Fictitious Lease Agreements Issue in Loan Recovery Processes in Latvia
PhD Student Rolands Neilands
Rīga Stradiņš University, Latvia
The aim of this paper is to research fictitious residential property lease agreements in Latvia (which are concluded to prevent takeover of the apartments or cottages mortgaged by debtors – private persons) to provide possible solutions for this problem and to prevent such activities in future. Methods of qualitative research were employed in the paper – comparative method, analytic method, inductive method, and deductive method.
Dishonest debtors (natural persons) occasionally enter into fictitious lease agreements. It is encouraged by the principle existent in Latvia – “a purchase does not override a lease”. If before placing in possession or during such the fictitious tenant produces the lease agreement, the bailiff has no right to evict such tenant from the residential property.
The research shows that there is possible solution for the fictitious lease agreements problem. If the solution described in the paper would be introduced, it would be useless for dishonest debtors and their relatives, friends or acquaintances to conclude fictitious lease agreements.
Mortgage, recovery, fictitious, lease, agreements
Article 1 of the Civil Act of the Republic of Latvia contains the principle of good faith: rights shall be exercised and duties shall be performed in good faith. The principle of good faith means that everybody needs to exercise his or her subjective rights and perform his or her subjective duties in view of justified interests of other persons. Unfortunately, in practice it is a common occurrence that the principle of good faith is not followed and certain entities abuse the opportunities provided by the laws and regulation to infringe justified interests of other entities. One of such instances is entering into fictitious lease agreements between the debtor and its affiliates.
1. Purpose of the Fictitious Tenancy Agreements
Pursuant to Article 2174 of the Civil Act, when a lessor or a landlord alienates the object of lease or tenancy, the acquirer has to comply with the lease or tenancy agreement only if it is registered with the Land Register. Quite an opposite principle is set forth in Article 8 of the Residential Premises Tenancy Act: “If a residential house or an apartment is transferred in freehold of another legal entity or an individual, the tenancy agreement of residential premises concluded by the previous owner are binding on the new owner.” Arising out of this legal provision, in all cases when the residential house or the apartment is being transferred, the new owner has to follow the concluded tenancy agreements. Furthermore, it is of now relevance whether the property is alienated in a voluntary transaction or as a result of a forced auction.
For the purpose to delay the process of enforcement, play for time in bringing the new owner in possession of the outbid property, to act in detriment to the mortgagor, as well as provide oneself and one’s family with an opportunity to live in the mortgaged apartment or residential house as long as possible, without paying either mortgage fees or actual rent payments, dishonest debtors are known to enter into fictitious tenancy agreements with their relatives, in-laws, friends or acquaintances. Such fictitious tenancy agreements are binding on the new owner, who has bought the apartment or residential house in an auction held by a bailiff.
2. Consequences of Fictitious Tenancy Agreements
If the winning bidder of the real estate has asked the court to place him in possession of the won real estate, upon ratifying the auction statement, the court resolves on placing the acquirer in possession of the real estate (Article 613(7) of the Civil Procedure Act). Placement in possession is procured by the bailiff under the procedure set out in Article 742 of the Civil Procedure Act. Upon placing the acquirer in possession of the real estate, the bailiff invites the debtor to vacate the real estate by removing property owned by the latter and leave the real estate along with his family members and other persons, who live with his family (Article 6206(2) of the Civil Procedure Act). If, upon placing in possession, it is established that other persons inhabit the apartment or residential house on the grounds of a tenancy agreement, the bailiff is not authorized to evict them.
Placing in possession of the real estate does not concern the rights of a tenant, because the residential premises tenancy agreement of the debtor is binding on the acquirer.  As a result, the new owner is unable to use the real estate bought in auction for the purposes it was bought (habitation, actual tenancy, or sale for a price conformant to the fair market value). The only way to evict the fictitious tenants from the real estate lawfully and recognize the fictitious tenancy agreement null and void, is to bring an action in court for recognition of the tenancy agreement null and void and eviction of the fictitious tenant from the real estate along with the persons cohabiting with the tenant.
