Risks related to acquiring new residential real estate in Russia

Risks related to acquiring new residential real estate in Russia

Update July 17, 2019. Because of the amendments to the Law on Shared Construction Agreements, I have decided to publish a new blog post about the rules after this amendment has entered into force.
Although the information in this blog post is no longer up to date, it still contains relevant information for understanding the rules from July 1, 2019. That’s why I decided to leave it online.

This post about new real estate in Russia is the logical sequel to my last post about risks related to second-hand residential real estate in Russia. In this post, I will give an overview of the risks related to acquiring new residential real estate. Since the most common, and the riskiest, way to acquire such real estate is to do so before it is built, this is what I will focus on in this post.

The reason why this is popular is simple: once an apartment is finished its value increases by 20-30% on average, compared to the price paid in the investment stage.

Shared construction agreement (SCA)

A shared construction agreement is an agreement, according to which a construction company attracts money in order to build a real estate object with more than one apartment. The agreement is considered to be concluded from the moment it is officially registered. It should be registered with Rosreestr. Signatories of an SCA are called participants since the idea is that they participate in the shared construction of a building. This registration process of a right a future object was introduced into the law to deal with the problem of the same object being sold twice. This has proved to be an adequate measure.

According to art. 5 par. 3 of the law on SCAs, Law 214 FZ, payment according to an SCA takes place strictly after registration of the SCA. According to art. 14.28 of the Law on  Administrative Offences a legal person can be fined up to a million rubles if they take money from the client in a way contrary to the law ( for example before the SCA is registered). Moreover, a construction company, which does not deliver the object by the time stated in the SCA, should pay a fine to its client of 2 times 1/300 of the refinancing interest rate of the Central Bank of Russia (currently 8,25%) for every day of infringement, if the participant is a natural person. If the participant in an SCA is a legal person, the fine is only half this amount: 1/300 of the refinancing interest rate of the Central Bank of Russia for every day of infringement.

To circumvent the protection buyers have under an SCA, construction companies sometimes try to use an agreement similar to an SCA, but with a different name. There is, however, consistent case law in which agreement with the same essence as an SCA, but a different name, are qualified by Russian courts as SCAs. But, obviously, it is preferable to work with the right documents from the beginning.

Consumer Protection

Apart from the law on SCA’s. The general law on consumer protection is also applicable to an SCA. At least, in theory, this means that a person who put his money into an SCA can, in case a construction company does not finish the apartment on time, not only claim a payment of the abovementioned penalty, according to the SCA law, but also payment of а penalty according to the law on consumer protection, of damages and of ‘moral harm’ based on the consumer protection law.

Damages have to be proven. This can, for example, be the rent of an apartment for the period between when your apartment was supposed to be ready and when it was actually done.

The penalty payment is calculated according to the formula in art. 13 par. 6 of the law on Consumer Protection: 50% of the amount of money being awarded to the claimant by the court. In accordance with art. 14 of the law on Consumer Protection the judge decides on the amount of compensation for moral harm. This compensation usually does not exceed 15 thousand rubles.

It should be mentioned that not all courts take the same stance on whether a claimant should be allowed to claim all of the above at once. Moreover, almost all courts will lower the total amount of compensation significantly. Usually, the argument for them lowering the amount of compensation is protection of construction companies for the general interest.

This is a rather odd argument, taking into account that the possible total amount of compensation for a participant in an SCA used to be much higher: maximum 300% of the money invested by the participant. This amount has already been lowered significantly by the legislator and the maximum of what one can realistically expect is now closer to 20% and probably less.

In Saint Petersburg, if a participant wants to claim all the above-mentioned penalties and damages from a construction company, he should announce so beforehand in the formal complaint he sends to the construction company. With this Van Rhijn & Partners can help you.

Often construction companies insert a clause into an SCA, according to which they are relieved of all liability, in case they do not deliver the apartment on time, due to certain acts or failure to act from public officials. One could argue that such a clause should be left without application, on the basis of art. 16 par. 1 of the law on Consumer Protection.  Unfortunately, courts in Saint Petersburg often leave these clauses intact, even though art. 4 par. 4 sub 2 of the SCA Law is quite clear: the date by which the apartment should be handed over is an essential condition of an SCA.

