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Developers Guarantee Fund: More drawbacks than benefits?

Work is underway on a bill called the Act on Protection of the Rights of Acquirers of Residential Units or Single-Family Houses and the Developers Guarantee Fund (print 985). The bill was approved by the Sejm, the Senate adopted amendments, and the bill will now be reconsidered by the Sejm. Entry into force of the new act will impose additional new duties on developers. The aim is to better protect homebuyers against the loss of funds invested in residential developments, particularly when the developer becomes insolvent before the project is completed. Is the new instrument likely to fulfil its intended function?

The process of acquiring an apartment or single-family house on the primary market in Poland generally involves several stages, spread out in time. It begins with conclusion of a development contract between the developer and the future buyer, under which the developer undertakes to build the home and transfer it to the buyer in exchange for payment of the purchase price. The buyer pays the price for the future home to the developer in stages as the work progresses.

Protection of buyers—current law

To protect homebuyers in Poland against the negative situations that can occur between conclusion of the development contract and acquisition of ownership of the property, the Act on Protection of the Rights of Acquirers of Residential Units or Single-Family Houses was adopted and entered into force on 16 September 2011.

The 2011 act covers factual and legal actions by developers and buyers from the commencement of the development venture, through the stage of issuing a prospectus on the process of offering units or houses, the stage of conclusion of development contracts, and finally transfer of ownership.

Special obligations are imposed on developers in connection with receipt and spending of funds from future acquirers of apartments or single-family houses. Funds from buyers of residential properties are deposited by the developer in a residential escrow account operated by a bank selected by the developer, separately for each project. The funds from the escrow account are earmarked for construction and finishing of the homes.

The developer can choose between an open or closed residential escrow account. The difference is that in an open account, partial tranches are released to the developer in stages, after acceptance of partial works, while depositing the payments in a closed account requires the developer to temporarily engage its own funds, as the escrow is released to the developer only upon transfer of ownership of the unit or house to the buyer.

The longstanding practice since this act entered into force shows that developers overwhelmingly choose open escrow accounts, which are more flexible for them and allow them to reduce overall project costs (current financing of the project out of funds from future buyers allows the developer to avoid taking out credit from financial institutions to cover the current development costs).

Although more convenient for the developer, use of an open escrow account provides less protection for the interests of the buyers in the event that the developer becomes insolvent before completion of the project. Funds are paid out of the account to the developer before transfer of ownership of the property to the buyer, increasing the risk that buyers will lose both their funds, which are consumed going forward by the developer, and the property, because if the developer goes broke the project may not be completed. In practice, developers do not establish the recommended additional security for the funds received from prospective buyers, in the form of a bank or insurance guarantee, which would provide them protection similar to that offered by a closed residential escrow account.

The current Bankruptcy Law also provides inadequate protection for the interests of buyers. It does specially regulate the rights of acquirers of residential units and houses in bankruptcy proceedings involving developers, awarding them the position of secured creditors. However, if the developer’s bankruptcy is declared before completion of the project, and a decision is taken to liquidate the developer’s assets, the funds gathered in an open residential escrow account will never fully satisfy the buyers’ claims, as the funds have partly been used by the developer. The buyers’ priority in satisfaction out of the collateral (the real estate) before other creditors holding a different status will not always help them.

Proposed regulations

The bill currently being considered would create a complex system of modern instruments for protection of homebuyers, one of which is the Developers Guarantee Fund. The provisions governing operation of this new fund are patterned on provisions that have been tested in practice under the Tourism Guarantee Fund, as a segregated bank account within the Insurance Guarantee Fund.

The bill, drafted by the Office of Competition and Consumer Protection (UOKiK), provides that the developer will still be entitled to select the type of escrow account that will be operated for the given project. The bill retains two types of residential escrow accounts—open and closed—but provides that with introduction of the Developers Guarantee Fund, the open escrow account will no longer be secured by a bank or insurance guarantee. Regardless of the type of escrow account maintained for the project, the developer will have to deduct a contribution for the guarantee fund from each payment to the escrow account. The amount will be set by executive regulations, but will be no higher than:

  • 2% in the case of an open residential escrow account (or 1% under the amendment adopted by the Senate)
  • 0.2% in the case of a closed residential escrow account (or 0.1% in the Senate version).

The effective protection of homebuyers via the new fund would consist of allowing them to claim compensation from the fund for amounts they could not recover directly from the escrow account because the funds were consumed by the developer. Money would be paid out from the fund:

  • Under circumstances described in detail in the act, involving the developer’s bankruptcy or restructuring
  • In the event of cancellation of the development contract by the buyer for reasons enumerated in the new act (e.g. due to defects in the contract, noncompliance of the development contract with the prospectus for the project, or failure by the developer to cure defects in the home on a timely basis) and failure to recover funds paid in directly from the developer
  • In the event of bankruptcy of the bank operating the residential escrow account (to the extent compensation is not covered by the Bank Guarantee Fund, because the guaranteed limit is exceeded).

The new act is to enter into force after a 12-month grace period, except that the Developers Guarantee Fund is to be created within 30 days after publication of the new act.

The idea of creating the new fund has been criticised by developers. Although the proponents argue that the mechanisms for operation of the new act, including the fund, were drawn up in consultation with entities operating on the residential development market, and certain concessions in this respect were made during the work on the bill, the controversy continues unabated.

The aim of establishing the Developers Guarantee Fund is to collect a financial reserve of PLN 140 million per year. This amount was calculated to secure consumers against the hypothetical bankruptcy of one larger developer and two smaller developers. By way of illustration, over the nearly 10 years in which the current act has been in force, two developers have gone bankrupt. And considering the current value of the residential development market and the currently proposed level of contributions to the fund, the Polish Association of Developers (PZFD) estimates that the resulting reserve would be several times greater than planned. Moreover, the reserve would be artificially inflated, because contributions to the fund would be non-refundable, even if the prospective buyer cancelled the development contract and the same unit were sold to another buyer (in which case the same contribution would be charged twice).

Considering the overall shape of the bill, developers claim that the already high price of new apartments in Poland would rise even more, without offsetting benefits for buyers.

Olga Połowianiuk, attorney-at-law, Michał Gliński, attorney-at-law, Real Estate practice, Wardyński & Partners