What legal issues (if any) cannot be covered by usual legal due diligence?
Real Estate (3rd edition)
Within the framework of a legal due diligence examination, the actual circumstances on site cannot be checked (or only to a very limited extent), e.g. building permits, border superstructures, technical defects. This is regularly checked by a technical due diligence examination or by the involvement of experts.
In addition, there may be restrictions on ownership and rights of use which may be not reflected in the public registers and directories and the documents disclosed.
Usually legal due diligences do not encompass technical aspects, such as the physical state or condition of any asset, or the valuation, state, condition, boundaries and/or measurements of the real estate properties, analysis of plans and other technical documents from an extra-legal point of view, etc.
8.1 There are some real property interests that bind a purchaser even though the interest is not registered at the Land Registry. These are known as ‘overriding interests’, details of which are set out in the Registered Land Law (2018 Revision). Some of these rights may be apparent from inspection (e.g. occupiers), while others may be discoverable by raising enquiries with third parties (e.g. utility installations). Lawyers do not generally physically inspect real property as party of their work.
8.2 In addition, a professional inspection or survey is always advisable to ensure compliance with building control, health and safety, environmental and other matters relevant to the state and condition of the subject property. The nature and scope of such engagement will depend on the transaction. In particular, the boundaries shown on the registry map and area shown on the land register are approximate only unless a fixed boundary survey has been carried out and registered.
The due diligence process aims to gather the basic information and to discover possible risks associated for the transaction. These risks may be very serious in which case the purchaser is advised that it is dangerous to proceed with the transaction. Some less serious risks are dealt by inserting certain protection clauses in the contract or by requiring from the Vendor certain waivers and guarantees. Although, the contract will aim to protect a purchaser against the risks, the Vendor may breach the contract in which case the purchaser may have to resort to Court proceedings.
In case of a transfer of shares, it is difficult to obtain a high level of comfort regarding the company’s current and potential liabilities if the seller is unwilling and unable to provide due information and documentation or if the seller has no knowledge of such liabilities (i.e. an estate in bankruptcy). In these situations, a buyer would normally assess whether an asset transfer would be possible instead in order to mitigate substantially claims from third parties originating from the seller’s ownership period.
If the seller has set up an exhaustive, genuine and truthful data room, the legal due diligence should cover all legal risks in relation with the transaction.
There are some land interests that bind a buyer even though the interest is not registered in the land registry.
In addition, the buyer's lawyers cannot (or only to a limited extend) assess compliance of the building with building permits and zoning laws (as most of this will depend on factual questions) as well as superstructures (for the same reason) and they will not cover technical issues and defects, building control, health and safety or environment issues as part of the legal due diligence. Specialist surveyors and technical experts can be employed to deal with these issues.
Certain undetectable circumstances in a legal due diligence, such as acquisition by possession (usucaption/adverse possession), which may not be publicly registered, may impair the property rights. However, such a risk may realistically only lurk in large rural areas, where physical possession may not always be obvious or easily assessable. Circumstances which may also deserve attention is the observance of r specific provisions on urban or zone planning.
The actual size and exact location of the real estate shall be verified a surveyor (i.e. whether registered data is in line with actual status).
Rights that are not registered with the land registry are requested in course of the due diligence and warranties shall is also be given that the provided information is true and complete. Environmental and regulatory matters are typically limited to the knowledge of the seller and technical matters fall rather within the scope of technical due diligence.
Some legal issues which are not apparent from title documents, revenue records and inspection in the office of the Sub-Registrar are:
- Claims of persons in possession, like persons claiming adverse possession (for more than 12 years) or squatters or tenants protected from eviction - may require survey of the property by a Surveyor in order to be ascertained.
- Legal status of construction on the property where construction or part thereof lacks requisite permissions - professional advice from Architects and Surveyors is required on these issues.
- Information on pending or likely Government actions to the extent not disclosed by the transferor or whether any proceedings which may result in liability for payment of income tax or any other tax, interest or penalty have been initiated against the transferor.
- Whether the property is notified for or reserved for compulsory acquisition by the Government.
- Whether the property is attached for recovery of any amount.
There are certain legal issues that potentially may only be identified through a physical inspection of the property in sale such as environmental issues, issues with access and services, and unknown occupants as well as issues of technical compliance with the planning laws. Best practice is for the buyer to arrange for a professional survey and valuation of the property in sale to be carried out.
Legal counsel do not normally conduct on-site DD, so the issues requiring physical inspection of property would not be covered by DD. For instance, the following matters would not be covered: the matters requiring physical DD related to (i) regional regulations; (ii) architecture or construction; (iii) environment; (iv) city planning or zone use; and (v) actual boundary. An appraisal report, engineering report, and property report is usually provided to investigate those points not covered by the legal DD. Where those reports highlight specific issues, legal DD on the specific issues would be undertaken.
