The Effects of the Coronavirus on Real Estate Law
1. COVID-19 Pandemic in the Federal Republic of Germany
The "coronavirus" or "COVID-19 pandemic" issue (hereinafter "Covid-19 Pandemic") has been given considerable attention in real estate law in recent months.
Due to the Covid-19 Pandemic and its consequences, Germany first imposed a coronavirus lockdown, to be followed by the so-called "federal emergency brake". The federal emergency brake which came into force on 23 April 2021 amended the Infection Protection Act (IfSG) in Germany. The regulation of the federal emergency brake stipulates that as soon as a district or municipality in Germany exceeds an incidence rate of 100 for three consecutive days, additional, uniform federal measures will apply in these districts as of two days later. The restrictions of the coronavirus lockdown and the federal emergency brake include, among others, the closure of restaurants, the hospitality industry, leisure and cultural centres and retail outlets, with the exception of stores for daily needs, such as supermarkets, drugstores or pharmacies.
One of the first legal issues to be intensively discussed in connection with the effects of the COVID-19 Pandemic was the impact of officially ordered closures of operations on commercial leases (hereinafter "coronavirus-related closure orders"). This is because nearly all commercial leases are affected by the impact of the Covid-19 Pandemic. In view of the increasing number of coronavirus-related closure orders, there is uncertainty due to claims arising as a result of non-compliance with contractually agreed obligations, such as the reduction or suspension of rent payments.
By now, a number of rulings have been issued in connection with coronavirus-related closure orders in the Covid-19 Pandemic, so that some case law could be established. However, the Federal Supreme Court (BGH) has not yet made a decision. This memorandum contains an overview of the main regulations on commercial leases (see item 3), current case law on commercial leases during the Covid-19 Pandemic (see item 4) and our legal advisory services (see item 5).
The Covid-19 Pandemic poses major challenges, particularly for commercial lessees who have had to close or limit their business operations due to a coronavirus-related closure order, at the latest since the lockdown. According to prevailing judicial decisions until now, commercial lessees have neither a right to reduce rent under section 536 of the German Civil Code (BGB) nor a right to reduce rent due to an impossibility under section 275 BGB. With Article
240 section 7 Introductory Act to the German Civil Code (EGBGB) in connection with section 313 BGB on the interference with the basis of the transaction of lease agreements, however, the instrument of the interference with the basis of the transaction facilitates a contractual adjustment. The new regulation establishes a presumption that the Covid-19 Pandemic and coronavirus-related measures lead to a serious interference with the basis of the transaction. However, this does not say anything about whether the other requirements of section 313 BGB are met. The commercial lessee must also demonstrate and, in the event of a dispute, prove that the requirements of section 313 BGB are met and that there is a right to adjustment of the agreement. The decisive factor for an adjustment of the agreement is the reasonableness. In order to determine how reasonable such an adjustment would be, all interests must be weighed extensively. According to the jurisdiction of the highest courts, the aim is to achieve an optimum balance of interests with the smallest possible reduction or increase in a liability.
Since there has not yet been any supreme court ruling on this subject by the Federal Court of Justice and the courts to date have ruled inconsistently, commercial lessees who withhold rent during coronavirus-related closure orders continue to run the risk of being sued for payment and, in the case of lessor-friendly rulings, of being ordered to pay. Likewise, lessors face the risk of losing an action for payment in the event of lessee-friendly judgments. In this case, we advise our clients primarily to find an amicable solution and to conclude supplements, deferral agreements or instalment payment agreements.
3. The Covid-19 Pandemic and its consequences for commercial leases
An increasing number of commercial property lessors are being faced with requests from commercial lessees for rent reductions due to coronavirus-related closure orders, who are struggling with drops in sales due to the Covid-19 Pandemic. There is legal uncertainty among many commercial lessees despite legal regulations and obligations to pay rent. Here, many commercial lessees assume that they have the right to reduce or even completely withhold rent for the period of the coronavirus-related closure order.
