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Counsel, Head of Real Estate
and Construction Practice,
Specifics of Real Estate Due Diligence in Ukraine
It is hard to overestimate the value of legal due diligence in real estate transactions, especially when multi-million euro investments are being considered. Since the mid-2000s, legal due diligence has become a standard part of real estate transactions in Ukraine. However, in the 1990s and early 2000s, when cross-border deals were rare in Ukraine, conducting legal due diligence was a real challenge.
At that time, most title documents, cadastral plans and technical documentation were maintained and stored only in paper format in various state and municipal archives, with access allowed only to the title-holders and their representatives. In such circumstances, carrying out a legal due diligence investigation depended much on the willingness of the property owner to disclose the relevant documents and information on the real estate. In practice, sellers did not demonstrate much cooperation and often took a “take it or leave it” position.
The situation changed significantly in the mid-2000s with an increase in the number and value of cross-border deals, which were conditioned by the positive outcome of legal due diligence. In 2013–2014, when title registration reform began and since that time, several public state registers have been established as a valuable and trusted source of information for legal due diligence in Ukraine:
— State Register of Proprietary Rights to Real Estate (let’s call it the title register for the sake of convenience) is an online digital register available to any third party containing information on the registered property rights to real estate and land, such as ownership, long-term leases, title documents, mortgages, easements, arrests and prohibitions on alienation, basic information on the property, its location, the title holder and title documents;
— State Register of Encumbrances over Movable Property contains information on tax pledges, including those affecting real estate. Information from this register may be obtained via a notary who has access to the register;
— State Register of Court Decisions is an online digital register available to any third party containing information on court disputes and decisions and injunctive measures, including those affecting real estate;
— State Cadastral Map is an online register available to any third party. As part of the State Land Cadastre, the State Cadastral Map contains basic information on land plots, their designated use, cadastral number, area and title thereto;
— Register of Construction Permits of the State Architecture and Construction Inspectorate is an online register available to any third party containing information on issued and registered construction permits and declarations on commencement of construction works.
At present, the above-mentioned state registers are open to the public and enable the carrying out of initial due diligence independently without the involvement of the property owner. In light of the various specifics of the Ukrainian real estate market and local regulations, such as controversial court practice, poor protection for good–faith purchasers, specific and rather expensive title insurance, the possibility to conduct an independent due diligence investigation is a step forward to protect buyers and investors and reduces market risks.
Local legal and market specifics often affect the scope of due diligence. For example, the standard practice of requesting the seller to provide representations and warranties in order to mitigate the potential buyer’s risks does not work well in Ukraine. This normally works in share deals driven by English law, which is often chosen as the governing law in cross-border deals. However, this becomes an issue in real estate asset deals with the targeted property located in Ukraine, which may only be governed by Ukrainian law. Because representations and warranties as concepts are not duly implemented and do not fully comply with Ukrainian contract law, the incompleteness or inaccuracy of representations and warranties would not normally create a valid ground for a lawsuit under Ukrainian law. In such circumstances, the great importance of conducting a deep legal due diligence investigation rather than a basic title check is obvious. Scrutiny of the assets should enable the timely identification and evaluation of risks, provide arguments for price negotiation and place the obligation of the elimination of risks on the seller as a part of pre-closing obligations.
So, what are the key points to be considered to determine the scope and conduct a real estate legal due diligence in Ukraine, which will save your time, nerves and investments?
Surfing the public title register is a good start, as it helps to identify zones for further investigation, but a detailed analysis should follow.
Please keep in mind that the state registration of title to real estate in Ukraine only confirms the validity of the title at the moment the respective title record is available in the title register, but does not confirm the legitimacy of the acquisition of the title. Any historical defect may become the basis for challenging the title registration and its cancellation. For this reason, the acquisition history of the property, the legitimacy of such acquisition and the fulfilment of obligations under the respective title transfer deeds should be studied with care.
Another aspect to be considered is that some rights and encumbrances to real estate and land are not subject to mandatory state registration and so are not reflected in the title register. For example, a lack of information on mortgages in the title register does not mean that there is a lack of such mortgages. This is because mortgages concluded prior to 8 August 2012 were considered valid even without their state registration. Summing up the above, the existence of unregistered mortgages, preliminary agreements, short-term lease agreements, the pre-emptive rights of tenants and some other third-party rights to real estate and land, should also be verified.
Do Not Rely on a Limitations Period when Establishing Timeframes for Due Diligence
When establishing the timeframes for due diligence, many investors consider the term within the general limitations period, which is three years under Ukrainian law. However, it is often overlooked that a court may renew the limitations period if it is missed due to a reasonable excuse, and as a matter of practice Ukrainian courts renew the limitations period on a regular basis.
The calculation of the limitations period may also be an issue, considering that it starts from the date when a person whose rights were violated by a deal became aware, or should have been aware, of such a violation rather from the date of the deal. Such issues often arise in deals involving vacant land plots that were not used for a long time and where the legitimate owner was not able to identify any violation of its title.
Privatised Property, State and Municipal Land Plots are in the Risk Zone
Under Ukrainian law, defects in privatisation or land allocation procedures may be the basis for the invalidation of the respective privatisation or land sale deed. An invalid deed does not create any legal consequences. According to court practice, this means that regardless of the number of transfers of property, in case of the invalidation of the original deed, all subsequent title deeds are also considered invalid, regardless of whether or not the purchaser proves its good-faith status. Therefore, in order to exclude the risk of withdrawal of the property, it is advisable to strengthen the focus on the legitimacy of the privatisation or land allocation of former state-owned or municipal real estate and land in the course of due diligence.
Site Visits are Recommended
Under Ukrainian law, the purchaser of a building acquires the title to the underlying land belonging to the seller. An owner of real estate also has the right to lease or buy-out the underlying state or municipal land without a land auction. It often happens that several buildings owned by different persons are located on the same land plot. At the same time, a lot of real estate in Ukraine remains without a title registered in the title register. The lack of such registration of title does not always mean the invalidity of title, and the unregistered owner of real estate may further claim its rights to underlying land. Therefore, if a real estate asset deal is targeted on the further lease or acquisition of the underlying land, a site visit is recommended and should not be avoided by the purchaser, as it may enable the timely discovery of the existence of third-party buildings on the targeted land. The site visit should also exclude the situation where property that exists according to documentation does not exist physically (already demolished, or the title documents were fabricated).
Technical Due Diligence should not be Avoided
A technical due diligence often helps to identify various hidden risks that may not be discovered by lawyers on the basis of a review of documents. The most typical issues that may be discovered in the course of technical due diligence are overlapping borders of land plots with adjacent plots, unauthorised rebuilding of property, unexpected underground networks and utilities that may affect the value or possibility of construction.
Chose your Legal Advisor Responsibly
Due diligence concludes with the issuance of a due diligence report. At this stage, there is a risk that a highly promising commercial project may be over before it even starts because of an overestimation of the materiality or probability of risks, or due to a lack of understanding of the available options for the elimination or mitigation of risks. In order to avoid such a problem, it’s reasonable to select a legal advisor to carry out legal due diligence with a deep understanding of the respective market, previous experience with similar projects, with a good reputation and understanding of the best international practices. A good advisor would normally not only identify risks, but would also provide a realistic risk assessment and offer options for risk mitigation or elimination, including by the local counterparty as a part of its pre-closing obligations.