Unfortunately, judicial proceedings are slow in Latvia, and the timeline for the new owner to accomplish recognition of the fictitious tenancy agreement null and void and eviction of the tenant through court may even amount to 3-5 years. During that time the new owner is unable to use the real estate and incurs losses. In practice there have been cases, when an apartment, on rent of which a fictitious tenancy agreement is concluded, oblivious of this is bought by a young family with small children for the needs of their residence, by borrowing the necessary amount of funds for the purchase of the apartment from the bank. Only after the auction statement is ratified by the court, upon performing placing of the new owner in possession of the apartment, it becomes clear that the apartment is burdened with the fictitious tenancy agreement. In such case, the young family is unable to use the apartment and live here; nonetheless, they have to repay the loan to the bank. The family will be able to use the apartment only after recognition of the fictitious tenancy agreement null and void is achieved through court, and the fictitious tenant and the persons living with him are evicted from the apartment.
Not only the new acquirers of apartments and private houses incur losses from the fictitious tenancy agreements, but also the mortgagors. If a debtor announces to a bailiff before an auction held by the bailiff that the property is encumbered with the tenancy agreement, the bailiff has to include this information in an announcement of the auction. This, conversely, means that bidders in the auction will be ready to place considerably lower bids than it would be the case should the property was not encumbered by the tenancy agreement. As a result, the mortgagor recovers a considerably lower amount after sale of the apartment or the residential house in order to satisfy his claim.
Not only the new acquirers of the real estate and mortgagors incur losses from fictitious tenancy agreements, but also the government, because the fictitious tenancy agreements have negative impact on the national economy and budget. First, while normal use of the apartment or the private house on the real estate market is hindered, for example, through failing to gain income from actual lease of the apartment or the residential building, which might be taxable by personal income tax or corporate income tax. Secondly, the debtors who enter into the fictitious tenancy agreement with their family members, in-laws, friends or acquaintances do not declare these tenancy agreements with the State Revenue Service. Consequently, the government does not receive the income tax from such fictitious tenancy relationship.
It should be noted that the fictitious tenancy agreements may be encountered not only in cases, when the residential property is mortgaged and enforcement procedures (foreclosure) are launched against it. Even upon simply buying an apartment nobody can ascertain about absence of a tenancy agreement; therefore, the buyer may face a situation when he buys an apartment on borrowed means, whereas is unable to enter the residence because tenants are already there; therefore, he is forced to rent some other place to live, while making payments to the bank. 
3. Indications of the Fictitious Tenancy Agreements
Usually several indications imply existence of the fictitious tenancy agreement which occur in various combinations:
1) the fictitious tenancy agreements are concluded regarding residential houses or apartment against which enforcement procedures are launched – a bailiff has commenced enforcement and served a notice on execution of enforcement, or forced auction of the real estate is already announced, or else, the auction has already occurred, and the fictitious tenancy agreement is submitted to the bailiff;
2) the fictitious tenancy agreements are concluded with retroactive effect;
3) the fictitious tenancy agreements are concluded with family members, in-laws, friends and acquaintances of the debtors;
4) the fictitious tenancy agreements are concluded for a long term – 10 to 40 years. Occasionally there have been fictitious tenancy agreements for a term of 99 years;
5) the rent established in such agreements is incommensurably low, such as EUR 1.42 per month for a private house of more than 300 m2 in area;
6) the agreements contain provisions that the tenant has paid the rent in cash for a long period of time, for example, for 10 years in advance. Of course, it is impossible to prove actual payment of such rent;
7) the agreements stipulate that utility and management fees for the private house or the apartment are paid by the landlord;
8) the agreements stipulate considerable contractual penalties, if the landlord unilaterally withdraws from the tenancy agreement, for example, one fictitious tenancy agreement prescribed such contractual penalty in the amount of EUR 15,000.
It should be noted that, regardless of the above described indications and the tenants specified in the fictitious tenancy agreements, in reality the debtors themselves along with their family members live in the apartments or residential houses delivered in fictitious leasehold.
4. Judgment of the Constitutional Court in Case No 2013-17-01
Based on separate applications from the Civil Court Panel of the Riga Regional Court and one individual, the Constitutional Court has evaluated conformity of the first sentence of Article 8 of the Residential Premises Tenancy Act to Article 105 of Satversme (Constitution) of the Republic of Latvia (right to property) and on 7 July 2014 passed a judgment in case No 2013-17-01.
