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Questions and answers in real estate and construction

06.04.2020
11 min read

1. May the current situation be regarded as force majeure and how can parties to a lease use their opportunities in practice?

Force majeure is regulated by article 401 of the Russian Civil Code (the "Civil Code"). Under clause 3 of this article “a person that has failed to perform or has improperly performed its obligation during entrepreneurial activities is held liable unless it proves that proper performance was impossible owing to a force majeure”. By “force majeure” the law means “extreme circumstances unavoidable in the given situation”.

Beyond doubt, the outbreak of COVID-19 is an extreme and unavoidable event. Yet, the question of whether it is a force majeure for the purposes of a lease may be answered differently with respect to various specific obligations. For instance, sanitary measures may become a force majeure circumstance preventing the performance of an obligation to transfer premises to the tenant (in view of a prohibition on this type of activity imposed by regulations issued by state authorities). At the same time, it may turn out that such measures are not a force majeure circumstance for other obligations (for instance, for obligations of a lessor to ensure the security of a property and the removal of garbage from it or for obligations to pay the rent).

Consequently, to rely on force majeure a party to an agreement will be required to analyse in detail what obligations specifically were impossible to perform owing to force majeure. It will also be required to send to the other party a notification (by registered mail with a list of contents and return receipt, unless the contract provides for another procedure) specifying which obligations the party is unable to perform and which circumstance is a force majeure in this situation. This must give the notifying party an exemption from liability for the non-performance of its obligations. However, if the other party disagrees with the classification of this circumstance as a force majeure, a conflict may arise that will have to be resolved through a court. The court hands down the final decision as to whether the force majeure has really made it impossible to perform that specific obligation. It should be noted that such circumstances as a lack of funds, lack of goods on the market or breach of obligations on the part of the debtor’s business partners are not a force majeure.

It is important to understand that, by virtue of article 401(3) of the Civil Code, a force majeure only exempts the party from liability, but does not terminate the obligation itself. This means that the tenant, for instance, will still have to pay the rent for months of idle time. The exemption will only extend to penalties for not paying the rent or for delays in rental payments and to the compensation of the landlord’s potential losses. In turn, the landlord will remain obliged to transfer the premises to the tenant and not to interfere with the tenant’s use of the premises, but if the landlord breaches this obligation, it may not have losses or penalties charged to it, either.

In this regard we would like to draw your attention to the position of the Moscow Chamber of Commerce and Industry (MCCI) published on 26 March 2020. The MCCI recognises a force majeure and issues opinions confirming a force majeure only if your business has been directly affected by the measures undertaken by state authorities to counteract the epidemic. For instance, the Moscow city mayor’s Decree No. 34-UM dated 29 March 2020 suspended the work of cafés, bars, restaurants, canteens, diners, retail shops, beauty salons and other enterprises. Moreover, the introduction of such restrictions does not relieve the relevant enterprises from the obligation to pay the rent for the period when their operations were suspended.

We believe, however, that the situation is not so simple, and under some circumstances exceptions can be made to this rule, meaning that a tenant may be exempted from rental payments in full or in part. For instance, account should be taken of clause 5 of the Court Practice Overview No. 2 (2015) approved by the Resolution of the Presidium of the Supreme Court dated 26 June 2015. The overview specifies that the tenant “is not obliged to pay the rent for a period in which it is deprived of the opportunity to use the leased property owing to circumstances beyond its control”. This may give rise to the question of not only whether an exemption from state duty may be required, but also whether there is the principal obligation to pay the rent during the period when it is impossible to use the rented property. We believe that the outcome in this situation may be affected by various factors. For instance, whether the tenant and the tenant’s personnel had actual access to the leased property (a restaurant in a shopping mall that was actually closed) and whether they could have used the property in question for conducting business (e.g. in an alternative way, such as offering takeaway food and delivering it via courier services), whether it was possible to perform operations for which the lease had been concluded (among other things, whether your business falls under the epidemic restrictions), and others. Attention should be paid to situations that may be specifically provided for in lease agreements. For instance, certain leases provide that the landlord must ensure the work and occupancy of the shopping mall (i.e. that a certain minimum number of sales outlets should be open) as a pre-requisite for rental payments.

As for the economic circumstances of the landlords’ operations (a fall of revenues, reduction in turnover, the fall of the rouble exchange rate against foreign currencies), including those caused by the pandemic and the economic downturn, such circumstances are unlikely to be recognised as a force majeure.

In addition, it should be remembered that there are other measures of legal protection that may potentially be applicable and available in the current situation. These may include amendments to and the termination of the agreement in connection with current changes in circumstances in accordance with article 451 of the Civil Code, as well as the termination of obligations in connection with a regulation being issued by the state authorities pursuant to article 417 of the Civil Code.

Article 451 of the Civil Code states that the obligation may be terminated or amended in connection with a “material change in the circumstances that the parties proceeded from when entering into the agreement”. At the same time, these circumstances must change to the extent that the parties could not have reasonably foreseen such a change when entering into the agreement and the change must be insurmountable for the parties.

