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Appetites of Municipalities

Federal Law №149-FZ, dated July 17, 2009 has not eliminated legal lacunas and conflicts of Federal Law №159-FZ.

It has been more than a year since the Federal Law № 159-FZ on Particularities of Disposition of Property Owned by Subjects of RF and Municipalities, and Being Leased to Subjects of Small and Medium-Sized Business, dated July 22, 2008, has come into force. Since then the legal practice has brought to light legal lacunas and conflicts which unfortunately have not been eliminated by the Federal Law № 149-FZ, dated July 17, 2009.

The absence of legal criteria for listing the property provides the municipalities with possibility to factually to repeal the Law №159-FZ within their territory. Nothing hinders municipalities from listing all of the property they own. For example, the respective List of Ekaterinburg municipality includes 1115 properties, it is more than in the similar List of Moscow (1062 properties). By such actions municipalities abuses their powers because these actions are aimed exclusively at obstructing redemption of premises being leased by small and medium-sized business (SMB).

Moreover, the situation is complicated by the following. The law does not provide any control mechanism for actual use of the premises included in the List for the benefit of SMB. Proceeding from the name of the List it can include only the property intended to be transferred to the subject's of the SMB possession and (or) use. Nevertheless, having included a specified property in the List, municipality is free not to transfer it actually to the subject's of the SMB possession and (or) use. The Federal Law №159-FZ neither provides real possibilities for examination of intended use of property by municipality, nor procedure for listing specific property in the List at request of SMB.

Furthermore, the Law №159-FZ does not authorize the SMB lessee to contest listing of specified property in the respective List. Such situation has been examined by the Arbitrazh Court of Sverdlovsk region. In the Decision №А60-13771/2009-С9 of June 9, 2009, the court refused to satisfy the entrepreneur's claim to hold the normative act which approves the respective List inoperative, to the extent it lists the specified premises. The court pointed out that municipality in its quality of owner has right to dispose of its property, including making decisions on procedures and conditions for its privatization.

Ambiguity of Law

The deliquescence of terms is illustrated by the provisions on lease period, for example. The subject's of the SMB right to purchase the premise being leased arises upon 2 or more years of continuous use which has started before the date when this Federal Law came into effect, in other words, prior to August 5, 2008 (subpara.1, para. 3 of Art. 3 of the FL №159-FZ).

Beyond any doubt, for the purpose of redemption it would be more reasonable to start counting the premise's use period from the date the application on intention to redeem the premise being leased is filed by a specified SMB, rather than the date when the law comes into force. According to the Law №159-FZ in effect, SMB which has been using the premise being leased, for example, for a period of August 5, 2007 – October 2009, will never acquire the right to redemption in view that it has been leasing the property for a period less than two years as of August 5, 2008.

In practice, some more significant disputes have arisen over such condition for exercise of the right to redemption as "duly" making lease payment during the lease period (subpara. 2, para. 1, Art. 3 of the FL №159-FZ).

Using this wording, the municipalities were massively denying the right to redeem the premise in event if there was any delayed lease payment for any month, including one-day delay. However, considering such cases the arbitrazh courts are proceeding from necessity to assess the significance of the violation for every particular case. For example, the Arbirtazh Court of Kemerovo region in the Decision №А27-358/2009-5 of February 13, 2009 has come to the conclusion that the violations committed by lessee "were not significant and systemic in view that the overdue time period was insignificant and payment was delayed only in some instances". Today Russian Arbitrazh court practice in this matter is rather unified.

An apparent ambiguity of this provision was cured by the Law №149-FZ: henceforth, the condition for exercise of the right to redemption by the subjects of the SMB is considered to be the absence of the lessee's default in any of the lease payments as of the date of filing application on redemption.

Such wording cured the previous ambiguity of this criterion, however, unfortunately, it opened a possibility for municipality to abuse of its right.

Thus, an entrepreneur who has been leasing a premise for more than 10 years, applied to municipality to redeem the premise. In response the municipality calculated liquidated damages for delayed lease payment for all the period of use of the premise (more than 10 years). Notwithstanding the insignificance of delays (from one to seven days) and proceeding from the liquidated damages' amount of 1% of lease payment, as well as the significance of the amount of monthly lease payment, the municipality calculated the total amount of liquidated damages of about one million rubles. Without any doubt, the main portion of the calculated amount is beyond the three-year period of limitations, and in event if the municipality filed an action to collect the damages, the liquidated damages for the past three years would had been reduced by the court on the grounds that they are unproportionate (Art. 333 of the CC of the RF). Nevertheless, formally until the moment the liquidated damages are payed in full municipality has right to deny SMB its right to redemption. We believe that the actions of municipality in this situation represent the abuse of right (Art. 10 of the CC of the RF), however it is quite difficult to prove it to the court.

