Housing Construction Through the Purchase of Bonds. It Is Not That Simple.

Alteration of the legislative basis for the participation of the investors in the real estate construction has compelled all the actors of this process to establish more complicated multistage contractual relations. Thus, as distinct from the previous situation when to obtain the estate property investor could conclude a single agreement and carry out the payment, today the investor has to conclude three different agreements. Understanding of the whole system and of all the steps which are to be taken will help the investor to comprehend the situation and even to avoid some mistakes. Sergey Burya, a lawyer and managing partner of the law firm “Burya & Partners” tells us in details about differences of the new and old procedures and about the peculiarities, weaknesses and strengths of the new system.

PT: What was the former practice of the purchase of the real estate at the stage of its construction?

S.B.: Implementation of the construction project requires the builders to have reliable and stable sources of financing. As a rule at the initial stages of the construction the builder had to involve its own or loan funds. However, with the progression of the construction the necessity for the loan proceeds had been reducing and the builder could fully use new financial flows, i.e. investors’ funds (funds of natural persons). Legal basis for the involvement of such funds was investment agreement (shared participation in the construction) which was concluded between the builder and investor and which was not subject either to registration or to notarial attestation. The investor, deprived of the control of the use of funds, carried out the payment in accordance with the schedule and remained outside observer of the construction process hoping that construction would be successfully completed within the set terms.

PT: Did such situation influence the market?

S.B.: Certainly. Lack of the financial control over the money flows has enabled some of the builders to ‘make use’ of the situation which in its turn has caused losses to the construction market and to the philosophy of the relations between the builder and investor. Impossibility to return deposited funds has caused massive outflow of the investors from the participation in construction. On the other hand this situation has compelled the builders to seek for new, more reliable and transparent schemes of the investor involvement. The situation has also negatively affected general investment climate and thus the legislator was required to introduce new provisions and rules regulating the process. The problem was resolved by the adoption of the legal act which prohibited investment activity with regard to the residential projects involving non-governmental funds of the natural persons and legal entities. At the same time the exclusive list of the possible construction investment modes was introduced. One of these modes which has gained widest popularity is issuance of the interest-free bonds which have the real estate project as their basic goods.

PT: What has changed after the securities where introduced?

S.B.: Construction market and its actors have acquired certain elements of the stock market. The activity of the issuers of the bonds, its sellers and investors has been regulated by the legislation on securities and stock market. The very scheme of the acquisition of the real estate through the purchase of the bonds has become as follows. The builder with the purpose of involving additional funds issues registered interest-free bonds which is a security confirming deposit of the funds by its owners and obligations of the issuer to pay off nominal value of the bonds within the envisaged terms. It is important to understand that the bond established loan relationships and debt liability between the owner of the bond and its issuer. By virtue of the peculiarity of the specified purpose bond coverage of issuer’s obligations can be done by goods or services. Such goods in the case at hand are residential and non-residential areas calculated in square meters. Thus, in present system as distinct from the former procedure the investor deposits its funds not on the basis of the investment agreement but through the purchase of the builder’s debenture bonds.

PT: At first sight it seems that acquisition of securities has become a secure mechanism of the return of the invested funds.

S.B.: This is partially caused by the complexity of the bonds issuance procedure and by the fact that several entities including such significant ones as institutions of joint investment and banks participate in the circulation of the securities. The so called institutions of joined investment, i.e. corporate investment trusts or unit investment trusts have an important role to play in the ‘promotion’ of the builder’s bonds. The main task of these institutions is involvement of the investors’ funds with the purpose of obtaining the profit through the investment of these funds in the securities of other issuers. These assets are created and managed by the management companies which carry out their activities on the basis of license. In practice in order to minimize taxation the issuer itself establishes unit venture investment trusts of non-diversified and closed type which sells the complete set of the issued bonds. From that moment assets management company acts as a seller of the bonds and independently in its own concludes agreements on the sale of the bonds with investors.

PT: How specifically the procedure of the sale of the bonds is carried out?

S.B.: As a rule bonds are of non-documentary form and are kept in electronic form in commercial banks or stockjobbers which posses a license for the care of securities and facilitation of securities circulation and securities operations of the issuer. It is advisable to agree with the securities seller and to select single securities keeper during the conclusion of the sale agreement. This will ensure effective retirement of the bonds within the frameworks of single depositary in future. To purchase the bonds the investor and securities keeper conclude the agreement on the establishment of the securities account. Conclusion of the new agreement on the purchase of the very bonds is the next step of the investor.

PT: What are the peculiarities of this agreement?

S.B.: A particular feature of the purchase of the specified purpose bonds is that they should be exchanged for the areas stipulated earlier. Bond holdings are organized in indivisible bond lot. Its size and features are determined by the very issuer and as a rule it is established in the equal real estate objects (apartments or other non-residential premises). The seller shall indicate all the characteristics of the lot which is acquired by the investor in the section relating to subject of the agreement (type of securities, issuer, series, cost, quantity of bonds, terms of the retirement of bonds). The same section should contain information on the real estate to which investor is entitled after full taking out of the lot and its exchange. Parties shall establish the price of a single bond which is fixed to US dollars. At that the price of the lot is amounts to the cost of a single bond multiplied by the number of bonds in the lot.

