Legal trends in the commercial real estate market
The year 2022 was a time of transformation for the commercial real estate market, which after the lockdowns and restrictive measures during the COVID-19 pandemic is once again being tested for resilience and adaptability to change.
Trends in commercial real estate largely align with the general mood in the business environment: increasingly the need is felt to conduct a qualitative review of business strategies, taking into account the specifics of the particular industry and assets, and to implement “countermeasures” in response to the pressure of sanctions and the mass exit of foreign companies from the Russian market.
The following trends are particularly of note:
- an increased number of transactions on the transfer of assets to Russian companies, including at a significant discount;
- the desire of foreign tenants to get out of contractual relationships as quickly as possible, sometimes at great cost, which was most clearly seen in the first half of 2022;
- landlords’ reorientation of towards Russian market players and companies from “friendly” countries and their needs, as well as the desire to offer the widest possible range of solutions for tenants in the hybrid office segment;
- Russian tenants’ adaptation to contemporary realities: optimising leased space and rental costs in general; and
- taking into account anti-crisis rule-making when structuring relationships in the field of commercial real estate.
Naturally, the new geopolitical and economic realities could not but affect legal regulation of the commercial real estate sector, and in 2022 an entire raft of legislation was introduced to stabilise and support the market in turbulent conditions. At the same time, the vector of development set by legislators last year will in all likelihood continue in 2023, as can be seen by, for example, the extension of many of the anti-crisis measures.
Below we consider the main legal developments of 2022 which had and continue to have a significant impact on commercial real estate market players.
New procedure for real estate transactions
A key feature of 2022 was the creation of a new statutory category of persons: foreign persons associated with states that commit “unfriendly” acts against the Russian Federation, and entities controlled by them (“Restricted Persons”).
Since 2 March 2022, real estate transactions with Restricted Persons are generally subject to approval by the Government Commission for Control of Foreign Investment in the Russian Federation (the “Government Commission”).
Who is subject to the restrictions?
Transactions entailing the creation of ownership rights to real estate (e.g. contracts of sale, gift, exchange) concluded between Russian legal entities or individuals, on one side, and Restricted Persons, on the other side, must be approved by the Government Commission.
The question of whether transactions concluded exclusively between Restricted Persons are subject to approval is as yet not expressly regulated in the legislation. Based on a literal interpretation of the new legal provisions, we take the position that permission from the Government Commission is not required for such real estate transactions. Similar guidance was given by Rosreestr in November 2022, although previously the registration authority interpreted the new restrictions broadly and extended them to, among other things, transactions concluded exclusively between Restricted Persons.
Which transactions with Restricted Persons do not need to be approved by the Government Commission?
Exceptions have gradually been made to the general requirement on the approval of real estate transactions. As a rule, such exceptions are found in extracts from the minutes of meetings of the sub-committee of the Government Commission published by the Russian Ministry of Finance.
First of all, the restrictions were lifted for many transactions performed by individuals, and then certain restrictions were eased for companies as well.
It is not necessary to obtain the approval of the Government Commission for:
- transactions in respect of real estate located outside Russia, provided that the payments under such transactions are made using accounts opened by Russian individuals or entities at foreign banks abroad and disclosed to the Russian tax authorities;
- transactions between Russian residents and Restricted Persons if (i) the latter’s ultimate beneficiaries are Russian individuals, and (ii) the relevant information on control is disclosed to the Russian tax authorities;
- transactions as a result of which the title to real estate is transferred from Russian residents to Restricted Persons;
- transactions as a result of which title to real estate is transferred from Restricted Persons registered abroad to Russian residents, provided that the purchase price under such transactions is credited to a type C account.
Such accounts are opened for Restricted Persons at a Russian bank in roubles, and they can be used only for transactions permitted by the Bank of Russia (such as paying taxes and other obligatory payments to the Russian budget); - transactions between Russian residents and real estate development companies that are under the control of Restricted Persons; and
- transactions between Russian residents and Russian legal entities, part of the participatory interests or shares in which are owned (directly or indirectly) by Restricted Persons, as follows:
- not more than 25% minus 1 share/vote – for non-public joint-stock companies and limited liability companies; and
- not more than 50% minus 1 share – for public joint-stock companies.
It can be said that all the exceptions made are conservative and often targeted, so the general approval procedure for real estate transactions still affects most participants in the commercial real estate market, whether Restricted Persons or their Russian counterparties.
Is approval required when a party to the transaction is a foreign company that is not a Restricted Person?
In such cases approval is not required. There is, however, one important exception: permission from the Government Commission is required for a Russian resident to purchase real estate from a foreign counterparty which, although not a Restricted Person, purchased the same real estate from a Restricted Person after 22 February 2022.
What criteria does the Government Commission apply when granting permission for real estate transactions?
At present, there are no express criteria for real estate transactions.
However, based on the practice of issuing permits, which we are familiar with, it seems likely that when considering whether to issue a permit the Government Commission will be guided by the conditions established for transactions involving shares and participatory interests in Russian companies sold by Restricted Persons, namely:
- the availability of an independent valuation of the market value of the asset;
- the purchase price should not exceed 50% of the market value of the asset;
- setting of key performance indicators for the new owners; and
- payment in instalments over one to two years or a voluntary payment to the federal budget of at least 10% of the purchase price.
