Time for Changes

The financial crisis has caused a difficult situation in the market, both for construction companies and for real estate investors. The times they are a-changing: the cash deficit experienced by all market participants has resulted in the review of existing credit conditions, while at the same time affecting the approach of retail investors to investing capital.

As the sales of properties under construction are dropping against predicted sales, banks are renegotiating interest rates on, or even requesting early repayment of, granted loans. At the same time, construction companies and real estate investors are finding themselves in a situation where they are in default of their payment obligations but new facilities are limited.

Under these conditions, construction companies are reducing the number of projects or resorting to the retail market by letting assets that are not sold at the moment to earn some short-term profit. Many developers who had previously carried out construction projects by themselves or using investors' funds are now ready to involve strategic partners, diluting their own positions significantly. Others will have to sell their projects in case they cannot find additional financing. Moreover, there will also be projects, for which their owners had pledged their rights to banks, which will be sold if the borrower cannot perform its duties under the amended conditions.

Concurrently, however, new buyers will emerge, primarily companies with strong monetary reserves, which regard the crisis as an opportunity to obtain projects at relatively low prices. As a result of the temporary shutdown of construction, a market has formed for selling certain obligations of developers divided into smaller parts that allowed for greater liquidity. Investors must appraise clearly where their money will be invested because there is great risk that the rate of return on investment will not be realized as soon as was the case in recent years or completed construction will not occur according to the agreed timetable. It is necessary to carry out legal due diligence to allow parties to avoid future disputes and problems.

Existing assets and shares in projects (in respect of either strategic or non-strategic assets) are also being offered for sale for more favorable conditions as sellers try to make the deals as attractive as possible to potential buyers. To this end, not only the technical features and the history of rights to the project are important, but the whole web of agreements, permits and contractual relations should be solid and in place to assist the potential investor in making up its mind.

In the acquisition of such an assets market, participants should exercise extreme diligence in relation to the legal aspects of a deal. It is necessary to consider all legal risks, including the possibility of dissolution of the investment contracts because of improper performance of investor obligations owed to local administrations or risks relating to land requisition for use for residential construction, as provided for by the recent law "On promotion of residential construction" which was introduced in the summer of 2008.

In the preparation of deals it is necessary to pay more attention to considerations of applicable law and dispute resolution. For a direct sale of a piece of real estate the Russian law should be the applicable law due to the imperative norms of the Russian legislation and Russia (State Arbitration Court) should be the place to consider disputes.

In relation to a purchase or sale of a company holding title to real estate the parties have more flexibility. If any of the parties is established in a foreign jurisdiction the relevant agreements may be governed by foreign law, which may be preferable for the purchase/sale of the company for protection of the parties' interest. In this case one of the main international arbitration centers could consider the dispute as agreed by the parties taking into account the specifics of the transaction.

What is important to note is that against the backdrop of the current crisis each action of the market participants has to be thoroughly considered from a legal perspective. The number of litigation cases is increasing, both in respect of outstanding loans and invested monies, and in respect of rights to the real estate given as security for the money extended. The involvement of professional legal advisers in such disputes is irreplaceable as it helps to avoid unnecessary legal proceedings. The participation of qualified lawyers is even more imperative on new transactions as strong legal support will be one of the key ingredients for the successful realization of projects.