Russia

A. Security

1. Can security be granted to a foreign lender?

Yes.

2. Can lenders take a mortgage over land and buildings on the land?

2.1 The distinction between mortgages on land and buildings on the land?

Yes. Russian law contains a general principle of “unity of the land and the buildings located on it” and pursuant to this principle a building must be mortgaged simultaneously with the land plot on which it is located.

It is worth noting that there are specific limited circumstances in which it is possible to take a mortgage over land without a simultaneous mortgage over buildings on it. However, generally we do not recommend this as being a satisfactory security structure.

2.2 Are mortgage certificates for a certain value issued? What is the cost? Are they transferable?

Mortgage certificates (“mortgage bonds”) may be issued by the Property Registry (upon application). This document certifies the right of the bondholder to have the issuer perform the secured (i.e. monetary) obligations. The mortgage bond must contain confirmation of the secured amount (or at least the method of calculating or determining the secured amount). The cost for issuing a mortgage bond is included in the state duty (approx. EUR 100) payable for mortgage registration and need not be paid separately.

As a mortgage bond is a registered form of interest it can be transferred to any third party by way of endorsement. The party transferring its rights to the mortgage bond makes an endorsement (a record) on the mortgage bond stating in detail the full name of the new holder of such mortgage bond. In addition, to support the transfer, the current bondholder and the new bondholder enter into a simple written agreement assigning the rights to the mortgage bond.

2.3 Can second ranking security be taken? If so, how is it registered? Is a priority deed also registered?

Second ranking security may be taken. Under Russian law registerable security is ranked according to the date on which it is registered. Any subsequent mortgage is possible provided it is not prohibited by a preceding mortgage. There is no concept of ‘priority deeds’ under Russian Law and there is no provision under Russian law supporting the prioritisation of claims between parties.

2.4 Can the real estate be transferred to a third party (being still subject to the mortgage) without the lender’s consent?

The default position under Russian law is that real estate cannot be transferred to a third party without obtaining any mortgagee’s prior written consent. The parties may agree, however, in the mortgage agreement that the mortgagee’s consent is not required.

2.5 Are there any preferred creditors (other than a prior ranking mortgage holders)?

Yes, under solvent and insolvency liquidation procedures.

During solvent liquidation: 
Creditors’ claims are satisfied in the following order of priority: (i) personal injury claims; (ii) severance benefits, wages for employees of the liquidated company and copyright royalties; (iii) compulsory payments owing a budget or a non-budget fund; and (iv) claims of other creditors.

Creditors’ claims which are secured by mortgages are satisfied from the sale proceeds of the mortgaged property ahead of other creditors, except for the creditors listed at (i) and (ii) provided that their rights to claim were created before the mortgage agreement was completed.

During insolvency liquidation: 
Russian law applies mandatory priorities under which creditors of the same class will rank equally. In brief these are: (i) “current claims” (e.g. insolvency costs, liabilities incurred after the start of the insolvency proceedings, (ii) “first priority claims” (personal injury), (iii) “second priority claims” (employee related, and royalties) and (iv) “third priority claims” (secured and unsecured claims of other creditors).

Secured creditors are entitled to payments realised from the sale of secured assets, subject to the following thresholds: for secured claims under a facility agreement, the lender is entitled to 80% of the realised proceeds, with the remaining 15% for first and second priority claims, and 5% for insolvency expenses. For other secured claims (other than under a facility agreement) the respective thresholds are 70%, 20% and 10%.

2.6 Can “all monies” mortgages be taken?

No. The scope of the secured obligations should be agreed by the parties in advance and described in detail in the security document.

2.7 Can a landlord’s right to receive rent be charged, assigned or transferred to a lender by way of security? If so, how?

Yes, there are two ways to grant security over the rental income: (i) under a pledge of rights to receive rent under a lease agreement; and (ii) under an assignment of rights under a lease agreement.