In summary, the structuring of real estate transactions has clearly become more complicated due to the need to analyse various new factors and the impossibility of short-term planning of the closing of transactions. These factors include:
- the fact that there is no deadline for the Government Commission to review applications;
- also, no clear criteria have yet been established for the assessment of real estate transactions by the Government Commission;
- there is no procedure for appealing decisions made by the Government Commission.
All these factors generally increase the risk that the necessary approval will not be obtained.
Failure to provide the permission of the Government Commission (in cases where it is required) when applying for state registration of the transfer of title to real estate results in the suspension of such registration and eventually denial of registration if the approval is not subsequently received.
Anti-crisis solutions for landlords and tenants in the trade and catering sectors
During the period of the mass exit of foreign tenants from the Russian commercial real estate market, Russian legislators provided landlords and the new owners of foreign businesses with additional measures to protect their interests.
Unilateral change of the amount of rent by landlords
Statutory provisions granting landlords additional rights have been extended to the end of 2023. Such additional rights are grantedsubject to the following conditions:
- the tenant is a trade or catering organisation under the control of a Restricted Person;
- the rent specified in the lease depends on the tenant’s business performance (e.g. turnover rent); and
- the amount of rent has decreased significantly (by more than 50%) because the leased property was not being used.
In particular, in such cases the landlord has the right to require the tenant to pay rent for the period when the tenant was not using the leased property, in an amount equal to the average monthly rent for the year 2021 or, if the lease commenced on or after 1 January 2022, for the period from 1 January to 24 February 2022.
If the tenant fails to comply with the landlord’s request for payment within ten business days or fails to resume using the premises, the landlord can terminate the lease. The landlord’s right to unilaterally terminate the lease, however, does not apply from the date the tenant ceases to be under a Restricted Person’s control.
Prohibition against amendment or termination of a lease at the landlord’s initiative
Until the end of 2023, landlords are prohibited from amending or terminating a lease agreement if the agreement was concluded on or before 24 February 2022 with a tenant that ceased to be under a Restricted Person’s control after 24 February 2022 and:
- changed its name, trademark or service mark, or the goods and brand of the goods sold; or
- has come under the control of a Russian individual or entity or of a foreign company under the control of a Russian individual or entity.
This measure is aimed at supporting market players that buy up the business of “departing” foreign retailers and protecting them from landlords’ claims that have accumulated during the “downtime” of the premises under the previous owner.
We have already seen similar emergency measures to regulate the rental market during the coronavirus pandemic. So we can assume that, as then, the parties to a lease will resort to new grounds for terminating a lease only in extreme cases where they are unable to reach an agreement to amend or terminate the lease in question through negotiation.
However, as the number of companies leaving the Russian market grows, we cannot rule out an increase in the number of disputes that end up in court, including those related to the application of the new rules described above.
The special military operation and sanctions as force majeure invoked by tenants
In 2022, tenants began citing the special military operation or sanctions as events of force majeure, arguing that the failure to fulfil their obligations under lease agreements was due to circumstances related to military action or increased sanctions pressure.
Unless such a possibility is expressly excluded by the terms of a contract, the tenant may be released from liability for non-payment of rent (e.g. from having to pay a penalty) if it proves that payment was rendered impossible due to an extraordinary and unavoidable circumstance.
As a rule, the courts tend not to accept the argument that the special military operation has impacted the contractual relationship with a landlord, rightly noting that, among other things, a causal link between the special military operation and the inability to fulfil the specific obligation, i.e. to make payments under the lease, has to be proved for the circumstance to be recognised as force majeure.
Foreign economic sanctions may be recognised as force majeure, but the courts often view the suspension of a tenant’s activities as an assumption of business risk.
In addition, military action and sanctions cannot be considered an unforeseeable situation if the parties entered into the lease after they began or were introduced.
Back in March 2022, a bill was submitted to the Russian State Duma which provides for the possibility to terminate and suspend obligations due to sanctions imposed on Russia. However, it has not yet been passed into law.
Concluding comments
In 2022 there were significant changes in legal regulation of the commercial real estate market, the participants in which were forced to adapt to the new realities in an extremely short period of time.
The purpose of most of the measures imposed is to protect Russian individuals and entities (and the Russian economy in general) in the face of the mass exit of foreign companies and loss of profits as a result of foreign sanctions.
A comprehensive analysis of the new rules will help in making informed decisions on the acquisition or disposal of assets, optimising costs with the aid of the proposed support measures, and assessing the risks when choosing a particular strategy for further development of a business.
Our team is always ready to provide full legal support on any issues associated with doing business in Russia.
Should you have any questions regarding this material, please contact Artashes Oganov, Partner, Head of Real Estate & Construction Practice.
Authors
- Artashes Oganov, Partner, Head of Real Estate & Construction
- Dmitry Bogdanov, Senior Associate
- Elena Foteeva, Associate