Conversely, the Civil Court Panel of the Riga Regional Court filed the application specifically in respect to a fictitious tenancy agreement. Under review by the Riga Regional Court there was civil case No C30655811, which was initiated on the basis of an appellate claim of AS „GE Capital Latvia” (former name AS „GE Money Bank”) about the judgment of 27 December 2013 of the Riga City Vidzeme Suburb Court, by which the claim of AS “GE Capital Latvia” for termination of a tenancy agreement and eviction from an apartment was dismissed. AS „GE Capital Latvia”, as the creditor after an abandoned auction acquired the apartment in freehold, however, it was unable to exercise its property right, because the previous owner of the apartment had delivered the apartment in leasehold on 10 January 2006. AS „GE Capital Latvia” claimed to having been unaware of such tenancy agreement, because it was allegedly concluded before the recovery notation was registered with the Land Register and it was not registered with the Land Register.
In its judgment, the Constitutional Court acknowledged that the contested provision limits property rights of persons who have acquired a residential house or an apartment through a forced auction. At the same time, the Constitutional Court concluded that: 1) restriction of the fundamental rights included in the contested legal provision is established by a law adopted and promulgated in due course; 2) the restriction has a legitimate purpose – protection of other persons, namely, tenants of residential premises; 3) the measures used by the legislator are applied for a purpose to achieve a legitimate objective; 4) no more lenient measures are found through which the legitimate purpose of the restriction could be achieved at least in the same quality; 5) the benefit gained by the general public through the contested legal provision is higher than the damage caused to rights and lawful interests of an individual. As a result, the Constitutional Court inferred that the contested legal provision conforms to the principle of commensurability and is not contradictory to the right of the person to property established in Article 105 of the Constitution, and recognized the first sentence of Article 8 of the Residential Premises Tenancy Act to be in conformity with Article 105 of the Constitution of the Republic of Latvia.
5. Aspect of Criminal Law
Reluctance of the police and prosecutor’s office to launch criminal proceedings on the basis of applications from mortgagors and new acquirers of residential housing poses huge problems in practice. Even though features of two criminal offences are obvious in conclusion of the fictitious tenancy agreements (forging of documents for financial gain and failure to comply with a court ruling or delay of enforcement thereof), usually, upon receiving applications with a request to initiate criminal proceedings, the police inspectors resolve not to initiate criminal proceedings noting that it is a dispute subject to the civil law, which shall be settled under civil law procedure, or pointing out that there is no substance (corpus delicti) of a criminal offence. Prosecutors, on the other hand, leave the decisions of police inspectors in effect supporting their arguments. Only in rare cases criminal proceedings are initiated in respect to the fictitious tenancy agreements being concluded.
One of such cases has been reviewed in all three court instances in case No 12060013311. The actual circumstances of the case were as follows: “In late 2011, while no later than on 8 September 2011, at a time and location not accurately identified during the pre-trial investigation, /G.G./, aware that the apartment he owned before at /address/ is sold in auction and the premises are to be vacated with immediate effect, knowing full well unlawful nature of his actions, for personal financial gain, executed a tenancy agreement for residential premises at /address/ with a retroactive effect, dated 1 February 2010, that is, a document that vests right in a tenant to reside in the apartment until 30 January 2030, while charging as a landlord a rent prescribed by the agreement in the amount of LVL 20 per month.
Afterwards /G.G./ asked his acquaintance /J.H./ to sign the agreement as a tenant, who, without paying attention to the date and contents of the agreement, fully aware that he has never rented or wanted to rent an apartment at /address/ from /G.G./, signed the tenancy agreement, untrue in terms of content and non-conformant to the actual situation. Thus, /G.G./ achieved the outcome favourable for him, by unlawfully gaining possession of a forged document with a purpose to use it as a genuine one for personal financial gain.
Continuing with implementation of his criminal intent, on 8 September 2011 /G.G./, fully aware that the tenancy agreement is fictitious and the fact of delivery of the apartment at /address/ in leasehold does not conform to the truth, submitted an application signed by /J.H./ to bailiff /J.T./ with a copy of the fictitious tenancy agreement enclosed for the personal financial gain. Afterwards the new owner of the apartment at /address/ – SIA „Transform 3” – was unable to fully use its title and freely dispose of the real estate, whereas /G.G./ thus unjustifiably obtained the right to live in the real estate at /address/ owned by SIA „Transform 3”.
In this case the Riga City Centre District Court recognized the accused guilty of the criminal offence referred to in Article 296 of the Criminal Act (delay of execution of a court ruling) and imposed a fine in the amount of 5 minimum monthly salaries, while recognized him not guilty of the criminal offense referred to in Article 275(2) of the Criminal Act (forgery of a document and use of a forged document for personal financial gain).
