveloped pending reform (see 1.4 Proposals for Reform), in practice the lease is the only arrangement to govern the use and occupation of real estate for a limited period of time.

Even though the lease is based on a contract, by virtue of law, occupational leases “attach” to the real estate itself and therefore normally transfer together with title to the real estate. This increases the protection for the tenant, who then cannot be evicted merely because the real estate was sold to another owner.

In the real estate area, the primary distinction is between a commercial lease for operation purposes and a construction lease, which is used to build new real estate objects on land plots owned by other persons (often publicly owned land plots) without acquiring ownership title to the land.

In a lease between commercial entities, rents and lease terms are freely negotiable. In publicly owned real estate, mandatory regulations may fix the rental fees and the procedure for their adjustment, as well as establish a limitation on the lease terms (up to 49 years depending on the specific parcel of land and the purposes of the lease).

In the wake of the COVID-19 pandemic, the Russian government offered a relief package for select tenants, applicable for 2020. In particular, tenants could insist on a rent review during the periods of lockdown or other restrictions when they could not use the leased property. If the landlords failed to voluntarily reduce the rent, the tenants could file a court action to adapt the lease agreement (typically the courts reduced the rent by 50%).

Select tenants operating in the industries most affected by the COVID-19 pandemic are also eligible for the deferral of payment. The landlord must conclude an addendum to such leases within 30 days of the tenant’s request.

It appears that no similar relief packages are planned for the future, so COVID-19-related exigencies now have to be regulated by contract (see 6.4 Typical Terms of a Lease).

The terms most commonly used in a commercial lease are as follows.

  • Lease term – leases can be indefinite or fixed term, with the typical length being three to five years for major real estate objects (see also 6.3 Regulation of Rents or Lease Terms).
  • Renewal – the tenant generally has a statutory pre-emption right after the expiry of the initial lease term. However, landlords often insist on excluding this right in the lease agreement. Furthermore, as a default rule, if the tenant continues to use the leased property after the expiry of the initial lease term without objections from the landlord, the lease is considered to be renewed on the same conditions for an indefinite term. In this event, each party is entitled to terminate the lease for convenience, normally by giving three months’ notice.
  • Rent and frequency of rent payments – rent is usually payable on a monthly basis, and is usually calculated as the total of base rent (based on sq m leased) and variable rent (utility and telecommunication payments, landlord’s additional services). In many cases, the base rate is in USD or EUR, but is payable in RUB. In view of the instability of the RUB, many parties wish to agree on currency adjustment clauses or a contractual currency rate.
  • Repair, maintenance and improvements – as a general rule, the tenant is to maintain the leased property, while the landlord remains responsible for the maintenance of shared spaces (see also 6.13 Tenant’s Ability to Alter and Improve Real Estate). It is also customary to agree on the exact permitted use of the real estate (eg, office premises) in order to ensure its proper use by the tenant.
  • Hardship/force majeure clauses – for new agreements concluded after the COVID-19 pandemic, government restrictions and lockdowns will no longer trigger any statutory relief after 2020 (see 6.3 Regulation of Rents or Lease Terms). Therefore, it is strongly advisable to regulate the consequences of any potential public restrictions directly in the lease agreement.

There is no statutory rent review in commercial leases of privately owned facilities. Therefore, the parties generally agree upon a procedure for a periodic increase of rent, especially in long-term leases.

In commercial lease contracts it is usual to link the new rent to inflation, the consumer price index or the tenant’s turnover. Usually, the rent is increased annually by a pre-agreed percentage. Other ways of reviewing rent are possible (such as a rent increase based on official inflation or a certain index), but less commonly employed. Turnover-based rent is often used for some types of commercial property (such as in shopping malls).

For publicly owned property, the rules for rent review are established by law. Generally, the rent is reviewed annually based on official inflation or in cases where the cadastral value of real estate is changed.

With regard to a commercial lease, VAT is payable on rent at a rate of 20%.

It is standard practice to request the tenant to pay a security deposit (several months’ rent) at the commencement of a lease. In some cases, the tenant may be required to purchase insurance policies (eg, insurance covering third-party liability) at the outset of a lease. Since long-term lease agreements concluded for more than one year are subject to state registration, the registration fee is also payable (however, such a fee is not significant).

