1) What is a preliminary contract for the purchase and sale of an apartment?
Issues related to the preliminary contract are governed by Article 390 of the Civil Code of the Republic of Kazakhstan (hereinafter “the Civil Code”).
Pursuant to paragraph 1 of Article 390 of the Civil Code, under a preliminary contract, the parties undertake to enter in the future into a contract for the transfer of property, the performance of work, or the provision of services (an underlying contract) on the terms and conditions stipulated by the preliminary contract.
Thus, based on the above definition, it can be concluded that a preliminary contract for the purchase and sale of an apartment is a contract under which the parties undertake to enter in the future, within a certain period of time, into a contract for the purchase and sale of an apartment, on the terms and conditions stipulated by such preliminary contract.
2) Peculiarities of Preliminary Contract with Developer
The peculiarity of a preliminary contract with a developer consists in the specifics of the category of preliminary contracts, and here it is necessary to figure out what is their fundamental difference and for what purposes they are executed.
While under the underlying contract for the purchase and sale of an apartment, the seller’s primary obligation is to transfer a certain immovable property into the ownership of its purchaser and the purchaser’s primary obligation is to pay the price agreed upon by the parties, in the preliminary contract, the parties only undertake to enter in the future into the underlying contract for the sale and purchase of an apartment on the terms and conditions stipulated in the preliminary contract. Thus, the difference between the apartment purchase and sale contract and the preliminary agreement is significant.
As the first and most important point, we would note that such preliminary contracts may be entered into only in respect of apartments located in houses that have already been built and commissioned for operation. Otherwise, it will be a shared construction, which in Kazakhstan implies a ban on the use of preliminary purchase and sale contracts in any form. This will be described in more detail below.
It should be noted that it makes sense to enter into a preliminary contract when the parties have already agreed on all of the essential terms and conditions of the future contract but there are still some points (non-essential from the legal point of view or not requiring considerable time to revise them) that must be agreed at the negotiation stage, and in order to formalize the agreements reached, the parties enter into a preliminary contract.
Another case when it is worth to enter into a preliminary contract is when the seller has leased the immovable property to a third party and may not terminate such lease due to certain circumstances but is ready to sell such property upon expiration of the term of its lease. In this case, the parties, when entering into a preliminary contract, agree upon the terms and conditions on which the purchase and sale contract will be entered into in the future. This will help the seller to be sure that its property will be sold within a certain period of time and the purchaser to be sure that he / she will be able to purchase an apartment on the preliminarily agreed terms and conditions.
The next case when it would be expedient to enter into a preliminary contract is a situation where the purchaser has no available funds at the moment. Let’s suggest that the purchaser has currently no available funds but some time later he / she will receive certain proceeds, or will be returned his / her debt to, or will be issued a loan to, that will objectively enable him / her to purchase the apartment. In such case, the preliminary contract will be useful to the parties.
In practice, however, the majority of developers enter into preliminary contracts not for the purpose for which such contracts are contemplated by the legislator. They rather do so in order to avoid responsibility and law.
In our previous articles, we have mentioned that now the Law of the Republic of Kazakhstan “On Equity Participation in Housing Construction” imposes high-level requirements on developers and, therefore, developers, not desiring to enter into an agreement on equity participation but desiring nonetheless to receive money from equity holders, enter into preliminary contracts.
At that, under such preliminary contract, the purchasers make payments for the immovable property and actually perform their obligations under the underlying contract although, as mentioned above, under the preliminary contract, a party thereto is only obliged to enter into a contract in the future on certain terms and conditions, and the conditions must be basically fulfilled after a purchase and sale is entered into. In this connection, it is highly recommended not to enter into a preliminary contract for the purchase and sale with a developer, if it comes from the necessity to avoid the requirements of legislation of the Republic of Kazakhstan on shared construction of housing.
It is important to note that the above Law contains minor exceptions when the Law does not apply.
3) What documents the parties (the developer and the purchaser) must provide to formalize a preliminary contract for the purchase and sale of an apartment?
The legislative acts of the Republic of Kazakhstan are silent about the list of documents required to enter into a preliminary contract for the purchase and sale of an apartment. Thus, the list of documents to be provided will depend on the demands of the parties (i.e., the seller and the purchaser).
In order to minimize any future risks, the purchaser is recommended, prior to consummation of a transaction, to verify the seller’s rights to the apartment, the existing encumbrances over it, and the documents in respect of immovable property.
4) What risks might arise when executing such type of contract?
Risk Associated with a Failure to Enter into the Underlying Contract
If a party fails to enter into the future contract, the other party may recover losses it has incurred.
