Journey to the Commercial Property Lease: Was There an Agreement?

Commercial property development has evolved rapidly over the last decade. Parties engaged in property prefer documenting lease intentions as early as possible. Nevertheless, Russian law states that the ownership title to property accrues only upon state registration, and leasing out property is only allowed by the registered owner.

State registration may last months or even years, and parties to the lease relations need to formalize the transaction prior to state registration of the property, with several mechanisms allowing (or purporting to allow?) such at their disposal. As we further suggest, it is up to the parties to determine if they are really choosing a legally "safe" journey to entering the lease.

Desperate: entry into a 'lease'

Valeria Subbotina,Senior Lawyer, Capital Legal Services

When entering into a "lease agreement" prior to obtaining ownership title to the property, all the parties are looking for is to start using such property immediately. However, the circumstances may change, and one of the parties may later choose to terminate the relations -- with everything put to use, including legal grounds and the means to annul such agreement, even though they entered into it voluntarily. Going around the law may inevitably put either party at risk. This scheme may also invite close attention of the tax authorities -- with relevant consequences.

Compensation for finishing works on the premises is then most likely to be resolved by court, with all deliverables under a void transaction being subject to return. This is also applicable to deposits made by the "tenant" to the "landlord," but not to the rent (payments made for the use of the premises).

Conscious: a preliminary lease

Choosing this option shows that the parties realize legal impossibility to enter into a lease before the title to property is registered, and this option is actually recognized by some courts as legally valid. Opinions of the courts are however mixed and there may arise difficulties when facing a decision to determine legal grounds for terminating such an agreement. Another issue is how the fit-out investments and various monetary transactions, such as rent or security deposit (or advance payment), are to be treated.

Courts often approach a preliminary lease in the same way as the master lease: if there is no registered property, the preliminary agreement on the lease of the future property is void – for example, on the grounds that claimant as of the effective date of such agreement, was not entitled to dispose of the property by executing the agreement, as the claimant was not the owner of the property as of the date in question.

Positively creative: 'mixed' agreement structure

The mixed agreement is a valid civil transaction structure that cannot -- because of its legal nature -- be classified as any type of contract existing under Russian law. Mixed agreements are commercial property use agreements, access and use agreements etc., incorporating elements of different types of agreements, for instance, those of preliminary leases, construction, agency, commission, storage agreements and others.

The only requirements toward mixed agreements deal with compliance of their provisions with the effective legislation. Consequently, such agreements are not subject to direct application of the legal provisions governing lease.

Presently, this position is not supported by all courts. The courts have resolved a number of cases that since the party providing the property did not accrue the right to dispose of the leased property (due to the absence of registration), it is not entitled to enter into any agreements in respect to such property.

The Federal Arbitration Court of the Moscow region has classified mixed agreements on the use of property as preliminary leases and consequently annulled transactions with unregistered property. It is hard to agree with this approach, and it is currently being challenged in the Supreme State Arbitration Court.

The natural question is whether the significance of state registration is to be deemed depreciated given the recognition of legal validity of concluding a mixed agreement in respect to unregistered property. Not at all. Primarily, the property registration matters for the accrual of ownership title to it. If there is a potential dispute over the title before registration, then the possibility to use the facility is likely to only advance settlement between the contenders to the title. If there is no such dispute, there is no sense in slowing down the pace at which the ultimate owner starts gaining returns on money invested through putting the property into operation.

The Supreme State Arbitration Court has every reason to develop a unified approach to this legal dilemma. In the meantime, the parties that enter into such legal relations should have a clear understanding of the rules governing such relations and associated risks. It is equally important to choose the legal position when concluding the agreement in order to be ready to substantiate it either before the government authorities or court.