Still, a rent reduction in the case of coronavirus-related closure orders is neither regulated by law nor have German court decided them to date. The majority of German courts dealing with coronavirus cases have ruled that ‑ in accordance with the general and real estate law warranty rights and rights to influence a legal relationship ‑ there is not generally a right of commercial lessees to a rent reduction under section 536 BGB (cf. item 3.1), or impossibility under section 275 BGB (cf. item 3.2) during the coronavirus lockdown. Instead, case law revealed that commercial lessees can only demand an adjustment of the lease agreement ("Adjustment of the Agreement") pursuant to section 313 (1) BGB in exceptional cases due to coronavirus-related closure orders. In addition, a new statutory provision (Article 240 section 7 EGBGB in conjunction with section 313 BGB) was issued which contains a statutory presumption that the coronavirus lockdown and the coronavirus-related closure orders constitute an interference with the basis of the transaction pursuant to section 313 BGB (cf. item 3.3). This memorandum presents the respective court decisions in item 4. In detail:
3.1 Rent Reduction Right, Section 536 BGB
The right to rent reduction is regulated in section 536 BGB. According to section 536 (1) BGB, rent may generally be reduced if the leased property has a defect which restricts significantly or removes its suitability for the contractually agreed use. According to the prevailing opinion of German courts, however, the coronavirus-related closure order does not represent a defect of the leased object entitling to a rent reduction and does not justify a right to rent reduction.
In this regard, it is explained that although impediments to use and restrictions - such as the coronavirus-related closure order - can lead to a defect. According to judgments of the Federal Court of Justice (cf. BGH, decision of 13 July 2011 - XII ZR 189/09), a requirement is, however, that the restrictions of the leased object have their cause precisely in its condition and relationship to the environment and not in the personal or operational circumstances of the lessee.
The statutory intervention or prohibition does not generally restrict the use of the leased property, its location or condition but rather the type of business operations of the commercial lessee. Therefore, according to case law, the commercial property as leased object is also suitable for use during the coronavirus-related closure. Also, in the opinion of the Federal Court of Justice, the commercial lessee bears the risk of use. The lessee must take into account the fact that subsequent legislative or official measures may have an adverse effect on commercial operations and that profit expectations may, as a result, not be fulfilled (cf. BGH, decision of 13 July 2011 - XII ZR 189/09).
3.2 Impossibility, Section 275 BGB
As a reason for rent reduction, several commercial lessees also argued that the coronavirus-related closure orders established an impossibility in terms of section 275 BGB.
Section 275 BGB regulates the impossibility. However, impossibility does not occur as soon as the performance of the service is impeded, but only when it becomes impossible for the lessor to perform the service. Against this background, the owed assignment of use of the leased object for the contractually agreed rental purpose would have to be completely or partially impossible. If one were to assume that the coronavirus-related closure orders lead to an objective legal impossibility of using the commercial property pursuant to section 275 (1) BGB, then the lessee of that commercial property would consequently no longer be obliged to pay rent by way of the conditional synallagma from section 326 (1) sentence 1 half sentence 1 BGB.
According to the prevailing opinion of the German courts, an impossibility under section 275 BGB was however rejected. The courts argued that a coronavirus-related closure of the business premises exclusively affects the lessee's use of the commercial property but does not change the lessor's obligation to provide use of the premises. By making the leased property available to the lessee of the commercial property in a condition suitable for use, the lessor fulfils the main obligation. The circumstance that the lessee of the commercial property may not use it as intended by the lessee is not due to the commercial property itself. The obligation in return to pay rent is thus not waived due to an impossibility under section 275 BGB.
3.3 Interference with the Basis of the Transaction, Section 313 BGB, New Regulation Article 240 Section 7 EGBGB
Finally, the German courts increasingly often deal with "interference with the basis of the transaction" under section 313 BGB. Until today, judgements on the adjustment of the rent payment obligation in accordance with the principles of interference with the basis of the transaction in case of coronavirus-related closure orders and sales losses have not been uniform, as is the literature published on the subject.
While individual lessor-friendly rulings of regional courts which rejected a claim of the commercial lessee to rent adjustment were issued at the beginning of 2020, since then several regional courts and higher regional courts have affirmed a claim of commercial lessees to rent adjustment according to the principles of interference with the basis of the transaction at the end of 2020 and the beginning of 2021.
Due to a new regulation of Article 240 section 7 EGBGB in conjunction with section 313 BGB, a legal presumption was established to the effect that coronavirus-related closure orders lead to a serious change in the contractual basis between the parties to the lease and thus open up the scope of application for a "contractual adjustment" Nevertheless, it is still necessary to balance interests for a possible adjustment of contract. It depends on the individual case whether the requirements for a reduction of rent are met. There is no automatic rent reduction. In detail:
a) Section 313 BGB
A provision deviating from the principle pacta sunt servanda is the principle of interference with the basis of the transaction pursuant to section 313 BGB. Interference is provisional upon:
- Circumstances which became the basis of a contract have significantly changed since the contract was entered into (real element),
- The parties would not have entered into the contract or would have entered into it with different contents if they had foreseen this change (hypothetical element), and
- Taking account of all the circumstances of the specific case, in particular the contractual or statutory distribution of risk, one of the parties cannot reasonably be expected to uphold the contract without alteration (normative element).