Admittedly, the outbreak of COVID-19 is incomparable not only to anything that has happened in the history of modern Russia, but also to anything that has happened throughout many decades. Bearing this in mind it would be a reasonable assumption that, when entering into the agreement the parties could scarcely have taken account of a possibility of a similar pandemic. No doubt, the parties cannot overcome this circumstance using their own resources and it may place one of them in an extremely onerous position (for instance, in the absence of revenue the obligation to pay the rent for empty premises puts the tenant on the verge of a bankruptcy).

In such a situation a party to the agreement (both the tenant and the landlord) may receive the right to demand that changes be made to the agreement to adjust it to the new conditions (for instance, the parties may amend the method of settlements or suspend the accrual of rent). If they fail to come to an understanding about such amendments this may become a ground for terminating the agreement with recourse to a court.

The above article, however, only establishes conditions under which the parties may demand amendments to or termination of the agreement. The set of facts required for amending the agreement is quite complicated and contains a number of evaluative categories. The court will consider each case separately. Moreover, no case law is available at present with regard to this article being applied in Russia and, therefore, it is hard to assess the prospects of a case. On the other hand, no comparable circumstances have occurred in this country until now, so courts will probably start applying it in the near future.

It is also suggested in article 417 of the Civil Code that “an obligation terminates (in full or in part) if a state authority issues a regulation making its performance impossible”.

This measure may turn out to be relevant for small and medium-sized businesses in the context of the Moscow city mayor’s Decree No. 34-UM dated 29 March 2020, which suspends the work of retail facilities (among others). For instance, a landlord or tenant may pose the question of the termination of obligations to rent out non-residential premises and to pay the rent, respectively, for months in which the restrictive sanitary measures remain in effect.

2. How to ensure safety and outline the rules of the game for those involved in the real estate market and for regulators? How are the landlord and tenant held liable if any adverse incidents are identified in office premises?

We believe that in order to ensure safety and viable rules of the game, participants in the real estate market and regulators should consider the introduction of extensive economic support measures. Among such possible measures are temporary tax benefits, vacations, deferrals with respect to compulsory payments and social security charges. The government could also support market participants by extending beneficial loans and subsidising their payments under obligations to banks, which would enable many of them to avoid a dismal outcome.

In addition, for participants in the commercial real estate market it may be useful if employers were exempted from payments under sick leaves for the first three days of an employee’s temporary incapacity to work with such obligation being imposed on the Social Security Fund, as well as temporary measures aimed at compensating lost salary to those employees that cannot work remotely. This will allow market participants to painlessly cut salary expenses without staff redundancies that may lead to additional one-off expenses in the form of severance payments.

With respect to liability in the context of the COVID-19 outbreak, account should be taken, in the first place, of article 6.3. of the Russian Code of Administrative Offences, which establishes liability for a violation of legislation concerning the sanitary and epidemiological welfare of the public (for instance, for working in violation of the ban imposed by the state sanitary inspector). At present, legal entities may be held liable in the form of a fine of RUB 10,000 to RUB 20,000 or in the form of an administrative suspension of their activity for a period up to 90 days. Close attention should also be paid to possible future amendments to this article.

3. What kind of lease agreement may protect tenants in future if business processes are changed?

Based on our observations, after the economic downturns of 2008 and 2014 it became a widespread practice on commercial real estate market to make the rent dependent on the value of returns. Today, we believe it may be prudent to create broader flexibility in contractual relationships between landlords and tenants. Market participants should probably make provision for exempting tenants from rental payments and compensating the landlord for such an exemption, as well as establish the ground and procedure for granting such benefits. The parties may also agree, for instance, to take out insurance against the losses resulting from an epidemic or other circumstances leading to a temporary inability to conduct commercial operations.

In addition, closer attention should be paid to the force majeure sections of contracts. It would be prudent for the parties to describe in greater detail which consequences they will regard as a force majeure, how they will confirm them to each other and what the contractual implications will be.

4. Which factors will ensure sustainable business in the area of commercial real estate for investors and developers?

We believe that the sustainability of a business in the area of office real estate can be attained by ensuring that benefits are introduced that involve a deferral of or a temporary exemption from rental payments that are permanent expenses for investors and developers. For instance, landlords and developers would benefit from a greater itemisation and expansion of such measures as property tax vacations, as well as benefits and deferrals relating to rental payments for land. Temporary VAT benefits could also be useful.

The readiness of investors and developers to unite to protect their economic interests collectively may also play an important role. For instance landlords and developers could work through existing organisations, such as industry associations, chambers of commerce and industry, regional unions of employers, and the Russian Union of Industrialists and Entrepreneurs to coordinate their efforts and conduct a constructive dialogue with the state authorities. This may enable investors and developers to obtain those specific measures of economic support from the government that they need most.

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