Practical Law Company
The Q&A gives a high level overview of the main trends and significant deals; the main parties; procurement arrangements; transaction structures and corporate vehicles; financing projects; security and contractual protections that funders require; standard forms of contracts; risk allocation; excluding liability, including caps and force majeure; contractual provisions covering material delays and variations; appointing and paying contractors; subcontractors; licences and consents; projects insurance; labour laws; health and safety; environmental issues; corrupt business practices and bribery; bankruptcy/insolvency; public private partnerships (PPPs); dispute resolution; tax and mitigating tax liability; the main construction organisations; and proposals for reform.
Overview of the construction and projects sector
1. What are the main trends in the local construction and projects market? What are the most significant deals?
Over the last year the construction and projects market saw a continuation of the upturn that started in 2011, with a general increase in the number of new projects and a restarting of suspended projects.
The general mood of market players is positive due to stable macroeconomic results (that is, in relation to the performance, structure, behaviour and decision-making of an economy as a whole). The majority of market players consider the market as stable and demonstrating calm, with confident growth that is hardly reminiscent of recession.
The most dynamic results were demonstrated in logistics and retail projects. Logistics projects continued their rapid growth and attracted high interest from investors, especially considering that the current average vacancy rate for warehouses is about 1%, which is much lower than for offices and retail premises. It is typical for more than half of any future warehousing to be let out to tenants before even the walls are up. Retail property is also impressive in its results and growth.
Following drastic restrictions on new developments in Moscow, developers have focussed on regional development projects. In addition to logistics and retail, other popular segments are regional residential construction and hotel and leisure facility development. Specialised investors are also particularly interested in:
Finally, regional airport facilities and infrastructure renovation and reconstruction projects demonstrated a very high investment interest, predominantly from local core investment groups.
Restrictions on the implementation of construction projects without town-planning documents have also gradually started coming into force. For example, from 2013, construction permits in most cases must not be issued without licences/consents for acquisition of land use and development (see Question 19). These restrictions have been constantly postponed over the last few years, though the legislator has finally allowed them to enter into effect. This has forced local authorities to speed-up the preparation of the long-awaited town-planning documents.
Amendments to the Federal Town-Planning Code (Federal Law No. 190-FZ of 29 December 2004) (Town-Planning Code), intended to establish a clear liability structure for town-planning activities, have also entered into force in 2013. The Code imposes default liability for any harm caused by damage to or destruction of a facility on the developer during construction and the owner after commissioning.
The main projects include:
Major projects in Russia have involved large development groups (such as O1, Kortros, Regions Group and Amtel (all of which are considering initial public offerings (IPOs) in the next few years)). Hines International has unveiled its plans to invest US$1 billion in Russia in 2013. There have also been projects and works to restore historical heritage mansions in Moscow.
2. Which are the most common procurement arrangements if the main parties are local? Are these arrangements different if some or all of the main parties are international contractors or consultants?
The main parties involved in a project are the:
Technical employer. This is the party with expertise in exercising construction supervision (for example, inspection of completed works and their quality).
The developer generally enters into the following agreements when implementing a project:
The following forms for transactional relations are also frequently used:
These arrangements are generally the same if some or all of the main parties are international contractors or consultants.
3. What transaction structures and corporate vehicles are most commonly used in both local and international projects?
The main forms of transactional structure and vehicle are relatively simple:
Construction contract. Employment of a construction contractor by a developer.
Transaction structures are generally the same for both local and international contractors or consultants. However, international projects involve more sophisticated corporate and finance structures. In particular, corporate structures managed from a foreign jurisdiction (for example, Cyprus, BVI, Jersey, Guernsey and The Netherlands) are increasingly used. Use is sometimes made of vertical structures, made up of several special purpose companies, to comply with statutory limitations on foreign involvement.
4. How are projects financed? How do arrangements differ for major international projects?
Before the economic downturn, most real estate projects were funded through bank loans, where the role of international banks was hard to overestimate. Currently, the most active on the real estate market are the largest local banks and professional investors who lend for development of the most marketable projects that are close to completion. Another standard financing method is equity.
Initial public offerings (IPOs) are not currently considered, due to the current economic situation. In addition, instruments such as mezzanine finance, forward financing and bond issues are currently less common.
Security and contractual protections
5. What forms of security and contractual protections do funders typically require to protect their investments?
Funders typically require that one or several of the following forms of security be used to protect their investments:
If the investments drawn into the construction project are subject to foreign law, contractual tools such as warranties, step-in rights and assignments of contractual rights are used.
