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Trust ownership as an alternative to a mortgage

From 17 October 2019, a new form of securing performance of obligations – a trust ownership, introduced by Law No. 132-IX – has started operating in Ukraine.

From 17 October 2019, a new form of securing performance of obligations – a trust ownership, introduced by Law No. 132-IX – has started operating in Ukraine.

The concept of “trust ownership” is not new to Ukrainian legislation and it has long been enshrined in the Civil Code of Ukraine (hereinafter referred to as the Civil Code of Ukraine), but only from the end of October 2019, the trust ownership began to exist as a form of securing performance of obligations.

We propose to analyse in detail the legislative regulation of the Trust Agreement and the benefits of using such a method of securing.

  • The essence of Trust Agreement

According to a Trust Agreement, one party (the trustor) transfers the property (movable/immovable) to the other party (the trustee) upon trust to secure the debtor’s obligations under the loan agreement.

From the moment of establishing the trust ownership, the trustor’s ownership right is deemed to be terminated, whereas the trustee receives the right of trust ownership of such property. However, the trustee does not have the right to alienate such property on its own, except for the purpose of the foreclosure, as well as for its redemption for public needs in accordance with the procedure established by law.

At the time of establishing the trust ownership, the property may be used by: the trustor, the trustee or a third party. The user shall be identified in the Trust Agreement. The law does not impose any requirements for the compensatory nature of such use, so the use may be free of charge.

Notwithstanding the foregoing, the law establishes some peculiarities for the realization of the trust ownership rights in relation to the land plots. In particular, a trusted land plot may be used by a user (who is not a trustee) only on a leasehold basis with the following characteristics:

  • the term of lease of the land plot is terminated from the moment of the foreclosure on the land plot;
  • the leasee cannot carry out construction, extraction of minerals on the land plot or make improvements that cannot be separated from the land plot without causing damage.
  • Benefits of trust ownership as a form of securing performance of obligations

The trust ownership is beneficial to the creditor, as he should not be concerned about the trustor’s bankruptcy, which is not secured by a mortgage. Thus, the effect of the moratorium on satisfying the claims of creditors established in the debtor’s bankruptcy procedure does not apply to any trustee’s actions regarding the object of trust ownership. In addition, the object of trust ownership cannot be included in the trustor’s liquidation estate.

In addition, it is very important that from the moment of the conclusion of the agreement, the debtor loses ownership right to the trust property, and therefore is not able to carry out fraudulent activities with such property. In all state registers of Ukraine, it is the creditor who is designated as the trustee of the property, without whose consent such property cannot be alienated/divided/pledged.

  • Features of the Trust Agreement
  1. The Trust Agreement on immovable property shall be concluded in writing and shall be subject to a notarial certification. The right of a trust ownership under such an agreement arises from the moment of its registration in the State Register of Immovable Property Rights.
    The terms of the loan agreement secured by the transfer of the property to the trust ownership, may differ from the terms of the loan agreement secured otherwise.
  2. The trust ownership cannot secure the performance of obligations under the loan agreement, which was concluded prior to the entry into force of Law No. 132-IX, as well as obligations arising from the change (restructuring, refinancing) of obligations under the agreement, concluded before the entry into force of Law No. 132-IX. At the same time, Law No. 132-IX does not impose the prohibitions on securing performance of obligations under a borrow agreement, which was concluded before Law No. 132-IX came into force.
  3. Within five working days from the date of termination (including in connection with its full performance) of the principal obligation, the trustee is obliged to transfer the ownership right for the object of trust ownership to the trustor, unless otherwise specified in the Trust Agreement. If the trustee evades the said obligation, the debtor or other person, entitled to obtain the ownership right for the object of trust ownership, shall have the right to file a lawsuit on recognition of its ownership right for the object of trust ownership or apply to a notary for the enforcement of the executive inscription on the recovery of the object of trust ownership from the trust owner.
  • When the creditor can foreclosure the property

The foreclosureis possible in the following cases:

  • in the event of delay in fulfilling the principal obligation for more than 20 calendar days (a part of principal obligation for more than 30 calendar days);
  • in the event of the debtor’s breach of the obligations specified in the Trust Agreement;
  • in the event of a user’s breach of its obligations to retain or use the object of trust ownership;
  • in other cases stipulated by the agreement, which entitles the creditor and the debtor to establish any other grounds foreclosing the property.
  • When the creditor is obliged to foreclose the property

In the Civil Code of Ukraine there are several cases in which the trustee is obliged to foreclose the object of trust ownership. Such cases are:

  • state registration of the decision on the termination of the legal entity-debtor in the principal obligation or the trustee;
  • adopting a court decision on recognition a debtor in a principal obligation or a trustee as bankrupt and opening a liquidation procedure;
  • death of the debtor in the principal obligation, its recognition as incapacitated or deceased.
  • How to foreclose the property

The Civil Code of Ukraine determines that foreclosure of the trust property may be effected by its selling by the trustee to any person who is the buyer. However, the Civil Code of Ukraine does not prohibit to determine other ways of foreclosing the object of trust ownership (transfer the right of ownership of the mortgaged property to the trustee; judicial foreclosure of the trust property, etc.).

Thus, the debtor and the creditor can, at their discretion, provide in the agreement the convenient ways to foreclosure.

  • Risks related to trust ownership

The Civil Code of Ukraine states that prior to granting a loan secured by the transfer of immovable property to a trust ownership, the creditor is obliged to offer the debtor the opportunity to secure these obligations in another way.

In our opinion, the above rule may be the basis for litigation between the trustee and the trustor, since the law does not specify:

  • in what form such a proposal should be implemented;
  • what the creditor has to do if the parties have agreed to transfer the property to the trust ownership after the loan has been granted;
  • whether the creditor should wait for a response concerning the refusal to secure the loan obligations otherwise;
  • whether to offer the debtor under the loan agreement other ways of securing performance of the obligation, if the trustor is not the debtor himself, but a third party.

The most obvious one may be a dispute over the recognition of a Trust Agreement as invalid due to the failure to comply with the abovementioned requirements of the Civil Code of Ukraine.

We believe that in order to minimize the risks in a Trust Agreement, wherein the trustor is the debtor, the reservation should be noted, according to which the debtor will confirm the offer of another type of security proposed by the creditor. In addition, the creditor should take a number of preparatory steps to secure the appropriate arrangements with the debtor in writing.

Conclusions

Despite some loopholes in the legislation, trust ownership, as a new way of securing performance of obligations, has the potential to become an effective tool for protecting the rights and interests of trustees. For a creditor, a trust ownership is a more profitable way of securing obligations than a mortgage because the creditor becomes, in fact, the owner (the trust owner) of the property transferred to the trust ownership. At the same time, in order to obtain the consent of the borrower to such a commitment, the creditor must offer something in return, for example, more favourable credit terms in comparison with a mortgage lending.

Iryna Kalnytska

Iryna Kalnytska

Partner, Head of Tax practice, Restructuring, Claims and Recoveries practice, Attorney at law

  • Recognitions
  • The Legal 500 EMEA 2020
  • Best Lawyers, Ukraine 2020
  • Who’s Who Legal 2020
  • Ukrainian Law firms. A Handbook for Foreign Clients 2019

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