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OVERVIEW OF LEGAL ENVIRONMENT IN UKRAINE
RELEVANT TO MORTGAGE-BASED FINANCING
by Gennadiy Shemshuchenko
I. PREFACE
Within last few years a block of new mortgage-related legislation came in
effect in Ukraine. In this context particular tribute must be paid to the Law on
Mortgage (Mortgage Law), which was adopted by the Parliament of Ukraine on 5
June 2003 and took effect as of 1 January 2004.
Mortgage Law is treated as key framework legislative document that is
called upon to govern mortgage collateral (hypothec), encompassing the whole
process from its creation to enforcement of creditor’s rights thereunder. In
particular, Mortgage Law defines grounds and rules for creation of mortgage
collateral, scope of mortgage, mortgage creditor’s and debtor’s rights and
obligations, requirements to publicity of mortgages, priority rules, foreclosure and
enforcement procedures etc.
Mortgage Law contains clauses, which are typical for mortgage collateral
regulation since the Romans till now in numerous jurisdictions. In particular,
Mortgage Law provides for the following concepts: (i) real estate could be pledged
without delivery of possession to a creditor; (ii) accessory nature of mortgage
rights; (iii) creditor’s right to sell mortgaged property in order to satisfy unpaid
obligation; (iv) debtor’s right to obtain excess proceeds of sale; (v) unsecured
creditor’s right to any deficiency in price of mortgage collateral; (vi) possibility to
pledge both present and future real property; (vii) in rem nature of mortgage,
which continues to attach to real estate regardless of transfer of title. In line with
above, Mortgage Law reflects some modern concepts basically referred to
explaining very detailed priority rules and foreclosure process.
Mortgage Law also refers to procedures of mortgages registration as well as
to secondary mortgage refinance mechanisms subject to more detailed and specific
regulation in separate pieces of legislation. On 1 July 2004 the Parliament of
Ukraine adopted the Law on State Registration of Property Rights in Real Estate
and of its Limitations (Registration Law). This Law provides for creation of single
State Registry of Rights in Real Estate, where, in line with titles and rights to real
property, limitations and encumbrances of those rights (including mortgages) shall
be registered. As of 1 January 2004 the Law on Mortgage Crediting, Transactions
with Consolidated Mortgage Debt and Mortgage Certificates (Mortgage Crediting
Law) took effect. This Law provides for surrogate type of mortgage-based
securities – mortgage certificates.
There is general perception to characterize the quality of Mortgage Law as
fairly high comparing to the same statutes in others Central and Eastern European
countries. However, practical implementation of modern concepts, which were
incepted in Mortgage Law and which are vitally important for efficient operation
of mortgage collateral in practical terms, appeared to be, contrary to expectations,
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at very low level. Mortgage Law constitutes only one of the blocks in legal
basement for mortgage lending in Ukraine. Proceeding from this effect, fairly high
quality of Mortgage Law turned out to be dissolved in the whole bulk of mortgage-
related legislation, which in general terms does not secure efficiency of mortgage
lending market in Ukraine.
The present Overview is intended to outline present status of affairs in the
major areas of legal environment vitally essential for development of efficient
mortgage lending market in Ukraine, comprising: legal treatment of mortgage
collateral; operation of registration system; creation of secondary mortgage re-
finance system etc. This Overview shall also briefly describe core problems in
given areas and identify their remedies.
II. MORTGAGE-RELATED LEGISLATION
Mortgage-related legislation in Ukraine can be classified into 3 major groups
of regulatory documents:
1. Specific mortgage-related laws of direct effect. This group of documents
includes those mentioned above – Mortgage Law, Registration Law and Mortgage
Crediting Law. Right now they constitute an umbrella for mortgage lending market
in Ukraine and directly identify efficiency (or inefficiency) of mortgage-based
financing system.
2. Regulations designated to fulfill separate tasks prescribed by mortgage-
related laws. This group of documents is often referred to as “under the law
normative documents”, since regulations usually treat separate technicalities of the
issues, particular settlement of which at this level is prescribed in the law. In
mortgage lending area the following regulations worthwhile to mention:
Securities Commission Resolution on Mortgage Note Standard Form
(September 2003) – as prescribed by Mortgage Law, provides for typical
requirements to producing and content of mortgage notes.
Cabinet of Ministers of Ukraine (CMU) Regulation on Provisional Order for
Mortgages Registration (March 2004) - as prescribed by Mortgage Law,
provides for temporary procedure of performance of registration deeds with
mortgages by Ministry of Justice.
2 CMU Regulation on Creation and Procedures for Allocation of Temporary
Housing (March 2004) - as prescribed by Mortgage Law, provides for creation
in Ukraine of residential premises facilities suitable for temporary placement of
houseless, including those evicted upon foreclosure of the mortgaged property.
2 CMU Regulations on Creation of the State Mortgage Institution (November-
December 2004) – according to these documents the State Mortgage Institution
was established as a second tier mortgage refinance company.
3. Laws of general (indirect) effect on mortgage-based financing. This group
of documents does not establish particular rules in the field of mortgage collateral
or mortgage lending, however they effect this area via regulation of such various
aspects as: property rights in real estate; transactions with land; performance of
obligations; securing such performance; creation and operation of legal entities;
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banking and financial institutions activities; notary’s deeds; taxation of transactions
with mortgages etc. The list of such laws shall include, but is not limited to:
Land Code (2001) – provides for legal regime of land and transactions with
land plots. This Law, in particular, imposes moratorium for sale of agricultural
lands until 2007 and stipulates a number of other restrictions regarding such
lands. This implies indirect prohibition for the use of agricultural land plots for
mortgage lending purposes.
Civil Code (took effect as of 1 January 2004) – provides for general grounds of
performance of obligations, securing such performance, status of legal entities,
property and ownership rights system etc;
Commercial Code (took effect as of 1 January 2004) – provides for general
grounds of business entities operation. This Law is quite confusing since often
overlaps with the Civil Code.
Marital Code (2002) – provides for joint ownership treatment of the real
property in disposal of spouses. This Law may incept certain confusion in pre-
contractual mortgage lending procedures by recognition of the civil marriage
concept. Since they are not subject to registration, mortgage lenders may not
have sufficient proves of the real estate being subject to joint ownership
treatment. Marital Code also stipulates complicated custodian authority’s
permission procedures for children replacement of housing, which makes their
forceful evection of mortgaged residential property nearly impossible.