Moreover, there are different possibilities to interpret the requirement concerning that during all the specified period the property being leased shall be "in the temporary possession and (or) temporary use of the subject of the SMB..." It could be constructed as if the right to redemption arises only in case when the lessee has been a subject of the SMB during all the two-year period. In practice there could be a situation when as of the date of filing the application on exercise of the preemptive right the lessee is a subject of the SMB, however it was not meeting the SMB criteria for some period during last two years. In addition, contrary to this situation it is possible that the subject of the SMB looses his status of SMB after filing the application on redemption.

We believe that proceeding from the intent of the law the question if the subject of the SMB has a preemptive right to redeem the premise being leased should be addressed as of the date of filing application on redemption, in view that it is the moment when the municipality's obligation to conclude with a subject of SMB a contract of purchase-sale of the property being leased arises.

Evasion of redemption

For the purpose to evade the premise's redemption by subject of SMB often municipality uses various practices.

The most common example is listing the property in the List of the property intended to be transferred to SMB's possession and (or) use after receipt of the SMB's application on redemption.

For example, the respective List of Ekaterinburg came into force on March 18, 2009, the application on redemption was filed by the entrepreneur March 5, 2009, in other words, prior to the effective date of the List. However, the municipality denied redemption on the grounds that the property was listed in this List. The Decision of the Sverdlovsk Arbitrazh Court №А60-24185/2009-С9 of September 10, 2009 held the denial of redemption illegal.

Aside from listing property in the List, municipalities are practicing transfer of the premise being leased into economic management of a municipal unitary enterprise or operational management of a municipal institution. Formally it is in compliance with the law, nevertheless in essence the only purpose of such transfer is to prevent the subjects of the SMB from redemption of premise.

Moreover, it is a common case when upon receipt of the application on redemption of the premise being leased the municipality rescinds the contract of lease with the subject of the SMB (or resiles from it) on any grounds, followed by selling the premise through auction sales to other persons which do not possess the status of the subject of the SMB.

A gross violation of the rights of the subject of the SMB occurred in Alapaevsk of Sverdlovsk region where collection ("at the suggestion" of the municipality as debtor) was enforced against the municipality's premises being leased by the subjects of the SMB. The premises were put up for auction sale in compliance with the procedures provided under the Federal Law on an Execution Proceeding. Moreover, in violation of the para. 1, Art. 77 of the Law on an Execution Proceeding, notwithstanding that the property of the debtor (municipality) was held by the third persons (lessees), collection against this property was enforced prior to the issuance of the respective instruction of the court. As of the moment the Procuracy of Sverdlovsk region intervened, some of the premises being leased have been already realized through auction sales to other persons which were not the subjects of the SMB until.

Violation of rights of subjects of SMB

Unfortunately, the Law №159-FZ does not explicitly prohibit to impose additional payments or property redemption charges on the subject of the SMB, and some municipalities are taking an unfair advantage of it. More specifically, the Novouralsk city district of Sverdlovsk region provided in the draft redemption contracts that the property assessment costs in addition to the redemption price of the property are beared by the subject of the SMB. Upon consideration of the pre contractual dispute, the Arbitrazh Court of Sverdlovsk region excluded this provision from the contract on the grounds that it is not in compliance with the Law №159-FZ (Decision of the AC of Sverdlovsk region №А60-30011/2009-С7, dated September 22, 2009).

The same rules concerning compensation of certain municipality's "additional charges" are provided under the Regulation on Procedure for Disposition of Real Estate Property Owned by Ivdel City District, which approves the contract form for the purchase and sale of the property. In addition to the buyer's obligation to pay the purchase price, it provides for its obligation to pay a certain "seller's fee for the actions connected to sale" (Section 2.3 of the Contract).

Although the procedure for payment in installments is provided under para. 2, Art. 5 of the Law №159-FZ (determination of the procedure and due dates for payment is the right of the subject of the SMB), in practice municipalities often try to limit this right of the subject of the SMB making provision on lump-sum advance payment for property being leased in the purchase-sale contract.