Bankruptcy of the construction company under an SCA

It happens that construction companies go bankrupt. For bankruptcy of construction companies, the special procedure of par. 7 of the Russian law on bankruptcy applies.

For SCA’s signed after 20 October 2017 Construction companies are obliged to make payments to the compensation fund for participants in SCA’s. This new fund, the founder of which is the Russian Federation, has been set up for cases in which construction companies don’t comply with their obligations. Its aims are to compensate citizens for their losses and to finish the construction of unfinished buildings.

Citizens can apply for compensation from this fund if the construction company has been declared bankrupt and it has paid its compensation payments to the fund.  Until the last day of the bankruptcy procedure, a citizen can file a claim for compensation with this fund.

Since this fund has only just appeared, not much can be said about its effectivity yet.

SCA’s signed before 20 October 2017 did not contribute to this fund and therefore have to follow the ‘normal bankruptcy procedure’ to get some form of compensation. Usually, the participants are badly organized among each other and this is to the advantage of the construction company.

This does not mean participants in SCAs signed before 20 October 2017 are necessarily left empty-handed. Subjects of the Russian Federation were free to use their regional budget to help participants in SCAs, who got into trouble and many of them did. At least in Moscow and Saint Petersburg there are such programs. Their help can consist of finishing an unfinished project, handing out a monetary compensation or offering alternative housing.

These programs, however, often try to discourage investment activity. For example in Saint Petersburg assistance is only offered to those participants, who don’t own any other real estate object.

Housing Cooperatives

SCAs aren’t the only way by which people can acquire real estate that has yet to be built. Another way to do this is by becoming a member of a Housing Cooperative.

With this construction, a person who wants to become an owner of an apartment first has to become a member of the cooperative. This is done by paying a buy-in fee. Subsequently, he will have to pay other contributions, aimed at paying for the housing, the ownership of which he wants to obtain.

The advantage of a housing cooperative is mainly for those who do not have the money to pay for their apartment straight away and want to spread out their payments. Moreover, the contributions to the cooperative (should) amount to less money than one would spend on a mortgage because all the guarantees that construction companies have to comply with under the SCA law are costly.

The obvious disadvantages related to housing cooperative is that they offer less security than is offered by the SCA law and other laws related to it.

Also, one should take into account that these housing cooperatives are not cooperatives in the traditional sense of the meaning. There is usually very little, if any, contact among its members. And even if there is contact among the members, they will most likely lack the specialized knowledge, that is required to run a building project. So, usually, the cooperative is completely set up and managed by a construction company.

Another disadvantage of this structure is that members may be required to put in extra money if it turns out that the building was built at a loss. Under an SCA, this is not possible, there you have a fixed price in the contract. (Under an SCA you can be required to pay more if the apartment happens to have a greater amount of square meters than mentioned in the contract, but that is another question).

Moreover, the norms of the Russian law on consumer protection do not apply to a person who put his money into a housing cooperative.

In case of bankruptcy of the housing cooperative, before the building is finished, members of the cooperative are in a much worse position than participants in an SCA. For them, there are no guarantees and no special funds, which aim to help them. So, in such a case, it is quite likely, that they will lose (almost) all the money they invested in it.

What you can do before signing an SCA

Before signing an SCA with a construction company you should check the reputation of this company. How did they perform with earlier objects they built? Were they finished on time? Were the buyers happy with the quality of the apartments? A lot of information can be found on the internet. On the Russian social network Vkontakte, for example, a lot of construction projects have their own group, where people can discuss the progress of the building they have invested in.

You should check what is the amount of their Charter Capital. Obviously, the higher the amount of Charter Capital, the better.

Basic information about the amount of Charter Capital on you can find on this site of the tax office.

For a more thorough check of the background of the company, there are other, paid, sites.

You could also check the database of the courts in the city where the construction company is active. In that way you can form a picture of the situation: are there a lot of complaints about the quality of the building this company builds? Is this company inclined to conclude settlement agreements or does it fight a lot of legal battles with its clients.

With all of the above Van Rhijn & Partners is able to assist you.

If you need assistance with any of the above or have further questions, contact us.

Ivo van Rhijn is a lawyer and a slavist. He specializes in consulting foreign individuals and companies in matters related to Russian law, in a broad sense.

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