• What to consider when purchasing real estate from compulsory sale?
  • November 26, 2010
  • Law Firm: Attorneys at Law Borenius - Tallinn Office
  • In connection with the economic recession, the real estate market has seen an increase in property sales due to execution proceedings and bankruptcies. The selection of objects on sale is quite diverse, including expensive commercial properties and unfinished development properties, as well as various residential properties, such as one room flats in suburb - being sold due to overdue repayments of SMS-borrowers - to more grandiose apartments in Old Town. As such, a number of favourably priced opportunities are available, and one can only assume a number of readers of these lines here have considered participating in these real estate auctions. On the other hand, for potential buyers real estate auctions raise several questions and uncertainties. Some of these can become obstacles to acquiring a property. Below we try to answer some of the most frequently asked questions.


    What becomes of mortgages and other rights entered in the land register?


    In most cases, immovable property sold under bankruptcy or execution proceedings is encumbered with several mortgages and other real rights. At the same time the land register contains different notations concerning disposal prohibitions. The most important aspect for a buyer is whether these entries stay in the register after the estate has been sold at auction. For instance, if a mortgage remains on the property, the buyer must consider the risk of losing the property due to another compulsory execution. Hence a property under such mortgage conditions is likely to be auctioned at a lower price than an object free from mortgage encumbrances.


    In the case of execution proceedings, the general rule is that the rights in the land register preceding or of the same ranking as the right of the claimant or the right securing the claim will remain, while other rights will be terminated. Also terminated is the right of the claimant for fulfilment, of which the claim for payment was made. Hence it is important to determine the ranking of the security or other right under which the claim for payment was made. For example, if the mortgage in favour of the claimant was in the first ranking, the mortgage and the rights following it are deleted and the buyer will buy the property without third party rights enabling a compulsory sale. However, if the mortgage in favour of the claimant is in the second ranking, a mortgage in the first ranking will remain. Yet a mortgage in the second ranking and any other rights following it will be deleted. If another right exists in the same ranking as that of the claimant, that right will remain as well.


    The legal implications of selling a property under bankruptcy proceedings are somewhat simpler, as all the rights that inhibit compulsory sale of the property encumbering real estate on sale are deleted.


    What happens to lease  agreements?


    Sometimes, properties sold under execution or bankruptcy proceedings are encumbered with lease agreements. In that case, the buyer must take into account that the lease agreement remains intact after the property changes hands, regardless of whether or not a lease contract is entered in the land register. If the lease agreement has not been entered in the land register, the new owner is entitled to cancel the lease  agreement within three months from purchasing the property by giving three months notice in advance. However, if the property under consideration is being used for residential or commercial purposes, the new owner can cancel the lease agreement only on proving urgent personal necessity, i.e., the buyer must be able to prove that they themselves need the rented space. In court practice, personal necessity must be substantiated with immediate, serious and actual reasons proving the need the owner may have to utilize the object of the lease  agreement. As an example, the Supreme Court has stated that building a hotel on an immovable property tied by lease agreements or applying for a loan on immovable property where repayment exceeds the financial ability of the applicant do not amount to urgent personal necessity that justify cancelling the lease agreement.


    Is the previous owner of the property, the bailiff or the trustee in bankruptcy liable for the state of the property?


    One must take into account that the previous owner, the bailiff or the trustee in bankruptcy are not liable for any defects in a property sold at auction under execution or bankruptcy proceedings. This means that if the buyer finds any defects after signing the purchase contract, the buyer cannot withdraw from the transaction, reduce the price of the property or ask for compensation by way of damages. Therefore, it is important to do thorough preliminary work and get as good an overview as possible of the object to be acquired, in order to take into account possible defects in the object (for example the absence of construction documentation) when making an offer.


    Financing the purchase with a bank loan


    An amendment to the Code of Enforcement Procedure at the beginning of 2010 states that real estate can be acquired at auction by financing the transaction with a bank loan by using the same object to be bought as security for the loan. When wishing to do so, one must inform the bailiff of the loan no later than on the day of winning the auction. Thereafter the bank deposits the money in the trust account of the notary or delivers a warranty letter to the bailiff assuring payment of the sale price. The bailiff, in turn, delivers their consent to the notary to establish a mortgage in favour of the bank. Hence the procedure is rather convenient and allows customary bank financing even with compulsory execution. When using bank financing, the buyer is not obligated to pay 1/10 of the purchase price on the day of winning the auction, which would be the case with self-financing.


    Does the purchase price include value added tax?


    In most cases, auction notifications do not mention whether the auction price includes value added tax. This issue arises only when the property in question is purchased by a legal entity. For the buyer this has a very practical meaning, as if the sale price includes VAT and the seller delivers an invoice for the sale price as required, the buyer liable for VAT can report VAT paid as deductible input VAT in their tax report. Therefore we advise that you consult with the previous owner beforehand to determine whether the price includes VAT and verify if the owner is prepared to issue an appropriate invoice for the sale price. With some real estate objects (especially with construction plots and properties with new structures) adding VAT is mandatory. However, if the previous owner does not deliver an appropriate invoice, the new owner may have difficulties declaring the input VAT reports.



    We hope that the guidelines above help to clear up some of the hesitation arising with purchasing property from compulsory sale and that, equipped with better knowledge, you will be able to benefit from the current economic situation and make profitable real estate transactions.