Generally, the landlord is responsible for the maintenance and repairs of communal areas, such as shared spaces or parking lots, as well as for any capital repairs of the real estate object. The tenant is normally only responsible for the current maintenance of the leased property, but not for any communal areas.

The tenant is normally responsible for paying utilities and telecommunications costs unless otherwise agreed by the parties. The tenant can compensate an amount of the costs to the landlord or enter into an agreement with the utility companies to pay directly. As a general rule, the amount to be paid is calculated as a portion of the building’s overall utility spending (based on the sq m leased), but in some cases individual utility meter devices may be used to measure the utility spending of each tenant.

The parties are free to agree which party is responsible for insuring the subject of a lease. In many cases, the tenant has to pay the costs of the insurance, which typically covers damage caused by fire and similar events, as well as damage to third parties.

Typically, the lease agreement contains a “permitted use” clause, which specifies the exact way the landlord may use the property (eg, only for office premises). In any case, by operation of law, the use of land and facilities is subject to compliance with the zoning and planning regulations and the permitted use specified in the Unified State Register of Real Estate.

The tenant is normally only permitted to make separable alterations or improvements to the real estate. However, any inseparable alterations or improvements are generally subject to the prior consent of the landlord.

Besides the Civil Code, a residential lease is governed by the Housing Code. Subjects of the residential lease have to be officially recognised as being fitting for residential purposes. As another example, an agricultural lease is also subject to specific laws and regulations.

Upon the commencement of any insolvency procedure, a landlord cannot levy or execute any procedures against the property of the insolvent tenant, other than under the rules of bankruptcy legislation. It is also prohibited to set-off claims against the tenant’s debt if it leads to the violation of the statutory priority of creditors’ claims or results in a preferential satisfaction of the landlord’s claims.

However, there is no automatic right to terminate the lease agreement in the case of the tenant’s insolvency (unless otherwise agreed between the parties in the lease agreement). The landlord may only terminate the lease based on general grounds for termination (see 6.19 Right to Terminate a Lease). Furthermore, as evident from case law, it may even be more difficult to evict a bankrupt tenant from the landlord’s facilities, as in some cases the courts tend to be overprotective of bankrupt entities.

It is common for landlords to insist on a security deposit (generally up to three months’ rent), which can be used to cover the landlord’s claims against the tenant upon the expiry of the lease (eg, repair costs, outstanding rental payments, etc). In some cases, suretyship agreements, parental guarantees or bank guarantees may be used.

In some cases, contractual arrangements to secure the tenant’s obligations are also used. For example, lease agreements provide for the landlord’s rights to suspend some of the services, such as electricity, in case of the tenant’s default, but this practice is questionable from the legal standpoint in cases where the tenant remains obliged to pay the rent.

As a matter of statutory law, the landlord is generally entitled to a lien over the tenant’s movable property located in the leased real estate, which allows the landlord to retain such property and even levy execution thereon in the event of non-payment.

After the termination of the lease contract, the tenant is obliged to vacate the real estate and hand it back to the landlord. However, if the tenant continues to use the property and the landlord does not explicitly request the tenant to vacate the property, the lease is renewed by operation of law for an indefinite period on the same terms, and may then only be terminated by giving three months' advance notice.

To ensure that the tenant leaves on the originally agreed date, landlords are advised to provide the tenant with a formal notice on termination of the lease after the expiry of its initial term. Many landlords also include liquidated damages/penalties payable as a result of a failure to leave the property on the agreed date.

Subleasing is normally only possible with the landlord’s consent. A notable exception is that publicly owned land leased for longer than five years may be subleased without consent but subject to giving notice to the landlord.

Parties to a lease with an indefinite term may terminate the lease for convenience by giving three months’ advance notice (a different notice period may be specified in the lease agreement).

Parties to a lease concluded for a fixed term may generally only terminate the lease for cause, unless the right to terminate for convenience is contractually agreed. Under default statutory rules, the events that allow a party to terminate the lease for cause include the following:

  • landlord’s grounds to terminate the lease – non-payment of the rent two times in a row, failure to use the premises in a manner contemplated by the agreement or in a manner that damages the leased object, or failure to perform repairs where they are the tenant’s obligation; and
  • tenant’s grounds to terminate the lease – failure to ensure the tenant’s ability to use the object in a manner contemplated by the agreement, the presence of defects that tamper with the normal use of the leased object, failure to perform repairs, or substantial deterioration of the condition of the leased object.