Housing Code (1983) – drastically obsolete Law, which stipulates housing
treatment based on former Soviet-style concept of the state granting housing on
free of charge basis. This Law also establishes utmost priority of residents to
retain hosing under most circumstances or to be evicted only being supplied
with alternative shelter. A few attempts to adopt a new Housing Code have
failed. However, in 2003 Housing Code was amended in the way that allows
eviction of residents from housing serving as collateral against a loan in case of
debtor’s default.
The Law on Banks and Banking (2000) – governs banking in Ukraine pursuing
to the best international standards. This Law does not govern mortgage lending;
however, general requirements to banking operation stipulated in this Law must
be honored in the course of mortgage lending bank’s activities. This Law also
provides for possibility of establishing specialized mortgage banks. At the same
time, any specific requirements to mortgage bank operation as well as particular
regulations related to their creation and activities are missing or not sufficient.
The Law on Financial Markets and State Regulation of Financial Markets
(2001) – provides general grounds for regulation of and supervision over non-
bank financial institution. This Law outlines certain types of financial
institutions that might grant mortgage loans (in particular credit unions) but
does not fix any rules of their involvement in this area.
The Law on Pledge (1992) – provided for general rules of pledging property as
security in performance of monetary obligations. However, since 2003 this Law
has no whatsoever effect to pledges of real estate.
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The Law on Securing Creditor’s Claims and Registration of Encumbrances
(took effect as of 1 January 2004) – provides for legal treatment of creation,
publicity, registration, operation and enforcement of charges in movable
property. This Law might be applicable to secondary mortgage re-financing, in
particular, with respect to identification of legal regime and requirements to
registration of mortgage coverage for mortgage bonds.
The Law on Enforcement Procedures (1999) – provides for extremely
uncertain, time- and cost-consuming procedures of forceful execution of court
decisions and other enforcement documents via special Execution Department
attached to Ministry of Justice. Inefficiency of enforcement procedures
stipulated by this Law directly affects inefficiency of judicial procedures of
enforcement against mortgages. This Law is treated as a “sacred cow”. Thus,
numerous attempts to amend it in positive manner have failed.
The Law on Renewal of Debtor’s Solvency and Bankruptcy Procedures (1999)
– governs bankruptcy procedures related to insolvency of legal entities with
exception to banks (their insolvency is subordinated to provisions of Banking
Law). According to this Law neither mortgaged property nor mortgage assets
backing mortgage securities are presumed to be segregated from debtor’s
liquidation estate, which makes bankruptcy procedures unfriendly to mortgages.
The Law on Notary Deeds (1993) – stipulates procedures for notary
authentication of transactions with real property (sales and mortgage contracts
inclusive). Notary procedures pre-suppose a huge number of formalities, which
sometimes block respective transactions. For example, notaries are liable for
verifying payment by real estate sellers of taxes and duties related to sales
transactions. Since 2005 new order of calculation and payment of personal
income tax on proceeds of the real estate sales was introduced. Due to absence
of respective Tax Office methodology for calculation of the tax, its payment
appeared to be impossible as well as submission to the notary of respective
payment evidence. As an outcome, notaries refused to authenticate sales
transactions with real property and the whole real estate market was blocked in
Ukraine for the first quarter of 2005.
The Law on Taxation of Citizens Personal Incomes (2003) – this Law is
purported to create tax incentives for citizens if they purchase housing financed
by mortgage loans. However, very vogue and confusing wordings may only
create problems, as it is indicated above in the case with notary authentication
of mortgage deeds.
The Law on Property Evaluation and Professional Evaluators Activities (2001)
– this Law provides for regulation of evaluator’s profession but it is not specific
on assessment of real estate.
The Law on Financial and Credit Mechanisms and Property Management in
the Course of Construction and Transactions with Real Estate (took effect as of
1 January 2004) – pretty ambiguous Law providing for financing of residential
construction business for account of investor’s funds attracted in trust of a
foundation managed by a construction company.
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III. OPERATION OF REGISTRATION SYSTEM
Importance of modern and efficient system of registration of rights to real
estate in the context of mortgage-based financing can hardly be overvalued. Lack
of reliable system for registration of property rights and mortgages represents
major impediment to development of mortgage lending market. Registration of real
property rights allows a creditor to determine that a debtor owns a property and has
the right to mortgage it, as well as to identify any third-party rights to the property,
which may interfere with enforcement of mortgage right. Registration of
mortgages assures mortgage lender priority over other creditor’s rights in the same
real estate.
Recent Registration Law is a key legislative document that provides for
compulsory state registration of titles to real estate (lands and buildings) as well as
of limitations or encumbrances of rights to real property (mortgages, leases, use
rights, servitudes etc) in the State Registry of Rights in Real Estate. This Registry
is supposed to be established according to the “single window” principle on the
basis of the Land Cadastre, which is administrated by the State Land Committee of
Ukraine.
Registration Law stipulates that state registration of rights to real estate shall
be made under cadastre number of the respective land plot by local (in each region
of Ukraine where property is located) registration authority subordinated to the
State Land Committee. State registration shall be physically performed by
qualified registrator - a person with law degree, who passed respective 6 month
training in registration system. Registrator’s institution is absolutely new for
Ukraine. Previously, all sorts of registration deeds related to real estate were
executed by notaries. At the moment there are no evidences of how efficiently this
institution would perform, since it exists only virtually.
Registrator is authorized by Registration Law to register (file) titles, any
limitations or encumbrances of rights to real property as well as to grant respective
certificates and\or abstracts. Registration Law defines general grounds for
registration of above mentioned rights to real estate, in particular identifying: list of
documents necessary for registration; grounds for refusal in registration; terms of
registration; eligibility of persons to apply for registration and to obtain respective
abstracts etc. However, Registration Law is not specific enough in description of
registration procedures, outlining them in very general terms. Besides, Registration
Law clearly states that detailed registration procedures and rules for operation of
the Registry must be established at the level of CMU regulation.
