Comments made by senior associate Evgeny Zverev to an article titled “Real estate sector unwilling to step out of the shade”

1 June 2011

The Law on Participatory Construction (which should protect the future property owners and civilize the real estate market) remained mere ink on paper. Only one third of development companies adheres to 214-FZ, the rest avoid using clear and transparent procedures to attract financial resources, under various excuses. And it seems that many builders turned the current tangled situation in the market to their advantage.

Not on the list

According to figures from the State Committee for Construction and Housing and Utility Complex, supplied to “Fontanka”, today only 60 of St.-Petersburg construction comply with the Federal Law no. 214 “On Participatory Construction”. 107 apartment blocks in St.-Petersburg are erected subject to the rules established by the government of Russia. These builders will duly post project declarations on their websites, comply with financial ratios, present the special reporting, register all the transactions with the Federal Registration Service, and should they fail to comply with deadlines (fail to meet the construction completion date), they shall even pay penalty cost to the buyer based on annual interest rate about 16 % (truth be told, the latter statement often remains an empty promise).

No surprises in the list of law-abiding companies: “UIT”, “GDSK” (LSR group) and “Glavstroy” lead the pack in terms of number of legally constructed houses. All the three builders declared their respect for legislation since approaching the St.-Petersburg market. The LSR group assured Fontanka reporter that “All of our projects are erected only with observance of the law. Construction of some houses began before 2005, i.e. before the effective date of the Law On Participatory Construction. Therefore this law does not apply to these projects, however, even at that time everything was within the limits of legislation.”

RBI also insists that they always comply with the law no. 214-FZ, however, this developer already suffers some variations in construing the laws. RBI Holding comprises several companies, including ZAO “Severny gorod” and OOO “Stroitelnye sistemy”, and there are no complaints against them - they comply with the Law “On Participatory Construction”. According to Roman Khokhlov, the deputy chief legal officer, another two projects are being erected by RBI, which is not on the law-abiding companies list. The RBI press-service refused to specify the official name of the legal entity concealed under this brand.

However, construction industry's big fishes are more likely an exception to the rule. Many leaders of St.-Petersburg construction market do not rank among the law-abiding companies. For instance, LEK holding is lawfully selling flats in only one in ten of their off plan projects–residential compound “Imperial” located near the Novo-Dyevitchiy monastery. Moreover, the company conceded to make contracts subject to the Law On Participatory Construction only after Smolny have laid down stringent terms for the company. To explain their unwillingness to operate in a lawful manner LEK usually refers to “taking care of interest-holders”. “Making contracts subject to the Law no. 214 is very time-consuming , therefore it is more convenient to initiate construction work and sales without waiting till the documents are duly formalized and approved,” stated Pavel Andreev, the director general of the holding. Curiously enough, the holding outwardly appears to be a quite decent entity – there are project declarations for each project posted on their website. LEK even obtained building permits for five projects, at the same time, the rest are of dubious legality, moreover, there is no project declaration for residential compound “Graf Orlov”, a long-delayed construction project of LEK.

Another major developer - ZAO “Stroitelny Trest” is currently erecting four residential units in strict compliance with the law. However, in December this company began constructing a house on Kondratyevsky avenue having no approvals whatsoever. These actions were declared illegal by both the public prosecutor's office, and the State Construction Supervision and Expertise Department which has twice fined the developer (last time in March, for 500 thousand ruble). Works did not stop despite ZAO “Stroitelny Trest” was instructed to “eliminate the detected violations”. Several floors are already completed, and the company will hardly consent to dismantle them, even if the project shall be declared uncontrolled development. The legal department of ZAO “Stroitelny Trest” refused to explain the situation to the Fontanka reporter. Admittedly, sales of flats in the off plan property did not start yet, therefore one cannot say that the company does not observe the law no. 214-FZ; they are just engaged in uncontrolled development (building a house without a construction permit).

Operation “Cooperation”

Some developers (for instance, “Centr dolevovo stroitelstva” and “LenSpetsSMU”) prefer to use housing cooperative format which is currently considered legitimate. As reported earlier, LEK joined them in autumn 2010. To explain their predilection for this selling format, companies refer to their desire to provide the most favourable conditions for shareholders: “The main advantage of housing cooperative lies in the fact that a shareholder can participate in a long term installment plan, to settle in a new flat upon project completion and to live in it, continuing to pay his share. On the contrary, participation construction involves the necessity to pay the apartment’s cost before the project completion, and that is not good enough for people who count upon long term installments,” said Andrey Erehinsky, the directorof legal services at the holding Etalon-LenSpetsSMU. “Moreover, the housing cooperative is in complete control of shareholders. In contrast, participation construction does not invest interest-holders with such ample powers”.

By the way, cooperatives sit well not only with shareholders, but also with developers. Building companies are especially attracted by the two factors: first, cooperative membership and the installment schedule do not necessitate state registration and are not subject to statistical recording, second, share contributions paid by a citizen for a flat in the housing cooperative are tax-exempt, therefore developers are released from VAT. Besides, development companies offering flats via such selling format tend to keep secret that all the cooperative members shall incur joint liability, i.e. they shall assume risks of the developer.

Dmitry Nekrestyanov, Head of real estate investment at the law firm “Kachkin & Partners”, explained that “such selling format as housing cooperative is chiefly a convenience for developers, because rights guarantees for interest holders provided by the law no. 214-FZ (tight deadlines, responsibility, pledge of land plots, etc. )” are not applied for housing cooperatives. This being said, shareholders’ rights are specified in by-laws of a housing cooperative (compiled by developers without resorting to interest-holders), and in the resolution of the general meeting adopted before real interest-holders joined the housing cooperative. Put it another way, developers tend to set risk limits on their own, thus invariably increasing risks borne by ordinary interest-holders.”

