A Lender's Guide to Surface Rights in Spain: Scratching the Surface

For lenders financing Spanish real estate, understanding surface rights (derecho de superficie) is essential. This uniquely Spanish concept – sitting somewhere between a long lease and a carve-out of ownership – creates both opportunities and risks that require careful structuring. Here's what you need to know.

1. What is a surface right?

A surface right (derecho de superficie) is a Spanish law construct which can be established by a holder of freehold land (the "Landowner") under a surface right agreement which needs to be raised to public status and registered with the Land Registry. Whilst it is similar to a long lease under English law, a surface right differs in that it:

• grants a third party (the "Surface Right Holder") the right to own and/or develop a construction / property over a plot of land, without any rights to, or ownership of, the freehold land itself (which will be retained by the Landowner); and
• separates a plot of land from the construction / property over that land (i.e. land v structure).

From a legal perspective, the main advantage of this separation between ownership of the land itself and ownership of the development/property over that land is that, for the term of the surface right, it allows the legal splitting of the freehold land rights and the superficiary rights of the property (the only way to do this under Spanish law) – therefore permitting separate legal transactions to be carried out in respect of them.

From a more commercial perspective, if consideration is paid for the surface right, this can be paid as freely agreed by the parties, usually upfront to the Landowner by the Surface Right Holder or in instalments as if it were a lease. Although the creation of a surface right will normally trigger the payment of VAT in the context of business transactions, it is often a more cost effective option for the Surface Right Holder than actually acquiring the freehold land itself, because the taxable base excludes the value of the land which remains with the Landowner.

2. The surface right agreement

The terms of the surface right agreement will set out the rights and obligations agreed between the Landowner and the Surface Right Holder, including the consideration (i.e. price), the term, the assignability of the surface right, and liability for costs and expenses. The general rule is that the Surface Right Holder may dispose of and encumber the surface right as it wishes, although this right may be expressly restricted by the parties. Once agreed, the surface right agreement should be notarised before a Spanish notary and then registered at the Land Registry. This process:

• is a legal requirement under Spanish law for the valid existence of the surface right, and also provides a great deal of legal certainty for the Surface Right Holder as its due registration has erga omnes effects (i.e. defendable against any third party, not just those involved in a transaction); and
• will involve notarial fees, Land Registry fees, and stamp duty which shall be payable by the Surface Right Holder (normally calculated as a percentage of the value assigned by the parties to the surface right agreement).

The surface right term can be freely agreed by the parties and can last for a maximum term of 99 years. Therefore, the initial term may be shorter than this, with the surface right agreement including provisions that allow the term to be extended up to 99 years (subject to certain conditions, possibly including an extension fee). The surface right will normally be terminated upon the occurrence of, among others, one of the following:

• expiration of the term;
• a breach of the surface right agreement (subject to any exclusions and/or qualifications agreed by the parties); and/or
• complete destruction of the construction / property which is subject to the surface right.

At the end of the agreed term, the Landowner will resume ownership of the construction / property which is subject to the surface right. It is not unusual that the Landowner requires the Surface Right Holder to dismantle the constructions executed by it before or upon the termination of the surface right.

3. Mortgages over surface rights

In any financing involving the creation or acquisition of a surface right, the lender(s) will likely require a mortgage over the surface right. Unless expressly agreed otherwise, the Surface Right Holder should be permitted to grant such a mortgage without the consent of the Landowner. This mortgage will be registered with the Land Registry and should take priority over any other mortgage over the surface right which is granted after such registration. The rights of the lenders (as mortgagees) would expire on the earlier of (a) the termination of the surface right, and (b) the date on which the secured obligations are satisfied.

The Landowner will normally acknowledge the existence of such a mortgage under the terms of the surface right agreement. Additionally, the parties to the surface right agreement may be required to covenant that they will not amend or modify the surface right without the consent of the lenders as beneficiaries under the mortgage.

4. Additional protections for lender(s)

As a mortgage over the surface right cannot in and of itself enable the lenders to take ownership of the freehold land in an enforcement scenario, the lenders may seek to enhance their protection. On a recent deal Ashurst advised on, such protection took the form of a call option pursuant to which the Landowner granted the Surface Right Holder a right to purchase the underlying freehold land in certain circumstances.

The term of the call option should align with the term of the surface right itself, and the call option should also be registered at the Land Registry. The lenders should be a party to the call option as it will include rights in their favour (for example, any transfer, amendment or termination of the call option should require the lenders' consent). Furthermore, for this protection to operate in practice, the sale and purchase of the freehold land should be automatically formalised upon the exercise of the call option by the Surface Right Holder and/or lenders, without requiring any further action from the Landowner and without the Landowner being able to oppose such acquisition.

While dependent on the nature of the specific transaction at hand, from an enforcement perspective lenders normally have two options for enforcing the call option:

• the Surface Right Holder may grant the lenders a Spanish law irrevocable power of attorney, under which the lenders are able to assign the call option to themselves (on behalf of the Surface Right Holder) in an enforcement scenario; or
• if there is a share pledge over the Surface Right Holder's shares granted in favour of the lenders, the lenders could enforce that share pledge so that they effectively hold the call option on their own behalf (as the shareholder of the Surface Right Holder, which is the direct holder of the call option).

In the event that the lenders: (a) enforce the mortgage over the surface right; and (b) successfully exercise their rights over the call option (either by assignment or by enforcing the share pledge, as mentioned above), the lenders would then hold the full freehold title to the land. The existence of a call option therefore enables the lenders to mitigate the limitations of a mortgage over a surface right, providing a path to full ownership in an enforcement scenario.