To perfect the security under an assignment of rights under a lease agreement a formal notice of assignment must be served on each tenant. Failure to notify a tenant will mean it is not obliged to perform its payment obligations to the assignee (the lender).

2.8 It is customary/possible for a lender to take a charge/security over bank accounts of the borrower? Is it usual for lenders to contractually restrict rights to withdraw funds in accounts until the scheduled interest and capital repayments are made?

Effective security over Russian accounts is not available. However, it is common practice for an account withdrawal (direct debit rights) agreement to be concluded by the lender, the obligor and the obligor’s Russian account bank, in respect of the obligor’s account(s). This agreement provides the lender with the right to withdraw funds from such account(s) without notifying the borrower, in the event of a breach by the borrower of its covenants and obligations to that lender.

It is not possible for a third party to take a security over bank accounts as the security provider should owe a direct payment obligation to the lender. Any underlying security should contain a direct reference to the lender’s power to obtain a direct debit from the borrower or a third party obligor (where a third party is providing the security for the right of the borrower).

Despite the respective contractual covenants, Russian law does not impose any restriction on a Russian account holder in the operation or maintenance of its accounts.

3. What are the mechanisms for registering land and for registering and perfecting security?

3.1 Consequences of failure to register?

Rights to and encumbrances (ownership, long-term lease, servitude etc.) over real estate are subject to state registration.

A mortgage will only come into existence on registration.

3.2 Formalities for execution of security and costs?

All Russian law security documents must be executed in written form, be bound and sealed with the parties’ corporate seals.

The lender’s legal counsel would usually review the constitutional documents of the Russian obligors, their respective authorisations and corporate approvals prior to execution. Ratification of the agreements by Russian companies is not advisable where there is a threat of challenge.

Constitutional documents, relevant resolutions, powers of attorney and other respective authorisations should be filed with the registration authority together with the mortgage agreement.

Where the lender/mortgagee is a foreign entity, the relevant documents will need to be ‘legalised’ for Russia. This will mean the documents are apostilled in the country of the lender’s incorporation, then translated into Russian, with the translation being attached to the documents and notarised.

4. Can the lender use a Security Trustee to hold security on trust for creditors?

4.1 What happens if the lenders change later on e.g. on a transfer? Does new security have to be signed?

Russian law does not recognise the concept of trustees and so the security trustee mechanism is not available for use. To work around this issue, off-shore secured financings often use structures such as the creation of a “parallel debt obligation”, creation of joint creditor relations and subparticipation through a secured lender. Each of these structures has different characteristics and disadvantages and advantages.

5. Does the landlord/borrower have control over changes in tenants if the tenant wants to transfer the lease to a new tenant and is the original tenant still bound by the lease?

Under provisions of the Russian law the assignment of a tenant’s rights does not require landlord’s consent unless otherwise stipulated by the lease agreement. Once the rights under the lease agreement are assigned to the new tenant, the original tenant is no longer bound by the lease.

6. How can the lender enforce its security?

6.1 Can a foreign jurisdiction (either a court or arbitral tribunal) be chosen to settle disputes and under what circumstances may such a choice not be recognised?

In respect of Russian law security (relating to Russian assets), we would not recommend seeking a resolution in a foreign court as this will cause concerns regarding enforcement in Russia.

6.2 Does the local law allow for the enforcement of arbitral awards or foreign judgements without review?

In respect of foreign law documents, this mainly concerns “proof of debt” as regards any action against a Russian obligor. There are few jurisdictions with which Russia has an agreement for reciprocal enforcement of court judgments, or in relation to which principles of reciprocity apply. Russia is a party to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, as a result an arbitral award obtained in another signatory jurisdiction should be enforceable by a Russian court. For this reason it is common to designate in credit agreements that disputes will be subject to the jurisdiction of international arbitration. Although consideration of the jurisdiction of foreign courts may still be relevant, in particular if the Russian obligor has assets abroad.