One additional point. A large part of LEK’s projects is being constructed without building permits, so all the penalties shall be suffered by ordinary members of cooperative. It may happen that they shall incur developer’s debt to electricity, heat & water suppliers as well.

Make pretence and you shall lose

However, provisional sale agreements have always been, and remain the most common selling format used to evade laws. While not officially prohibited, such transactions are described as "dubious" by lawyers. For instance, Elena Bukharina, head of the department at the Public Prosecutor's Office of St. Petersburg has analysed one of these transactions and concluded that “Any sales agreement signed between the developer and the buyer of an apartment in an off plan property, with payment of the apartment’s cost, should be deemed as void, because it is a sham transaction”. The supervisory agency stated, “Rules that should be applied to it are the same as applied to the implied transaction.”

Evgeny Zverev, senior associate of the law firm “S&K Vertikal” also noted that any liability to make all/the most part of payments (as a rule, in the form of “safety” payments ) prior to signing the principal agreement is indicative of sham nature of provisional sale agreements. “In the meantime, it may happen that the developer and the interest-holder enter into a provisional purchase agreement for an off plan property, conditional upon making symbolical payment in advance. From our point of view, such agreement might be deemed as not a sham transaction”, explained the lawyer.

On the other hand, developers’ resorting to contrivance may play onto the hands of the off-plan property buyers. According to explanatory statements made by the Federal Service for Consumer Rights Protection and Human Welfare, such transactions must abide by the Consumer Protection Law, including provisions granting buyers the right to claim for penalty of 0.5% per day (annual interest rate of 182.5 %! ) in case of developer’s failure to comply with deadlines. In case of delay the law authorizes the client to withdraw from an agreement and to demand from developer to return the entire paid amount. The same rights are held by persons who signed the provisional sale agreement, if the company failed to close the main sales transaction within the time specified.

However, it is not so easy to defend one’s rights in court. Indeed, the above cited LEK enters in provisional sale agreements only “rough term” object delivery. The servants of Themis tend to construe such norm ambiguously, though most of clients nevertheless manage to refuse buying flats in houses which were constructed behind schedule. However, nobody managed to successfully insist on payment of interest provided by the law; according to |”Fontanka” - judges reduce the amount of penalty on various excuses. For instance, the St.-Petersburg municipal court consented to collect only 500 00 rubles (less than 2 % annual interest) for Natalia Borzenko who paid over 8.7 million roubles to OOO LEK three years ago. Anyway, the Arbitration court is now reviewing about 20 claims filed by interest- holders of LEK to their developer which failed to meet contractual obligations. Let us remember, dates of completion for residential compounds “Graf Orlov" and “London Park” were changed several times, and the residential compound “Imperial” remains at the stage of 80 % readiness since 2009.

Twilight watch

Development companies are obliged to register concluded transactions with the Federal Registration Service only in one case - if construction is carried out in compliance with the Law no. 214-FZ. Should construction works be carried out in any other format, the registration procedure shall take place at any time at the developer’s discretion. As a result, no market expert can accurately assess the current situation of construction since its benchmark – the amount of sold flats is unknown. Actually, any development company which evades the Law no. 214-FZ, can report any sales volume whatsoever. Therefore all forecasts and analytics are based on indirect indicators - for instance, on flats listing periods, prices declared in open sources, amount of marketed flats. This method allows one to set the trends, however, it does not provide a fair view of market situation.

Moreover, as some companies start building houses without permits, approved design, and even without any town-planning documents - for instance, on land plots meant for private housing construction, one cannot accurately assess the number of developers operating on St.-Petersburg market. One way or another, the Construction committee of St.-Petersburg has no accurate statistics. Approximately about 200 development companies operate in the city, and about 800 projects are being built.

Aspiration to make the real estate market more transparent is perhaps the main reason why developers were urged to comply with the law no. 214-FZ. However, to judge by developers’ active resistance to such shift, current “twilight” is OK with many players of the real estate market. Especially considering the amount of black money transactions, barter trade and widely applied practice of tax avoidance using dummy companies.

Curiously enough, banks which extend hypothecary credits to consumers for the purchase of flats on new homes market, are not especially concerned with legitimacy of selling formats used by developers. Should the development company disappear, the borrower shall assume responsibility. “Quite naturally, selling a property in compliance with the law no. 214-FZ looks more preferable from the point of view of risks,” said Vitaly Demidov, Head of Territorial Administration of the North-West region of Absolut Bank. “But even then one cannot guarantee the total absence of risks at purchasing an off-plan property. At the same time other selling formats are quite legitimate. For instance, the possibility to conduct sales via provisional sale agreements is provided by the Civil code of the RF.” That is, buyers of real estate actually incur both risks of developer, and risks of banks.

Of course, interest-holders can put developer’s activities in issue. In case of violation of laws they can apply to the public prosecutor's office and even be successful in an action. However, they shall not succeed in buying a flat with recovered money, due to inflation rates and low speed of domestic judicial proceedings. That’s why one should probably take lawyers’ advice and minimize potential risks from the very beginning— for instance, to try and avoid purchasing flat via the provisional sale agreement.

Kira Obukhova, Pavel Netupsky, ""

Back to the list