In Depth: Lack of Cohesion in Government Circles


Many note that laws in effect in Moscow are far from perfect, they lack clarity and are contradictory. At the same time all agree that the legislation is quite mobile and comprehensive, furnished with administrative resources and effective enforcement instruments, which makes it possible to settle practically any issue arising in the course of implementation of investment contracts, even if slowly and not directly.

Until recently, advantages and disadvantages of that system were balanced, with opponents being unable to challenge its key provisions. For years the city hall managed to keep investment and construction projects within a specific legal space, based largely on unofficial interpretation of federal laws and legal acts issued by the city hall to fill in the gaps in federal legislation. Nowadays, many of those gaps have been removed but apparently the result is not what the Moscow government and market operators had hoped for.

Guilty Without Guilt

Investment and construction activity is governed in Moscow for the most part by administrative regulations, within the framework of administrative law. City officials’ attitude towards other fields of law remains largely negligent and not always proper. When issuing government decrees and signing contracts – most often, investment agreements – government bodies often have to deal with gaps in legislation and sometimes act in defiance of law.

That problem has to do not only with interaction between officials on all levels and with lawyers. Almost all market operators raise the issue of negative consequences of the legal mess produced by the city hall, on the one hand, and lawmakers on the other. As an example one may cite numerous refusals of the Russian registration authority – Rosregistratsiya – to register leaseholds in plots of land allocated for development under the rules set by the Moscow city hall. It plays no role as to who is to blame for mistakes in those cases – the city authorities of the Federal Registrar Service – but those who suffer the consequences are, for the most part, investors and developers.

The debates between the Moscow parliament and federal lawmakers on the draft of the new town-planning code and amendments to the Land Code, to all appearances, have brought no satisfaction to either of the parties and moved into the sphere of law enforcement practice. Each of the parties is trying to play by its own rules, which brings about serious contradictions fraught with high risks for all companies active on the Moscow property market.

Instead of coming to terms on the general rules of the game, officials at all levels hold market operators hostage to their ambitions, as they struggle to establish control over investment and construction projects in the city. And while those rules often contradict one another, both investors and developers find themselves in a position of offenders. What seems to satisfy Moscow often fails to satisfy the federal government, and vice versa.

That is where the real problem lies, in my opinion. Judge for yourself – investors are not free in signing investment agreements and other deals with the government, such as leasehold agreements, for example. The terms and conditions of those deals are harshly imposed by the city hall in line with the principle: “If you don’t like it we will find someone more compliant, while you will face fines for failure to meet registration deadlines.”

Any company rejecting the rules of the game set by the authorities faces immediate expulsion from the market. Even if those rules fail to conform to the law, the partners of the government often have nothing to do but to accept those rules and in doing so violate the law. Take for example the practice of collecting lease tenure payments under leasehold agreements, unregistered with the federation registrar bodies. The registration procedure may take up to 4 months.

By law, such deals are not considered made until they are registered. However, the Land Resources Department almost always demands payment as soon as those agreements are signed, in defiance of federal laws and leaseholders’ rights, protected thereby. Where a leasehold tenant fulfils the department’s requirements and makes payments under the deal he will face tax claims, as leasehold payments are deducted from profit tax base.

Forced to act in violation of law, investors and developers cannot fully count on protection of their rights in a court of law. For example, a couple of year ago the city hall practiced sale of leaseholds for real estate development. Many of those sites entered the secondary market and were sold and resold many times, while their market price grew considerably. But some of those plots had been unsuitable fro construction from the very beginning.

Thus, the city hall had released a surrogate asset on the market, not envisaged in the federal law and hence not subject to legal protection. The end-buyer of the property faces heavy losses, which no one will ever reimburse in full.

Poor protection of contractors explains why most disputes arising during implementation of investment and construction contracts are rarely taken to court in Moscow and the courts of law, hearing lawsuits challenging the city hall clearly lack effectiveness. A handful of court rulings concerning those matters deal with singular issues of secondary importance and are scarcely of help in eliminating old and deep contradictions.

To illustrate the above-mentioned I would like to refer to the legal procedure in force, whereby investors face fines for delays in construction and failure to meet deadlines set for commissioning of the development. Lately, investment & construction projects in Moscow have been much slower to implement, while apartment buyers are forced to wait 5 to 7 years for their title to lawfully acquired apartments is registered.

For some reason, the city authorities blamed that problem solely on investors and moved without hesitation to slam sanctions on them. The fines imposed en masse on investors run into tens of millions of dollars.

But where are the courts? Where are those strict and comprehensive legal procedures that are supposed to establish maximum order in that sphere, with all sentiments and abuse reduced to a minimum? Municipal commissions and departments issue thousands of decrees imposing sanctions but things are right where they started. It is highly unlikely that the city budget will benefit much from those billions of dubiously imposed fines or that investment projects will be finalized sooner.

Wait-and-See Agreements

As to the deadlines set for investors and developers in investment contracts, that issue deserves being discussed separately. Let’s have a look at an ideal investment contract awarded to a winner of a competition, with town-planning documentation submitted in advance, envisaging construction of a relatively small property within 18 months, without any encumbrances, such as the requirement to provide residents with new apartments, pull down car garages, etc.