Last year the State Land Committee developed quite profound draft of such
regulation. However, as a result of long lasting conflict between this Committee
and Ministry of Justice for leadership in taking over registration function, the said
draft was obstructed and CMU failed to approve regulation on registration
procedures. This circumstance creates a major problem with operation of modern
registration system in Ukraine. Key problem in this area is that the State Registry
of Rights in Real Estate has not been actually established yet. This also means that
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in Ukraine still operates old-style, underdeveloped and highly inefficient
registration system, which consists of 3 basic elements:
(i) Titles to apartments and buildings are supposed to be registered at local
Technical Inventory Bureau. This is not centralized system and single electronic
database does not exist there. Technical Inventory Bureaus are managed by
regional municipalities. The whole procedure for registration and obtaining
abstracts is extremely cumbersome, since it takes a lot of paperwork and time
(from 1 week to 1 month). Moreover, Technical Inventory Bureau system operates
on semi-illegal basis - there is no legislation setting up clear mode of its operation.
(ii) Titles to lands are being registered at the Land Cadastre. This is
centralized system with single database. However, efficiency of its operation is
quite the same as of Technical Inventory Bureau system – only paper-form
registration is available and it takes a lot of time. General legal grounds for
operation of the Land Cadastre were established in Land Code. Specific rules for
its operation were supposed to be fixed in special Land Cadastre Law. Such law
has never been adopted and Registration Law came into force instead. This means
that legal basis for operation of the Land Cadastre is also insufficient.
(iii) Mortgages are subject to registration in the State Registry of Mortgages
administered by Ministry of Justice. Mortgage Law prescribed to CMU to secure
priority of mortgages and provide their registration on a temporary basis until
Registration Law is adopted. To this end, CMU adopted Regulation on Provisional
Order of Mortgages Registration, which stipulates execution of registration deeds
with mortgages by notaries simultaneously with notarization of mortgage
contracts. This Registry works pretty well. It is hold in electronic format and filing
entries are being made immediately upon lender’s application. However, operation
of this Registry right now is also semi-illegal, since both Mortgage Law and
Registration Law are pretty clear that with adoption of the later Law provisional
order for registration of mortgages by Ministry of Justice loses its effect.
Ministry of Justice manages a few other registries related to real estate. For
example, in 2003 there was an attempt to establish Real Estate Registry intended to
provide single window for issuance of ownership rights certificates for apartments
and buildings by combining databases of regional Technical Inventory Bureaus.
This registry exists in deficient format because not all Technical Inventory Bureaus
joined Ministry of Justice in their efforts to create it. In particular, Technical
Inventory Bureau in Kiev, the biggest in Ukraine, provides respective services
independently. Ministry of Justice also holds Registry of Prohibitions for
Alienations of Real Estate, which reflects data on contracts (including mortgages)
that contain clauses prohibiting alienation by the owner of respective apartment
and\or building. Tax liens on the whole debtor’s property still are subject to
registration in the State Registry of Encumbrances in Movables.
Proceeding from above picture, it is pretty obvious that from the date when
Registration Law came into force existence and operation of the old registration
system (as well as of its components) became contrary to the Law. On one hand,
this is for good, since that system is extremely unfriendly to mortgage lenders
interests. At least, it does not enable mortgage creditor to secure his priority and
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discover clearly debtor’s title, all encumbrances or limitations to debtor’s
ownership right to real estate. On the other hand, illegitimacy of previous
registration system and lack of the new one lead to huge legal risk for any
transactions with real property, which actually are being registered now in the old
ineffective registries, contrary to requirements of Registration Law.
There is only single way out of that situation. The Government of Ukraine
has to undertake immediate steps in order to approve regulation setting up rules for
operation and procedures of the State Registry of Rights in Real Estate as well as
to secure material and financial grounds for creation of modern registration system.
A few important concerns must be dully challenged in the course of fulfillment of
this task.
1. Formation of the database on comprehensive basis. The State Registry
of Rights in Real Estate has to incorporate in its database the whole bulk of
information related to real estate currently filed in databases belonging to the
Technical Inventory Bureau system, the State Land Cadastre system, the State
Registry of Mortgages, the Registry of Prohibitions for Alienations of Real Estate,
the State Registry of Encumbrances in Movables (in part of tax pledges) etc. This
is one of key practical problems for initiation of the Registry’s operation due to
two main reasons. First of all, current holders of respective databases do not
politically favor the idea to get rid of them. At least, long lasting arguments
between the State Land Committee, Ministry of Justice and Technical Inventory
Bureaus are obvious. Secondly, above databases are not technically compatible
with each other from point of view of their format and content.
2. Speed of registration. Most lenders would not release loan proceeds until
mortgage right actually has been registered. Registration delays can therefore
complicate completion of lending transactions. Registration Law positively meets
this requirement, stating that mortgage is being registered as of the date and time of
receipt by the Registry of creditor’s application. In practical terms, this legislative
norm can be implemented only if the Registry shall operate with the use of
electronic database. Registration Law does not establish any requirements to
operation of the Registry with utilization of electronic databases and electronic
means of communication. Respective CMU regulation must be clear on that.
Another circumstance, which might affect the speed of registration, is the
requirement imposed by Civil Code, stating that purchase and sale contract
necessary to establish ownership right to real property shall be valid as of the
moment of its state registration. Thus, at the time purchase and sale contract is
notarized it is not possible for a purchaser to simultaneously execute a mortgage
against respective property, which he does not legally own. This causes practical
difficulties in financing acquisition of a real property for account of mortgages,
since in order to execute mortgage and release loan proceeds a lender must wait
until ownership title would be registered in the name of a purchaser. However, this
appears impossible in most cases because a purchaser is not capable to disburse the
whole price of purchased property to a seller. Legislation must be amended in
order to secure validity of both sale and mortgage transactions, assuming that for
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the purpose of execution of mortgage a sale transaction is deemed to be valid
without its registration.
3. Cheap and quick access to information. Creditors need to have cheap
and efficient access to data on real property ownership and encumbrances.
Restricted access increases cost and time for execution of mortgage deed and
decreases reliability of mortgages. In principle, access must be extended to all
information in the Registry, including pending applications and registered
documents. By contrast to this concept, Registration Law stipulates quite opposite
attitude, whereby only the owner of respective real property is eligible to access to
Registry’s information. This attitude needs to be gradually reviewed, which
requires overcoming the problem deriving of public sensitivity of a broad access to
title information.
