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Associate in Business Consulting Practice, GOLAW. Kristina Kolchynska has in depth of theoretical knowledge and practical experience in commercial, tax and labor law. The associate specializes in issues related to contractual relations, including the development and maintenance of commercial real estate lease agreements.
The basic areas of Kristina’s activities are consulting entities on foreign trade transactions, taking into account the requirements of customs legislation and currency regulation. She has successful experience of solving commercial disputes, as well as representing clients during pre-conflict resolution and enforcement.
Specific Problematic Issues in the Conclusion of Lease Agreements on Commercial Real Estate
One of the most dynamic and fast growing areas in the Ukrainian economy is real estate. At the same time, this sphere is one of the most problematic. Owners of shopping malls are trying to lease their premises on the most advantageous conditions for them. Lessees, on the other hand, are trying to get the most attractive location in the shopping mall at the lowest price. In most cases the outcome of such a “race” is the conclusion of lease agreements with various ambiguous conditions that give rise to number of court disputes.
Ukrainian court practice has a high degree of unpredictability and inconsistency, which is why it is extremely important to keep in mind numerous details when concluding real estate lease agreements.
“Term of the Lease Agreement” vs. “Lease Term”. Requirements for Notarization
It is important to differentiate the concept of “lease term” from that of “term of the lease agreement”. The term of the lease agreement includes the entire period, from the moment of conclusion of the agreement to its termination. While the lease term is a more narrow term and includes only the term of use of the premises.
If under the lease agreement the mentioned definitions are equated and the lease term will correspond to the term of the lease agreement, it can lead to the situation when the lessor is obliged to pay a rent fee for the entire period from the moment of conclusion of lease agreement till its termination, including the period during which he did not actually use the premises.
As such, it is advisable to ensure that the lease agreement contains a detailed description of the procedure for, and the timing of, the handing over of the real estate for lease and its return to the lessor. It would be beneficial for the tenant to stipulate in the agreement extra days for vacating the premises after expiry of the lease term during which time rent will not accrue.
According to the Civil Code of Ukraine, any agreement on lease of premises for a term of three or more years must be attested by a notary.
To avoid the expense of notarization, which is often quite huge, the parties usually conclude a lease agreement for a term of 2 years and 11 months. On one hand, it helps to save money on notarization, but on the other hand it may lead to higher expenses for the tenant. Such a situation can occur if the tenant invests a lot of money in preparing the premises for lease and the term of 2 years and 11 month does not provide the possibility to obtain enough profit in order for repair expenses to be covered. In such cases tenants, on the basis of oral agreements with landlords, are confident that after the end of the term of the lease agreement they will be able to conclude a new agreement on a new term.
At the same time, tenants often do not take into consideration that the preferential right before other persons to conclude a lease agreement for a new term, provided by legislation and the agreement, is not unconditional.
The lessee can use it only under certain circumstances as:
— if the tenant properly performed his duties under the lease contract;
— if the landlord intends to lease out the premises;
— if the parties come to an agreement on all the terms of the new lease agreement.
Thus, actually after the termination of the lease agreement the lessor may propose to conclude a new contract on less favorable conditions for the lessee or refuse to lease the premises altogether.
Consequently, in some situations savings on notarization may lead to greater losses for tenants.
If, irrespective of the aforementioned, the tenant wants to avoid notarization and to lease property for more than three years, it can be done under the general provisions of the Civil Code of Ukraine.
According to Article 764 of the Civil Code of Ukraine, if the tenant continues to use the property after the expiry of the lease agreement, then in the case of absence of objections by the landlord within one month, the contract shall be renewed for the period that was previously established by the contract.
Thus, the parties may conclude the lease agreement for 2 years and 11 months. After expiry of this term the tenant should continue to use the premises and landlord should refrain from any objections for one month. In such case, the lease agreement shall be deemed as extended for the same term and on the same conditions. The parties are not obliged to notarize the agreement in such a situation.
How to Handle a Security Deposit
A specific feature of lease agreements is the application of a particular method of securing the obligations of the tenant (e.g. timely payment of rent, reimbursement of damages to property, etc.) by way of obliging the tenant to prepay a “security deposit” normally equal to the amount of one month’s worth of rent or another amount assessed based on the value of the leased property.
While the effective laws of Ukraine do not regulate matters of use of security deposits, the lease agreement should specify in detail all matters pertaining to its prepayment and utilization and repayment by the lessor.
In the first place, the lease agreement must provide an exhaustive list of situations where the lessor is entitled to make use of the security deposit obtained from the tenant.
The agreement should outline a detailed step-by-step procedure for advising the tenant of the intention to use the security deposit, for application of the security deposit and a term for replenishment by the tenant of the sum of the security deposit.
Additionally, the procedure of VAT taxation of security deposit depends on the order of its usage provided by the lease agreement.
Let us consider a few examples:
1. A security deposit is credited against the payment of a rent fee (for example, against the payment of rent fee for the last month of lease). In this case, the tax obligation of the lessor and the right on the tax credit of the lessee — VAT taxpayers, arises on the date of payment of the security deposit (according to the rule of “first event”). In case of early termination of the lease agreement, the security deposit is usually used as compensation of losses incurred to the lessor by the lessee. If in this case the amount of the security deposit is classified by the parties of the contract as a penalty, then charged tax obligations and the tax credit should be adjusted. This is due to the fact that penalties are not included in the VAT tax base.
2. A security deposit shall be returned in full at the end of the lease term. In this case, such payment is only a means to enforce obligations and the deposit does not lead to the occurrence of income and expenses in accounting and is not subject to VAT.
3. Sometimes, during the execution of a lease agreement, the parties change the second option to the first (i.e., the security deposit is to be credited against the payment of the rent fee). Then, at the date of change of direction of using the security deposit (for example, on the date of signing of an additional agreement to the lease agreement), the landlord must charge VAT obligations and write out a VAT invoice. The tenant shall have the right to a tax credit on the basis of a VAT invoice.
Practice shows that the most appropriate option for the parties is to establish in the lease agreement a security deposit (including VAT), and the procedure of its usage on repayment of an overdue rent fee and the cost of other services, which are included in the VAT tax base.
In any case the interests of each party to the agreement will be fully guaranteed if the parties agree in such an agreement on all essential terms and conditions, established by legislation, and specify to the maximum possible extent the procedures for interaction between them in the course of its fulfillment.