Inga Shakhnazarova
Associate
Salans

The rules of the game have changed for drawing up development and sales deals in the real estate market, as the country's highest arbitration court has ruled that the investment agreements common to such deals will be held to different legal standards.

The Supreme Arbitration Court has condemned the investment agreement, which is currently a typical means of financing construction projects. Time will tell how the lower courts will apply the high court's new plenum resolution on this subject, but it is already clear that there will be significant changes to how investors and developers relate to one other and how they draw up contracts.

With the Supreme Arbitration Court Plenum Resolution No. 54 of July 11, 2011, property that will come into existence in the future can be sold now. Under the resolution, there is no longer any doubt that the parties to a deal can sign a sale-purchase agreement before the seller's title to the property has been registered in the Property Register.

Investment contracts have been widely used in Moscow's construction market. "Investment agreement" in fact describes various contracts for the financing of construction. A developer enters into an investment agreement with an investor to construct the property as described in the agreement. The property, together with the freehold or leasehold title to the land, is then transferred to the investor.

In a rebuttal to years of real estate players using these agreements, the high court has determined that investment agreements don't constitute a distinct category of legal agreements unto themselves. Rather, the high court said, investment agreements should fall under one of the categories of agreements already established in the legal system.

According to the resolution, when considering disputes related to investment in construction, the lower courts must establish the actual legal nature of the investment agreement — whether it is a sale-purchase agreement, a construction agreement, a simple partnership agreement (prostoye tovarischestvo), etc. — and resolve the disputes in accordance with the Civil Code provisions on those agreements.

Though lawyers have long warned of the risk that courts could treat investment agreements as some other type of agreement, in our view this conclusion is contrary to the Civil Code provisions that parties are free to sign agreements and may include agreements both provided for in the law and not provided for. (This is the legal concept known as freedom of contract.)

In fact, the players financing construction have been using investment agreements, in part, because of this ability to freely agree upon conditions. In absence of clear and strict regulations, developers and investors were free to draft investment contracts as they wished.

Now, the preferred form of agreement for investment in construction will be the sale-purchase agreement for future property. The high court recommended applying regulations to this type of agreement unless otherwise established — that is, unless there are grounds for treating the contract as a construction agreement, simple partnership, etc.

Applying the regulations to sale-purchase agreements for future property will mean that the initial title to the property must first be registered to the seller (the developer in a investment agreement) and only then transferred to the buyer (the investor). Previously, the newly built property could be registered directly to the investor.

What practical affect will this high court resolution have on existing investment agreements? Undoubtedly, they will not become invalid. That said, in order to avoid problems with interpretation in the event of a dispute, we advise parties to investment agreements to determine what type of contract their investment agreement is and to amend it accordingly.

The Supreme Arbitration Court made its conclusion on the basis of a Civil Code provision that a sale-purchase agreement could be for a use that will be created or acquired by the seller in the future. The special Civil Code rules for sale-purchase agreements don't contain provisions prohibiting or restricting the sale or purchase of future property — that is, property that will be developed or constructed in the future.

Naturally, before there can be a registration of the property's title passing to the buyer, the seller's title must already be registered in the Property Register. It is in the buyer's interest to include in the sale-purchase agreement for future property a provision with a deadline by which the title to the future property should pass to the buyer.

What remedies will be available to a buyer who doesn't acquire ownership of the property by the deadline in the sale-purchase agreement? The buyer will have the right to take court action to compel a seller to perform its obligations to transfer the property. Also, the claim could be combined with a demand for state registration of the transfer of title.

If the seller performs its obligation to physically transfer the property to the purchaser but retains ownership, the buyer has the right to demand that the court issues a decision on state registration of the title transfer.

Such claims by a buyer can be granted only if the court establishes that the property physically exists, that it is in the possession of the seller and that the seller's title is registered in the Property Register. The court cannot compel the seller to take action to acquire or create property for subsequent transfer to the purchaser.

If the seller doesn't have the property — for example, the property hasn't been built, or it has been built but was transferred to another person — or if the title has not been registered in the Property Register, then the buyer has the right to three types of recourse.

Those three are a right to demand a refund of the price paid under the sale-purchase agreement for future property, a right to receive payment of interest on the price and a right to compensation of losses. The buyer could receive compensation of losses in the form of the difference between the price in the sale-purchase agreement and the current market value of the property.

Using sale-purchase agreements hasn't been common practice in the construction market, and one reason for that is the difficulty of identifying the future property. The Civil Code requires a sale-purchase agreement to contain information that allows the property for sale to be identified. If the property isn't duly identified in the sale-purchase agreement, the agreement is deemed unsigned and doesn't have legal consequences for the parties.

Because the most obvious means of identifying a property is its cadastral number, which is a record unique to the property, the courts have followed the practice of deeming a sale-purchase agreement unsigned without the cadastral number of the property in question.

The high court has clarified that a future property that doesn't yet have a cadastral number can be identified using other unique data: the address, approximate size and characteristics indicated in the design documentation.

Resolution 54 takes the assertive position that if the sale-purchase agreement doesn't contain enough information to identify the property sold, but a property handover certificate or other document does contain the required information, the agreement cannot be deemed unsigned. Previous judicial practice recognized the identification of the sold property only upon the signing of the agreement and excluded the possibility of clarifying the property post facto by means of ancillary documents.

The resolution does not provide criteria to be applied by the courts when determining how to handle investment agreements. The high court provides only two clarifications to assist courts. The first concerns construction agreements: The rules on construction agreements apply if one party provides the plot of land for construction and the other party carries out the construction. The title to the property created under this sort of agreement goes to the party that provided the land plot. If, according to the agreement, the party performing the construction is paid with ownership of a portion of the building, the agreement becomes a mixed agreement. That's because the obligation to transfer a portion of the building is subject to the rules on sale-purchase of future property.

The second explanation concerns simple partnership agreements. A relationship between parties should be treated as such an agreement if it allows each of the parties to make a contribution — transfer of a land plot, monetary contribution, labor, provision of materials, etc. — to achieve a common purpose, namely the creation of the real estate property.

If the contribution is in the form of a title or lease rights to a land plot, the plot must be formalized in the shared ownership of the partners, and all of the partners must be stated as lessees in the lease agreement. Otherwise, the title to the property built on the plot will be in effect only for the partner who has the title to the plot.

Recognizing the ability to conclude sale-purchase agreements for future property makes preliminary agreements less necessary.

According to the resolution, if the parties have concluded a preliminary agreement concerning the signing of a sale-purchase agreement for property to be acquired or created in the future, but the purchaser is required to pay all or a substantial part of the price before the main agreement is concluded, the courts should treat such preliminary agreements as sale-purchase agreements for future property with prepayment.

Though there is a risk the seller will not perform a sale-purchase agreement for future property, in our view, the ability to sign a sale-purchase agreement in place of a preliminary agreement gives the investor more legal protection.