Under appellate procedure, the Riga Regional Court revoked the judgment of the Riga City Centre District Court regarding the section where the accused was recognized not guilty of the criminal offense referred to in Article 275(2) of the Criminal Act. The court of appeals recognized the accused guilty of the criminal offence stipulated in Article 275(2) and Article 296 of the Criminal Act by perpetrating forgery of a document vesting him with rights and use of the forged document for personal financial gain, as well as delay of enforcement of a court ruling.
The Supreme Court revoked the judgment of the regional court due to the fact that the court of appeals did not evaluate legality of amending the indictment raised against the accused in the court of first instance (in his appellate complaint the accused has pointed out to unlawfulness of the amending) and resolved on forwarding the case for a new adjudication at the Riga Regional Court.
The above example is illustrative how difficult it is to trigger the liability established by the law – due to a prosecutor’s error (failure of the pre-trial investigation to raise an accurate indictment), which was not evaluated either by the court of first instance or the court of second instance in their judgments, the accused is still not sentenced for executing a fictitious tenancy agreement and use of it for personal financial gain.
6. History of Fictitious Tenancy Agreements
It should be noted that the issue with fictitious tenants is not just modern issue. It existent during the period between the two world wars as well. Initially, after adoption of the Premises Tenancy Act (in 1924) Article 27 of the act stipulated: “27. Upon a building being transferred in freehold of another person, the tenancy agreements concluded by the former owner shall be transferred to the new owner.” At a later time a problem identical to nowadays occurred with the fictitious tenancy agreements, and registration of the tenancy agreements with the Land Register served as a solution for this problem.
In order to prevent the abuse in 1934 Article 27 of the Premises Tenancy Act was amended because due to the provision incorporated therein it was possible in practice and also observed that a landlord, expecting sale of his building in auction, entered into fictitious agreements with the tenants. Pursuant to Article 27 these agreements were binding on the new landlord as well, and the latter was subjected to various possibilities of abuse.
After the amendments Article 27 of the Premises Tenancy Act was restated in the following wording: “27. Upon a building being transferred in freehold of another person, those tenancy agreements concluded by the former owner are binding on new owner, which are entered into the Land Register, while in other cases the new owner may amend the tenancy agreement or request eviction of the tenant on the grounds established by this act.”
Such a provision was mainly necessary to avoid conclusion of fictitious tenancy agreements, because in 1930s due to the economic crisis many people saw foreclosure of their properties to be auctioned off, and, in order to gain some benefit entered onto fictitious tenancy agreements on deliberately unfavourable terms for the landlord – long period of lease, advanced rent payment, no option set to increase the rent, etc.
It should be noted that in 1939 Article 27 of the Premises Tenancy Act was amended once again abandoning corroboration of the tenancy agreement with the Land Register as a precondition for the binding effect of the tenancy agreement on the new owner; “27. Upon a building being transferred in freehold of another person, the new owner shall have the tenancy agreements concluded by the former owner binding.”
7. Possible Solution of the Issue with Fictitious Tenancy Agreements
Taking into account that recognition of fictitious tenancy agreements null and void is a lengthy and expensive, if litigating the matter, during which the new owner cannot use the apartment or the residential house encumbered by the fictitious tenancy agreement, thus incurring losses, an effective solution is necessary not only to protect the interests of the new owners, but also protect creditors, because, as already mentioned earlier, use of the fictitious tenancy agreements notifying the bailiff thereof before auction of the property will mean losses to the creditor either.
Possibility to use fictitious tenancy agreements would be completely precluded, if only the tenancy agreements registered with the Land Register would be binding on the new owner. Consequently, Article 8 of the Residential Premises Tenancy Act should be amended, establishing that if the residential building or the apartment is transferred in freehold of another legal entity or individual, the tenancy agreements for the residential premises shall be binding on the new owner.
The current situation does not create trust in the auction institution, because the exposure to risk of the fictitious tenancy agreement and potential damages arising therefrom only cools interest about bidding in such auctions. If it was stipulated that only the tenancy agreements registered with the Land Register are binding on the new acquirer, then bidders in the auctions would be protected against the risk to acquire a residential property burdened by the fictitious tenancy agreement, whereas the mortgagors would not be exposed to the risk of losses due to decrease of the property in value that results from such fictitious tenancy agreements. That would facilitate more extensive use of auctions and increase in the bid amounts, which would be in the interests of both debtors and creditors, and overall national economy as well.