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Real estate finance

A lender to an investor looking to acquire or develop real estate, will typically insist on the full package of security instruments available under Russian real estate finance law. This includes pledges of shares, suretyships and parent guarantees, bank guarantees, pledges of assets and rights, mortgages of real estate and pledges of lease receivables. Under Russian real estate finance law, a mortgage offers one of the most effective forms of security. Mortgages are regulated by special legislation, primarily contained in the Law on Mortgages and, to the extent not regulated by this law, in the Russian Civil Code. A mortgage allows the mortgagee to receive compensation for the debtor’s default under a principle secured obligation, with priority over unsecured creditors. A mortgage is an encumbrance on the property and limits the mortgagor’s right to the free use and disposal of such property. For example, the mortgagor may only dispose of the mortgaged property with the consent of the mortgagee (unless the mortgage agreement provides otherwise). As a general rule, if the property changes hands and the mortgage has not been discharged, the mortgage will remain in place over that property (see also section 3.1 Mortgage above).
There are no particular restrictions on payments made to foreign lenders under a security document or loan agreement. However, certain currency control regulations must be complied with when proceeding with payment, for example a transaction passport and other currency control documents must be completed and submitted to the bank.

8.1 Russian real estate finance as security

The following real estate assets which are registered on the Property Register can be mortgaged to a lender:

  • plots of land;
  • buildings;
  • premises which form part of buildings;
  • facilities that have been registered as real property (e.g. water and sewage pipelines, fences etc.); and
  • registered ‘incomplete constructions’ (incomplete buildings where development was suspended and which have been registered as such in the unifed register).

A mortgage can also be created over other objects regarded as real estate under Russian law, including ‘enterprises’ (portfolios of real estate assets), aeroplanes and boats. It is also possible to create a mortgage (pledge) over a lease. A pledge over leased land is common in practice, particularly when the building situated on the land in question has also been mortgaged. Pledges over leases of buildings alone are rarely considered to be good security.

8.2 Trading of debt

Debt may be traded between lenders. As a general rule and unless the agreement states otherwise the secured debt can be assigned either by:

  • assigning or novating the debt itself, in which case the mortgage follows the secured obligation; or
  • assigning the mortgage agreement, in which case the secured obligation follows the mortgage (although this option is rarely used in Russia and may raise additional questions regarding any other security securing such debt).

If the mortgage is certifed by a mortgage deed (zakladnaya) the debt can only be assigned by a transfer of the mortgage deed.

8.3 Corporate governance

Russian Russian real estate finance law does not recognise concepts regarding ‘fnancial assistance’ rules or ‘corporate beneft’ rules. Under corporate law provisions, certain transactions are subject to corporate approval by a company’s general meeting of shareholders or the board of directors. In particular, such approval is required:

  • for major transactions, ie where the value of the property exceeds 25% of the company’s assets; and
  • for related party transactions.

Additional restrictions may be set out in the company’scharter.

8.4 Priority of security

Under the Mortgage Law it is not possible for an existing secured debt to be subordinated to a newly created debt.
The seniority of secured debt is set out by mandatory provisions of Russian insolvency and pledge/mortgage law and is based on the date of registration of the mortgages. These rules cannot be varied or excluded by agreement of the parties.
However by virtue of recent amendments to the Russian Civil Code which came into force on 1 July 2014, the seniority of pledges may be adjusted by an agreement between pledgees or an agreement between one, several  or all of the pledgees and the pledgor. In any case such agreements must not affect the rights of third parties which are not a party to the agreement.

8.5 Applicable law

Under Russian law, agreements which relate to real estate located in Russia must be governed by Russian law. This rule also applies to mortgages.
Where the real estate asset which is the subject of a mortgage is situated in another country, Russian courts will recognise the parties’ choice of governing law. In the absence of such choice the courts will generally apply the law of the country in which the asset is located.
In general the registration authorities must register a mortgage within 15 business days from the date of the parties’ application or within 5 business days if the mortgage agreement has been notarized.

8.6 Enforcement of security

A mortgagee is entitled to enforce a mortgage if the debtor under a secured obligation is in default. Events of default can be set out in both the loan agreement and the mortgage agreement. Typical events of default include:

  • non-payment of interest or principal loan repayments; and
  • insolvency.

