Serbia: Serbia's Land Conversion Law Raises Prospect Of Investment Treaty Claims

In Short

The Situation: Serbia's recently implemented Land Conversion Law regulates the procedure by which companies convert their land use rights into ownership rights. Although land use rights were previously adequate for companies to obtain construction permits, this is no longer the case under the new legislation.

The Result: To develop its land, a company must possess ownership rights. Companies holding land use rights must now instigate the lengthy and expensive conversion process, effectively requiring a repurchase of rights acquired at the time of the initial investment. These changes could diminish the value of investors' acquired companies in Serbia.

Looking Ahead: Affected companies may have a cause of action against Serbia under either Serbian laws or a bilateral investment treaty, as a result of expropriation or diminution in value of their assets and the violation of their legitimate expectations at the time of investment.

Historically under Serbian law, companies and individuals were unable to own construction land, as this right was reserved solely for the state. Instead, companies and individuals could possess "land use rights" over the respective land, which in many ways acted as a surrogate for land ownership and enabled the holders of such rights to obtain construction permits, among other things.

From 2009, Serbia initiated the process whereby holders of such land use rights could convert these rights into ownership, although it still remained possible for companies to obtain construction permits based on the land use rights (with a few limited time gaps). Entities or companies (and their successors) acquired through privatization must pay considerable compensation to effect this conversion process.

In 2015, Serbia introduced the Law on Conversion of Land Use Right into Ownership Right on Construction Land ("Land Conversion Law"). Article 20 of this law provided that starting from July 28, 2016, land use rights were no longer adequate to obtain construction permits, thereby effectively forcing any company wishing to obtain such a permit to initiate the conversion process.

The Land Conversion Law

Serbia's Land Conversion Law regulates the conversion of land use rights into ownership rights. The law, inter alia, applies to: (i) companies and other legal entities that were privatized, and their legal successors; and (ii) persons that acquired land use rights on undeveloped construction land, for development purposes (together, "Affected Entities").

The Affected Entities can convert their land use rights into ownership rights in return for the payment of "consideration," which is generally defined as the fair market value of the land at the time of filing the conversion application, subject to certain deductions and reductions (e.g., based on the location of the land in undeveloped parts of Serbia, and/or on account of the land serving for the regular use of the existing objects). Although the law provides detailed parameters to determine the consideration, ultimately the amount is determined by the relevant local state body.

The Land Conversion Law, however, does not apply where the purchaser acquired the assets (encompassing the ownership right on the object with the pertaining land use right on the construction land) prior to September 11, 2009:

  • through the public bidding process, under market terms and before the conclusion of the privatization agreement; or
  • from the privatized entity (after the completion of the privatization procedure) against consideration.

In these limited situations, companies are not required to pay consideration to complete the conversion process.

Affected Entities also have the option of instead completing a lease with the Serbian state, pending the completion of the conversion process. Such a lease will last for 99 years. The annual amount of rent is determined by dividing the fair market value of the land in question by 99. The lease agreement must include provisions for adjustment of the rent with the rate of inflation in Serbia, as well as a means of security for the payment of rent (e.g., a bank guarantee, mortgage, etc.), which usually makes the lease arrangement unattractive and burdensome for the Affected Entities. Such a concluded lease agreement provides adequate title on the land for the obtaining of a construction permit.

Upon the construction and registration of the object in land registries, the lessee may then carry out the land conversion process and benefit from a decrease in the consideration paid based on the relevant criteria relating to the land necessary for the regular use of the constructed object. Upon such completion of the land conversion process, the lease agreement ceases to apply.

Causes of Action

As outlined above, the Land Conversion Law dictates that land use rights are no longer adequate for companies to obtain construction permits. This forces companies wishing to develop their land to instigate the conversion process, which can be complex, expensive, lacking transparency, unpredictable, and slow. Furthermore, the majority of investors would likely have acquired the companies and/or entities on the premise that the land use rights were sufficient to obtain construction permits and equivalent to ownership rights, and certainly with no obligation to pay further compensation. The Serbian state's actions could be therefore tantamount to expropriation. Furthermore, the diminution in the value of the investors' investment, in the form of the companies or entities possessing the land use rights, could in itself give rise to both domestic or international claims.

What Are the International Remedies?

Investor–state arbitration provides an attractive option for aggrieved foreign investors, as it not only provides a specialized forum in which to bring a dispute against the relevant state (in this case Serbia) but also generally does not require the investor to exhaust local remedies or instigate domestic litigation ahead of bringing an investor–state arbitration.

A foreign investor could bring the arbitration under a bilateral investment treaty ("BIT") between Serbia as the host state and the state of incorporation of the investment company. At present, Serbia has 49 BITs in force, most notably with capital-exporting states such as the Netherlands, Austria, Germany, France, the United Kingdom, and the Belgium-Luxembourg Economic Union. Such BITs are designed to protect an investor's investments from unlawful action of the states that are party to the relevant treaty. The majority of BITs broadly define an investment, and as a result, such treaties will normally apply to all kinds of assets such as property rights, shares, contracts, and other assets having financial value.

The applicability of such BITs will depend on an investor's nationality in a signatory state. A company's nationality is primarily determined by its country of incorporation and/or the claimant's place of citizenship. Many BITs permit investors to make claims for directly or indirectly held investments as well as minority shareholdings. Thus, parent companies or individual shareholders are often able to assert rights relating to an investment held through a subsidiary company.

BITs will often provide broad-ranging substantive protections such as protection against illegal expropriation and discrimination, and the fair and equitable treatment standard, which includes the protection of an investor's legitimate expectations. For example, foreign investors in Serbia may have invested with the legitimate expectation that land use rights were a surrogate for ownership rights and would be sufficient to obtain a construction permit. The Land Conversion Law violated such expectations and could destroy or substantially decrease the value of investors' investments, making such investors potentially eligible to bring an investor–state arbitration against Serbia.

There are many advantages to investor–state arbitration. Successful claimants are typically awarded monetary compensation, which in some cases not only includes the amount invested (plus interest, costs, and expenses) but also lost future profits. Arbitral awards are binding on the parties and create an obligation for compliance. Most states comply with international arbitration awards voluntarily. In the event a party fails to comply with an award, one of the major advantages of arbitration (as opposed to litigation) is the international enforceability of arbitral awards as compared with foreign court judgments.

Two Key Takeaways

  1. Companies in Serbia are no longer able to obtain construction permits unless they possess land ownership rights. Companies acquired through privatization must pay substantial consideration to complete this conversion.
  2. Foreign investors having to pay consideration to effect the conversion process may have recourse against Serbia through one of the 49 BITs currently in place, as a result of Serbia's breach of the investors' legitimate expectations and the diminution in value of investors' investment.

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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