6.3 How can that security be enforced? Can it be sold to a third party? Is it possible for a secured party to appoint receivers/liquidators and if so how and what are their powers? Can security be enforced directly without recourse to the courts and are private sales of security possible? Does it have to be sold by auction?

As a general rule, a Russian pledge/mortgage would be enforced by the Russian courts with a subsequent sale by public auction. Recent changes to legislation provide for the possibility of certain self-help (or “out-of-court”) remedies.

Out-of-court enforcement of Russian pledges is possible if a prior written “Enforcement Agreement” is concluded between both parties to the pledge. The parties can agree: (i) to sell the assets at auction (to be arranged by an auction organiser); (ii) to sell an asset to a third party (to be arranged by a commissioner under a commission agreement); and (iii) to allow the pledgee to repossess the pledged assets in certain circumstances. The parties can agree the procedure for determining the starting/repossession price and other conditions in the Enforcement Agreement.

A certain level of co-operation from the pledgor/mortgagor will be required to implement the self-help remedy.

6.4 Is the lender responsible for maintenance and insurance of the real estate after default until sale?

After an event of default and until the sale of the mortgaged real estate, the mortgagor is the owner of the real estate and is responsible for the insurance and maintenance of it.

The lender/mortgagee is responsible for maintenance and insurance after sale if it is the purchaser of the mortgaged real estate. The lender/mortgagee can, in a few cases, also be responsible for insurance and maintenance even before the event of default has occurred if the mortgage agreement requires this. In such circumstances the lender/mortgagee will continue being responsible until the mortgaged real estate is sold to a third party.

6.5 Is there any method of foreclosure (lender obtaining good title to the real estate in satisfaction of all or part of its debt)? If so, does this require a court order and is it only automatically used when the real estate is not sold at public auction?

Under current mortgage legislation the mortgagee and mortgagor may enter into an agreement in relation to non-judicial enforcement. Such an agreement could stipulate that the mortgaged real estate may be repossessed by the lender without the lender holding an auction. The scope of such agreements is limited by certain restrictions relating to cultural, historical and other such properties.

7. Is there anything else that you would specifically point out to a foreign lender as being unusual or particularly difficult?

Rights to deal with/acquire or dispose of certain buildings and other legal assets can be restricted, when these assets have foreign owners (e.g. mortgage over the historical property).

B. Security Over Shares

Assuming real estate is held in a locally incorporated single purpose vehicle to provide an alternative to enforcement of the mortgage over real estate:

1. Can security be granted to a foreign lender?

Yes. Anyone can hold the local security. However, the security holder must be prepared to translate and notarise any documents that the local authorities may require in case of dispute or otherwise.

2. Can second ranking security be taken? If so, how is it registered?

A second ranking pledge (including in respect of real estate) can be taken. A relevant entry of a subsequent pledge will be made in the respective register (if applicable).

3. What are the mechanisms for registering and perfecting security?

Pledge over shares in the Russian joint stock companies.

A record of pledge should be entered into either: (i) the pledgor’s respective depository account maintained by an independent registrar (custodian); or (ii) the company’s internal share register. As a belt and braces approach our advice would be to follow option (i) and have the shares deposited into an account with a custodian.

Pledge over participatory interest in a Russian limited liability company.

A pledge agreement needs to be signed in the presence of a notary and notarised. After that, a notary files an application (signed by the parties in the presence of the notary) with the State Register of Legal Entities, and a relevant entry of the pledge is made in the register.

3.1 Consequences of failure to register?

Failure to register the pledge with the custodian or in the internal shareholders’ register will not affect the validity of the share pledge.

3.2 Formalities for execution of security and costs?

An obligor would usually bear all related costs.

4. Do the shares need to be transferred into the name of the lender or its nominee?

If the company maintains the shareholders’ register internally, the relevant entry is made in the internal register.

