The Case of the Problematic Developer

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Investing in commercial construction projects is an entrepreneurial activity that, according the Article 2 of the Legal Code of the Russian Federation, is undertaken at the investor’s own risk. Herein lies the primary difference in the consequences of a poor monetary investment by a legal entity or a private entrepreneur and the consequences of a developer not fulfilling his obligations before to the investor of the construction project.

Investors have a particular set of rights that, when employed in the manner prescribed by law, can protect their investments. This article will review them and provide an overview of how the investor can invoke these rights in such situations arising when the investor has not received the completed object as:
1) Construction of a building is 100-percent completed and is being exploited de facto, but cannot be exploited formally because legally valid permission do so has not been obtained. Consequently, the space cannot be delivered to the investor in accordance with either the law or the contract.
2) The construction deadline for the object of investment has by more than six months past, though the object is close to completion (with 90-100 percent completed). Supplemental financing is not needed to complete the building, and the construction firm maintains a stable position on the construction market.
3) The construction deadline is more than six months overdue and the building has uncompleted floors, for example. Meanwhile, the construction company’s means are not sufficient for completing the building and creditors have filed against the company to recoup debts. The object of investment has been built, but does not meet the conditions of the contract (for example, it lacks windows or communications infrastructure).      
4) The investment funds have been spent, but the investment object cannot be said to have been built: It may lack walls or a legally permissible floor or ceiling.

The object of investment can vary widely. It can be a commercial, free-standing building, a space within a building, or a space within a residential building under construction, among other things. Investors’ actions will be the same, only the number individuals/entities who must determine a unified plan of action will change.

Enter into Discussions

When the delivery of a commercial space is being delayed, one needs to collect as much information as possible and develop a plan of action. To begin, it is necessary to first hold discussions with the developer. 

As a rule, at the initial meeting after the construction delay the developer will propose concluding a supplemental agreement. One should not sign any documents right away, but weigh pros and cons. It should be remembered that if an investor paid 100 percent of the investment required by the contract, the object should have been delivered ready for exploitation. The law does not provide for a developer to receive building incomplete and not ready for use. It follows that additional payments are not obligatory even if some parties may try to assert this. Payment for “the appearance of additional meters” can be demanded only after a technical inventory has been conducted by an authoritative body and prior to signing a document confirming the receipt/transfer of the space.

The most important information for the investor to obtain at this stage is the deadline for bringing the project back on line and the sum required for additional construction, as well as a step-by-step plan for how builders propose to complete the object. In addition to this, it is important to contact other investors and determine the state of the construction firm.

Collecting this information is a labor-intensive process. One should consider involving a lawyer with experience in these particular kinds of cases. At this stage, the investor’s task, or rather the task of his lawyer, is to prepare a written declaration that the developer has been provided with the gathered information and to notify the construction ministry under whose jurisdiction the other party falls and the administrative bodies that granted the permission and documents for construction on the given plot. One can judge the state of the construction company from the number of suits filed against it by creditors, information obtainable on the official site of the arbitration court of the given jurisdiction.

Once the mood of co-investors has been gauged, one can determine whether it would be justified to invest additional money and extend the contract. It is unlikely that one would want to do this alone: Information from the developer’s representatives could be inaccurate, as they are interested in more investment. Situations occur when contracts are extended for different terms for different investors, and there are two possible explanations for this: The developer has permission from official bodies to bring the building housing the commercial space on line section by section, meaning the developer can deliver the object; or secondly, the developer has extended contracts serially in order to avoid suits seeking penalty payments. It should always be kept in mind that in signing an addendum agreement, an investor deprives himself of the possibility of defending his rights in court for the duration of the new term set for fulfilling contractual obligations.

When the group of investors has been determined, an action group can be formed. It has no legal status, so at the first meeting of investors, the question of the group’s authority must be addressed. Then a future plan for investor action should immediately be formulated. The first thing that must be decided is how to protect the investment if the developer delays in fulfilling his obligations to deliver or complete the object, or if the developer declares bankruptcy.


In the Case of Bankruptcy 
In the latter case, a bankruptcy trustee of the court (конкурсный управляющий) will initiate the confiscation of the debtor’s property for the timely satisfaction of the creditors’ demands. In collecting the debtor’s property, the bankruptcy trustee will register the object as a partially constructed property in the developer’s possession, since it was not delivered in accordance with the contracts and is located on a plot belonging to the developer. The object earmarked as partially constructed will be sold through a tender and investors will not retain any rights to it. In any case, the moment that state registration of the developer’s property is completed, the contract between investor and developer will cease to be in force, since one of the two parties to it will have ceased to exist.