4. Registration of mortgages in future acquired property and
incomplete construction. Mortgage Law clearly stipulates possibility for creation
of mortgage against both future property and incomplete construction. Titles to this
sort of objects are not supposed to be registered in mortgagor’s name
simultaneously with execution of mortgage. Therefore, special rules must be fixed
in legislation, which shall allow registration of mortgages in such objects as future
acquired real estate or incomplete construction, titles to which shall be registered
afterwards in the future. Unfortunately, Registration Law prevents from
registration of mortgages in those objects, which is resulted in impossibility to give
legal effect to this category of mortgages. This also makes impossible financing
construction business by mortgaging incomplete construction object, especially
when the land plot underneath is not owned by a borrower. In order to prevent this
situation, Registration Law must be put in conformity with Mortgage Law and to
provide special treatment for registration of mortgage deeds in future acquired
property and incomplete construction.
5. Indemnification against registration errors. In order to enhance
confidence in the registration system and mortgage lending, legislation can provide
assurances to mortgage lenders for reimbursement of their losses resulted from
errors in the Registry’s operation. Registration Law recognizes this concept,
whereby CMU was requested to submit proposals for creation of the special
guarantee fund. Unfortunately, any proposals to this end are missing by now and
the idea still was not realized even in theoretical sense.
6. Preventing duplication of registration functions. Any duplication of
registration function contradicts to the concept of a single Real Property Rights
Registry and can be detrimental to operation of the whole registration system.
Registration Law is intended to prevent such duplication. However, this Law does
not stipulate particular prescriptions to abolishment of registration functions
performed within the scope of Technical Inventory Bureau system or by numerous
registries hold by Ministry of Justice. This actually could be done at CMU
regulation level.
Above overview gives grounds to identify the following key problems in
the area of establishing in Ukraine modern system of state registration of titles,
rights, limitations and encumbrances of rights to real property:
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(i) Despite adoption of Registration Law, new single State Registry of
Rights in Real Estate has not been yet established, while highly inefficient previous
registration system is still in place.
(ii) Due to extremely doubtful legal effect of registration of transactions with
real property in the old-style semi-illegal registration system, huge legal risks for
legality of such transactions may arise. In particular, State Registry of Mortgages
hold by Ministry of Justice, where mortgages currently are being registered, must
have been abolished a long ago together with adoption of Registration Law.
(iii) CMU regulation related to rules of operations and procedures of the
State Registry of Rights in Real Estate has not been adopted yet, contrary to
requirements of Registration Law. Besides, common policy does not exist between
the State Land Committee, Ministry of Justice and Technical Inventory Bureaus
regarding unification of their databases and passing them over to the State Registry
of Rights in Real Estate.
(iv) Registration Law does not enable mortgage lenders to quick and cheap
access via electronic means to the Registry’s database. Registration provisions of
Civil Code may also lead to delays in execution of mortgage deeds.
(v) Registration Law does not provide for registration of mortgages in
future acquired property and incomplete construction, which might make
impossible mortgage-based financing of these objects.
(vi) In controversy to Registration Law, the concept for creation of
indemnities to mortgage lenders against errors or mis-operation of registration
system is still missing.
Resolution of problems in the area of registration of titles, rights,
limitations and encumbrances of rights in real property can be viewed from two
perspectives:
(i) From current perspective, it is drastically important to work out and
introduce appropriate regulation outlining on comprehensive basis rules of
operation and procedures of the State Registry of Rights in Real Estate with its
consequent establishment. From this perspective, it is also vital to introduce
consistent Government policy for formation of the single Registry’s database and
abolishment of rudimentary components of existing old-style registration system.
(ii) From strategic perspective, Registration Law and Civil Code must be
improved to meet essential mortgage lenders concerns. In particular, these Laws
must secure quick and cheap registration of mortgages as well as the same quick
and cheap access to the Registry’s database. They must support the concept of
mortgages in future acquired real property and incomplete construction.
IV. PRIORITY OF MORTGAGE CREDITOR’S RIGHTS
Mortgage Law stipulates making mortgages as public deeds subject to
registration in the State Registry of Rights in Real Estate. State registration of
mortgage deed establishes creditor’s right priority and grants opposability of
mortgage creditor’s lien to the real estate over third parties rights and claims to the
same property.
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Priority concept introduced by Mortgage Law is based on general principle
“first in time, first in right”. This concept shall serve as appropriate ground aiming
at settlement of possible conflicts between a few creditors to the same debtor’s real
property and preventing appearance of hidden charges to real estate.
However, efficient operation of priority rules set up by Mortgage Law is
possible under condition that legislation shall provide for obligatory registration of
not only contractual (mortgages) but also of public charges in real estate. It is
obvious that such public charges should not be hidden to mortgage creditors and
they should compete on equal footing with mortgages according to the priority
concept.
Public charges can be divided into those appeared on the ground of court
decision (court lien) or in virtue of law operation. The most broadly used type of
public charges in debtor’s property, which arise in virtue of law, is so called “tax
pledge” (tax lien). Tax lien is usually imposed by Tax Office as a result of tax
payer’s failure to fulfill timely and fully tax liabilities. Tax legislation subordinates
priority of tax lien to any previously registered rights and claims in the same
property.
Identification of problems.
(i) Ukrainian legislation does not stipulate obligation of courts (or any
participants of court procedures) to register judicial liens in real estate imposed
based on court decisions.
(ii) Ukrainian legislation does not provide for particular procedure of
registration of tax liens. In a virtue of previous experience, tax liens used to be
registered in the Registry of Charges in Movable Property. This happens because
tax lien is spread on the whole property rights of a tax payer in default comprising
both real estate and movables without their segregation. As soon as real estate is
not segregated from the whole debtor’s estate for the purposes of tax lien
regulation, it is not treated as a separate object of registration in any real estate
registry. But this is wrong attitude.
(iii) Lack of particular legislative requirements to registration of public
charges (both court and tax liens) creates a danger of hidden priority charges
appearance that may defect registered priority of contractual charges (mortgages)
in real property.
