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LEGAL FOCUS WITH PARTNER NORR STIEFENHOFER LUTZ

Risk associated with purchasing real estate properties

The real estate boom in Slovakia shows no signs of slowing down and all indications are that it is not likely to subside any time soon. The high rate of economic growth achieved in the last few years has ended up being reflected in rising prices in the real estate market. Real estate prices have in fact been rising much faster than the living standard of the general population.

Jana Bujnová.
photo: Courtesy of Norr Stiefenhofer Lutz

The real estate boom in Slovakia shows no signs of slowing down and all indications are that it is not likely to subside any time soon. The high rate of economic growth achieved in the last few years has ended up being reflected in rising prices in the real estate market. Real estate prices have in fact been rising much faster than the living standard of the general population. The sharp rise in the prices of real properties, particularly in Bratislava and its immediate vicinity, has not levelled off so far and the price gains in this sector are in fact expected to accelerate until the Slovak Republic adopts the euro, as it plans to do in 2009. In Bratislava, new buildings are going up almost everywhere yet the demand for properties continues unabated. On top of all that, the long-promised Act on Demonstrating the Origin of Assets, which was championed by the political party SMER before the election, could end up bringing about an even steeper rise in demand for real properties.

Pointing to the Czech Republic as an example, many experts believed that the pronounced rise in real estate values would only be a temporary phenomenon and would gradually peter out over the course of about three years. In fact, however, the Bratislava market ended up following a very different scenario. On one side you have the incredible potential of this city, its high rate of economic growth, continuing rapid development and outstanding location (70 km to Vienna, 350 km to Prague and 189 km to Budapest) and on the other side the limited amount of available space, which translates into limited opportunities for new construction. Despite the impressive rise in prices that has already taken place, the purchase of a real estate property continues to represent a very attractive investment opportunity. Nevertheless, there are certain risks associated with every transaction. And purchasing real estate is no exception.

All investors, whether foreign or domestic, corporate or individual, typically require the seller to present a current extract from the title list before purchasing a property. In Slovakia, however, this is not enough. Purchasers cannot assume that the party recorded as the owner is in fact the actual owner of the property.


Acquisition of title to real estate


Several preconditions have to be met before a purchaser can acquire ownership title to a real property. In addition to having a valid purchase contract, which must be in written form, it is also necessary to give legal effect to the transaction by registration of the information into the Real Estate Cadastre (Land Titles Register). This means that ownership title to a real property is acquired upon registration in the Real Estate Cadastre and such registration causes the legal right of ownership to arise. Under current Slovak legislation, the enforceable decision of the cadastral administration which authorises the registration makes an already valid purchase contract effective. By this step, the purchaser also acquires title to the property being transferred.


Principle that recorded information can be assumed to be materially correct


The fundamental precondition for a transfer of ownership title is the application of a principle originating from Roman law, that no-one can transfer to another more rights than he himself possesses ("Nemo plus iuris transferre potest quam ipse habet"). This means that ownership title can only be acquired from the owner and that all in-rem restrictions (restrictions relating to things) encumbering the thing being transferred pass to the acquirer. The acquirer obtains ownership title that is of the same scope as the ownership title of the original owner (for the sake of completeness, certain exceptions to this rule do exist).

A peculiar feature of and risk associated with the present legislative treatment of this area consists of the so-called principle of material correctness of entered information. Pursuant to this principle, the information described in ¦ 7 of the Cadastral Act (i.e., information on rights to real estate properties) "is trustworthy and binding unless proven otherwise". Accordingly, if it were to be subsequently determined that the owner recorded on the title list is not or was not the actual owner, there could be a problem.

This problem could be avoided to a certain extent by reviewing the Collection of Documents kept at the applicable Cadastral Office. However, it should be pointed out that access to the Collection of Documents is restricted and consequently an acquirer must rely on cooperation from the seller.


Withdrawal from a contract


The second problem during the acquisition of title to real estate arises in connection with withdrawal from the purchase contract. Upon withdrawal from the purchase contract, the legal grounds on the basis of which the applicable party acquired title to the property cease to exist and the original state of affairs is restored. But what about a case where the acquirer transferred the property to a third party before the withdrawal from the purchase contract took place? There is no uniform opinion among lawyers as to the answer to this question.

When withdrawal from a contract takes place, the contract becomes null and void, unless a law stipulates otherwise or unless the parties agreed otherwise. Withdrawal from a contract is a unilateral legal act that causes the contract to be null and void. The legal relations between the parties are restored to the state of affairs that would have existed if the contract had not been concluded. Any performance already rendered under such contract is deemed to constitute unjustified enrichment and each of the parties is obligated to return what they received under a contract that was withdrawn from. This also applies if upon such withdrawal, the contract on the transfer of title to a property, i.e. the contract on the basis of which ownership title was entered into the Real Estate Cadastre, becomes null and void. Since the legal grounds on the basis of which the acquirer obtained ownership title to the real property have ceased to exist, after the contract becomes null and void, the state of affairs that existed between the parties prior to the conclusion of the contract is restored, restored not only as concerns contractual-obligation effects but also with regard to the substantive legal effects of the contract. According to this legal view, the transferor continues to be the owner of the property and in fact never ceased to be the owner, even though a contract on the transfer of title was concluded. Consequently, if Party A transferred ownership title to a property to Party B and such Party B subsequently transferred title to Party C, then in the event that Party A withdraws from the contract it continues to be the owner of the property even though ownership title has already been transferred to Party C and Party C is recorded in the Real Estate Cadastre as the owner of the property.