Adequate compensation is understood not as full reimbursement of invested funds to the investor, but only as the sum remaining after the sale of a creditor’s property, including the sale of the investment object and other proceeds which will be divided among the creditors. In other words, let’s say that one hundred investors invested one million dollars each into a construction project. The building is not completed and is thus sold through a tender for 20 million dollars. Other than the investors, the debtor has another 50 creditors waiting in line. The result is that the investors do not receive one million dollars each, but 20 million dollars divided among 150 creditors in proportion to the sum owed each. When concluding a contract for selling the uncompleted object and debts to a third party, the sum is not that paid according to the last debt-restructuring contract, but according to the agreement between the developer and the first investor. In this way, the investor receives not the sum he invested several years ago, but something several times less. At the same time, the building or space may be ready for use to a large degree.

Further steps by the investor will depend on the degree of readiness of the investment object and the building it is located in. If the building is ready or already in use, but due to the inaction of the developer or administrative bodies has not received permission to come on line, then it will be necessary to collect information and conduct preliminary talks with the developer and the administration. If these talks do not produce results, the investors’ lawyers can file a suit to have the administrative inactivity declared illegal and to compel the issuance of permission to begin the exploitation of the property. It is necessary simultaneously to file a suit to have the space recognized as the developer’s property.

If construction of the building has not been completed but the investment object exists, the situation becomes more complicated. The fact is that court practice as regards this question is not yet completely formulated and courts render decisions both recognizing the property rights to an object in an unfinished structure and also asserting property rights to the unfinished structure. If it happens that precedents for the case are ambiguous, then the initial court will likely refuse the suit, forcing an appellate court to render an opinion either by upholding or overturning the decision. Prior to filing suit, it is necessary to study the practices in the given jurisdiction and be prepared to challenge the first court’s decision. The difference between suits seeking recognition of rights to the object and those seeking recognition of rights to the unfinished structure is that in the first instance, the court acknowledges the right if a document exists giving a concrete description of the object; in the second instance, the documentation describes the entire building housing the object. Such a document could be a technical passport. The difference in price for preparing these is palpable. Additionally, by preparing a technical passport for the entire unfinished structure, the investor makes it substantially easier to have the structure impounded and sold through a tender, which is risky. When filing a suit, one should petition to have the suit backed up by impounding the investment object so that during court proceedings nothing “happens” to it.

It should be noted that the recognition of property rights for an object in an uncompleted structure does not mean that the developer is freed from obligations or responsibilities. The contract is not annulled, and the developer remains bound by it. The above-mentioned suits are best filed en masse so as not to harm investors who may not have had time to apprise themselves fully of the situation. 

If a space is missing even one wall dividing it from another property, or a ceiling or a floor, then it will not be possible to have property rights to that object recognized, since it cannot be defined individually. In this case, it will be necessary to file a suit for rights to a share in an incomplete structure.

Annulling a Contract
The question of annulling a contract is a critical one. If the contract is annulled, the investor will not receive the investment object and risks receiving a writ of execution instead, which does not allow for collecting damages due to unfulfilled contractual obligations. This means losing everything. The best option if the developer does not have funds is not to annul the contract, but wait for the situation to improve.

What steps should be taken after court proceedings? A court verdict was of course not the aim of the investment; rather, it was to have the object of the investment completed and delivered.

How can the object be completed? If the developer’s accounts have not been frozen, or if there are no writs of execution regarding the recovery of funds, or debts are not large and co-investors are optimistic, then additional investment to complete the structure should be considered. But if these factors are not in play, then there’s no sense in putting in more money, since it will go straight to paying off the debts of the construction firm.

Another option for completing construction is to organize a new legal entity in order to gather investor funds to complete the structure, then independently hire contractors and finance the work. But before taking this step, the sum needed for completing construction needs to be determined. Figures offered by an existing construction company could have with complications: As a rule, those figures are exaggerated and include accumulated debts to contractors and suppliers. The exact sum for completing the project can be determined by having contractors bid for the work, for instance, for completing the roof or a floor. Competition between contractors will lead to lowered prices. The two best bidders, both in terms of price and the reliability of the contractors, should then pitch their offer. The entire selection process needs to be as transparent as possible. In the final analysis, investors should cast votes with an eye to cost. If trust issues exist on the construction site, these must be resolved, which is one of the hardest tasks. One must seek out allies in such projects. Doubtful investors and government representatives will move to the side that takes positive steps. The paradox is that often it’s harder to begin completing an unfinished structure than actually to complete it.

24 March 2010
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