If the company’s shares are recorded by an independent registrar (custodian), the custodian would usually require that the pledgee (lender) opens a depository account with it. However, the relevant record of the pledge is made on the pledgor’s depository account. Under the Civil Code, the lender may take possession of the pledged shares from day one (the concept of “Zaklad”), but in practice this rarely occurs.

5. How can the lender enforce its security?

5.1 Can it be sold to a third party? Is it possible for a secured party to appoint receivers/liquidators and if so how and what are their powers? Can security be enforced directly without recourse to the courts and are private sales of security possible? Does it have to be sold by auction?

As a general rule, a Russian share pledge would be enforced by the Russian courts with a subsequent sale at public auction (at an organised stock exchange, in the case of a public company).

Recent changes to the legislation provide for the possibility of a self-help remedy – out-of-court enforcement of a Russian pledge is possible if a prior written Enforcement Agreement in respect of the same has been concluded between both parties to the pledge. The parties can agree: (i) to sell the shares at auction (to be arranged by a auction organiser); (ii) to sell shares to a third party (to be arranged by a commissioner under a commission agreement); and (iii) to allow the pledgee to repossess the pledged shares in certain circumstances. The parties can agree the procedure for determining the starting/repossession price and other conditions in the Enforcement Agreement.

A certain level of co-operation from the pledgor will be required to implement the self-help remedy.

5.2 Are loans from shareholders subordinated? If so, how is this done? Is it customary for such loans to be waived or written off contractually as part of an enforcement of a share pledge should a default occur?

The loans of shareholders are not subordinated. It may be contractually agreed that the shareholders write off or waive their respective rights under the loans upon occurrence of certain circumstances, but these provisions may not be enforceable under Russian law or against a Russian obligor.

C. Leases

Legal issues that would be likely to impact upon the valuation and the security of income from an investment perspective.

1. Lease Structure

1.1 Typical lease length?

This can be classified by type. A class A lease typically relates to premises with excellent location, high-quality infrastructure and excellent professional management.

A class B lease typically relates to premises with good (versus excellent) locations, management, and construction. Often class B buildings will become class A after 5 – 7 years of use.

Leases of office premises are usually for a term of: 
For class A: 5 to 7 years (10 years is rare) 
For class B: 1 to 3 years or 5 years

Leases of trade premises are usually for a term of 3 to 5 years.

Leases of warehouse premises are usually for a term of: 
For class A: 5 years or more 
For class B: 3 to 5 years

For residential premises, the typical term varies from 2 to 5 years. 
However, lenders will often consider lease terms of 5 years as a sufficient length for secured lending.

1.2 Maximum/minimum lease length if any?

There are no statutory limitations at a federal level and the general rule is that the parties can agree any length of term, but subject to maximum in some cases, e.g. for land-plots in Moscow, the maximum term is capped at 49 years.

1.3 Statutory controls and obligations re renewal/termination of leases (does tenant have automatic right to renewal or can they apply to the courts for a new lease); also does some form of notice have to be served to terminate a lease to avoid renewal?

Under the default provisions of Russian law, unless otherwise stipulated under a lease agreement a tenant that has duly complied with its obligations under a lease has a pre-emption right to enter into a lease agreement for a new term. Should the landlord refuse to enter into the new lease agreement but enters into a lease with a third party for the same term, the former tenant may judicially request a transfer of the rights under the new lease agreement from the third party.

The pre-emption right of the tenant to enter a new lease is often expressly excluded by the parties.

If the tenant “holds over” (remains in occupation) after the expiry of a fixed term without any objections from the landlord, the lease agreement is deemed to be extended for an indefinite period and on the same terms and conditions of the current agreement. Such a lease can be terminated by either party on 3 months’ written notice.

1.4 Any overriding statutes concerning the ability of the tenant to break a fixed term lease (whether or not included as a term of the lease)?

None, save where the landlord is in breach or the lease does not accord with the general provisions of the Russian Civil Code.

