Perpetual usufruct: an obstacle race
Most investors in Poland regard perpetual usufruct as equivalent, in practical terms, to freehold. There are many obvious similarities, but the special features of perpetual usufruct can make it an obstacle race for the unwary.
It is therefore wise to carry out in-depth due diligence prior to any investment involving real estate that is held in perpetual usufruct.
Perpetual usufruct is a right granting long-term use of real estate that belongs to the Polish State Treasury or a local authority. It is established for a period of 40 to 99 years, and is fully transferable, can be inherited and encumbered (e.g. by a mortgage), and is enforceable against all parties. Buildings and other structures purchased or constructed on the land remain the property of the holder (referred to as the “usufructuary”).
The fact that investors are willing to pay the same price on the open market for perpetual usufruct as for freehold suggests that they believe their rights are the same. However, they often fail to take account of how the real estate will be used. There is, in fact, a fundamental difference between freehold and perpetual usufruct. Freehold provides a range of property rights limited only by acts of law and public policy (referred to in Polish law as “principles of social coexistence”). Perpetual usufruct is further restricted by the manner of use stipulated in the agreement or administrative decision by which it was established. This manner of use is also binding on the usufructuary’s legal successors. Investors are often misled into believing that the local zoning plan or favourable development terms obtained for neighbouring properties will allow them to carry out trouble-free development. They are likely to be disappointed.
If, for example, the local zoning plan allows for “residential multi-family occupancy and commercial development”, this may seem broad and flexible enough for the investor to construct an office block on a plot held in perpetual usufruct.
But this is not the case if the perpetual usufruct agreement specifies that the plot must be used for “residential multi-family occupancy development”. On its own land, the usufructuary will only be able to construct a multi-family residential building, regardless of what the zoning plan allows. In other words, in this specific case, the usufructuary would not have the right to use the plot for building an office block, and therefore will not be able to obtain a permit to construct such a building.
The specified use of the land held in perpetual usufruct applies for the entire term of the usufruct and is binding on legal successors. Investors purchasing land held in perpetual usufruct that has already been developed often wrongly believe that the original usufructuary has discharged the contractual obligations concerning the permitted land use, and when they buy the plot the only restrictions on further development are zoning plans and similar regulations. Similarly, they may wish to redevelop the building in order to change its use, believing that they are subject only to limitations imposed by construction law and zoning law. This is, in fact, not the case, since the new usufructuary will continue to be bound by the original mode of use. A change in the use is possible by agreement between the landowner and the usufructuary. The problem is that local authorities (in larger cities) demand special fees from usufructuaries for consenting to a change of use. The Warsaw City Council, for example, charges a fee of no less than 12.5% of the value of the land.
Many businesses acquired perpetual usufruct properties as a result of Poland’s political and economic transformations in the 1980s and 1990s, and they are now beginning to sell these properties on the open market. Although the great bulk of such administrative enfranchisement decisions did not specify how the real estate was to be developed, some commentators believe that the simple fact that the property is on the market can itself provide grounds for terminating the perpetual usufruct agreement, since plots which by definition were intended to serve a business (the original reason why the grants were made) are now being traded.
The agreement establishing perpetual usufruct normally specifies deadlines for the start and completion of construction work. The usufructuary and its successors are again bound by these deadlines. Special risks apply to investors who purchase the perpetual usufruct where the deadlines have already passed or are impossible to meet. They become liable to a special annual penalty equal to 10% of the value of the real estate (which may be cumulatively increased by a further 10%). Irrespective of this, if a usufructuary fails to construct buildings before the deadline specified in the agreement, the owner of the freehold may attempt to terminate the agreement in the courts. If a perpetual usufruct agreement is terminated in this way, the usufructuary is entitled to compensation only for any buildings constructed or acquired on the site. If no buildings have been constructed by the usufructuary or its predecessors and construction work has yet to commence, the usufructuary will receive no compensation at all.
When perpetual usufruct expires or is terminated, any encumbrances established on it, including mortgages, also expire. Mortgagees who lose mortgages as a result of such expiry are accorded statutory pledge rights on the usufructuary’s compensation claims for any buildings acquired or constructed on the site. If perpetual usufruct expires on real estate where there are no buildings (purchased or constructed by the usufructuary), the mortgage for obvious reasons will not transform itself into a pledge right, but the mortgagee will lose all of its collateral.
It often happens that an investor develops a project on two (or more) plots of land, one of which is owned in freehold while the other is held in perpetual usufruct. If the investor builds an office block, this will not have serious consequences. But if it constructs a residential building on a “mosaic” of plots, both owned outright and held in perpetual usufruct, it will not then be able to establish separate legal title to the individual apartments within the building, since the building will be on real estate owned by different persons (the investor and either the city or the State Treasury). The consequences of being unable to establish separate ownership of residential units and therefore sell them are obvious.
A problem that is just starting to appear on the horizon is obtaining an extension of perpetual usufruct. Cases where perpetual usufruct has expired are currently quite rare, but the numbers will increase with time. Under current law, providing that the usufructuary applies within five years before expiry of the term stated in the agreement, it may request an extension of the agreement for another 40 to 99 years. The authorities can refuse to grant such an extension only when important public interests are at stake. In the handful of cases that have come to light so far, the main issue is the effectiveness of the extension when the application was filed before expiry of the term but the landowner consented only afterwards, and the extension agreement was thus concluded after expiry of the term. Fortunately, so far it is generally accepted that notarial deeds covering such extension agreements have a similar effect to those covering the registration of properties in the land and mortgage register, which have retrospective effect from the filing of the application. A similar situation applies to cases where the owner has refused to extend the term, but the usufructuary obtains a court judgment in its favour, which can be used as the basis for concluding the necessary notarial deed.
Perpetual usufruct can be a complex matter, and it would be quite wrong to regard it as conferring the same rights as freehold.
Tomasz Zasacki, Real Estate & Construction Practice, Wardyński & Partners