Non-registrable interests (e.g. overriding interests) may not be able to be established by legal due diligence. Overriding interests under Kenyan law include undisclosed trust relationships, rights of compulsory acquisition, natural rights of light, air, water and support, etc. Presently, it is also a challenge to confirm matters related to compliance with environmental law issues other than licensing at the point of construction. In addition, some authorities are also not forthcoming with enquires made to them on issues such as riparian land or road reserve.
Under due diligence for commercial real estate transactions, most legal issues are covered. However, environmental risks are often difficult to assess since they require specialized knowledge and government regulation in this matter is vast and complex. Independent environmental law specialists and technical consultants are often involved in this type of due diligence.
Other area of material legal risk, which could have limited coverage by regular due diligence process, is the one related to agrarian property (ejidos); mainly consisting of matters arising from acquisitions through inheritance or from non-visible errors in converting ejido (communal property) land into private property land. Recently, an additional risk is at hand under a special forfeiture law (Ley de Extinción de Dominio) whereby the authorities may seize a property considered to be involved in illegal activity, even if the owner has not yet been condemned of any criminal offense.
A comprehensive due diligence should cover all legal issues.
Most of the chains of title cannot be verified back in time further than the interwar period, since the system of cadastral measurements, land books and archives had not been implemented throughout the Romanian territory and documents before 1989 are frequently missing.
Therefore, the last verified historic owner is usually the Romanian State and the subsequent transferees. However, certain individuals may challenge the Romanian State’s historic title over real estate. The invalidation of the Romanian State’s title may reverberate on the title of the current owner. Therefore, in certain circumstances, the due diligence exercise is limited to ensuring that no claims have been asserted against the Romanian State at the time of the due diligence (however such claims may be filed at any time after the due diligence).
Another issue stems from the fact that restitution of state-owned property was usually made without relying on any precise cadastral measurements and land plot plans. With property titles issued for multiple plots without a precise localisation, the risk of overlapping current titles exists in almost all localities, except where complete cadastral measurements have been completed.
Due to the deficiencies of the Russian public register system, some encumbrances and restrictions on real estate may be not registered. For example, underground power cables, pipes or other facilities may restrict the use of the land plot (e.g., for construction purposes), but are often not registered as encumbrances in the real estate register. Further, sanitary protection zones or other restrictions may exist, but may not be reflected in any the public register or publicly available documents. This risk can be reduced through an extensive due diligence, which is often performed by sending official inquiries to various parties (e.g., local grid operators, various state authorities, commercial entities that own neighbouring land plots) to obtain confirmation that there is no infrastructure that may interfere with the designated use of the land plot offered for sale, and by on-site visits.
Further, often the buyer’s decision to purchase the land plot depends on the local authorities’ plans with respect to further development of the area (for instance, the authorities’ plans to establish a railroad near the land plot may be a deal breaker). However, usual due diligence focuses only on existing city-planning documentation, and cannot assess the risk of its changes in the future. Moreover, for some areas, the city-planning documentation is unavailable (not yet developed) or may be inaccurate. Therefore, to reduce this risk, a more extensive due diligence is required, during which the local authorities would be contacted with inquiries on their specific plans with regard to the area of interest.
Moreover, historical risks in respect of the title to the privatized land plots and other real estate objects often cannot be assessed precisely due to the lack of public register system in that period and other factors (lack of the necessary documents, nontransparenсy of the privatization processes, etc.) that make it difficult to evaluate whether the privatization procedure was carried out in compliance with law. These risks are often regarded as remote, yet cannot be excluded completely.
Finally, where real estate is purchased from individuals (both through asset deals or share deals), due diligence cannot fully exclude the risks related to spousal consents, when the seller claims to be not married. Recent court practice shows that lack of spousal consent may be a ground for invalidation for the transaction even where the purchaser was innocent and could not know about the lack of spousal consent. At the same time, it is currently impossible to definitively establish whether an individual is married. Therefore, this risk is usually covered by representations and warranties, as well as title insurance.
Given the fact that the Land Registry is held electronically and publicly accessible and that the person relying on the information contained in the Land Registry may not suffer negative consequences as a result of relying on such information, legal issues which could not be covered by usual due diligence seem unlikely to occur. Any potential defects or problems relating to the ownership of real property are usually eliminated in the due diligence process and additionally contractually regulated between the contracting parties themselves.
The purchaser's legal due diligence does not usually cover building control, health and safety or environmental issues, requiring specialists and experts to be employed.
In addition, there are some land interests that bind a purchaser even though the interest is not registered at the Land Registry, known as "apparent easements" and also there could be certain occupancy contingencies (e.g. squatters) which, as lawyers do not generally inspect properties, would have to be verified by the purchaser itself.