Standard forms of contracts
6. What standard forms of contracts are used for both local and international projects? Which organisations publish them?
There are no Russian standard forms of contract. Major local industrial projects, particularly those financed by foreign banks and financial organisations, generally use standard forms of contract developed by the International Federation of Consulting Engineers (Fédération Internationale Des Ingénieurs-Conseils) (FIDIC). For more information, see Practice note, FIDIC Forms of Contract. However, these require thorough adaptation to local regulatory, reporting, tax and bookkeeping requirements, among other things.
Construction contracts for international projects usually consist of FIDIC models adapted to Russian legislation. This applies, in particular, to infrastructure and industrial projects. For more information, see Practice note, FIDIC Forms of Contract.
7. What risks are typically allocated to the contractor? How are these risks offset or managed?
The main risk the contractor faces is that of accidental loss of, or damage to, the construction facility before it is accepted by the employer/developer (except in cases where the construction facility is destroyed or damaged because of poor quality material or equipment supplied by the employer or execution of incorrect instructions from the employer). This risk is normally managed by taking out insurance.
In relation to the materials and equipment provided by the contractor, the contractor bears the risk of accidental loss or damage and the risk of being unable to use those materials and equipment in the construction. These risks can also be mitigated by insurance.
If the price of the contractor's work is fixed under the contract with the contractor, the contractor bears the risk of additional unforeseen costs arising during construction. This applies even in relation to costs that cannot be accurately calculated when the contract is concluded.
8. How can liability be excluded or restricted under local law?
Liability for non-performance and bearing of risk are differentiated under law. That is, in the event of force majeure (see Question 10), the contractor is released from liability but continues to bear the risk of accidental loss of, or damage to, the construction facility.
The contractor can limit its liability to the following:
Caps on liability
9. Do the parties usually agree a cap on liability? If yes, how is this usually fixed? What liabilities, if any, are typically not capped?
In most cases, the law does not prohibit the parties from setting a cap on liability, including a fixed amount. However, in practice, a monetary limit is applied very rarely and the parties usually limit their liability by other means (for example, they provide for reimbursement of actual damage only, without covering lost benefits, interest and so on) (see Question 8)).
10. Are force majeure exclusions available and enforceable?
Under Russian law, force majeure releases parties from liability. Russian law outlines the key characteristics that constitute force majeure but does not list force majeure events specifically. Situations that are urgent and irresistible can constitute force majeure. The following events may be treated as force majeure:
In addition, the law specifies circumstances that cannot be considered force majeure, in particular:
11. What contractual provisions are typically negotiated to cover material delays to the project?
The parties usually establish a penalty for delayed construction. The penalty may be determined as either a:
In addition, the contract often provides for the employer's right to terminate the contract if there is a significant delay in the contractor's execution of the works. In this case, the employer can also claim damages from the contractor.
Performance bonds, insurance, banks and parent company guarantees are also used extensively in construction projects.
12. How are material variations to the works usually dealt with in the contract?
Construction and related works should be carried out in accordance with the design and technical documentation defining the scope, content and other related requirements. This should be supplied with a calculation of the cost of works. The employer has the right to amend the design and technical documentation on the condition that the cost of any additional work caused by the amendment does not:
Revisions of a greater scope are subject to agreement between the parties.
Other negotiated provisions
13. What other contractual provisions are usually heavily negotiated by the parties?
The following terms and conditions are the most heavily negotiated:
Architects, engineers and construction professionals
14. How are construction professionals usually selected? Following selection, how are they then formally appointed?
If the employer is a commercial organisation, contractors and other construction professionals are usually selected by either a:
In the public sector, selection of a contractor is usually made on the basis of a binding bidding procedure, which is usually very formal, strictly regulated and differs from the tender procedures held by commercial organisations.
15. What provisions of construction professionals' appointments are most heavily negotiated? Are liabilities routinely limited or capped in construction professionals' appointments?
See Questions 8, 9 and 13.
Payment for construction work
16. What are the usual methods of payment for construction work? Are there ways for the contractor and consultants to secure payment or mitigate risks of non-payment under local law?
Methods of payment
The procedure for paying for construction work is based purely on the contractual provisions. It is similar in most construction projects and consists of the following:
Payment to the contractor for the work performed is secured by the contractor's lien right set by law. This entitles the contractor to retain the following until the payment is made:
However, this right is only applicable when the work is fully and properly performed.
See also above, Methods of payment.