Resolution of problems can be achieved in the following manner:
(i) Registration Law should be supplemented by provisions stating
compulsory procedure for registration of public charges related to real estate in the
State Registry of Rights in Real Estate.
(ii) The Law on Fulfillment of Tax Payer’s Liabilities (2000), which
establishes tax pledge provisions, should be amended in the way to provide for
segregation of tax lien on debtor’s real estate out of tax pledge charge of the whole
debtor’s property.
(iii) Registration Law and the Law on Fulfillment of Tax Payer’s Liabilities
should be amended in order to stipulate clear procedure for registration of tax liens
related to debtor’s real estate in the State Registry of Rights in Real Estate.
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V. MORTGAGE-BASED FINANCING OF INCOMPLETE
CONSTRUCTION
Evident problem in the field of mortgage collateral regulation in Ukraine is
resulted from certain conflict between Mortgage Law and Mortgage Crediting Law
as well as a number of ambiguous concepts referred to in the later Law. Mortgage
collateral provisions in Mortgage Crediting Law seem to be very close to those in
Mortgage Law but expressed in different terms. This sort of duplication may be
dangerous, since it gives rise to interpretation collisions between respective legal
norms.
Definition of the object of mortgage represents obvious discrepancy between
the two mortgage-related laws. Whereas Mortgage Law states that only real estate
(and a number of objects, whose legal treatment is very close to regime of real
property, like aircrafts and vessels) may serve as an object of mortgage, Mortgage
Crediting Law stipulates that “property rights to real estate under construction” can
also be used as mortgaged object. The later attitude gives rise to collisions with
Civil Code and the Law on Securing Creditor’s Claims and Registration of
Encumbrances, both defining property rights as movable property, which
according to Civil Code under no circumstances may serve as an object of
mortgage.
Mortgage Crediting Law is linked to the other ambiguous Law on Financial
and Credit Mechanisms and Property Management in the Course of Construction
and Transactions with Real Estate (Financial Mechanisms Law). Both of them are
intended to legalize peculiar mechanism of construction financing. In general
terms, financial model stipulated by these laws pre-supposes financing of
residential building construction directly for account of investor’s funds drawn into
trust management by financial intermediation entity associated with a construction
company. In this scheme investors are represented by citizens-purchasers of future
residential apartments in a building under construction.
If and were necessary, investors may obtain a loan from a bank, also
associated with a construction company, in order to finance respective investment -
purchase price of future property. Such loan, according to Mortgage Crediting
Law, shall be secured by mortgage of investor’s rights under investment (purchase)
contract. Exactly for this reason the concept of “mortgage of property rights to real
estate under construction” was fixed in Mortgage Crediting Law. This Law also
provides for issuances of mortgage certificates that might be secured by portfolios
of such mortgages.
Above financial model seems to be investor’s unfriendly, since it shifts to
them all risks in the course of residential building construction. This model has
certain resemblance with financial pyramid mechanism where construction
company business is fully pre-financed by investors, acting for their personal cost
and on their own risk. Mortgages created by the later may be re-financed by
investors in mortgage certificates secured by surrogate-type mortgages of property
rights in non-existing real property. Under these circumstances, it’s obvious that
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failure of a construction company shall entail crash of the whole pyramid, where
actual consumers shall bear unjustified financial losses.
Mortgage Law stipulates possibility for financing construction process by
granting to a construction company a loan secured by mortgage of a land plot
where incomplete construction is located. However, bank crediting of a
construction company, secured by mortgage of a land plot, appears to be not
feasible, since in most cases such land is granted to a construction company on
short-term lease basis rather than in ownership. Aside of that, a construction
company shall always prefer free investor’s funding (currently, this funding is
over-supplied in big cities) to high interest rate bank loans.
Identification of problems.
(i) Mortgage Crediting Law stipulates creating mortgage against uncertain
and unusual object, which from legal point of view constitutes pledge assignment
of rights under investment contract (in other terms – pledge of movables).
(ii) Mortgage Crediting Law and Financial Mechanisms Law provide for
high risk profile model for construction business financing of a pyramid-type,
where all financial risks burden is shifted to consumers (investors). This may
undermine the value of mortgage financing in general.
(iii) Alternative construction finance mechanisms are missing in Ukraine.
This artificially narrows the scope of banking credit in construction business with
usage of security in the form of mortgage of a land plot under future construction.
(iv) Ukraine is lacking perception of mortgage finance as of an element of
more complex mechanism of housing financing. Appropriate attitudes at the
Government level are missing.
Resolution of problems in the field of mortgage-based financing of
incomplete construction requires performance of the following steps:
(i) Initiation of the Government program, which shall outline consistent
approaches to creation of robust housing finance mechanism. This will require
high level of concentration and professionalism on part of numerous Government
institutions involved, directed to reformation of existing construction finance
model introduced by Financial Mechanisms Law.
(ii) Government policy towards introduction of capable and efficient housing
finance mechanism is a significant element for broadening implication of
mortgage-based finance vehicles. As a part of this policy, viable concepts related
to housing subsidies, mortgage insurance and guarantee schemes, second tier
mortgage re-finance procedures must be elaborated and fixed in respective
legislation.
(iii) Mortgage Crediting Law must be put in conformity with Mortgage Law
and Civil Code by amending provisions enabling mortgage of “property rights to
real estate under construction”;
(iv) New rules of land distribution in urban areas must be approved. In
particular, these rules should stipulate acquisition by a construction company of
ownership title (or at least long-term lease arrangement) to a land plot under future
real estate. This will enable construction companies to obtain bridge-type
construction loans secured by land plot mortgages.
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VI. ENFORCEMENT OF RIGHTS IN MORTGAGE COLLATERAL
Efficiency of procedures for enforcement of rights in mortgage collateral is
fundamental feature of legal regulation in the area of mortgage lending. Mortgage
Law recognizes this concept and stipulates its realization in two ways by using
judicial or non-judicial modes of enforcement.
According to Ukrainian legislation, judicial enforcement can be based either
on court decision or on notary writ. If there is a conflict between a lender and a
debtor, notary writ is usually appealed in the court. Therefore, judicial settlement
basically is a court process. Court decision (or notary writ) is subject to execution
according to provisions of the Law on Enforcement Procedures by the State
Execution Department attached to Ministry of Justice.
