Ukraine: Anti-Crisis Measure: Re-Negotiating Lease Agreements In Ukraine

Last Updated: 15 November 2012
Article by Vladimir Lukovich

Only a year ago it seemed that prices on the real estate market in Ukraine would continue to skyrocket without end. Not surprisingly, one of the most profitable businesses involved landlords who rented their premises (residential or non-residential) to the highest paying tenants.

During the golden era of the last 5 years, when all Ukrainian markets were experiencing unprecedented growth, local and foreign companies alike would lease immense office premises to accommodate their future growth, which seemed exponential at the time, often renting two or three times more space then needed.

In fact, until recently there was stiff competition for occupying the most prestigious offices in newly-built, western quality business centers at outrageous prices. The parties would usually enter into lease agreements for up to three years (with an automatic extension clause) in order to avoid certification by notary, which can be expensive (1% of the value of the lease agreement). Global companies were paralyzed with fear of the ever-rising lease prices, and tried to stabilize (lock in) the rates by entering into lease agreements for a much longer term (10 or more years) despite the related notary expenses. Everyone in Kiev would look at the ongoing construction and ask, "when is this bubble going to burst?"

The answer came in the form of a global economic crisis, which came unexpectedly crashing down, and with it the prices on the lease market tumbled. The crisis also ended most companies' aspirations of future growth and led to a sobering realization that in the foreseeable future customers will be few and far between regardless of whether a company occupies class "A" or "B" office space. Among other challenges, the arrival of the crisis forced companies with excessively large premises to confront the dilemma of whether to (a) decrease their rental payment; (b) shed extra space despite their long-term lease obligations or (c) terminate their lease arrangements altogether and move to more affordable premises (and suffer any penalties for unilateral/premature termination).

I. Discussion

Now that the crisis has destroyed all illusions of the never-ending increase of lease prices, many tenants are faced with the delicate task of terminating their lease agreements without violating the law. In this regard, the Civil Code of Ukraine allows premature termination of agreements in the following cases:

(i) upon mutual consent of the parties;

(ii) via a court decision in case of gross violation of an agreement or in other cases provided by law; or,

(iii) unilateral termination in cases provided by law or an agreement between the parties.

Unfortunately for the tenant, Ukrainian legislation does not provide any other practical options besides a consensus between the landlord and the tenant. And interestingly, practice reveals that, given the current economic climate, both sides are often happy to reach an amicable agreement. Currently, landlords meekly lower their rates, adjust prices according to the current Hryvnia rate (instead of the US Dollar rate), decrease operational expenses, and allow the tenants to sublet any extra space to save on lease payments.

II. Legal Arguments

In case a conflict between a landlord and tenant cannot be settled by good-faith negotiations between the parties, tenants still have an avenue for prematurely terminating a cumbersome lease agreement: Ukrainian court of law. Admittedly, this option is not ideal or flawless; however, this is the only legal avenue that could allow tenants to terminate their burdensome lease agreements.

Specifically, Article 652 of the Civil Code of Ukraine allows a party to amend or prematurely terminate an agreement in case of "significant changes" to the circumstances surrounding such agreement. A change of circumstances is deemed "significant" if the circumstances have changed to such an extent that if the parties could have foreseen such changes they would not have concluded the agreement or would have concluded the agreement with different conditions.

According to Article 652, if the parties fail to bring the agreement into correspondence with the significantly changed circumstances (e.g., by decreasing the rent, allowing to sub-lease, etc.) or refuse to terminate the agreement, then the agreement may be unilaterally changed by a court of law at the demand of an interested party, provided the following conditions are present:

(i) at the signing of the lease agreement the parties did not base their agreement upon the happening of such circumstances;

(ii) the change of circumstances was due to reasons which the interested party could not have avoided using the reasonable diligence and caution;

(iii) the performance of the agreement would violate the proprietary interests of the parties and would deprive an interested party of results expected upon conclusion of the agreement;

(iv) the risk of a change of circumstances should not be borne by an interested party taking into account the essence of the agreement or business custom.

Additionally, a change of an agreement due to a significant change of circumstances is permissible pursuant to a court decision when the termination of the agreement contradicts public policy interests or will result in damage that significantly exceeds the costs of performing the agreement under the conditions changed by a court.

Based on the foregoing, several arguments could be used to establish "significant" changes in circumstances which the parties could not and did not foresee when they entered into their agreements (including abrupt change in market conditions). Further performance under such lease agreements would arguably lead to a violation of the principle of contractual fairness under the Civil Code of Ukraine. As a result, such significant change of circumstances may lead to the termination or amendment of many lease agreements. If a court resolves to terminate an agreement due to significant change of circumstances, the court, at the demand of any party, will rule on the consequences of such termination based on the requirement of the fair division of expenses incurred by the parties while performing the agreement.

Landlords and tenants are painfully aware that pursuing their legal disputes through the Ukrainian court system would not necessarily lead to victory since there is no stable or predictable outcome to judicial proceedings. Therefore, for all of the above reasons, landlords and tenants usually are quite happy to re-negotiate their lease agreements without involving the court system.

III. Conclusion

The global crisis is an economic phenomenon that should have no influence on the principles of freedom and firmness of contract, including lease agreements. Nevertheless, numerous tenants find themselves between a rock and a hard place, forced to unilaterally and prematurely terminate their lease agreements in order to survive. Surprisingly, the landlords have become uncommonly realistic about their chances of finding new tenants, and have readily accommodated their clients. Still, the threat of "Ukrainian-style" litigation can be effective in bringing about the re-negotiation of a burdensome lease agreement. And a new-and-improved agreement is one of the key steps in surviving the economic crisis.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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