1.5 Any other security of tenure provisions available to a tenant that would frustrate possession or prevent receipt of market rents?

As mentioned above, unless otherwise provided for in the lease, a tenant who is not in breach of the lease has a priority right to a new lease ahead of any third parties. If the tenant notifies the landlord within the statutory period that it wishes to enter into a new lease and the landlord nevertheless leases the premises within one year from the expiry to a third party, the old tenant has the right to demand that its lease be renewed and claim compensation. This statutory tenant protection is invariably expressly excluded in a lease agreed on market terms.

2. Rent/Rent Reviews

2.1 Rental income receivable quarterly/monthly in-advance/in-arrear?

Monthly in advance.

2.2 Periodicity of reviews?

Usually annually.

2.3 Basis of review (upwards-only or variable, indexation or market rent)?

Reviews are linked either to a fixed index rate (e.g. 3%), or to the Consumer Price Index. Our experience is that reviews are upwards only.

2.4 Are rents/reviews subject to statutory control in regard to quantum or increase (i.e. rent control)?

No.

3. Lease Obligations: Who has responsibility for:

3.1 Internal maintenance, decoration and repair?

Under the Russian Civil Code default provisions, the landlord is responsible for “capital” repairs and the tenant is responsible for “running” repairs maintaining the property in a proper state, remedying any wear and tear. Parties may agree otherwise in the lease agreement.

3.2 External maintenance, decoration and repair?

Under the Russian Civil Code default provisions, the landlord is responsible for “capital” repairs and the tenant is responsible for “running” repairs maintaining the property in a proper state, remedying any wear and tear. Parties may agree otherwise in the lease agreement.

3.3 Structural repairs?

Under the Russian Civil Code default provisions, the landlord is responsible for “capital” repairs and the tenant is responsible for “running” repairs.

3.4 Insurance?

The lease usually provides that the landlord insures and the tenant pays or contributes to the insurance policy premium.

3.5 VAT?

Rental payments are normally subject to VAT (currently at the rate of 18%). This is paid by the tenant.

3.6 Rates?

Property tax is payable by the landlord.

3.7 Other typical outgoings?

These are usually agreed between the parties. Usually the tenant pays or reimburses the landlord for any such costs.

3.8 The ability to recoup any landlord outgoings (including management costs) by way of service charges?

This would be agreed between the parties. Usually the tenant pays or reimburses the landlord for the costs of maintenance and utilities (in proportion to the area leased by the tenant).

4. Enforceability

4.1 Are terms of leases/contracts recognised and supported by case law in the jurisdiction?

Generally yes, although there is inconsistency in the application of law by the Russian courts and on occasion court decisions and judgements are questionable.

5. Valuation and Environmental

5.1 To be recognised in the courts, does an appraisal have to be prepared by some domestically regulated/qualified party or is an RICS (Royal Institution of Chartered Surveyors)-qualified appraisal report accepted and recognised in each jurisdiction?

There are no requirements that an appraisal report be prepared by a domestically regulated/qualified party or an RICS person or entity. The Russian court will treat any such report as it deems fit in accordance with principles of court process.

5.2 Is it possible/customary to obtain environmental reports from a local government agency or a qualified, insured environmental professional?

As part of the construction/planning permitting process, the relevant authorities commission “expertisa” on various environmental aspects. Generally a purchaser or lender will require an additional environmental report from a qualified insured environmental professional.

5.3 Is it possible for liability in respect of past or present breaches of environmental laws to attach to a lender by it holding or enforcing a mortgage over real estate?

Prior to taking any enforcement action while a lender has a mortgage over real estate, it is not deemed to be the legal owner and is not liable for any environmental breaches of the borrower (either past or present).

However, if in enforcing a mortgage the lender subsequently becomes the owner of the real estate, the lender will then become liable for past or continuing environmental breaches. This liability is subject to limitation periods imposed by legislation.