Dealing With Future Things

In July, the Plenum of the Supreme Commercial Court clarified some issues about immovable property which is yet to be created or acquired. Overall, the ruling has lifted many unnecessary barriers but some of the court’s findings are controversial.

Dealing with things, particularly with real property, which have not yet come into existence or will be acquired in future is a fundamental problem of the Russian law. Business, however, needs a solution that would bypass the constraints created by the court practice in disputes over the future things.

In July, the Plenum of the Supreme Commercial Court clarified some issues about immovable property which is yet to be created or acquired. Overall, the ruling has lifted many unnecessary barriers but some of the court’s findings are controversial.

The Supreme Commercial Court has eliminated the principal uncertainty about the very possibility of the contract for the sale of immovable property where the subject has yet to be created or acquired. As stated in the Court’s Ruling №54, ‘the fact that at the time of entering the agreement, the seller did not have the property, the subject of the agreement, does not per se nullify the agreement’. Earlier, it was debatable whether the future property, the ownership on which has not been registered, could be a proper subject of a sale. This uncertainty added risks to investments in development.

By allowing the sale of future things (including unregistered property), the Supreme Commercial Court gave its authoritative opinion also on the sale of property which cannot be identified by reference to a cadastral number. The absence of a cadastral number, by itself, does not indicate that the parties failed to agree on the subject of their contract.

This clarification seeks to overcome the long-term trend in the court practice which assumed that the parties have not reached agreement on the subject of the sale if they hadn’t specified the property’s cadastral number. In addition, the position of courts was that property could be a subject to an agreement only after its creation (state registration, allocation from an existing property, etc.). Now this interpretation is in the past.

How to individualize a property which at the time of sale has not been assigned a cadastre number?

The Ruling №54 proposes to specify the location of the future object, its estimated area and other characteristics in accordance, for example, with the project documentation. However, other methods of individualization can also be used.

This will, no doubt, have a positive impact on deals with future property.

The ruling also has put an end to the debate about the legal nature of an investment agreement as a distinctive type of agreement: courts are encouraged to resolve disputes according to chapter 30 ("The Purchase and Sale Contract"), chapter 37 ("The Work Contract"), 55 ("Simple Partnership") or other chapters of the Civil Code. The investment contracts are classified according to their content. It is clear that the Supreme Commercial Court has drawn a clear line between the economic nature and the legal form of an investment agreement.

Among controversial findings of the Supreme Court we’d like to note the presumption that an investment agreement should be deemed a contract of sale of future things and that the law does not confer ownership on those who finance real estate development.

However, we should do justice to the Supreme Commercial Court and note that it tried to distinguish between relative and absolute rights in the area of financing real estate development.

The breach of a contract of sale of future property has become a matter of compromise. Now, a seller cannot be compelled to buy or create things to be transferred to a buyer (the buyer is entitled to demand the return of money paid plus interest and damages). A buyer can only demand the property if it already exists and the defendant owns it (and the title to property is registered in the State Register).

The uncertainty in the allocation of rights on a property built on a land provided for the construction has been removed. These relationships, based on the actual obligations of the parties, will be regulated either by the rules of the work contract or by the rules of simple partnership. According to the work contract, ownership on created buildings belongs to the one who owns the land (the developer). As for simple partnership, the share ownership on the building will occur only if the land is in the common share ownership of the partners.

It should be noted that the Supreme Commercial Court did not set the mechanism for legal protection of the right of partners in a simple partnership in which common ownership on contributions was not established. It is easy to see a situation when partners would not be able to claim their property rights, nor would they be able to terminate the agreement or claim damages.

The positive impact is that the Ruling №54 eliminates the need for state registration of contracts for the sale of future residential property.

Undoubtedly, allowing deals with future things is a good thing for the Russian law.

However, potential negative impacts of the decision should also be mentioned.

In particular, there may be negative consequences for individuals, members of co-investment building agreements. The Ruling №54 makes a reservation that "... the explanations contained in this Ruling shall not apply ... to disputes over real estate in accordance with the Federal Law №214-FZ of December 30, 2004 ‘On participation in co-investment building of apartment houses and other real estate’ (Paragraph 11 of the Ruling №54).

Today, several years after the enactment of the Law № 214-FZ, property is often sold by means of a preliminary contract. A preliminary contract is entered not with the builder but with another person, a broker firm. The rights are subsequently transferred to the builder (when and if the developer and the broker give the long-awaited property to the buyer). This approach is often used by bona fide builders as well as by scams.

Unscrupulous developers use this approach, through a ‘broker firm’, to achieve several goals. In particular, (i) it helps them to circumvent the requirements of the Law № 214-FZ; (ii) it makes it difficult for investors to claim the property or money they paid.

In 2003, the Supreme Court of the Russian Federation spoke on the issue and ruled that ‘... despite the great variety of contracts that facilitate the payment, in part or entirely, of the cost of an apartment, [courts] should be guided not by literal reading of the contract or its title, but by the purpose and the essence of the relationship between the parties’. In other words, the above set of contracts must be seen as a contract of sale with prepayment. And an individual, a buyer, and a developer should be considered as the parties to it and the law on consumer protection should apply. Thus, the courts of general jurisdiction were able to protect buyers and grant them ownership on the property in question.

However, unscrupulous developers tried to get round this protection. Quite often, when buyers have not obtained the property they paid for, the developer and the ‘broker firm’ start proceedings against each other. Thus, they move the dispute from the jurisdiction of the courts of general jurisdiction and preclude the application of the consumer laws; they get a favourable decision which they use as a prejudice in litigation with investors. For example, the commercial court would grant ownership to the developer and terminate contracts between the buyer and the broker firm. As a result, investors join the ranks of ‘defrauded investors’.

In the hands of unscrupulous developers the Resolution of the Supreme Commercial Court can become just another useful tool.

Article 8 of the resolution states that a preliminary agreement should be re-qualified into a sale contract and thus the resolution establishes that the parties to this agreement are the same as to the preliminary agreement, not the ultimate buyer and seller. Thus, the developer is excluded from potential legal claims. In addition, the Ruling №54 states that a broker firm does not obtain ownership over the property in question.

The Supreme Commercial Court’s ruling that the law does not grant property rights to those who finance the development, in our opinion, is harmful.

Even the presence of the provisions contained in the Law № 214-FZ about the responsibility (from 500 thousand to 1 million roubles, art. 14.28 of the Administrative Code) of those who attract funds in violation of law as well as the investor’s right to an immediate return of money, double amount of interest and damages do not have a positive effect because a broker firm often does not have assets and, therefore, would be unable meet its obligations.

The situation could be improved by a joint resolution of the Plenum of the Supreme Commercial Court and the Plenum of the Supreme Court which would address the sale of real property through preliminary contracts, as with the participation of individuals and without them, and protect the rights of all participants taking into consideration the realities of the Russian court practice.

In our view, a complete ban on preliminary contracts with real estate brokers as a means of raising finance for development of residential property would be justified.

Muranov, Chernyakov & Partners