In-Depth: Learning to Agree

Under construction

The first question building owners often ask if it is possible to enter into lease agreements with future tenants before the building is commissioned and the owner has the deeds to the building registered with the authorities.

The answer is yes. By law it is the building owner who acts as the lessor, and before his title to the building is registered he can enter into a so-called preliminary agreement with a lessee. The parties to such contracts specify that they undertake to enter into the main agreement after a certain period of time. In line with the provisions of the Civil Code of the Russian Federation, the parties to the preliminary agreement are legally bound to sign the main agreement as stipulated in the preliminary agreement.

The preliminary agreement provides a guarantee both to the future owner of the building and to potential lessees. Besides, in accordance with the existing arbitration practice, the preliminary agreement is not subject to registration with the state authorities, as this is not an agreement for the lease of space but merely an obligation to enter into a lease agreement. After the landlord has his title registered with the authorities he has the full right to enter into agreements.

In practice not less than 10 percent of the premises in buildings under construction are leased out with parties entering into preliminary agreements. That figure grows to 30-40 percent in cases when a building has already been commissioned but the owner has not yet had his title registered. Buildings are also often ‘reserved’ by potential lessees in accordance with the agreements of intent they sign. These agreements are not binding, but as a rule the parties always observe them. On the whole, it can be said that preliminary agreements are signed when future lessees trust the landlord and are particularly interested in receiving specific premises.

Advantages and disadvantages of registration

The joint state register of titles to real estate property and transactions involving such property was set up in Russia in 1998. In Moscow it is maintained by the Moscow Registrar Office, a territorial body of the Justice Ministry. Before 1998 the Moscow City Property Committee and other city bodies oversaw the issues of registration.

In accordance with the existing arbitration practice, registration is not compulsory for lease agreements signed for a period of less than 12 months.

In practice, the parties seek to sign an agreement for a period of less than 12 months. There are several reasons for this. To begin with, the building owner allows for the possible increase in real estate prices, and so as not to be bound by the terms of the agreement for a period exceeding 11-12 months he makes a transaction within that period.

Secondly, an agreement for a period of less than 12 months is not subject to registration with the state authorities. At the same time the parties may agree to sign a new deal after the term of the effective agreement expires. The newly signed agreement will not be an extension of the previous agreement, but a new deal, for example, for another 11 months.

The parties may seek to avoid registration for various reasons. For the most part, they are unwilling to waste time gathering a huge amount of technical documentation, title deeds and other necessary papers. The entire procedure may take up to several months. Moreover, by law the agreement on the lease of premises subject to registration comes into force on the date it is registered with the competent authorities. Thus, the landlord risks losing lease payments for the several months that are wasted on preparing the package of documents and having the agreement registered. At the same time, the parties can avoid difficulties if they turn for assistance to professionals who will quickly and efficiently prepare the set of necessary documents and carry out all the registration procedures.

In practice, in order to arrange a deal between the parties pending registration of a long-term agreement, Swiss Realty Group draws up a short-term agreement for its clients, which is effective pending registration. As regards the advantages, it should be noted that data on registered titles is included in the register and are open to the public. For instance, the Moscow Registrar’s Office is duty bound to provide information included in the register to any person requesting it. Such openness makes it possible for potential lessees to receive all the necessary data on the titles to leased premises. An extract from the register may contain such data as a description of the premises, the registered titles to the property, and restriction of title. It is extremely important that the extract also contains data on legal claims laid to the property as well as on the rights of claim to the property being asserted in court. This provides the lessee with information on obstacles and hidden risks when making a deal.

Along with the information open to the public, there is a list of data available only to certain people. For instance, data on the contents of title deeds (excluding public data on restrictions), general information on the titles held by a certain person to real estate property in his possession, as well as extracts containing information on the passage of property, are available only to the title holder, individuals and legal entities invested with a letter of attorney by the title holder, and to certain government bodies specified by the law.

Terms and conditions

By entering into a lease agreement, the parties should negotiate all the terms and conditions they deem essential and include them in the agreement. Lease agreement should contain a provision on the size of the lease payment. With reference to agreements on the lease of buildings and installations, by law an agreement containing no clause on the agreed size of payment is void.

Usually, the amount of payment is set in a foreign currency. Such a condition is lawful; however, at the same time it is necessary to specify that the payments will be effected in rubles at the currency rate set, say, on a date of payment.