Assuming the contractor obtains all necessary permission without delays, no delays occur as a result of mistakes on the part of either of the parties and no additional negotiations or adjustments are necessary. But even if everything runs smoothly the contractor will need at least 2.5 years to obtain all permissions, out of which:

- 2.5 months will be spent on registering the title to the plot and a leasehold agreement;

- 19 months to obtain permission for construction;

- 5.5 months to commission the property;

- 5 months to register title to the completed property.

In reality, the entire procedure will take much longer – at least because by the time when the developer obtains permission for construction, the act of sanctioned use – issued earlier for a 12 month period – will have expired and he will have to apply for its extension.

Once he applies for extension, it will most likely transpire that some of the documents concerning the terms and conditions of design works previously obtained by the applicant are no longer valid, as a result of toughening of a certain urban planning regulation. As a result, the applicant is denied permission for construction. And so it continues endlessly. Thus, it is absolutely impossible to complete the project in less than four years.

At the same time the city hall, without providing any reasonable explanation or discussing the issue with the investor sets the 2-year deadline for implementation of the project and after that term expires the investor faces fines at the rate of 2% of the property value. Nevertheless, investors fight with each other for such deals, pushing up their price to exorbitant heights, and prices of Moscow apartments grow correspondingly. Isn’t it ironic?

By Auction

Now, a few words on tenders. Investment tenders held regularly in Moscow these days, undoubtedly, constitute a more civilized and transparent method of allocating building plots, as compared to those practiced earlier. But this can hardly be said of the product put up for sale through auction. To begin with, that product is of poor quality. I am not talking here solely and not so of the quality of urban planning documents as of the legal quality of tender terms.

Quite often those terms invest bidders with powers that are absolutely not inherent in them, obliging them to provide residents with new living quarters or settle disputes with owners of properties subject to demolition, dismantle car garages, adjust borders of nature complexes, lift several other encumbrances, etc. However, there is no law that would help them to exercise those powers. In practice, such a scheme results in a legal impasse and revision of contract terms. Examples of gigantic lots, envisaging renovation of entire built-up areas are available to illustrate the situation.

As regards the quantity of lots sold through tenders, in 2004 Moscow’s tender committee sold 25 lots measuring a total of 2.53 million square meters, according to a press-release by that agency. If we look at the housing projects put up for tenders and exclude those that fail to meet legal requirements, as showed above, and in all fairness should be withdrawn from sale, we will come up with only 137,500sqm, or less than 3% of housing space commissioned in Moscow annually.

In 2005, despite all the efforts on the part of the Moscow tender committee the volume of housing building projects awarded through auctions dropped considerably – to 72,000sqm. Such conclusions are made on the basis of analysis of the tenders held. If all building plots are to be allocated solely through city-held auctions how then will the government be able to achieve sufficient volumes of housing construction?

Many blame such poor results on the shortage of building plots suitable for housing development. But that is not exactly so. What the city is really short of are plots cleared of all encumbrances. All other territories – industrial estates with no production facilities thereon, plots beneath dilapidated residential blocks or derelict unfinished developments – abound in the city.

The task lies solely in correct organization of works on those territories, to be more exact, in lifting artificially imposed restrictions preventing sale or lease of those lands on the market. So far, the situation is developing in the opposite direction. While earlier a landlord needed not more than 6 months to obtain permission for construction on the site beneath his property, today it is absolutely impossible to do so. The federal law envisages only two means of allocating plots for construction – purchasing a freehold or obtaining it at auctions. The former is blocked by the Moscow city hall, while the latter is unacceptable for owners.

Threats of Hope?

New federal laws governing land use and urban development are seen as quite well-founded as they are based on progressive and reasonable principles that may hardly be disputed, such as the system approach towards town-planning efforts, openness and transparency of decisions made and free market.

Federal lawmakers explain the need to introduce the new rules of the game among other things by the need to eliminate negative trends, which have been quite noticeable in Moscow, in conditions of the established procedure of allocating municipally-owned building plots and subsequent control over development projects. But taken together, legal acts adopted by the federal parliament, fail to provide a comprehensive set of rules applicable to all issues arising during development or reconstruction of municipally-owned properties.

With no detailed transition provisions and no clear-cut procedure of enactment of those laws a great number of development projects are now in the state of legal uncertainty. Here I would like to cite an example from own experience. As early as 2003 our company was awarded a contract to build an apartment house at 57 Mishin Street. Under the terms of the contract we signed upon winning the tender we immediately paid $9 million to the city government. Then, we spent another $2.5 million on eliminating faults in tender documents, design and interest payments.

However, up to the present the project is still on the drawing board, as due to mistakes in town-planning papers we had to apply for insignificant expansion of the plot for construction. The land is available and it is possible to allocate it without violating anyone’s property rights. But land use officials say: “We beg your pardon, but the laws have changed. Today doing so is only possible through an auction, but in your case holding an auction is impossible. So you can only wait till the legislation gets adjusted to your situation.” As they say, no comment.