Enforcement of security is not possible if the breach is insignifcant and the amount of outstanding debt is disproportionate to the value of the mortgaged asset. For example, it would be considered disproportionate if the amount of debt is less than 5% of the total value of the mortgaged assets and the payments due are outstanding for less than three months. Continuing obligations must be breached more than three times within a twelve month period in order for it to be possible to enforce security (unless otherwise stipulated in the mortgage agreement).
In the case of a mortgage of an enterprise (a portfolio of assets), enforcement is only possible after the expiry of one year from the date of completion of the mortgage agreement.
The mortgage can be enforced either by means of a court order or, if the parties so agree in the mortgage agreement, out of court. The latter option is not available if the asset which is subject to the mortgage is an undeveloped parcel of agricultural land, state owned property, a property of special historical or cultural importance or falls within certain other categories specifed by law.
As a general rule, after the mortgage is enforced, the mortgaged assets are sold at public auction. If the parties to a mortgage agreement are legal entities or private traders, then the mortgagee can take possession of the asset at the price determined by an independent appraiser and then offset the sale proceeds against the secured debt. This
option is not available in the same cases as listed above where out of court enforcement is not permitted.
However as a result of recent amendments to the Russian Civil Code which came into force on 1 July 2014, in the event of judicial foreclosure, pledged property can still be disposed of at a public auction or, if the pledgee and the pledgor so agree or the law specifcally prescribes, by way of
(i) the pledgee retaining the pledged property or (ii) selling it to third parties at a price below market rate. In the event of an out of court foreclosure, the pledged property can be disposed of at an auction held in accordance with the Russian Civil Code or the agreement between the pledgor and the pledgee. Furthermore, if the pledgor is a business entity, the parties to a pledge agreement can agree that the disposal of the pledged property will be performed by the pledgee retaining the pledged property or by selling it to third parties (as described above).

8.7 Non-insolvency procedures

If a company meets the legal criteria for insolvency, the shareholders of that company may provide support by granting the fnancial aid required to fulfl the company’s obligations. This is known as ‘sanitation’ (‘санация’). However, sanitation does not affect the rights of a mortgagee.

8.8 Effect of borrower’s insolvency

The treatment of mortgages during the insolvency process varies depending on the stage in the insolvency proceedings. For example, the ‘supervision’ stage creates a moratorium which completely prevents any creditors (including mortgagees) from enforcing their security. During the
‘fnancial rehabilitation’ and ‘external administration’ stages a creditor can only enforce the security in court and only if the debtor cannot prove that such action will prevent it from becoming insolvent again. Under insolvency legislation any transaction (including a mortgage) by a borrower can be rendered invalid by the court in certain circumstances, such as when it constitutes a transaction at undervalue. Generally, in order for this to happen, the security must have been created within
a certain time period before the commencement of the insolvency process. Such time period varies depending on the circumstances, but can be up to three years.

8.9 Order of payment in the event of insolvency

In the case of insolvency, secured creditors have priority over unsecured creditors, but not for more than 80% of the sale price (if the mortgage secures a credit facility) or 70% of the sale price (if the mortgage secures other debtors’ obligations). If several mortgagees have security over the
same real estate asset, in general, they will rank in priority according to the date of registration of the mortgages.
There are certain prior claims which apply to the proceeds of sale from the realisation of assets which are subject to a mortgage.

These include:

  • 15% of the sale price (if the mortgage secures a credit facility) or 20% of the sale price (if the mortgage secures other debtors’ obligations) is set aside for compensation for death or injuries, unpaid wages, and other similar claims; and
  • the costs of the insolvency process which are also met from the sale proceeds.

Unsecured creditors rank behind secured creditors and rank equally between themselves (the pari passu principle).
The latest changes to the Russian Civil Code regulating pledges came into force as of 1 July 2014 and provide that the cash collected from the sale of pledged property is to be distributed between the co-pledgees proportionately to their secured claims unless otherwise agreed. A joint pledgee who receives cash from the disposal of the pledged property is obliged to pay what is due to the other joint and several pledgees in equal shares, unless an alternative arrangement has been made between them. Russian real estate finance.