The foregoing fact would be entered into the Real Estate Cadastre by recordation. Under such a situation, no further party could acquire ownership title to the subject property from the acquirer, since the acquirer cannot transfer a right that he does not possess.

In contrast with this, there is also the opposite legal view which argues that withdrawal from a contract can have legal consequences solely on the parties to the contract. Such withdrawal therefore cannot impact the position of a third party that duly acquired ownership title to the asset constituting the subject matter of the contract that was withdrawn from. Otherwise such a situation would breach the principle of legal certainty, the foundation block of the rule of law.

If this principle did not apply, the owner of an acquired asset could never be certain of his ownership. Ownership title could be taken away from the owner through no fault of his own and he could not rely on the fact that prior to acquiring title he verified (from the Real Estate Cadastre) that the seller was in fact the owner of the property being sold.

An argument frequently presented in support of this view is the argument that when a contract becomes null and void, the parties have an obligation to return to each other everything that they received pursuant to the contract. However, if at that point the property has already been transferred to another party and consequently it is not possible to return the performance received pursuant to the contract, monetary compensation must be provided instead.

So if the transferor transfers ownership title to an asset in a legally valid manner, the new acquirer's ownership title cannot be affected by the fact that the transferor's legal predecessor-in-title (the previous owner) subsequently withdrew from the agreement.

Both of the foregoing legal opinions rest on sound arguments and are the subject matter of legal debates. The impossibility of acquiring ownership title from a party that is not the owner and the consequences of withdrawal from a contract on transfer of title to a real property are issues that end up being opened quite frequently. A similar legislative treatment also exists in the Czech Republic. In a ruling dated 19 April 2006 that addressed the effects of withdrawal from a contract, the Czech Supreme Court and leaned towards the former of the two above-described legal views. But even in this case, the approved text of the ruling was not entirely clear-cut since five of the judges held a differing opinion and such differing opinion is also held by several faculties of law in the Czech Republic as well as by the Czech Constitutional Court and the Supreme Administrative Court of the Czech Republic. According to such opinion, withdrawal from a contract cannot have an impact on the position of a third party that duly acquired ownership title to the asset constituting the subject matter of the contract.


Risks


As was already mentioned, every transaction involves a certain amount of risk and this also applies to purchasing real estate. Purchasers should keep in mind that they are not buying a loaf of bread and, unless their area of expertise happens to be the law, they should seek out legal advice. The purchase of a real property carries certain risks that need to be considered (starting from the matter of whether the seller is the actual owner and ending with the procedure for the payment of the purchase price) and even the fact that the transaction is being arranged by a real estate agency is not a 100% guarantee that the purchaser cannot one day end up without the property he paid for, without even being able to get back the money he paid for it.


Title insurance


In addition to seeking out legal advice, purchasers should also consider the use of title insurance, which insures ownership title to a real property, as well as the use of insurance against cadastral risks. The term title insurance originated in the US at the time of colonisation, when land was typically surveyed but not registered. Registration did not occur until later, but without any guarantees. The first title insurance law was enacted in the state of Pennsylvania in 1876 and the first title insurance company was established in the same year in Philadelphia.

Title insurance is not new in Slovakia but it is still largely unknown. It is used here only for large transactions, despite the fact that such insurance is not only available to corporations but also to individuals. Throughout the world this insurance product is used quite frequently and provided for a lump-sum insurance premium but in Slovakia it is not offered that often. The product insures the title to a real property pursuant to an insurance policy concluded between the insurer and the insured which promises indemnification in the event the insured party sustains a loss or damages. Title insurance is retroactive and generally covers all matters excluded by lawyers, differences between the actual state of affairs and the state of affairs set forth in the Real Estate Cadastre, including title defects. One advantage of title insurance is that indemnification is provided in full, without it being necessary to demonstrate mistakes. One important fact should be kept in mind. Title insurance can never serve as a substitute for legal advice!


Due diligence


All foreign and Slovak investors would be well advised to have a legal and, if applicable, tax due diligence performed prior to purchasing a real property, as well as prior to the purchase of a company. During this process, all contracts, documents and other materials relating to the asset to be purchased are reviewed. In the case of real properties, the due diligence also covers a review of title lists, encumbrances upon the real properties, as well the legal grounds on the basis of which the properties were acquired. Such aspects must be reviewed for a period of the last ten years plus one additional title before that. The reason is that if a party occupies a property continuously for a stipulated period of time (10 years in the case of real estate), such occupying party acquires ownership title to the property on the basis of the legal principle of acquisitive prescription. The amount of time that the asset was duly held by the legal predecessor of the current occupier is counted as part of such period.

After reviewing and evaluating all of the provided documents, the law firm will prepare for the client a due diligence report based on the information contained in the submitted materials. Such report also evaluates the risks associated with the potential transaction so that the investor can decide whether or not to go ahead with the transaction. After familiarising himself with all of the potential risks described in the due diligence report, the investor is well prepared to make the decision on whether the degree of risk associated with the transaction is acceptable to him. It should be pointed out, however, that no law firm can assume responsibility for the completeness of the documents submitted by the seller.

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