17. How do the parties typically manage their relationships with subcontractors?
The general contractor generally engages subcontractors to perform certain types of work without seeking the employer's prior consent. The parties may agree that the general contractor should seek the employer's prior consent for engaging subcontractors or agree on the list of potential subcontractors in advance. For example, information on approved subcontractors can be specified in the general contractor's offer for participation in the tender.
In both cases, the general contractor continues to be liable to the employer for work performed by subcontractors as if it had performed the work itself.
The employer does not usually interfere in the relations between the general contractor and its subcontractors. The general contractor and the employer can, however, agree that the employer will employ and pay the contractors directly. In this case, the general contractor is not liable for the works performed by direct contractors, these being liable towards the employer.
In certain cases, subcontractors must have a Certificate of Admission issued by a relevant self-regulating organisation (SRO) (that is, an organisation that exercises some degree of regulatory authority over a specific industry or profession) (see Questions 2, 18 and 19).
18. What licences and other consents must contractors and construction professionals have to carry out local construction work? Are there any specific licensing requirements for international contractors and construction professionals?
On 1 January 2010, reform of the regulation of construction activities came into force, together with a transition from licensing of construction activities to self-regulation. The key regulation governing self-regulation in construction works is the Town-Planning Code.
Construction work affecting safety can now only be performed by parties holding a Certificate of Admission issued by a relevant SRO (see Question 19). The SRO consists of professional developers. Before the reform, licences were issued by state agencies. There are more than 370 types of work requiring a Certificate of Admission, ranging from engineering surveys and preparation of design documentation to specific construction works and works associated with organising construction.
In most cases, the general contractor, the designers and the technical employer should be members of an appropriate SRO and hold a Certificate of Admission issued by a relevant SRO.
19. What licences and other consents must a project obtain?
Before construction work is launched, all of the following must be obtained for the project:
During construction, the construction supervisory authority (either regional or federal, depending on the project) carries out inspections in accordance with the schedule specifically issued for each construction site. For some minor construction projects, state construction supervision is not carried out.
On completion, all the following must be obtained for the project:
20. What types of insurance must be maintained by law? Are other non-compulsory types of insurance maintained under contract?
Self-regulating organisations (SROs) generally establish insurance requirements. In practice, the parties also agree that additional insurance must be obtained. Obtaining insurance is usually the responsibility of the contractor, although it is sometimes imposed on the employer, for example, when the construction is covered under the employer's general insurance (including international insurance, primarily if the employer is an organisation operating in several countries).
The following types of insurance are usually maintained:
SROs require insurance to be maintained as a condition for membership and also to reduce the burden on SRO funds. This is because, under the legislation, an SRO is subject to secondary liability for damage caused by its members and must pay out of its indemnification fund.
No special insurance is generally taken out by employers as the General Contractor is the party that effectively controls the construction site.
21. Are there any labour law requirements for hiring (local and foreign) workers?
Local construction workers must:
Certain hazardous professions cannot be held by women (the list of such professions is also established by the federal government).
There are no other general limitations on employment of Russian citizens.
Foreign nationals can be employed if they are over 18 years of age and have a work permit issued by the Federal Immigration Service.
Work permits are issued for a term not exceeding one year (or three years for highly specialised workers), on the basis of immigration quotas fixed annually by the federal government. Quotas do not apply to all highly specialised workers and regular workers of certain positions, a list of which is established each year by the Ministry for Health and Social Development. A foreign national employee is likely to be considered highly specialised if his average annual income is at least RUB2 million.
Foreign nationals can work without a permit provided both:
22. Which labour laws are relevant to projects?
The federal Labour Code is the main legislation regulating labour relations. This establishes mandatory requirements on maximum working hours, night work, payments and so on. For example (Labour Code):
Additional guarantees (for example, shortened working week, prohibition of work at night and overtime work, and so on) are provided for certain categories of employee (women, minors, and so on).
23. Must an employer pay statutory redundancy or other payments at the end of a project? Are all employees eligible?
Employees can be engaged on either a:
Health and safety
24. Which health and safety laws apply to projects?
Health and safety laws are set out in numerous laws and standards. The main health and safety regulations applicable to construction work are set out in the:
The employer's basic obligations are to:
25. Which local laws regulate projects' effects on the environment?
The following local laws, among others, regulate the effect exerted by projects on the environment:
Air pollution is regulated by Federal Law No. 96-FZ of 4 May 1999 "On Protection of Atmospheric Air". See also above, Local laws.
Water pollution is regulated by:
See also above, Local laws.
Waste is regulated by:
See also above, Local laws.
