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Case Law Developments Support the Commercial Real Estate Market

Case Law Developments Support the Commercial Real Estate Market

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Estonia’s commercial real estate sector is enjoying steady growth in practically all segments, with the construction of numerous new office buildings, logistics centers, hotels, and industrial buildings. Even though the majority of transactions are still being made by local property funds, there is an increasing inflow of foreign capital looking for decent returns in a stable environment. One critical aspect facilitating foreign investments into Estonia’s property market is the favorable legal environment.

First, it is worth pointing out that Estonia uses the so-called strong land register principle, which means that individuals can rely on data in the Land Register. Buyers of real property can rely on the register’s identification of the owner of a real property, without the need to trace all historical transactions involving the property. A buyer can also rely on the absence of encumbrances (e.g. mortgages, servitudes) on the property, unless they are registered in the Land Register. Coupled with very low transaction fees, this makes acquiring real property in Estonia straightforward and cost-effective. 

When buying commercial real estate, buyers are primarily interested in steady cash flow deriving from leases. It is therefore critical that term leases are indeed enforceable for the whole term of the agreement. In this respect, Estonian court practice has been favorable towards landlords. The Supreme Court has confirmed that a tenant may not easily exit a lease agreement concluded for a fixed term. Tenants may terminate a lease agreement prematurely under certain specific circumstances — such as a lay-off or the need for more space – but in such cases landlords are entitled to full compensation for their loss. 

Tenants who simply do not need the premises any more and would like to terminate the lease agreement may do so only with their landlord’s consent. If the tenant simply walks away, the landlord may keep the lease agreement alive, in which case the tenant would still be liable for full payment of the rent and accessory expenses.

Where the tenant is in material breach of the lease agreement and the landlord terminates the lease agreement due to the breach, the landlord is again entitled to full compensation for loss. Significantly, the parties cannot agree in advance in the lease agreement on a penalty to be payable by the tenant upon termination of the lease. According to court practice, such agreement is null and void. This means that a landlord can not rely on a liquidated damages provision, but has to prove damages.

The landlord’s loss to be compensated by the tenant would normally include the loss of rental income during the period when the premises are vacant and, where a new tenant pays a lower rent, the difference until expiry of the orginally-intended lease term. Of course, the landlord is under an obligation to mitigate losses where possible – for example by making efforts to find a new tenant on market terms. According to a recent decision, landlords who sell their properties after termination of a lease at a price that is lower due to the vacancy may also be entitled to compensation by the tenant.

Estonian law establishes an automatic pledge of the landlord over all assets situated in the leased premises. The Supreme Court has ruled that the pledge extends also to third party property in the leased premises, unless third party rights were communicated to the landlord in time. Depending on the nature of the business of the tenant, this statutory pledge may provide a significant additional collateral for the landlord.

All in all, it can be concluded that Estonian real estate-related legislation and case law supports a healthy and reliable property market. Coupled with steady economic growth and an  innovation-driven society, this makes the Estonian property market an attractive destination for foreign capital.

By Aivar Taro, Partner, Cobalt Estonia

This Article was originally published in Issue 6.11 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.