Legal issues relating to title, use, access rights, mortgages and other encumbrances, planning/zoning, litigations etc. are normally relatively easy to cover under a normal due diligence procedure, thanks to publically available and reliable information. The exception would of course be contractual liabilities that are not registered with any public authority, such risks will however normally be addressed through Q&A and/or sufficient SPA regulations.
Legal due diligence covers review of title deeds and relevant agreements referred to on the back of the title deeds, but does not cover the land survey.
The land survey process normally consists of detailed investigation of land plots, area measurement, reviewing documents/information retained by relevant land officers. As the land survey sometimes takes an additional amount of time and requires expertise of personnel, it is therefore only conducted when the real estate is the key asset of the transaction, or where special issues or concerns are addressed.
Therefore, usual legal due diligence sometimes may not cover the following:
- Whether the actual areas of the land plot reflect information provided in the deeds in terms of measurement and occupation.
- Whether there are any issues threatening the ownership or the rights in property, e.g., whether the land plots relate to permanent forest areas, whether a boundary line investigation is needed and whether the distance to the public road is in compliance with relevant laws, for example, the Building Control Act 1979.
- Other uninformed factual facts, as we do not conduct physical land due diligence.
Since registration of the title deed has a protective effect regarding the acquisition of ownership and entitlement to limited rights in rem on real estate, the risk is low. On the other hand, contractual rights such as leasing or pre-emption right etc. can not be asserted to the third parties unless they are annotated before the acquisition to the land registry.
Please note if there is an expropriation decision or a pending case related to the real estate, these are usually notified to the land registry. However, for a limited time - until the notification is received by land registry- they cannot be seen on the records, and this can be deemed as a risk not covered in due diligence reports.
Additionally, we usually recommend checking the real estate physically in order to avoid any intruder occupant risks.
There are some land interests that bind a buyer even though the interest is not registered at the Land Registry. These are known as 'overriding interests'. Details of these rights are set out in the land registration legislation. Some of these interests may be apparent from inspection e.g. squatters' rights. As lawyers do not generally inspect properties, the buyer will need to satisfy itself on this issue. For overriding interests that are not apparent from inspection, the CPSE (see Q6 above) will ask about these interests.
In addition, buyers' lawyers do not cover building control, health and safety or environment issues as part of the legal due diligence. Specialist surveyor and experts can be employed to deal with these issues.
Generally, a purchaser would take title to real property subject to matters of which it is actually aware as well as those for which it is on constructive notice. Constructive notice attributes knowledge to a person or entity of those things that would be known if a search were carried out by a reasonable person even if such person or entity did not in fact carry out such search or have actual knowledge of the result thereof. While in the typical due diligence process lawyers commission and review most of the searches that would otherwise result in constructive notice, there are some searches that are not performed by lawyers. For example, matters that would be apparent from a physical inspection of the property would be imputed to a purchaser.
The key legal issues mentioned in our previous answers should all be covered. However, there are certain other issues that can complicate real estate due diligence in Indonesia, including the following:
- Unregistered land that lacks evidence of ownership and may be subject to unforeseen claims.
- In certain areas, privately held land may overlap with concession areas granted by the government of Indonesia for mining, forestry and plantation activities.
- There is no centralised or electronic land registry in Indonesia, so conducting land title searches requires the involvement of third parties (such as local land deed officials/notaries) and cooperation from land owners. As noted above, the government is introducing new regulations to allow digital registration of land titles to make them more easily accessible. However, the new system is not yet up and running.
- The licencing process for land development in Indonesia is complex and regulations may vary from region to region. There are various licensing requirements that developers need to obtain prior to and during the development phase.
- Certain Indonesian laws and regulations relating to land and real estate are unclear and conflict with other laws and regulations. For example, regulatory uncertainty exists in relation to strata title assets due to the absence of implementing regulations. This vacuum is filled by government policies which may not be consistently applied. Enforcement of regulations by regulators is generally uneven due to lack of resources and may, at times, be driven by political factors.
- In respect of the management of strata title developments, the owners of the strata title units are obliged to establish an Association of Owners and Occupants (“Owners’ Association”). A regulation issued in late 2018, requires the owners of strata title units to establish an Owners’ Association, and the developer must facilitate its establishment within one year after the first delivery of a strata title unit to the owner. The Owners’ Association applies ‘one owner, one vote’ rules in certain circumstances, rather than distributing votes based on the relative size of the plots. This may lead to developers having limited decision-making power over the property despite owning a substantial part of it.
Certain legal issues such as technical issues and defects, environmental issues, issues with access and services, unknown occupants as well as issues of technical compliance with the planning laws or health and safety rules may potentially only be identified through a physical inspection of the property.
Certified surveyors and technical experts can be assigned for this purpose and risks may also be addressed by inserting specific representations and warranties.