Legal Nature of the Contract and Risks of Investing in Construction

Despite the war and the resulting complex economic and security environment, Ukraine’s real estate market is steadily recovering. More and more frequently, there are updates regarding the completion or initiation of new urban development projects, and new development companies are entering the market. Although it may still be premature to speak of pre-war indicators, investing in real estate construction remains one of the primary tools for preserving and increasing capital.

At the same time, the possibility of erecting residential or commercial buildings is invariably tied to property rights in the relevant land plots. In particular, under the Law of Ukraine On the Regulation of Urban Development, one of the main legislative acts in this area, only a person “who owns or uses one or several land plots or owns or manages a building/structure and intends to carry out preparatory and/or construction work” may act as a construction client. Moreover, new construction is only possible if the relevant rights to the land plot are in place.

It is no secret, however, that for an institutional investor in Kyiv, Lviv, Odesa, or other significant cities and regions, finding a vacant land plot with an appropriate legal status—and, moreover, with acceptable zoning and functional designation for the implementation of a particular urban development project—is extremely difficult, not always successful, and even risky. Among other things, this is due to certain gaps in the regulatory framework governing the legal mechanisms for raising construction investments.

Such legislative shortcomings, in turn, lead to legal uncertainty in applying various legal norms and to ambiguous interpretations regarding the lawfulness of actions by urban development project participants. As a result, there are many cases of protracted and costly court proceedings, sometimes with repeated reviews, whose outcomes are not always favorable for the investor.

From our firm’s experience, perhaps the most problematic in this respect are those urban development projects that are based on contracts concluded by commercial business entities for the construction of certain facilities on land plots that are in the possession/use of state enterprises or institutions.

These contracts may have various titles (investment, shared participation, joint construction, or simply construction contracts). Nonetheless, they share the common feature of providing for construction on state-owned land plots not designated for that purpose, where the disposition or use of such plots for other purposes is not only restricted but also conditioned on compliance with certain procedures—or may even be outright impossible.

Such contract practices have long been widespread, often (and quite likely not infrequently) entailing corrupt factors whose purpose was to “stake a claim” to choice pieces of land on behalf of certain commercial structures “for better times,” or to “sell the project” later—especially given that these choice plots grow fewer each year, whereas many state institutions continue to have large swathes of land under their operational management.

As a result, even today, many of these unrealized contracts remain in force and are offered in the market to institutional investors or developers as the legal justification for a given urban development project’s viability and as a legal mechanism for “entry” and financing.

Hence, in the context of the legal assessment of these “construction contracts,” which legal pitfalls must be anticipated when deciding to invest in such projects? What should one know to safeguard the success of one’s investments?

Risk of Contract Invalidation as the Key Issue

As judicial practice shows, the main and most common risk—which can in fact nullify the entire possibility of project implementation—is that the relevant construction contract may be declared invalid. This is understandable, given the legal significance of such a contract as described above.

A lawsuit seeking invalidation of the contract may be filed by a party to the contract—a state enterprise or institution whose management has changed over time or that has undergone reorganization—as well as by the authority managing that enterprise (and whose consent would have been required to conclude the legal transaction). Far more frequently, however, it is the prosecutor’s office, acting on behalf of the state, that initiates such suits.

The legal grounds for claims seeking to invalidate such contracts can vary (depending on the specific circumstances). However, in almost every case—save for a few exceptions—disputes revolve around one key question: determining the legal nature of the contracts at issue and, in that context, whether they exhibit the characteristics of a joint activity agreement.

Why is this Question so Decisive?

The essence lies in the fact that if a contract is determined to be a joint activity agreement (within the meaning of Chapter 77 of the Civil Code of Ukraine), its conclusion should have been preceded by a rather involved approval procedure set forth (depending on the parties involved) in Article 5 of the Law of Ukraine On the Management of State-Owned Objects or Article 7 of the Law of Ukraine On the Specifics of Managing State-Owned Objects in the Defense and Industrial Complex, as well as in the Procedure for Concluding Joint Activity and Asset Management Agreements by State Enterprises, Institutions, Organizations, and by Business Companies in which the State Holds More than 50% of the Shares (and whose charters do not require the establishment of a supervisory board, or in which a supervisory board is not provided for by the charter), approved by Resolution of the Cabinet of Ministers of Ukraine No. 296 of 11 April, 2012 (hereinafter – Procedure No. 296).

