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<P align="center"><font color="#660000"><b><font face="Arial, Helvetica, sans-serif" size="4" color="#990000">Frequent
Legal Issues for Contractors on <br>
Sakhalin Oil and Gas Projects<br>
</font></b></font><font size="2" face="Arial, Helvetica, sans-serif">(Appearing soon in the Russian Energy Law Journal)</font></p>
<p align="center"><font color="#990033" size="2" face="Arial, Helvetica, sans-serif"><strong>XVII.
Leasing Real Estate in Russia: Considerations for Lessees</strong></font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif"><em>Presented by
<a href="../subpage/attorneys.html#rh">Rita Hoffmann</a>, 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.</em></font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">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:</font></p>
<blockquote>
<p><font size="2" face="Arial, Helvetica, sans-serif">· be aware
of obligatory and discretionary lease provisions under Russian law,<br>
· understand the specific steps that must be taken with respect to leasing
complete and incomplete construction, <br>
· know whether a preliminary lease agreement is necessary, <br>
·
be aware of the scope of due diligence required to protect a lessee’s
interests, <br>
· understand how the status of the parties to a lease agreement as Russian,
foreign, entity or individual can impact the transaction, <br>
· be aware of the potential pitfalls of financing construction with advanced
lease payments, <br>
· know the limitations of mortgages as security and mortgage foreclosure
procedures under Russian law, <br>
· and consider the best venue for dispute resolution.</font></p>
</blockquote>
<p><font size="2" face="Arial, Helvetica, sans-serif">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 <font size="1">(195)</font>.
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 <font size="1">(196)</font>. A lease
with a term of less than one year is not subject to state registration
<font size="1">(197)</font>. Property must be used
in accordance with both the particular use permitted by agreement and
with its designated use under zoning provisions.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">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 <font size="1">(198)</font>.
As a result, ownership and/or any existing lease <font size="1">(199)</font>rights
to complete construction may
be verified through a search of the state registry. When ownership rights
in complete construction are properly registered <font size="1">(200)</font>,
the parties may execute a lease agreement, as the right to lease right
is immediately available.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">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.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">A preliminary lease
agreement obligates the parties to execute a lease at some point in
the future <font size="1">(201)</font>. 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.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">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 <font size="1">(202)</font>.
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 <font size="1">(203)</font>. Obligations
under preliminary leases cease if the principal lease is not concluded
within the time
period established in the preliminary lease. <font size="1">(204)</font></font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">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.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">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.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">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. </font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">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.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">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).</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">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. </font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">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. <font size="1">(205)</font> Notarization
and state registration of the mortgage agreement is required <font size="1">(206)</font>.
There is a notary fee of 1.5% of the value of the property to consider
<font size="1">(207)</font>, 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
<font size="1">(208)</font>, until this 60-day time period has lapsed <font size="1">(209)</font>,
any loan agreement to be secured through the mortgage remains unsecured.</font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">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. <font size="1">(210 )</font>However,
as the Civil Code prohibits entering such agreements in advance with
respect to real estate <font size="1">(211)</font>,
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. <font size="1">(212)</font> The
mortgagee is then compensated through the sale proceeds. <font size="1">(213)</font></font></p>
<p><font size="2" face="Arial, Helvetica, sans-serif">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 <font size="1">(214)</font>.
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.</font></p>
<p><font size="1" face="Arial, Helvetica, sans-serif"> (195) Russian Civil
Code, Article 651(1).<br>
(196) Russian Civil Code, Article 610(2). <br>
(197) Russian Civil Code, Article 651(2).<br>
(198) Russian Civil Code, Article 131; Federal Law No. 122-FZ “On State
Registration
of Real Estate Rights and Related Transactions,” July 21, 1997 (“Law
on State Registration”), Article 26.<br>
(199) Law on State Registration, Article 13(2), para. 3.<br>
(200) Russian Civil Code, Article 753(2), para. 2; Enactment of USSR Ministry
Board on Acceptance for Exploitation of Completed Construction Objects, No. 105,
January
23, 1981.<br>
(201) Russian Civil Code, Article 429.<br>
(202) Russian Civil Code, Articles 429(3), 607(3), 654(1).<br>
(203) Russian Civil Code, Articles 429(5), 445(4).<br>
(204) Russian Civil Code, Article 429(6).<br>
(205) Law on State Registration, Article 13(2), para. 3.<br>
(206) Federal Law No. 102-FZ “On Mortgage (Pledge of Real Estate),” July
16, 1998 (“Law on Mortgage”), Article 10.<br>
(207) Law of the Russian Federation No. 2005-1, “On State Fees,” December
9, 1991, Article 4(4), para. 3.<br>
(208) Russian Civil Code, Article 131(1); Law on Mortgage, Article 10.<br>
(209) The two 30-day terms referenced are the maximum time periods afforded for
registration. State registration authorities may complete the process in less
time.<br>
(210) Russian Civil Code, Article 349/1, para. 2.<br>
(211) Russian Civil Code, Article 349/1.<br>
(212) Russian Civil Code, Article 350(1); Law on Mortgage, Articles 57, 59.<br>
(213) Russian Civil Code, Articles 334(1), 349, 350; Law on Mortgage, Article
1(1).<br>
(214) Russian Federation Arbitrazh Procedural Code No. 95-FZ, July 24, 2002,
Article
38(1).</font><br>
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