It is the Ekaterinburg municipality which has gone the furthest in this matter. In the Regulation on Procedure for Disposition of Real Estate Property Owned by the Ekaterinburg Municipality and Leased by Subjects of the Small and Medium-Sized Business it provided that the amount of the first installment under the contract of the purchase and sale of the real estate property being leased shall not be less than 50% of the redemption price of the premise (Para. 28). Currently the Arbitrazh Court of Sverdlovsk region with participation of the Procuror of Sverdlovsk region is considering the case brought upon the application of the subject of the SMB who claims to invalidate the normative act (to the extent it provides for advance payment). The Decision of the Arbirtazh Court of Sverdlovsk region №А60-32107/2009-С9 of October 13, 2009 held the Regulation mentionned above (to the extent it provides for advance fee in the amount of 50%) non compliant with the Law and inoperative.

Neither the Law №159-FZ regulates the possibility for redemption of the portion of the premise being leased, although due to various reasons the subject of the SMB may intend to redeem just a portion of the premise rather than the entire property, naturally, on condition that the premise can be portioned technically (according to the inventory rules) and it is possible to use it as a separate property.

This possibility is very important for the subject of the SMB in view that the Law's provision on the subject's of the SMB right to redeem a portion of the accommodation being leased authorizes it to exercise its right even in case when the total surface area of the premise it leases exceeds the limits of the surface area values for premise provided under the law of the subject of the RF out of which arises the right to redeem the premise.

We believe that as one of the legal lacunes of the Law №159-FZ we should point that the law does not authorize the subject of the SMB to exercise discretion in bringing into the proceedings an appraiser for determination of the redemption price of the property being leased in case when municipality evades to conduct an appraisal.

In practice rather often the respective authority obstructs the right to redemption of the subject of the SMB by simply not ordering an appraisal of the premises being redeemed. In this case the municipality can invoke such objective reasons as absence of funds in the municipal budget to pay for the appraiser's services.

Due to the explicit provision of para. 3, Art. 9 of the Law №159-FZ the respective state (municipal) authority has an obligation to ensure the appraisal (i.e. conclude an appraisal contract and make payment under it).

Thus, in the Decision №А60-30011/2009-С7 of September 22, 2009 the Arbitrazh Court of Sverdlovsk region did not take into consideration the appraisal conducted by the lessee himself. The Court pointed that "as it follows from the implication of the Federal Law №159-FZ, the appraisal obligation lays upon the defendant (the municipality)". Following the logic of the arbitrazh court, it is "this appraisal which represents a necessary condition for approval of decision on privatization of the property being leased by a respective authority ...".

Right of sub-lessee

The Law №159-FZ shows a significant ambiguity in regulation of the sub-lessee's right to redeem the premise.

As a general rule, according to para. 2, Art. 615 of the CC of the RF the rules for lease contract apply to sub-lease contracts unless otherwise provided by the law or other legal acts.

It is of principle that the Law №159-FZ itself does not provide any provision on its application to sub-lease contracts. i.e. all the rules on lease contracts apply to sub-lease contracts, including the rules of the Law № 159-FZ. It means that the sub-lessee if he is not a subject of the SMB has also the right to claim the preemptive redemption of the premise being leased by him in accordance with the provisions of the Law №159-FZ (certainly, subject to all of the other provisions of the law).

Nevertheless the arbitrazh practice follow the path of denial to the sub-lessee of the right to redemption.

More specifically, the AC of Sverdlovsk region in its decision №А60-24852/2009-С9 of September 28, 2009 pointed (without giving any grounds) that "the sun-lessees do not have the preemptive right to redeem the property under the procedures provided by the Federal Law №159-FZ". However the court neither invoked, nor evaluated para. 2 of the Art. 615 of the CC of the RF in its decision.

The AC of Smolensk region in its decision №А62-6465/2009 of October 5, 2009 concluded (without any grounds as well) that "the rules on lease contract apply to sub-lease contracts except for the provisions of the Federal Law №159-FZ, date July 22, 2008".

Nevertheless, para. 2 of the Art. 615 of the CC of the RF does not provide that only the rules of the CC of the RF apply to sub-lease contracts, accordingly any legislative rules on lease apply to sub-lease contracts. In this case the arbitrazh court has distorted the scope and implication of this rule of the law.

Obviously, actually the lessee which enters into a sub-lease contract and transferred the premise to possession and use of the sub-lessee, act only as an agent during the term of the lease and does not use these accommodations. Pursuant to the rules of the Law №159-FZ, the right to redemption must arise for the person which is actually using the premises being leased.

Proceeding from the letters of the Law №159-FZ we can conclude that the rights of the lessee-agent who is neither using, nor holds the premise being leased prevail the rights of the sub-lessee being the subject of the SMB who actually uses and holds the premise being leased.

Privatization, Real Estate, Real Estate Disputes

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