Pursuant to paragraph 5 of Article 390 of the Civil Code, in instances where a party which entered into a preliminary contract fails to enter into a contract stipulated thereunder, such party is obliged to reimburse the other party for losses caused by such failure, unless otherwise provided for by legislation or the contract.
In doing so, the legislator does not specify what losses are subject to reimbursement to the affected party. As a general rule, losses mean real damage and lost profits. Since the above provision does not specify what kind of losses a party is entitled to recover, the payment of both real damage and lost profits may be claimed.
In its Article 390, the Civil Code does not provide for the possibility to force the other party to enter into a contract. In this regard, in the doctrine, there are many disputes related to the possibility to oblige the other party to enter into a contract.
Risk of Recognizing Preliminary Contract as Not Executed
The preliminary contract must mandatorily contain the following: (i) the obligation of the parties thereto to enter in the future into the contract for the purchase and sale of an apartment; (ii) and the essential terms and conditions of the contract. While item (i) does not cause any difficulties, item (ii) requires a closer look at.
In accordance with paragraph 1 of Article 393 of the Civil Code, a contract is deemed to be executed when the parties thereto have reached agreement on all of its essential terms and conditions, in the form as required in the relevant cases. Essential terms and conditions include the conditions regarding the subject of the contract, the conditions that are recognized as essential by legislation or are necessary for contracts of the given type, as well as all those conditions in respect of which an agreement must be reached, as stated by one of the parties.
For a contract for the purchase and sale of an apartment, the terms and conditions regarding its subject matter, i.e. about the immovable property, will be regarded as essential. It is important to most fully identify the subject of the transaction and to indicate its full address and area (both residential and non-residential) and the number of rooms therein. We also recommend to indicate the condition of the apartment in which it should be transferred to the purchaser at the time of entering into the underlying purchase and sale contract and, if the apartment is transferred with furniture, to list all furniture and to describe its condition.
Risk of Double Selling
As a preliminary contract, unlike a shared construction contract, is not subject to records and registration with the state bodies, there is no guarantee that the seller did not sell the same apartment to several purchasers at once.
5) Is it possible to terminate a preliminary contract for the purchase and sale of an apartment?
Yes, it is possible to terminate the preliminary contract or to refuse to perform it, however this depends, to a large extent, on the terms and conditions of the contract.
The general contract rules apply to a preliminary contract. Pursuant to paragraph 1 of Article 401 of the Civil Code, a change and termination of a contract are possible by agreement of the parties, unless otherwise provided for by this Code, other legislative acts and the contract.
In accordance with paragraph 1 of Article 404 of the Civil Code, a unilateral refusal to perform a contract (repudiation of the contract) is allowed in the instances provided for by this Code, other legislative acts or the parties’ agreement.
Thus, when terminating a preliminary contract or repudiating it, it is necessary to follow the termination procedure established in the preliminary purchase and sale contract entered into by the parties.
It should also be noted that if termination of a preliminary contract is impossible, then either party may apply paragraph 6 of Article 390 of the Civil Code.
Pursuant to paragraph 6 of Article 390 of the Civil Code, the obligations stipulated by the preliminary contract shall terminate unless, prior to expiration of the term within which the parties must enter into the underlying contract, such underlying contract is entered into or either party sends to the other party a proposal to enter into such contract.
However, in doing so, a party failing to enter into the underlying contract in the future may be held liable in the form of reimbursement of losses, as mentioned above.
6) When it might be recognized as invalid?
Non-Compliance with the Form of Contract
Pursuant to paragraph 2 of Article 390 of the Civil Code, a preliminary contract shall be entered into in the form established by legislation for the underlying contract, or, if the form of the underlying agreement is not established, in written form.
For a contract for the purchase and sale of an apartment a simple written form is established. Accordingly, the preliminary purchase and sale contract must be entered into in written form. In the event such form is not met, such contract is void.
General Grounds for Invalidation of Transactions, Contemplated by Article 159 of the Civil Code
In addition to the above, a preliminary purchase and sale contract may be recognized as invalid for the following grounds:
- if the transaction is aimed at unfair competition or violates the requirements of business ethics;
- if the transaction was consummated by a minor person (under 14 years of age), or a disabled person, or a person with limited legal capacity, etc;
- if the transaction was consummated as a result of delusion, or under the influence of deception, violence, or threat, or if a person was forced to consummate the transaction due to a confluence of reduced circumstances on the conditions extremely unfavorable for him / her;
- if the transaction was consummated due to a bad faith collusion of a representative of a party with another party; or
- if the transaction was consummated by a legal entity in contradiction with the objectives of activities, definitely restricted by the Civil Code, other legislative acts of the Republic of Kazakhstan, or its constitutive documents, or in violation of the authority of its body under the charter.
Prepared in August 2018
By Victoriya Chagay, Lawyer