Environmental impact assessments (EIAs)
See above, Local laws.
See above, Local laws.
26. Do new buildings need to meet carbon emissions or climate change targets?
Russia has no legislation setting specific requirements regulating carbon emissions or climate change targets.
27. Are there any rules prohibiting corrupt business practices and bribery (particularly any rules targeting the projects sector)? What are the applicable civil or criminal penalties?
There are no construction-specific corruption laws in Russia.
Individuals can be penalised for:
Legal entities can be held administratively liable with a fine of up to 100 times the amount of the bribes, but not less than RUB1 million. In addition, a legal entity's officers can be criminally prosecuted.
Illegal transfer of money or any other assets to a company manager in order for him to take actions in the interests of the transferor is punishable by:
28. What rights do the client and funder have on the contractor's bankruptcy or insolvency?
A contractor's bankruptcy or insolvency does not generally constitute grounds for the other party to withdraw unilaterally from the contract by law. For the employer, the main consequence of the contractor's bankruptcy is that:
However, contractual agreements usually provide for the right of unilateral withdrawal from the contract in the event of the contractor's bankruptcy or insolvency.
29. Are public private partnerships (PPPs) common in local construction projects? If so, which sectors commonly use PPPs?
In the last few years, Russia has increasingly considered PPPs and the need to develop them further.
A number of major PPP projects involving construction of plants for waste processing, road construction and upgrading of airports have recently been launched. These projects, with a few exceptions, are structured as concession agreements. PPP is also used at the local level in municipalities, mainly in relation to utility services and social welfare facilities.
However, Russian legislation requires amendments to provide for implementation of PPP models commonly used worldwide (for example, build, own, operate, transfer (BOOT) and build, transfer, operate (BTO) models, and so on). A legislative framework is currently being developed for application of some PPP tools, such as concession agreements, production-sharing contracts and so on.
30. What local laws apply to PPPs?
Major laws governing PPPs are the:
In 2010, to develop PPP in Russia, the PPP Expert Council of the State Duma (the lower chamber of the Federal Parliament) developed a model law on PPP. This encouraged the regions to adopt their own regional PPP legislation. About 60 regions out of 83 have adopted regional PPP legislation.
In addition, a series of amendments to the federal legislation aimed at further strengthening and developing PPP in Russia is currently under discussion. It is expected that a Federal Law "On PPP" will be adopted in 2013 or 2014.
31. What is the typical procurement/tender process in a PPP transaction? Does the government or another body publish standard forms of PPP project agreement and related contracts?
The procurement/tender procedure is regulated by statute for a few PPP forms and differs, depending on the PPP form:
Some Russian regions' laws also include rules governing tenders for the right to conclude PPP agreements.
The tender procedure is currently controversial and disputable in practice. This is because certain different laws establish inconsistent and separate rules for tendering, for example, in relation to land procurement.
32. Which are the most common formal dispute resolution methods used? Which courts and arbitration organisations deal with construction disputes?
Formal dispute resolution methods
The majority of disputes are settled in state arbitration (commercial) courts.
If the contract includes commercial arbitration clauses, disputes between the parties are referred to the appropriate court of arbitration (see below, Courts and arbitration organisations). The state arbitration court's decision is binding and, generally, can only be challenged in a state court on procedural grounds.
Courts and arbitration organisations
There are no special courts to deal with construction disputes, which are usually resolved by state arbitration (commercial) courts.
Foreign parties often establish a contractual clause requiring adjudication in an arbitration court of the International Chamber of Commerce (ICC), the International Commercial Arbitration Court (ICAC) under the Chamber of Commerce and Industry of the Russian Federation or other international arbitration institutions.
For more information on arbitral institutions, including the ICC, see Practice note, A quick guide to the rules of the leading arbitral institutions.
33. What are the most commonly used alternative dispute resolution (ADR) methods?
In 2010, the Federal Law "On the Alternative Dispute Resolution Process Involving a Mediator (Mediation)" came into force and appropriate changes were made to the Arbitration Procedural Code. In particular, mediators can now be engaged in resolving disputes even if the Court of Arbitration has already begun the trial. The main purpose of the law is to offer a fast and convenient method for resolving disputes, which is flexible and ensures that enforceable decisions can be made during mediation to save costs.
34. What are the main tax issues arising on projects?
Value added tax (VAT)
The VAT on transfer (sale) of real estate is generally 18%. No other transfer or turnover taxes apply to transfer of real estate, except for nominal stamp duties and profits tax charged at 20% on any realised gain.