Failure to adhere to these regulatory provisions constitutes a clear ground for invalidating such contracts. This position has been confirmed in numerous decisions of the Supreme Court (see rulings dated 18 May 2023, in Case No. 910/7975/21; 23 January 2025, in Case No. 910/9030/20; 27 July  2022, in Case No. 910/7966/21; 18 April  2018, in Case No. 910/4501/17; 3 November 2020, in Case No. 920/611/19; 16 January 2020, in Case No. 922/1362/17; 27 November 2018, in Case No. 905/1227/17; 11 July  2019, in Case No. 910/10673/18; etc.), which examined the application of Articles 203, 215, and 1130 of the Civil Code of Ukraine in resolving disputes over declaring contracts invalid that display features of joint activity agreements, as well as the application of Procedure No. 296. In one of these rulings, the Supreme Court explicitly concluded that, in order to protect public interests and prevent the dilution of state property rights, the principle of freedom of contract is restricted where joint activity agreements are concerned.

Given the above, defendants in these types of cases typically argue the lawfulness of disputed contracts by contending that the de facto relationship between the parties does not amount to joint activity, since (a) the obligations for the specific actions provided under the contract lie with the party that is not the owner of the land plot, without any signs of collaborative activity, combined contributions, or pooled labor; (b) the portions of the facility to be divided among the parties are not held in their joint fractional ownership but belong to each party respectively under the contract’s provisions, and (c) the parties maintain their legal independence throughout the contract’s performance. Accordingly, the contract lacks the features of joint activity and should be deemed a mixed contract comprising elements of obligations under investment (investment agreement), works (construction agreement), and other legal relationships that do not conflict with civil and commercial laws. Thus, no prior approvals were required.

However, in its findings (see rulings of 23 March  2021, in Case No. 916/2380/18; 1 October  2020, in Case No. 910/21935/17; 15 June  2018, in Case No. 916/933/17; 4 July  2018, in Case No. 916/935/17; 17 January 2019, in Case No. 923/241/18; and others), the Supreme Court has repeatedly emphasized that the legal nature of a contract does not depend on its title but rather on its substance. Therefore, in assessing whether the parties’ intentions and the concluded contract reflect their actual legal relationship, the courts must provide a legal assessment of the contract’s provisions and the parties’ rights and obligations to determine both the direction of their actions and the associated legal consequences.

Article 628(2) of the Civil Code of Ukraine does allow for the conclusion of a mixed contract containing elements of different contracts. However, the important point is that in such contracts, the provisions of the relevant legal acts concerning each type of underlying legal relationship (unless the law or the contract itself provides otherwise) apply equally, with no single set of elements taking precedence over the others.

In light of this, the Supreme Court has instructed lower courts, when examining the legal nature of disputed contracts such as those discussed here, to pay particular attention to the following significant factors:

• If the content of a particular contract (regardless of its designated name) suggests that it exhibits features of a joint activity agreement, then the general rules of the Civil Code of Ukraine on joint activity and any special legislation regulating joint activity among certain categories of business entities shall govern the relationship. In a mixed contract, a critical aspect is the parties’ unity of purpose, achieved via the regulation of different legal relationships.
• In identifying the rights and obligations of participants in a joint activity agreement, the typical “right of claim – debt” model, common in most contractual arrangements (including construction and investment contracts), does not apply. Rather, the rights and obligations of participants in a joint activity are not reciprocal in this sense.
• In a broad sense, a joint activity agreement is by definition always associated with an element of investment, while investment activity, in turn, may qualify as a form of joint entrepreneurial activity effected by pooling participants’ contributions (investments) and efforts to achieve the stated goal (creating profit and/or obtaining a social effect). At the same time, an investment contract (agreement)—which, pursuant to the Law of Ukraine On Investment Activity, is the principal legal document governing the relationships among investment participants—may include provisions from various types of commercial agreements depending on the subject matter and purpose of the investment (such as joint activity, capital construction, financing, purchase and sale, trust management of property, etc.).
• Under Article 1130(2) of the Civil Code of Ukraine, joint activity may be carried out either with or without the pooling of participants’ contributions. The pooling of contributions is a hallmark of a simple partnership (as one form of joint activity), and when present, the participants in a simple partnership acquire joint ownership of the respective property (the contributions themselves and the results of the activity), must maintain shared accounting records, etc. The absence from an agreement of these terms—characteristic specifically of a simple partnership—is not by itself sufficient to conclude that the agreement in question is not a joint activity agreement. Nor does Procedure No. 296 imply that its regulatory framework extends only to simple partnership agreements rather than to joint activity agreements in a broader sense.

Undoubtedly, courts’ observance of the Supreme Court’s recommendations and guidance will promote greater legal certainty, something that is still lacking in these types of cases.

At the same time, these factors should serve as key considerations for both investors and developers in evaluating urban development projects they intend to finance, as well as for attorneys performing legal due diligence and developing strategies to protect their clients’ interests.