Court proceeding and execution procedure are highly uncertain, time- and
cost- consuming. In particular, Ukrainian procedural legislation gives numerous
grounds for delays. In real life, judicial enforcement may last from 6 month up to a
few years. It may cost up to 30% of a debt value in the form of numerous fees,
commissions, duties, legal expenses etc.
State court system in Ukraine is notorious of being extremely awkward. It
creates a key problem in the area of judicial enforcement. In 2004 the law was
adopted establishing private arbitration system, which may expedite terms of
dispute settlements. However, private arbitrators are not allowed to resolve on
eviction. Due to this fact, the scope of private arbitration in the area of enforcement
of creditor’s rights in residential mortgages is very limited.
As far as eviction is concerned, Mortgage Law has amended Housing Code,
whereby restrictions on eviction of residents from housing in case of their default
on mortgages were lifted. But such eviction is conditional. If a debtor is not
financially capable, the State must grant him\her temporary housing. Even though
respective regulations for creation of temporary housing were adopted by CMU in
2004, this sort of accommodation does not physically exist. Inability to supply
temporary housing may lead to significant problems in the area of judicial
enforcement in part of debtor’s eviction.
Mortgage Law outlines very detailed and transparent procedure for sale of
mortgaged property at a tender hold by specialized organization. In order to raise
efficiency of sale procedure, Mortgage Law also prescribed CMU to submit to the
Parliament draft law on activities of specialized organizations. Such law was
supposed to introduce competition in the area of selling seized property. This
market at the moment is highly monopolized. The only organization authorized to
operate with forced sales of seized property is Ministry of Justice subsidiary called
“Ukrspetsjust”. State Execution Department refers just to them in order to sell a
property and for some peculiar reasons sale price often appears to be very low.
Other companies are not treated as eligible to be involved in sale process, since
legislation does not establish ground for such eligibility. Unfortunately, respective
law on activities of specialized organizations has not been adopted yet and any
drafts are missing.
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Since procedural legislation can hardly be curable in a short run, Mortgage
Law, as an alternative to judicial settlement, provides for extra-judicial foreclosure,
which does not require courts or the State Execution Department involvement.
Respective procedures have negotiable character and may stipulate taking
ownership of mortgaged property by a creditor or direct sale of this property by a
lender to any person, who offered the best price. Despite very detailed and
reasonable definition of extra-judicial procedures in Mortgage Law, practical effect
of this innovation remains untested.
This problem is pre-determined by 2 key reasons. First of all, default rate on
residential mortgages in Ukraine for the last few years was extremely low – nearly
close to zero. Of course, this is good for market. On the other hand, non-existence
of precedents makes it difficult to judge on efficiency of extra-judicial foreclosure
procedures. Secondly and consequently, any court practice related to resolution of
conflicts and judicial approaches to extra-judicial settlement is also missing.
There is another problem in enforcement area related primarily to
commercial mortgages, namely - enforcement of mortgagee’s rights in case of
mortgagor’s bankruptcy. This issue is governed by the Law on Renewal of
Debtor’s Solvency and Bankruptcy Procedures (Bankruptcy Law). Mortgagor’s
bankruptcy does not terminate mortgagee’s rights. The later is granted senior
priority in the course of bankruptcy procedure. However, bankruptcy procedure
impedes greatly rights of secured creditors for the following reasons.
From the date of appointment of a receiver for a debtor, court shall impose
moratorium for satisfaction of creditor’s claims. Despite the fact that mortgaged
assets can be used only for the purpose of satisfaction of secured claims, these
assets shall also be considered to be a part of “liquidation mass” of a bankrupt.
Therefore, claims secured by mortgage of debtor’s property, in line with any
unsecured claims, might be satisfied only upon completion of bankruptcy
procedure, which lasts much longer than judicial enforcement process in respect to
mortgage collateral.
Bankruptcy case in average takes approximately two years. Within this time
a mortgagee is restricted in rights to use any extra-judicial remedies stipulated by
Mortgage Law. Bankruptcy Law also does not stipulate any particular obligations
of a receiver (liquidator) in respect to debtor’s mortgaged assets (for example,
preservation requirements). This creates the risk of mis-managing respective assets
by a receiver (liquidator).
Mortgage Law stipulates that in case of initiation of bankruptcy procedure
against a mortgagor, a mortgagee can immediately enforce against mortgaged
property. However, in practice such foreclosure may be feasible if respective
amendments shall be made to a Bankruptcy Law intended to separate assets that
had been previously pledged (mortgaged) from liquidation mass of a bankrupt.
Identification of problems.
(i) Judicial enforcement of creditor’s rights in mortgage collateral is
extremely inefficient, lengthy and costly for creditors. Procedural legislation in
Ukraine provides numerous grounds for delays in the course of court and\or
execution proceedings.
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(ii) Ukrainian legislation does not provide legal grounds for activities of
specialized organizations in the field of mortgaged property sales. This market
segment is highly monopolized, which leads to selling property significantly below
market rates.
(iii) Eviction procedure can be affected by actual non-existence in Ukraine
of temporary housing program.
(iv) Extra-judicial foreclosure stipulated by Mortgage Law has not been
tested and did not prove its efficiency.
(v) Mortgage Law and Mortgage Crediting Law contain a number of
technical errors and mismatches that may decrease efficiency of enforcement
procedures.
(vi) According to Bankruptcy Law neither mortgaged property nor mortgage
assets backing mortgage securities are presumed to be segregated from debtor’s
liquidation estate, which makes bankruptcy procedures unfriendly to mortgage
lending.
Resolution of problems in the area of creditor’s rights enforcement in
mortgage collateral is a very complex issue. Globally, it requires reformation of the
whole court and execution system in Ukraine. Realistically, this task represents
lengthy undertaking heavily based on political will. Perfection of enforcement
procedures in a more specific (but limited in the scope) manner can be done by:
(i) Putting Mortgage Crediting Law in conformity with Mortgage Law as
well as deletion of technical shortcomings in their respective enforcement parts.
(ii) Adoption of special legislation on activities of specialized organizations
in the field of mortgaged property sales.