PT: When specifically the investor becomes the owner of the lot?

S.B.: The bonds holding (lot) fully paid for by the buyer is transferred to the buyer’s account in securities. From the very moment of the entrance of the securities in the buyer’s account, the investor enjoys full ownership right over the lot. The confirmation of the ownership right over securities is the statement of account which should be granted by the securities keeper to the investor. At the same time it is important to underline that statement of account is not to be considered as an agreement which entails ownership right to the securities.

The determination of the moment of the rise of ownership right is very important since starting from that moment the buyer can concede this right to another buyer. Until the moment of the full redemption of the lot the lot is indivisible and thus the buyer may not concede its rights to lot to another person. The buyer can do so after the full redemption of the lot.

Before signing the agreement on the sale and purchase of the securities the investor should clarify the possibility of concession of its rights to another buyer. It happens that bonds seller denies the right of the buyer to concede the ownership right without any valid reason or allows for such a right only with respect to the close relatives of the buyer.

PT: What are the other agreements which should be concluded by the investor?

S.B.: Often conclusion of the securities sale and purchase agreement is accompanied by the signing of the agreement on the participation in construction or reservation of the apartment. It is significant for the buyer of the securities to know conditions and terms of the construction, list of the works which are to be carried out in the residential (non-residential premises), etc since the investor is offered to buy bonds retirement of which is inherently connected with the construction process and its successful accomplishment.

PT: The main issue for the investor is specific date of the acceptance of the real estate and not the construction terms. What in particular should be thoroughly examined during the conclusion of such agreements? How the date of the acceptance of housing should be determined?

S.B.: There are not so many companies which do include specific date of accomplishment of construction and installation works in the agreement and particularly of the date of acceptance of the real estate object. Such terms are expressed in periods of six months or quarters. To make the object more attractive minimum terms of construction are indicated however the builder avoids such specification. Often this date is contained in several articles of the agreement.

For instance, the builder indicates the estimated date of the completion of construction and putting of the object into the operation, e.g. 3rd quarter of 2007. This date is considered as the date of accomplishment of the construction and acceptance of the object by the builder’s sales department. However having read the agreement attentively we can find that another provision envisages different definition, in particular ‘term of the transfer of the real estate within seven months starting from the estimated date of the putting of the object into operation’. Thus, terms of the acceptance of the object are postponed for another seven months. Furthermore, as far as the penalties and liability of the parties are concerned the builder acknowledges its own responsibility for the delay in the transfer of the object during seven months from the estimated date of the putting of the object into operation only if such delay exceeds 90 days term. Otherwise, the investor is not entitled to the receipt of the penalties. Thus, the builder provides itself with additional 3 months. It is important to mark out that in our particular situation specified purpose bonds which have its own terms of retirement are concerned.

Factual acceptance of the real estate object which is preceded by the retirement of the registered bonds can be carried out only after accomplishment of the construction, putting into the operation and measuring of the object by the Technical Inventory Bureau.

PT: Who establishes the procedure of the redemption of bonds?

S.B.: As a rule the procedure is established by the very seller. Sometimes the investor is offered to conclude an agreement with the housing and communal services otherwise the bonds are not retired. It must be underlined that neither the legislation on securities, nor procedure of its retirement foresees any conditions other than that provided for in the law. Moreover, it is stated that the builder itself under the instructions of the investor shall pass the newly constructed object to the operating organization for further exploitation. The parties may determine the final cost of the real estate and its area after the control measurement by the Technical Inventory Bureau and the registration of the ownership right over the real estate object.

PT: Is existing investment mechanism reliable?

S.B.: Yes and no. In case of non-fulfillment of the obligations by the builder there are no affective mechanisms for the solution of the problem except for the interest-free bond of non-documentary form which can serve as a basis for reimbursement of the investments. With due regard to the increased prices per square meter it may be assumed that investors involve loan proceeds. The question is how the investor should deal with the interests paid for the loan, inflation indexes and moral damages? The investor would have to confirm all these losses in courts.

One of the positive points distinct from the former system is that investor is entitled to undertake certain informational monitoring of the issuer. In particular, the investor is entitled to the special information about the issuer, namely the changes undergone by the commercial activity of the latter and its influence on cost of the securities or profit receipt through the securities. On the other hand, it is unknown why the legislator has not established more rigid and reliable procedure for the protection of investor’s funds. For instance, if the bonds are at stake it deems to be quite reasonable to provide additional security of the bonds according to which in case of non-payment of main sum in arrears by the issuer its obligations are guaranteed in full or partially by the insurance company or guarantor. The mortgage bonds can be applied as well, in particular non-fulfillment of the obligations by the issuer entitles the owner of the bonds to claim its rights to be satisfied at the account of mortgages. However this question most probably will remain without answer. Let’s hope that existing system will be well-established and will ensure that investor is not disappointed neither in Ukrainian legislation nor in the builder.

[ ["Property Times" # 41 (141) 30.10-5.11.06] ]

 

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