With regard to parcels of land, the Land Code provides for the landlord’s additional right to terminate the lease, for instance, due to the land being used in violation of the relevant land category and permitted use.

Leases exceeding the term of one year have to be registered in the real estate register and are ineffective against third parties without state registration. Both the landlord and the tenant are entitled to apply for state registration of a lease. The state fee for registering a lease is RUB22,000 (approximately EUR250), paid by the party that applied for state registration.

A tenant’s default may allow the landlord to terminate the lease agreement (see 6.19 Right to Terminate a Lease), the consequence of which is an obligation for the tenant to leave the premises. If the tenant fails to leave voluntarily, it may be forcibly evicted through court action. However, since court proceedings are necessary to evict a tenant, this process usually takes a substantial amount of time. Therefore, it is advisable to set liquidated damages/penalties in the lease agreement for the tenant’s failure to leave the leased property voluntarily in order to cover the landlord’s losses.

During insolvency proceedings, the insolvency officer may terminate the lease contract.

In cases where the lease term exceeds one year and the lease is not registered in the real estate register as an encumbrance, the lease is not automatically effective against any purchasers of the real estate and may be terminated without compensation from the new owner. As a result, it is necessary to ensure that a long-term real estate lease is properly recorded in the real estate register.

There are two main types of price structure used in construction projects: fixed price or cost-plus basis. In some areas, such as oil and gas drilling, daily or even hourly rate arrangements are widespread (eg, a fixed day rate for each day of drilling).

In a fixed price arrangement, the price is defined at the outset and is not normally changed, subject to possible price adjustment or hardship clauses. This means that the contractor assumes the risks of market fluctuations, which normally leads to a risk premium being calculated into the fixed price. However, this structure is often preferred by major clients, who prefer certainty on the price to the potential ability to reduce costs by using an open-price structure.

In a cost-plus arrangement (also known as “open book”), the contractor is paid on the basis of its actual cost plus a pre-agreed overhead/profit margin. This makes the price less predictable at the outset but reduces the possibility of overpayment.

A peculiar feature of the Russian market, especially when it comes to projects with governmental involvement and many private Russian projects, is the use of the so-called “smeta” estimates. These are similar to a cost-plus arrangement, but the price is calculated based on the so-called “smeta norms” (standard prices approved by the state authorities and adjusted by way of applying a certain index rate agreed by the parties in the construction contract) rather than actual costs.

Construction owners often prefer to have one contractor responsible for both design and construction of a project (a so-called “general contractor”). The general contractor is then able to involve subcontractors for specific assignments, but remains liable for the entire project before the construction owner. The general contractor also runs the procurement of materials and equipment. The main benefit is that the general contractor acts as the single point of responsibility, which comes with increased comfort for the client, but also leads to an increased cost of the project due to the risk premium involved.

As an alternative to the “general contractor” method, in some projects the clients prefer to involve a separate design contractor and a separate construction contractor. In this case, the design contractor normally develops only the basic design, while the detailed design is almost always the responsibility of the construction contractor. In any case, the separate figures of designer and construction contractor may lead to difficult legal issues of allocating responsibility between them. For this reason, if this approach is chosen, it is highly advisable for the construction contract to provide that the contractor has fully reviewed the design documentation and accepts the design risks involved.

Various devices are used to manage construction risks. It is common to provide for warranties of conformity and fitness for purpose. A warranty period, often five years, is normally foreseen. However, most contractors will insist on a substantial limitation of liability, which will exclude the recovery of lost profits and limit damages to a particular figure (an overall liability cap is generally negotiated as a percentage of the contract price; the parties may also indicate separate caps for certain types of breaches).

A constructor’s all-risk insurance policy is also normally used to reduce construction-related risks.

Many clients typically insist on a penalty payable in case of breaches of the agreed schedule. In most cases, however, only the final deadline is subject to a penalty, but the parties may also decide to establish penalties for the interim deadlines. Penalties are enforceable in court, but Russian state courts tend to reduce the penalties by reference to their excessive amount, even in sophisticated commercial deals. For these and several other reasons, major construction projects generally opt for arbitration rather than litigation for dispute resolution. However, even where arbitration is used, an alleged excessiveness of the payable penalty may cause problems with the enforcement of the arbitral award in the Russian courts.