(iii) Elaboration of recommendations on implication of extra-judicial
settlement procedures at the level of public organizations (Mortgage Association
can be used for this purposes).
(iv) Amending Bankruptcy Law in order to allow quick sale of mortgaged
property separately from the other debtor’s assets.
VII. MORTGAGE INSTRUMENTS
Non-existence of efficient easy-to-use mortgage instruments, which might
allow a creditor to transact with mortgage assets in a quick and cheap manner, is an
obvious problem of the Ukrainian mortgage lending market.
Mortgage Law defines grounds and rules for creation of mortgage collateral
and stipulates requirements to the content of mortgage agreement. Notary format
of transactions related to real estate is very deep rooted in the Ukrainian legal
system and it represents highly formalized procedure. This might be treated as
reasonable at the point of creation of mortgage. Though, certain requirements
imposed by Notary Law, like necessity to notarize mortgage deed only at the place
of real estate location, may seem as redundant.
However, notary procedure for assignment of rights under mortgage
agreement on contractual basis, together with the necessity of its further
registration, totally prevent from portfolio transfer (or portfolio pledge assignment)
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of mortgage assets in order to re-finance them. This happens due to high
consumption of time and cost for performance of notary and registration deeds.
In order to enable transfer of mortgage assets portfolios, Mortgage Law
incepted the concept of “mortgage note”, which is treated as promissory note
bearing creditor’s rights and claims both under loan and mortgage agreements.
Transfer of mortgage note by its simple endorsement creates the same legal effect
as contractual assignment of loan and mortgage agreements, but with the
distinctive difference – transfer of mortgage note is exempted from the scope of
any notary or registration requirements.
Mortgage note may serve as an ideal instrument for transfer of mortgage
assets, since it is not associated with cumbersome notary and registration
proceedings. In particular, mortgage note may be fruitfully used in the process of
mortgage securities issuances as an instrument for creation of mortgage coverage.
However, this benefit of a mortgage note has not been used yet in mortgage
transactions and none of mortgage notes were issued.
Identification of problems.
(i) Mortgage Law contains a few provisions, which prevent banks from
practical utilizations of benefits deriving of mortgage note. In particular, Mortgage
Law presumes that if mortgage note (defined in the Law as “security”) was issued,
loan agreement loses its effect as the basis for presenting monetary claim to a
debtor. For banks this provision may mean that traditional loan transaction, as a
result of mortgage note issuance, can be interpreted as a transaction with securities.
According to present accounting rules for banks, in this case mortgage loan should
be accountable at the balance sheet account “transactions with securities”, which is
not acceptable to banks.
(ii) Mortgage Law stipulates that at the moment of mortgage note issuance
it is subject to registration (but transfer of mortgage note is not a registered deed).
At the same time, legislation does not fix any procedures for mortgage notes
registration. In the other words, mortgage note is invalid without registration but
performance of such registration is not feasible.
(iii) Securities Commission Resolution on Standard Form of the Mortgage
Note does not provide for the content of a mortgage note as of the negotiable debt
instrument, as prescribed by Mortgage Law.
Resolution of problems can be achieved in the following manner:
(i) Respective provision in Mortgage Law must be amended in the way to
cancel requirements to mortgage mote registration.
(ii) Respective provision in Mortgage Law must be amended in order to
delete reference to negative mortgage note issuance effect on a loan agreement.
(iii) National Bank of Ukraine has to approve special mortgage notes
accounting rules in the books of commercial banks.
(iv) Securities Commission Resolution on Standard Form of the Mortgage
Note must be improved in order to create mortgage note as negotiable debt
instrument.
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VIII. MORTGAGE SECURITIES AND RE-FINANCE MODELS
For the last 2-3 years in Ukraine there were numerous discussions devoted to
introduction of mortgage securities. Practical outcome of those discussions
appeared to be miserable – none of mortgage-related securities were issued in
Ukraine by now. Besides, any single and consistent concept of mortgage securities
is also missing.
As a matter of fact, Mortgage Law provides for issuances of mortgage
securities, namely - mortgage bonds and mortgage certificates. At the same time,
Mortgage Law refers governance of mortgage securities to a special law. In
particular, by final provisions of Mortgage Law, CMU was requested to draft and
submit to the Parliament respective law on mortgage securities. In the early 2004
CMU submitted this draft law to the Parliament, but at the fall of 2004 for peculiar
reasons the draft was rejected. Right now, Securities Commission is searching for
opportunity to submit draft Mortgage Securities Law to the Parliament again.
At present days, mortgage securities concept is reflected in Mortgage
Crediting Law, whereby rules for mortgage certificates issuances were stipulated.
In general terms, it must be noted that this Law is of a very poor quality - wording
used there are very confusing, contradictive and can be interpreted in many ways.
Failure to properly formulate the concept urges market participants just to neglect
Mortgage Crediting Law due to its very vogue content.
From point of view of substance, Mortgage Crediting Law stipulates two
types of mortgage securities – mortgage certificates with fixed yield and mortgage
certificates of participation. Proceeding from what is written in the Law about
certificates with fixed yield, it might be understood that they represent a surrogate
of covered mortgage bonds. Although, Mortgage Crediting Law does not pay too
much attention to secure, safe and predictable for investors mode of their
operation.
First of all, it is not clear why certificates should bear “fixed yield” only. It is
not also clear whether this sort of certificates represent amortizing or non-
amortizing instruments, redeemable or non-redeemable. Mortgage Crediting Law
keeps silent on what is exact legal treatment of underlying mortgage assets and
how to enforce investor’s rights against them in case of issuer’s default on
certificates. The Law does not fix any over-collateralization requirements in
respect to mortgage certificates with fixed yield as well as stipulates full issuer’s
discretion to substitute or dispose of particular mortgage assets in mortgage
coverage.
In general, legal treatment of mortgage certificates with fixed yield
according to Mortgage Crediting Law does not correspond to best international
practices in the sphere of covered mortgage bonds legal regulation. Besides, there
is no any reason why very traditional and clear instrument called “covered
mortgage bond” should be associated in the Ukrainian legislation with very
uncertain instrument named “mortgage certificates with fixed yield”. This would
be confusing for investors from the rest of the world. Finally, Mortgage Crediting
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Law does not secure attractiveness of certificates to conservative investors. They
would rather treat them as risky instruments.
