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Did COVID-19 Redefine the Czech Real Estate Deals Landscape?

Did COVID-19 Redefine the Czech Real Estate Deals Landscape?

Czech Republic
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The COVID-19 pandemic undoubtedly hit the real estate market. In response, the government adopted a series of measures that included an extraordinary moratorium, often used by commercial tenants, and a rent reduction scheme in which the government subsidized the rent in cases where the landlord was willing to provide a discount. Most importantly, the crisis made the government abolish the 4% real estate transfer tax.

The latter actually paved the way for a new wave of asset deals. Most Czech real estate deals up until then were SPV-based share deals, in an obvious attempt to tax-optimize. Yet, tax exemptions granted to shareholders after the respective holding period may still be the prevailing tax-optimizing tool and result in a preference for share deals.

Nevertheless, what are the legal benefits of an asset deal? The buyer may principally rely on the title information recorded in the Real Estate Register, and their good faith in those records is well protected against third parties’ claims based on rights not duly recorded. This may significantly limit the need for extensive due diligence. On the other hand, the buyer must focus on other specific issues and make sure that these are carefully investigated.

While the scope of due diligence might be very limited or almost inexistent in respect to land plots with no permits attached, land under development, land with structures or tenants in the buildings will require more attention.

The buyer will, in particular, need to dig into what the relevant utility and grid connections are and whether there are any specific rights in order to get access to the property. Statutory pre-emptive rights may cause a lot of trouble, as they are typically not recorded in the Real Estate Register. At the same time, intellectual property rights do not automatically follow the property and their importance is often underestimated.

More attention is now being paid to often-overlooked lease agreement clauses, such as change-of-circumstances or vis maior clauses. Similarly, inflation brought by the COVID-19 pandemic also caused indexation to be a part of almost every lease – even short-term leases.

The transaction mechanics also vary. While share deals are pretty straightforward and the title to shares is transferred instantly, the requirement for a real estate title transfer recording in the Real Estate Register delays the actual closing and final settlement. There is a 20-day standstill period between the filing and actual recording and the title transfer is effective retroactively as of the date of filing. This may create discomfort, particularly when there is a need to amend or novate the leases during the stand-still period.

Speaking of leases, by law all leases are transferred with the land and any sale of land cannot trigger lease terminations. In the case of leases that deal with rights and obligations beyond the scope of the lease itself, it may however be disputable whether such rights and obligations are also transferred by law, or whether a specific assignment is required.

Both the seller and buyer must also be cautious when the property being sold is the substantive property of the seller, which is almost a tradition in the case of real estate SPVs. First, specific corporate approvals might be required. Second, the buyer bears the risk that it may become jointly and severally liable for the seller’s debts which are linked with the property. Finally, depending on what the property is used for, it may qualify as a business unit, where the actual title transfer conditions and the scope of assets being transferred are different, and much wider, than in the case of a pure property transfer.

In conclusion, the situation around COVID-19 helped to remove the disadvantageous tax treatment of asset deals and stimulated certain segments of the real estate market – particularly those related to vacant land transactions and apartment sales. At an institutional level, share deals still appear to be preferred due to their well-proven predictability, clarity, legal certainty, and associated financial benefits linked with an SPV takeover. Yet, if serious red flags are found that are linked purely to the SPV or if there is a lack of time to conduct extensive ownership title due diligence, shifting to an asset-based deal is now a much easier option.

By Jiri Hornik, Partner, and Jakub Porod, Lawyer, Kocian Solc Balastik

This Article was originally published in Issue 9.3 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.