Due Diligence of Commercial Real Estate Objects in Russia
- By Sergey Markov
- Mar. 18 2008 00:00
Head of Analytics and Legal Monitoring Practice, Mikhailov and Partners
Taking into account the complexity of legislation for land sales and other commercial real estate, the due diligence procedure, which is well known to foreign investors, is increasingly used in Russia as an efficient instrument that allows investment risks to be minimized.
It should be noted that due diligence performed before making an investment involves a thorough evaluation of the object of the investment that includes a comprehensive examination of the legality and commercial attraction of the project. Such an examination is a weighty argument when considering whether to decrease or increase the price of the asset being acquired.
The specific character of due diligence related to commercial real estate depends on the legality of the real estate's privatization, which occasionally is disputed by lawyers. Authorized bodies' decisions regarding the privatization of real estate are not only contradictory to the current Russian legislation but also violate the rights of third parties. For example, in view of the reorganization of state organizations of the agroindustrial complex (collective and state farms), all the property was distributed between its former members, who were given certificates of land share ownership. However, the reorganized enterprise was also given documents establishing rights to the corresponding land plot. Thus, in practice the situation can arise in which other parties claim or can claim rights to the land being sold. Therefore when acquiring rights to agricultural land plots, it is important to carefully examine the legality of the reorganization process of the agricultural enterprise. In the review, a whole range of specific issues should be considered, including the type of use permitted for the plot and the goals of the acquisition.
There are general issues as well. If the land plot was acquired or is being acquired from a federal or municipal property, it is necessary to examine the powers of the public authority or local government body issuing land property directives as well the powers of the body concluding the corresponding contract. In practice, there are cases when the corresponding property is managed not by the authorized body, which can cause substantial risks for the acquirer of the property. In addition, following the procedure of the land plot acquisition is important, especially the necessity for the approval of other levels of government regulated by the legislation of the particular region.
It is also necessary to establish the presence or absence of the right to acquire the land, that is to say the right to possess the land plot by a concrete person as well as circulability of the land plot itself. For example, the land plot can be withdrawn from circulation or limited in circulation.
When conducting a legal review, it may become clear that the land plot is encumbered with third-party claims, so it is advisable to make sure that no third-party rights are being violated in the acquisition process.
In accordance with Russian legislation, all lands are used according to an established target purpose and permitted use. Therefore, it is necessary to define the correspondence of the target purpose and permitted use of the land plot with its presupposed functional purpose, since one of the reasons for confiscating land plots is its improper use.
In addition, it is necessary to establish whether the land plot is reserved for state and municipal needs. If it is reserved, it is considered to be a restriction of its circulability as well as a reason for its possible confiscation.
One of the most important issues of due diligence is an environmental and a town planning regulation conformance review of the plot. Nonconformity with legislation can cause substantial risks for the acquirer.
It is also necessary to establish conformity with the legislation related to land plot formation. In particular, issues concerning boundary alignment with neighboring land-users, carrying out of survey works, as well as issues regarding the legality of the land plot registration with the State Cadastral Register.
When examining contracts that were documents of title for the property being acquired, it is necessary to establish that the parties agreed to the substantial contract conditions and their proper fulfillment.
The state's registration of rights to real estate property and related transactions is the only evidence of the existence of the registered right. This means the legality of the state's registration should be carefully examined. It is advisable to check the title of ownership for "imperfections." In some cases it happens that the real estate could vest under a privatization plan, but it had not passed through state registration. This kind of frequently occurring imperfection may considerably reduce the value of the acquired asset.
An investor may face the risk of existing or potential claims raised by third parties to acquired assets, including lawsuits, as well as complaints made by administrative and law enforcement authorities.
Due to the purely specific features of each land plot as well as the specific character of the laws in each region, it is impossible to cover all the issues to be considered during due diligence in this space.
Therefore, don't ever undervalue the importance of the due diligence conducted by experts of your own company or hired advisers when accruing rights to lots and other real estate.