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Developers behind bars?

The Developers Act has not come into force yet but has already generated much controversy. Whom will it truly protect?

According to the legislative justification for Poland’s Act on Protection of Rights of Buyers of Residential Units and Single-Family Houses dated 16 September 2011 (Sejm Document No. 4349), the main goal of the Developers Act (as it is popularly known) is to protect homebuyers by introducing regulations minimising their risk if the development project fails.

To this end, the act introduced a number of legal institutions which should eliminate the risk of losing funds paid in by the buyer toward the intended purchase of a home—if not the risk of loss of rights to the property itself.

Under the act, developers must provide homebuyers at least one method for securing their payments, from among those listed in Art. 4 of the act, namely:
a) a closed residential trust account,
b) an open residential trust account and an insurance guarantee,
c) an open residential trust account and a bank guarantee, or
d) an open residential trust account.

The funds from open residential accounts will be paid out to the developer by the bank in stages, in line with the progress of the work on the development project. (Progress will be verified by a qualified construction expert appointed by the bank, on the basis of entries in the construction log). Funds which the buyer pays into a closed trust account will be frozen, and paid out to the developer only upon conclusion of the deed transferring the home to the buyer (in the form of rights to a residential unit, freehold of land developed with a single-family house, or perpetual usufruct of the land and title to a single-family house built on the land, as the case may be). In addition, the contract with the developer must be concluded in the form of a notarial deed. The developer is also required to issue a prospectus for the project, which is incorporated by law into the development contract. If there is a discrepancy between the terms of the prospectus and the other terms of the development contract, or between the prospectus and the actual legal or factual state as of the date of conclusion of the development contract, the buyer will have a statutory right to renounce the contract within 30 days after concluding the contract.

These are just some examples of selected legal institutions in the Developers Act that are intended to protect homebuyers.

The Polish Developers Association says that it agrees that statutory regulation of development contracts is necessary, but claims that the Developers Act is a legislative lemon.

Not all developers will obtain consent from banks to establish and maintain trust accounts. Even developers who have been active on the market for a long time may have difficulty opening trust accounts in the current economy—not to mention that under typical development practice, the investor is a special-purpose vehicle established solely to carry out a single development project and thus has no financial track record.

The costs of maintaining the trust accounts will fall on the developers, and because they require significant activity on the part of the banks (assessment of the justification for paying out funds from the trust account), the costs are expected to be high. This will in turn lead to an increase in the prices of new homes, which is not in the interest of buyers.

The provision on security itself has holes. If a developer is required to offer buyers “at least” one of the stated methods of security, it will almost certainly offer the least burdensome method of security (an open residential trust account), and the other options will fall by the wayside.

The act prevents developers from carrying out projects by financing construction out of the funds contributed by buyers under the current rules. Many developers who bought sites several years ago, counting on using this method of financing, will not be in a position to carry out construction. They will drop out of the market, and their place will be taken by larger players, with their own capital or secured lending. The limitation of competition may be another factor driving up prices of new homes.

An even greater flaw is the form for the prospectus (an appendix to the act). The developer will be required to state in the prospectus the zoning of the neighbouring plots, the permissible height of construction, and the permissible percentage of the plot that can be built on. If there is no local zoning plan in force, this should be noted in the prospectus. The developer will also be required to include information from publicly available documents concerning other anticipated developments within a 1 km radius of the property.

It is easy to imagine the difficulties developers will face when attempting to gather the information required for the prospectus. The first requests for information have already been filed with the local communes. Given the range of information required, it is very time-consuming to prepare the responses, which is certain to slow down other essential work for citizens (e.g. on adoption of local zoning plans). Moreover, local officials do not know how they should respond to these requests. The provision referring to “anticipated” developments within 1 km of the property is vague, but the consequences of providing inaccurate or incomplete information on this point are serious.

Developers will be liable to homebuyers for the information included in the prospectus. Under Art. 33 of the Developers Act, anyone responsible for information included in a prospectus who provides false information or conceals the true information is subject to a fine, probation, or imprisonment up to 2 years. But it may happen that at the stage of selling units in the first phase of a project, the developer is unable to predict whether it will also carry out a second or third phase, and the sales results in the first phase often determine whether additional phases will be carried out.

Given the penal sanctions imposed as well as the far-reaching civil consequences (the buyer’s right to renounce the contract), it may be assumed that the section of the prospectus concerning public information will soon become the biggest headache of developers—more of a pain even than financing their developments.

The Developers Act permits indexing of prices (through an indication of the basis for the adjustments in the prospectus, as an appendix to the contract), which developers may use as an argument to propose such clauses in contracts with homebuyers for construction of their units.

However, the greatest controversy arises out of Art. 37 of the act, which provides that the act applies to development projects for which sales began after the effective date of the act. But the act itself defines the start of sales as “publication of information on commencement of the process of offering residential units or single-family houses as part of a specific development project.” So is it enough to place an ad in the press concerning sale of units in a given projects? Certainly many developers will do so at a stage prior to obtaining a building permit, if only to avoid the necessity to conduct residential trust accounts. But the apparent intention of the Parliament was to enable projects started prior to the effective date of the act to be completed under the existing legal conditions.

The room for interpretation is great, and the grace period will soon end, as the act goes into force on 29 April 2012.

Even the Parliament itself did not feel confident of its ability to predict what effect the Developers Act would have when it went into force. The act includes a provision requiring the Government to conduct a review of the functioning of the act and to submit a report to the Parliament on the effects of the act, with proposed amendments, within 2 years after the effective date of the act.

Michał Wons, Corporate Law, Restructuring and Business-to-Business Contracts practices, Wardyński & Partners