More attention in Mortgage Crediting Law is paid to mortgage certificates of
participation. This part of the Law is the same vogue as the previous one, but it
clearly represents a sketch of US securitization model. Certificates of participation
can be understood as securities granting investor the right to obtain a share in cash
flow generated by mortgage assets, which were put in trust of certain not very clear
entity, associated with the issuer. At the same time, Mortgage Crediting Law does
not provide for concepts that are essentially important for securitization
transactions, like: “true sale” principle; special purpose vehicle operation;
structured transactions with mortgage-backed securities etc. Instead, the concept of
putting mortgage assets in “trust ownership” was established, which is completely
alien to Ukrainian legal system and contradicts to Civil Code basics.
Regarding both types of mortgage certificates, Mortgage Crediting Law does
not accommodate investors with sufficient levers to supervise issuer’s compliance.
Instead, this Law proposes to introduce complicated supervision model over
issuer’s operations, which must be implemented by three financial market
regulators – National Bank of Ukraine, Securities Commission and Financial
Markets Commission. All three regulators were prescribed to develop their
regulations in order to implement respective requirements imposed by Mortgage
Crediting Law. However, none of these agencies by now has adopted any
regulations intended to introduction of mortgage certificates that makes this section
of Mortgage Crediting Law ineffective.
By contrast to Mortgage Crediting Law, draft Mortgage Securities Law
developed by CMU incorporates mortgage bond concept. On one hand, there is
intention to fix covered mortgage bond model typical for EU. On the other hand,
this draft stipulates usage of structured mortgage bonds for securitization purposes.
Draft Mortgage Securities Law seems to be of higher quality in explaining covered
mortgage bonds and securitization mechanisms. However, this Law, if adopted, is
not compatible with Mortgage Crediting Law: these two laws can not exist
together, since they have the same subject matter.
Analysis of Mortgage Crediting Law and draft Mortgage Securities Law
shows certain confusion in implementation of 2 major international mortgage
securities models – covered mortgage bond and securitization mortgage-backed
securities systems. There is an intention to combine both models within the same
statute. But it is likely the case when keeping two different wild fruits in the same
basket is impossible. Consistent Government policy here must be elaborated,
proceeding from the fact that utilization of securitization vehicles is pre-mature for
Ukraine. At least, absence of modern financial market infrastructure and portfolio
investors is obvious to this effect.
At the fall of 2004 two CMU resolutions were adopted in order to establish
the State Mortgage Institution as second-tier mortgage re-finance company. The
primary purpose of the State Mortgage Institution is, in the absence of viable
mortgage securities vehicles, to set up simple mechanism of mortgage lenders re-
financing. This mechanism is based on corporate bonds issuances. The later, due to
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formation of Institution’s portfolio only by purchasing (or taking as collateral)
mortgage assets, have certain resemblance with mortgage securities and shall
function on the same safe basis, providing fairly cheap resources to mortgage
lenders.
However, any particular re-finance procedures, business-plans or feasibility
of the State Mortgage Institution are not in place. Thus, today absolutely
impossible to predict how efficiently second-tier mortgage company may operate
in Ukraine and how compatible its operation might be comparing to mortgage
securities mechanisms.
Identification of problems.
(i) Consistent Government policy towards introduction of mortgage
securities is missing in Ukraine. Respective legislation is being adopted chaotically
without following particular challenges and objectives in mortgage lending area.
(ii) There is clear overestimation of US securitization model for Ukrainian
mortgage lending market. At the same time, perception of the priority importance
of covered mortgage bonds concept is missing.
(iii) Mortgage Crediting Law provides for mortgage certificates, whose legal
treatment is formulated in a very confusing and investor’s unfriendly manner.
Deficiencies of this Law may discredit mortgage securities concept in a whole.
(iv) A little more advanced draft Mortgage Securities Law has very vogue
chances for adoption in forthcoming perspective. Besides, in the present form it’s
adoption can be hardly competitive with existence of Mortgage Crediting Law,
since both provides for essentially the same attitudes to combine covered mortgage
bond and securitization models under the same umbrella.
(v) By establishing the State Mortgage Institution, second-tier mortgage re-
financing model was initiated in Ukraine. However, any indications for selected
mode of its operation do not exist.
Resolution of problems in the area of mortgage securities and mortgage re-
finance totally depends on depth and consistency of the respective Government
policy, which may comprise the following items:
(i) Splitting up legal treatment of covered mortgage bonds from
securitization vehicles.
(ii) Recognition of priority of the covered mortgage bond model
implementation in Ukraine.
(iii) Improvement of the draft of Mortgage Securities Law with its
development into Mortgage Bond Law.
(iv) Amending Mortgage Crediting Law with its possible transformation into
purely securitization piece of Ukrainian legislation.
(v) Setting up at CMU regulation level particular procedures of mortgage
creditors re-financing by the State Mortgage Institution.
IX. SUMMARY
Mortgage Law had conceived the concept of mortgage based financing in
Ukraine. Despite its only recent adoption, Ukraine already has got substantial
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massive of legislation relevant to mortgage. This Overview may prove that this
legislation is not always consistent and reasonable. Besides, development of
mortgage lending market in Ukraine is not strongly supported by respective
Government policies in housing finance area, which basically are missing.
Objectives of the further development of the Ukrainian mortgage lending
market shall require improvement of both components of legal environment –
legislation and Government policies. This improvement presumes undertaking due
and consistent steps in the following strategic directions:
1. Setting up reliable and favorable to mortgage lenders system of state
registration of rights to real estate.
2. Development of comprehensive housing finance policy, in particular,
directed to creation of solid financial grounds for construction of new
residential property.
3. Introduction of soluble mortgage re-financing mechanisms with a
particular stress to operation of covered mortgage bond model.
4. Perfection of procedures of foreclosure on mortgage collateral
comprising both judicial and extra-judicial settlements.
5. Securing priority of mortgages by creation of equal conditions to
publicity and registration of contractual and public charges in real
property.
6. Development of mortgage instruments, suitable to satisfy mortgage
lender’s needs.
In addition, taxation treatment and prudential requirements to mortgage
lenders must be improved. However, these issues are out of the scope of this paper.
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