Land Issue

The land issue remains the main stumbling block in relations between the city hall and the federal government. While federal laws governing construction are based on regulation of procedures for allocation of building plots also on freehold basis, Moscow continues to practice investment contracts aimed chiefly at collecting the so-called city’s share in cash or in-kind.

The land issue remains the main and most sensitive issue for all real estate market operators and other economic entities. Moscow’s land-use authorities continuously crack down on developers and building owners even for the most trifling violations of the city-imposed land use regulations. The most common violation is the use of territories by companies who have failed to register leaseholds on time.

Not only that the procedure of such registration itself takes at least 12 months or longer, the city lacks real mechanisms for allocation of plots. Today Moscow in fact rejects the legal procedure, envisaged in all legal acts, whereby each project requires not only a plot beneath the structure but also the area around it, necessary for normal maintenance of the building.

The procedures of land-surveying and delimitation of property rights to land, foreseen in the law, in practice work so slowly that it seems that the government intentionally obstructs their normal enforcement. Suffering the consequences of that legal mess are land users, national business and economy, social tensions are growing.

Investment contracts practiced in Moscow are a universal vehicle applied in every situation, which cannot be said of the federal regulations on allocation of building plots. Federal laws focus on the development of properties in the so-called open country regime, where plots are allotted cleared of all legal, engineering and other encumbrances. In real life, there are no such ideal plots in the city.

On the other hand, it is absolutely unclear how the federal lawmakers plan to organize a tender or an auction to allocate building plots where a plot is encumbered with freeholds or leases. Most often such situation emerges as regards to plots of land beneath real properties or plots necessary to ensure maintenance of those properties. Such cases require changing the sanctioned (functional) use of the plot temporarily, instead of allocating a new plot.

Has not the owner the right to refurbish his property without having to ask the city government to hold a tender or an auction? And what will be the terms of the tender? Who will own new properties? The federal law gives no answers to those questions.

Lately, however, the main directorate of the Federal Registrar Service in Moscow (Gosregistratsia) has been rejecting all applications from those who apply for registration of their leasehold agreements, sanctioning the development of the plot, if the agreement was signed not at the tender. Here we witness an absurd situation where the owner seeking to replace his old structures with a new property, even if without expanding the useable space, cannot start construction being unable to register all land-use documents. The share of such commercial properties in the structure of municipal construction projects is quite substantial.

Hostages to those conflicts of law are numerous enterprises, especially those working on large-scale projects involving relocation of production facilities and those who are trying to overhaul their real properties. The majority of those projects have been put on hold lately. Our company’s investment portfolio, too, contains such projects.

The Moscow science and industry department has informed us that prospects are unfavorable for developers as regards most decrees to be issued by the Moscow city hall on relocation of production facilities and rehabilitation of their territories. The analysis of the inflow of Moscow government decrees on issues concerning commercial development reveals that lately the number of those documents, and, subsequently, the number of decrees ordering construction and reconstruction of real properties, has dropped approximately by two-thirds. In April 2005 the Moscow city hall issued 38 decrees on construction and redevelopment at the expense of private investors; in April 2006 only 12 decrees were issued. I assume the reason lies in further exacerbation of the above-mentioned contradictions.

The dispute between Moscow and federal lawmakers on adoption of the new urban development code and amendments to the Land Code, to all appearances, has failed to satisfy either of the parties, and moved into the sphere of law enforcement practice. Each of the parties is trying to play by its own rules, which results in a rather contradictory situation, fraught with serious risks for all property market operators.

Instead of coming to terms on the general rules of the game, officials at all levels hold market operators hostage to their ambitions, as they struggle to establish control over investment and construction projects in the city. And while those rules often contradict one another, both investors and developers find themselves in a position of offenders. What seems to satisfy Moscow often fails to satisfy the federal government, and vice versa.

As regards the quantity of lots sold through tenders, in 2004 Moscow’s tender committee sold 25 lots measuring a total of 2.53 million square meters, according to a press-release by that agency. If we look at the housing projects put up for tenders and exclude those that fail to meet legal requirements, as showed above, and in all fairness, should be withdrawn from sale, we will come up with only 137,500sqm, or less than 3% of housing space commissioned in Moscow annually. In 2005, despite all efforts on the part of the tender committee the volume of housing building projects awarded through auctions dropped considerably – to 72,000sqm. Such conclusions are made on the basis of analysis of tenders held. If all building plots are to be allocated solely through the city-held auctions how then will the government be able to achieve sufficient volumes of housing construction?

AFTER THE ISSUE WENT TO PRINT

On June 27, 2006 the Moscow city hall issued the long-expected decree No. 431-PP “On transfer of plots of land on the territory of City of Moscow to private ownership”. Investors hope that the decree will help streamline legislation governing land-use and construction and eliminate many problems discussed in this piece.

This piece was contributed to Vedomosti by Marat Manasyan, project development director at KomStrin. The point of view of the author does not necessarily reflect the position of the editors.