Over the past several years the real estate sector in Bulgaria underwent substantial developments which led to the adoption of a specific approach to the financing of real estate projects based on a combination between techniques traditionally used in project finance and expertise in real estate and construction law. However, the preceding rapid growth in the real estate sector was followed by the current stagnation in bank lending, which in turn led to a change in the evaluation process of the lenders, with substantial focus on the legal aspects of the project.

Legal framework

The real estate finance in Bulgaria is set on the basis of the relevant contractual framework for the project and the applicable Bulgarian real estate legislation.

The main aspect with respect to the contractual framework, applied for real estate finance is that the facility agreement and other finance documents are governed by the law of the jurisdiction of the lender, while the security documents are governed by the Bulgarian law. With respect to security documents, VAT security matters should be carefully considered during the implementation of real estate finance projects. 

VAT security

Typically the contractual framework of real estate financing includes a VAT facility to pre-finance recoverable VAT during the construction period and a security over the recovered VAT. This security is characterized with certain specifics which are not common for foreign lenders. Pursuant to the Bulgarian Obligations and Contracts Act a security assignment, which under the Bulgarian legislation is denoted by the term pledge, may be established only with respect to receivables that can be validly transferred. On the other hand, a statutory prohibition on the assignment of receivables towards the government is expressly regulated under the Bulgarian Tax and Social Security Procedures Code. Consequently, VAT recovery claims against the Bulgarian tax authority cannot be considered as a validly provided security, however as soon as the amounts are recovered to a bank account of the developer, the public nature of the receivables ceases to exist and the developer is thus entitled to pledge the positive balance on the bank account without any restriction.

The Bulgarian real estate and construction legislation should be complied with without prejudice to the applicable legislative framework regulating all other types of secured lending in Bulgaria. The main  Bulgarian legal acts governing the real estate finance are the Ownership Act, from 1965 (last amended in 2006) and the Territorial Development Act (“TDA”) from 2001 (last amended in 2006), which regulates inter alia  the development process, the participants in it and the relations between them. Since the adoption of the latter act, the sector has undergone significant developments and currently there are a number of areas that need further regulation. There are various Ordinances of the Ministry of the regional development and public works on the application of the TDA. For example, in the context of a development facility, Ordinance No 3 on the Acts and Protocols Executed During the Construction Works from July 2003 (last amended in 2006) sets the basis for defining the conditions precedent of the first and the next drawings of/under the loan, since it regulates the construction related documents, certifying the stages in the construction process.

Construction risks

Providing lending to a development project is very a different preposition from funding the acquisition of a fully let office or residential building. In addition to the other common for the lending risks, the bank has to carefully consider the risks related to the construction of the building, including the cases where the building might not be constructed properly, within the expected timescale and the original cost estimate or even completed at all. In order to mitigate the construction risks lenders usually sets forth a number of requirements towards the developer (i.e. the bank's borrower) such as:

• the developer's contribution to the project to be made first;
• a monitoring survey to be executed;
• use of a single or special purpose vehicle to decrease the risk of unrelated activities of that developer resulting in its insolvency.

Step-in rights of the lender

Along with the measures undertaken to reduce the construction risk, the lender also requires that all the contracts and appointments entered into by the developer be capable of being assigned by way of security to the funder.

It should be noted that any provision in the finance agreements to the effect that, upon an the event of default, the lender will become an owner of the property provided as security is unenforceable under the Bulgarian law. Agreements which stipulate in advance that upon the occurrence of default a lender shall become owner of the property, as well as any other agreement which stipulates in advance a manner for satisfying a lender, other than as provided for by the law, i.e. through court and out-of -court enforcement proceedings, shall be invalid. Therefore, a stepping-in by the lender would be within these limits of the Bulgarian law and would be typically structured in the form of pledge over the receivables arising out of the constructions agreements.