To further secure their position, construction owners often require a parental guarantee/surety from the contractor, which should often remain effective throughout the warranty period. Since the contractors usually ask for a significant portion of the price to be paid in advance of the acceptance, it is customary to request bank guarantees to secure the return of unearned advance payments in case of contract termination.

Construction contracts also often provide for security retention (5-10% of the contract price) to be deducted from each payment owed to the contractor. This retention can then be used by the construction owner as security in case of losses caused by defects revealed during the warranty period. To ensure sufficient cash flow, the contractors may request for the retention to be replaced by a bank guarantee for the same amount.

The Russian Civil Code by default entitles contractors to a lien with respect to the work result, the employer’s equipment or other property that remains in the contractor’s possession if the customer fails to pay the contract price or other sums due to the contractor. Such a lien can be removed upon full discharge of the customer’s obligations. If the customer fails to fulfil its obligations, the contractor is entitled to enforce the lien in a manner similar to a pledge in order to satisfy its claims from the proceeds. The parties may exclude or amend this default rule in the construction contract.

Commissioning certificates must be obtained before a project can be inhabited or used. This certificate is issued by the same competent authority that issues a construction permit, and certifies the compliance of the completed works with the applicable regulations/standards and the design documentation. The commissioning procedure may be quite complex, and the assistance of the designer and the construction contractor is often required to provide additional documents and information.

If the facility uses hazardous equipment, an additional permit from the state controlling authority may be necessary in order to use said facility.

VAT at 20% is generally payable on the sale of real estate. The tax is to be paid by the seller but is calculated into the price. However, VAT is not applied to residential real estate, the sale of land or share deals (with some exceptions).

As share deals are VAT exempt, the main method of mitigating tax liability associated with the acquisition of real estate portfolios is to structure them through the purchase of a corporate entity rather than the assets themselves. However, in cases where it is found that the sole purpose of a share deal is to avoid taxation applicable to an asset deal, the VAT will still apply.

There is no tax on the occupation of premises in Russia.

Two types of taxes apply with regard to ownership of real estate:

  • property tax for buildings and structures; and
  • land tax for land plots.

The property tax rate depends on the specific region of Russia, but is capped at 2.2% of the cadastral or accounting value of the object.

Land tax rates depend on the location of the land. However, there are tax rate caps –  agricultural, residential and farming land tax rates are capped at 0.3% of the cadastral value, while the tax for other land cannot exceed 1.5%.

Since in practice many land plots and real estate objects are leased from a public authority and not owned, land tax and property tax do not apply to such land and objects, and rent is payable instead. The amount of rent is generally determined based on the cadastral value of the real estate, and may be regularly adjusted based on official inflation or certain indexes.

Rental income is subject to 20% taxation, which is generally withheld at source if payable to a non-resident.

Capital gains from the sale of immovable property in Russia are subject to 20% tax (for corporate entities). Unless the foreign entity is registered with the Russian tax authorities, the tax will be paid by the Russian counterpart by deducting it from the payment made to the foreign entity (withholding tax).

In some cases, depreciation is applicable to some types of property (excluding land plots) for the purposes of income tax reduction. Furthermore, VAT paid as a result of buying real estate may be deducted from the sum charged with income tax (Article 170 of the Tax Code).

Sirota & Partners

Ducat Place II
7 Gasheka St., bld.
1, office 430
123056, Moscow
Russia

+7 495 234 18 75

+7 495 234 18 76

artem.sirota@sirotapartners.com www.sirotapartners.com
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Law and Practice

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Sirota & Partners is a boutique-style firm specialising in real estate and construction, including dispute resolution in this area. Since 2003, Sirota & Partners has focused on supporting international clients pursuing business opportunities in Russia, supporting their projects throughout their life cycle. For example, the firm has been handling Redpath Deilmann’s multimillion-dollar shaft sinking project with Uralkali, Russia’s major potash producer, since the tender in 2011, supporting the client in drafting the construction contract, handling arbitration on a complex dispute with Uralkali, and drafting a major settlement agreement between the parties. The firm was also entrusted with drafting and negotiating the contractual framework on the next stage of the project, namely surface buildings. Sirota & Partners also handled Zorlu Holding’s major investment into two power plants in Moscow, including construction consents, disputes with construction supervision authorities, investment contract prolongation and securing land use rights.

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