Legal Line

Daniel Klein’s Legal Line

Each month Daniel Klein fields corporate legal questions posed by Passport’s readers. Do you have a Russia-related legal question you’d like Daniel to address? Tell him about it at dklein@passportmagazine.ru.

Dear Daniel:

Our stock-listed Western company is planning to set up operations in Russia and would like to purchase a warehouse and light manufacturing facility in or around Moscow — potentially an existing plant or brown field site.. I have been told that buying real estate in Russia can be quite tricky and riskier than in the West. Do you have any advice about pitfalls we should look out for as we proceed?

Dear Factory Developer:

I’m sorry to say that your goal of purchasing a brown field site in Moscow may be very difficult to accomplish. First, there are virtually no land plots left for sale within Moscow’s city limits. The number of industrialized zones in the city is dwindling, and those that remain are rapidly being rezoned for commercial and/or residential use. Even if you manage to find a property that is still zoned for industrial use, be aware that the zoning may change at a moment’s notice. In addition, it is, practically speaking, all but impossible to buy land in Moscow itself. In general, the prevalent model is to rent from the city for a maximum of 49 years. Outside Moscow’s city limits, the purchase of land is easier and more feasible, although, depending on the site, land leases are still common there as well.

Another reason that purchasing commercial real estate in Russia can be more complicated than in the West is that here these transactions often take the form of the sale of a company that has the real estate as its principal asset. Whereas in the West a single due diligence — on the real estate itself — would be necessary, in Russia, if you end up purchasing a company which owns a plant, you will want to carry out a second due diligence.

To do this, it is common practice to search federal, regional, and municipal databases for information relating to titles, mortgages, liens, etc. However, even after doing that, there is no guarantee that issues will not come up aft er a purchase is made. There are horror stories in which real estate owners have seen their transactions invalidated based upon an obscure claim made by, for example, the Federal forests commission. Purchasers of recently privatized properties have extra due diligence burdens with respect to the privatization procedure.

Another difference between Western and Russian norms when it comes to the purchase of commercial real estate is the question of power upgrades. An increase in power supply, should your property require it, may be difficult to obtain (or even impossible, depending on the capacity of the local power station). Sometimes the electric/gas company may charge millions of dollars for a seemingly small increase. Finally, be aware that making signifi cant changes to your brown field site may require a painful and costly rezoning that could cause delays to your project. Even worse, the municipality may try to have the purchaser execute what is known as an “investment contract.” This is a complex agreement by which the investor (i.e., the purchaser of the real estate) may be required to give the government a share of the company that owns the real estate with an option to buy back the government’s share at a later date. Another type of investment contract arrangement may require the investor to fund the construction of local roads, schools, etc.

The bottom line is that purchasing real estate in Russia can be complicated, so the best advice is to consult an expert who is familiar with your own particular business model and needs.