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Is Act 116 scaring off foreign investors?

Is Act 116 scaring off foreign investors?

Posted: May 15, 1996

By Jasek, Tim

Loopholes in the commercial property leasing law are raising consumer prices and keeping investment to

a minimum

by Tim Jasek

No one disputes the fact that if Prague's commercial property market is to mature, it will need substantial interest from foreign investors. But for that to occur, more than a stable political and economic environment will be required: The country's leasing laws will also have to change, according to experts.

"Commercial leasing is fundamental to attracting investment," said Evan Lazar, a real estate attorney with Weil, Gotshal & Manges. Sporting a number of loopholes with which tenants and landlords can break leases, he said, the present non-residential property leasing law is not only scaring some investors away - those with the courage to open shop here are charged higher rents as a security measure. This, in turn, is trickling down to consumers, who are paying more for everything from Bohemian crystal to a pint of Budvar.

And just what exactly is wrong with the Act on Lease and Sub-Lease of Non-Residential Premises, otherwise known as Act 116? Practically everything, most attorneys and property agents agree.

"First of all, Section 3 states that a prospective tenant has to get approval from their district government office for their specific business activities before they can sign the lease," said attorney Robert Pergl of Vana, Orsula & Partners. "I've had tenants come to me with leases that were signed before they received district permission, or because they changed their business in some manner. At that point, there is nothing we can do."

Attorney Otakar Svorcik of Vsetecka & Partners agreed. "I don't see any reason why the local authorities should have to give approval to leases," he said. Whereas the process is intended to protect zoning standards and trade licensing laws, attorneys say these laws stand on their own, and that Act 116 is yet one more corner to turn in what is already a bureaucratic maze for those wishing to conduct commerce.

"Section 14 states the lease is canceled upon destruction of the premises," Lazar said. "So if the building burns down, for instance, the lease is terminated, even if it is Year 3 of a 100-year lease. Location is everything in real estate, so the fact that the tenant doesn't have an option to rebuild if they want is ridiculous."

Then there is Section 9. "This is the biggest problem with Act 116," Svorcik said. "It specifically lists the circumstances under which a lease can be terminated. And that's fine, but it should allow for exceptions agreed upon by both parties. As it is, the law is very restrictive."

For instance, Section 9 states that a contract can be terminated if rent or any applicable service charges are overdue by one month or more. "Can you imagine having your lease canceled because you didn't get your 100 Kc phone bill paid on time?" Pergl asked. "This law is crazy."

Among other things, Section 14 states that a lease is canceled if "it was decided that changes are to be carried out which would prevent the use of the non-residential premises."

"We've had cases where the landlord uses this law to get rid of tenants," Pergl said. "Because of it, he can apply for a construction permit for, say, a restaurant on the ground floor or a swimming pool in the basement. The lessees are not participants in this process. So if the construction permit is granted, the tenants get three months' notice, and then it's bye-bye. Maybe this isn't ethical, but it's legal."

In the minority of those who see few problems with the law is Miroslav Sipovic, who represents the Academy of Performing Arts (AMU) in its still-unresolved 1991 leasing dispute with Boston-based H.N. Gorin over Cafe Slavia. The cafe, part of the school's facilities, was the longtime hub for Prague's dissident community before 1989. It reopened in November 1993 after Gorin sub-leased the premises to a group of Czechs and Americans, but AMU successfully challenged the lease by citing a clause in Act 116 that states the property cannot be subleased.

"The law could be better, but I think it's okay as it is," Sipovic said. "I think a bigger problem is with the very low level of experience of judges on the first level of courts. For example, there was one instance where the judge said it was possible to get approval [from the district government office] after the lease was signed. She must not have read the law."

But Sipovic agrees with other attorneys that problems with this and other laws could be remedied if only the Czech Republic had a common law system (such as that in the United States and the United Kingdom) in which laws evolve by respecting precedents. The existing civil law system leaves each judge to make a standing decision, based entirely on his or her opinion. And that means it will be up to Parliament to change the law.

Will that happen anytime soon? No one thinks so. "For four years now," Pergl said, "the Ministry of Economy [under whose jurisdiction this law falls] has been trying to agree internally on how to streamline the construction permit process, which is a disaster. So I would say Act 116 is not a priority for them, nor will it be fixed anytime soon."

Prague councilman Filip Dvorak offers no hope. "There were some big problems with Act 116 after 1990 but I think there are not so many problems now," he said. "There simply is no ideal law. I think it's acceptable in its present form."

Try telling that to real estate agents, who unanimously bemoan the leasing law.

"The majority of developers and investors in this market who are refurbishing properties are not the well-financed, publicly traded companies prevalent in mature markets, but individuals who don't have much capital up front," said Healey & Baker partner Robert Neale. "The point is that leasing structures are very important here, and will continue to be until the market matures."

But the question remains to what extent the Czech commercial property market can mature without changes to Act 116.

By Jasek, Tim

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