Sale of land plots is VAT exempt.
Special rules exist for calculating VAT in cases of investment agreements, construction funded with the developer's own resources and other specific types of agreement.
Developers face a considerable amount of input VAT during construction, which be refunded on completion. The Russian Tax Code allows developers to recover the difference between input and output VAT in cash. However, the tax authorities tend to refund large amounts of input VAT only by court order (that is, litigation is required).
Recently, an improvement has been seen in this area, with many clients reporting increased chances of refund in cash being obtained without litigation.
Agreements for the avoidance of double taxation
Many double taxation treaties (DTTs) signed by Russia establish a period within which a construction site cannot be deemed to be a permanent establishment of the developer. Income tax is not due during this period. The conditions for application of tax benefits under the relevant DTT should, however, be carefully reviewed, as the Russian tax authorities tend to challenge application of these tax privileges.
Interest deduction for loans is limited to:
The Central Bank rate is determined on the date of receipt of the borrowed funds (for borrowings establishing a fixed rate for the duration of the loan) or on the date of interest deduction (for other borrowings). Certain DTTs allow for unlimited deduction of interest as long as it is at arm's length.
Russia also has thin capitalisation rules. These apply to Russian companies with direct or indirect foreign ownership exceeding 20% of the Russian company's capital. For these companies, deduction of interest is restricted on loans either:
In this case, deduction of interest arising under controlled loans is restricted if the loan exceeds three times the borrower's net assets (or 12.5 times for banks and leasing companies), calculated according to Russian accounting rules. Interest exceeding these limitations is reclassified as dividends for profits tax (withholding tax) purposes.
In the landmark Severny Kuzbas case, the Supreme Arbitration (Commercial) Court ruled that non-discrimination provisions, as well as other DTT provisions, do not prevent domestic anti-abuse regulations, including thin capitalisation rules, from applying (see Resolution of the Supreme Arbitration (Commercial) Court No. 8654/11 dated 15 November 2011).
Currently, courts tend to uphold the tax authorities in applying thin capitalisation rules without regard to DTT non-discrimination provisions. This approach is a 180-degree change in position by courts, which previously granted protection against thin capitalisation rules under various interpretations of DTT provisions.
In another case, a cassation court upheld extension of the rules to loans from a sister company (which are technically beyond the scope of the rules due to their wording) on the basis of the general argumentation that the arrangements were conduit in nature (see Resolution of the Federal Arbitration (Commercial) Court for the Moscow Circuit No. A40-1164/11-99-7 dated 27 February 2012). The overall trend is for courts to scrutinise transactions under the substance-over-form approach, which might jeopardise use of various intercompany arrangements aimed at avoiding thin capitalisation rule exposure. On the basis of the mentioned case law developments, compliance with the thin capitalisation rules is going to become an issue to consider when structuring financing for projects.
35. Are any methods commonly used to mitigate tax liability on projects? Are there any tax incentives to carry out regeneration projects?
The following methods are commonly used to mitigate tax liability:
Costs of land regeneration and environmental protection reduce the profits tax base.
Other requirements for international contractors
36. Are there any specific requirements that international contractors or construction professionals must comply with?
Since 2010, companies that perform design and construction no longer need to be licensed in Russia. These companies must now be members of an SRO and obtain a Certificate of Admission to perform the relevant works (see Questions 18 and 20).
This applies equally to both Russian and foreign companies.
Real estate construction is generally regulated by the national legislation. In particular, this greatly affects application of the FIDIC model contracts, which are subject to material adaptation and adjustment.
In addition, the rules for employing foreign and Russian workers must be complied with (see Question 21).
Reform and trends
37. Are there any proposals to reform construction and projects law? Are there any new legal or regulatory trends affecting projects?
The current legislation on construction and projects may be affected by the overall reform of the civil law currently under discussion. This includes significant amendments to the Civil Code, for example in terms of rights to land plots for construction, authorised construction and the rights to real estate facilities under construction. However, reform has slowed down somewhat and the timeframes for new amendments coming into force are unclear.
A substantial reform of the land and town-planning legislation is also currently being considered. These are intended to simplify the implementation of construction projects and include, among other things:
The changes are also intended to distribute duties more clearly between authorities responsible for land formation and for town-planning regulation.
Lawmakers are discussing the opportunity to use design documents that have passed examination in the EU for construction in Russia without local examination, and therefore avoiding double examination.
Finally, the laws regulating PPPs are under discussion for amendment, for example, to increase the investment appeal of PPP projects.
New trends affecting projects include: