Brexit: What’s next for real estate developers, contractors and funders in CEE

Brexit’s CEE real estate impact

Putting general market confidence and risks of political contagion to one side, we consider that the primary legal impact for real estate projects located in CEE, or for construction companies headquartered in CEE and working on projects elsewhere, are threefold: legal ownership; financing terms; and commercial arrangements with contractors and others. The extent of the impact will depend on the final outcome of the negotiations and continuing relationship between the UK and EU.

In March 2016 the UK Ministry of Finance (HM Treasury) published a paper setting out possible EU relationship models for the UK, (“Alternatives to Membership: possible models for the United Kingdom outside the European Union”). Of the three models discussed: (i) joining the European Economic Area (EEA), the “Norwegian Model’; (ii) bilateral agreements; or (iii) reliance on the WTO, only the Norwegian Model would essentially retain the status quo in those areas relevant for CEE real estate.  However, due to the requirement for the UK to agree to the four core EU freedoms, including the free movement of people, politically this may be hard to achieve.

Ownership

In a number of CEE countries, either permission is required, or limitations apply for a non-EU or non-EEA person (including companies) to acquire real estate or agricultural land. In the UK there are currently no restrictions on foreign ownership and, thus, in countries where ownership restrictions are subject to reciprocity, the impact of the UK leaving the EU should be limited. However, in other countries, permissions or exceptions may be required by UK owners in respect of real estate or agricultural land already owned, unless ownership questions are dealt with either by EEA membership or by bilateral treaty. Where foreign ownership is permitted via a local corporate subsidiary, UK owners should engage in the corporate restructuring of those assets.

Financing terms & taxation

A significant number of financing arrangements currently in place and applying to CEE real estate projects are either governed by English law and/or involve UK financing institutions. 

In general, a UK exit from the EU should not affect English law as the governing law of financing agreements. The EU Rome 1 and Rome 2 Regulations will apply in those CEE countries that are Member States of the EU and the Regulations largely require that the courts in those countries give effect to the parties’ decision to choose English law as the governing law.  There may, however, be challenges to English courts having jurisdiction to hear a dispute and an increased burden to enforce judgements of an English court in the EU. This is considered below in relation to contractor relationships.

Other terms contained in financing agreements, and the interpretation of those terms, will be affected. An obvious example is the inclusion of the UK in the use of definitions of “European Union” and “European Economic Area”. Another is the scope of increased costs clauses and the exposure of CEE borrowers to increased costs incurred by UK-based lenders as a result of changes to UK legislation following EU exit. More clearly, there is likely to be an impact in relation to the tax treatment of payments to UK institutions or sponsors.

Tax is, in general, a matter for each Member State, although tax policy must be exercised in compliance with EU rules on, for example, non-discrimination and state aid. Future tax effects in relation to UK financing institutions and sponsors will depend on the type of relationship that the UK negotiates. Under the EEA (“Norwegian Model”), tax policy must not be used to discriminate against other members. However, under a bilateral arrangement, or WTO model, discrimination may be permitted. This may result in financial transaction taxes on interest payments from a CEE borrower to a UK lender. Similarly, once the UK leaves the EU it will not be required to follow the Parent-Subsidiary Directive and, thus, distributions from a CEE project to a UK holding company may be subject to double taxation, unless a double taxation agreement is in place. Whilst the UK has a wide network of double taxation agreements with Member States of the EU and those CEE counties outside of the EU, not all provide for a full exemption from withholding tax.

Given the likelihood of an impact on financing terms and the possibility of additional taxes on interest payments or distributions, parties should consider reviewing and discussing amendments in those agreements that will continue past the expected date of a UK exit.

Commercial agreements: contractor and operating agreements

As with financing arrangements, commercial agreements used in CEE real estate projects may be governed by English law and subject to the jurisdiction either of the English courts or arbitration in London. Similarly, contractor and sub-contractor agreements entered into by construction companies headquartered in CEE counties and working on projects in the UK or internationally may be subject to English law and English jurisdiction.

A UK exit from the EU should not affect English law as the governing law of agreements. There may, however, be challenges to English courts having jurisdiction to hear a dispute and an increased burden to enforce judgements of an English court in the EU.

Courts

Notwithstanding the form of relationship between the EU and UK after the exit of the UK, English courts would generally accept jurisdiction on the basis of a valid governing law clause in the agreement.

However, if the UK is no longer subject to EC law through membership of the EEA or by bilateral agreement, jurisdiction clauses determining jurisdiction of the English courts may not be accepted by courts in other EU Member States. This is particularly the case where proceedings have already begun elsewhere, or where jurisdiction is not exclusive.

Of equal importance is the likelihood of practical difficulties in service of proceedings and enforcement. If the EC Service Regulation or similar provisions no longer apply, and there is no UK address for service set out in the agreement, it may be difficult even to serve UK proceedings on counterparties located in CEE. Similarly, the procedure for enforcement of English court decisions in CEE will be more onerous and time consuming, with a higher involvement of local law considerations by national courts in deciding whether the standard of proof or substance for enforcement have been met.

What can parties to English law agreements in CEE do? Quite clearly, it is important to review current agreements to ensure that choice of law and jurisdiction terms will be valid and enforceable after a UK exit, or even to change the law governing the agreement to the appropriate CEE local law (and amend terms more generally for compliance under that local law). If English law and English court jurisdiction is kept, parties should be required to have a UK address for service of proceedings, and may also agree not to challenge any court decision to facilitate enforcement elsewhere.

Arbitration

By contrast, agreements subject to arbitration in London, and the enforcement of arbitral awards, should not be affected by a UK exit. This is because arbitration is generally governed by national law or international instruments and the cross-border enforcement of arbitral awards is governed by the New York Convention, to which the UK and CEE jurisdictions are signatories. 

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Wolf Theiss is the largest independent law firm in CEE. We advise sponsors, companies and financial institutions on real estate projects in CEE, and also CEE-headquartered companies on construction, PPP and development projects internationally.

This article highlights only a few issues relevant to a UK exit. For CEE headquartered companies working in the UK, other areas for consideration include potential changes in the application of procurement, environmental and employment laws.

As a first step, we would suggest that it will be prudent to review ownership and the corporate structure of CEE real estate and land, particularly for UK based sponsors or financial institutions. Additionally, where companies are parties to English law agreements, a review of choice of law, jurisdiction and enforcement provisions is necessary to ensure that contractual and non-contractual rights are not lost, or unintentionally acquired under local laws in CEE, following Brexit. Agreements may also be converted to local CEE law to ensure enforceability.