When fixing the rental rate it should be taken into consideration that by law the amount can be changed by mutual consent, but only once a year. In connection with that restriction, a question often arises as to whether a condition can be included in the agreement stipulating that the amount of the lease payment can increase through an adjustment for inflation, and whether it is possible to peg the rental rate to a foreign currency, the rate of which changes constantly.

The answer to that question was given by the arbitration court, which specified that the condition that must remain unchanged during the year is the condition setting the fixed amount of payment or the procedure for the calculation thereof. Since the condition on the adjustment of the rental rate is the fixed procedure of calculation, a change in the foreign currency rate or growing inflation will not be considered in this case a change in the fixed amount.

Importantly, an agreement on altering the payment clause signed under the lease agreement subject to state registration is also subject to registration since the new agreement, being an integral part of the previous one, alters the subject matter and conditions of restriction the agreement imposes.

Sometimes it so happens that the lessee moves out before the lease period expires and refuses to pay the rent. Here it should be noted that the mutual obligations of the parties are effective pending the expiry date of the agreement. That is why the discharge of a contract requires the consent of the lessor.

If the agreement is signed sine die, it may be terminated at the initiative of any of the parties provided it warns the other party accordingly, no later than three months in advance. In this case, if the parties do not agree otherwise, the lessee will be able to stop payments only three months after informing the lessor on the termination of the agreement.

To minimize costs the lessee who no longer needs the leased premises may sublet them pending the expiry of the general agreement. At the same time, the lessee must take into consideration that entering into a sublease agreement requires the lessor’s consent. This consent can be included in the lease agreement in advance.

Importantly, lease agreements and sublease agreements remain effective after the change of lessor (lessee). But a sublease agreement cannot be concluded for a period exceeding the period of lease.

Act of acceptance

Along with signing a lease agreement the parties should draw up an acceptance act. This is explained, firstly, by the fact that by law if one of the parties fails to honor its obligations, the other party can suspend counter-execution of obligations under the contract or to rescind it altogether. Hence, so as to fix the date when the property was de facto leased out it is necessary to draw up an acceptance act.

The act should include complete data on the property being transferred to the lessee, specifying all the existing defects. This will help to determine whether the defects existed before the property was transferred to the lessee, or they emerged afterwards.

Inseparable improvements

Lessees of warehouses, retail space or other premises often make improvements to the leased property, such as redevelopment and renovation, etc. In cases when such improvements are separable, as, for example, a removable air-conditioner, they remain in the ownership of the lessee. But if the improvements made are not separable without damage to the property, by general rule they will be owned by the lessor. Before making any inseparable improvement of the property, the lessee needs to obtain the written consent of the lessor, whereby the lessor will undertake to compensate the lessee for the expenses incurred.

Rescinding the agreement

The law stipulates that rescission of the lease agreement in a court of law can be initiated at the request of the lessor and at the request of the lessee. The parties can add other conditions to that list. In most case the agreement is rescinded in court if the court rules that there has been a substantial breach of the agreement by the other party.

It should also be noted that before filing a claim the lessor must send the lessee a written warning on the necessity to perform its obligations within a reasonable time.

By law a lessee who has properly performed his obligations upon the expiration of the terms of agreement has, under otherwise equal conditions, a preferential right before other persons for the making of a lease agreement for a new term. The lessee is obliged to inform the lessor of his wish in writing. The parties may include that condition in their lease agreement. It should also be noted that if the lessor refuses to conclude an agreement for a new term with the lessee, but within a year makes a contract of lease with a third party, the lessee will have the right to demand in court the transfer to itself of the rights and obligations under the new contract and compensation for the damages caused by the refusal to grant a new agreement. However, the lessee is free to make such demands only if the lessor has leased out the property to a third party; if the property was transferred to the third party for free use, the lessee will not be able to exercise his preferential right.

In line with the provisions of the law and court practices, the lessor does not have the right to demand from the lessee the lease payment for the period of delay of return of the leased property if the lessor avoids accepting it back. In this connection, if the lessee has vacated the premises by the date of rescission of the agreement and has signed the act of transfer, his obligations should be considered fulfilled. That is why if the delay in return of property to the lessor was brought about by the lessor not accepting it, it is the lessor who has committed the breach.