The aforementioned circumstances must therefore have changed seriously after the conclusion of the contract. These must be circumstances that constitute the basis of the contract but have not become contents of the contract. The legal consequence of section 313 BGB is, at first, an adjustment of the contract insofar as, taking account of all the circumstances of the specific case, in particular the contractual or statutory distribution of risk, one of the parties cannot reasonably be expected to uphold the contract without alteration. If adaptation of the contract is not possible or one party cannot reasonably be expected to accept it, the disadvantaged party may revoke the contract. (cf. Item. 3.4).
b) Article 240 Section 7 EGBGB – Statutory presumption
Before the new regulation of Article 240 section 7 EGBGB came into force, the courts had differing opinions as to whether the Covid-19 Pandemic and its consequences - in particular the official closure orders and the loss of sales - were to be regarded as an interference with the basis of the transaction. The new regulation then established a so-called "presumption rule" regarding the real element. In detail:
(i) The new regulation
In December 2020, the legislator introduced the new regulation of Article 240 section 7 EGBGB on the handling of commercial leases in the event of coronavirus-related closure orders. The applicability of the new regulation is limited to lessees of land or premises that are not residential premises but are/were not usable for the lessee's business or were usable only with significant restrictions as a result of government measures to combat the Covid-19 Pandemic. The new regulation of Article 240 section 7 EGBGB now stipulates that the provisions on an interference with the basis of the transaction are applicable in the special situation of the Covid-19 Pandemic.
(ii) Presumption rule
This is based on the "presumption rule". The presumption only applies to the real element from section 313 BGB and is rebuttable. Specifically, it is now presumed that a circumstance in terms of section 313 (1) BGB which has become the basis of the lease agreement has changed significantly after conclusion of the agreement.
However, this does not result in an automatic rent reduction or an automatic right of the lessee to withhold rent. In addition, the presumption does not apply in cases where the lease was concluded at a time when the spread of the Covid-19 Pandemic had already been foreseeable. The idea of the new regulation is to simplify negotiations between commercial lessees and owners.
However, the presumption only applies to the so-called real element and not to the other elements of section 313 (1) BGB. If the requirements for the presumption rule are met, it can be assumed that the real basis of the lease agreement has changed seriously. Nevertheless, the lessee must fulfil the other requirements of section 313 (1) BGB, as these remain unaffected by the new regulation. The commercial lessee must still present the hypothetical and normative elements and, in the event of a dispute, prove them.
As to the normative element, it must therefore also be examined in the future ‑ in each specific individual case ‑ whether it is economically reasonable for the lessee to maintain the unchanged contract and pay rent in full. The lessee bears the burden of presentation and proof. Thus, interests must be weighed, taking into account all circumstances, in particular the advantages and disadvantages. Relevant factors may be how long the lease agreement has already existed and whether it has been possible to create reserves in recent years. In addition, possible public or other grants have to be taken into account as well as saved expenses, such as short-time allowance or compensations, such as through online trading.
c) Consideration of the circumstances in the individual case
An automatism that commercial lessees may demand a reduction of rent or any other adjustment of the agreement in case of coronavirus-related measures, however, is not implied by the new regulation. Since, in principle, only those legal consequences can be sought which bring the interests of both contracting parties worthy of protection into an appropriate balance. Consequently, an overcompensation is not granted. For instance deferral agreements, agreements on instalment payments, termination agreements as well as the reductions of leased areas etc. are also possible.
In the course of a comprehensive consideration of the circumstances of the individual case it then has to be decided whether the rent payment has to be adjusted in the specific case. Factors relevant to the consideration include:
- the reasonableness of the full rent payment for the commercial lessee in consideration of the lessee's reserves,
- the reasonableness of the reduction of rent for the lessor,
- amount of the rent in relation to the comparable rent customary at that location,
- the specific economic situation of both parties,
- the extent of the loss of sales suffered by the commercial lessee,
- as well as the amount and the time of state financial aid.
d) Threat to the existence and obligation to present the case in court of the commercial lessee
An unreasonableness within the meaning of section 313 (1) BGB has to be assumed in the course of the above-mentioned balancing of interests if the full payment either destroyed the existence of the commercial lessee or impaired it so seriously that an adjustment of the agreement was required even taking into account the legitimate interests of the lessor.
The commercial lessee then has to provide a detailed justification of the threat to the existence - for instance, in the opinion of the Higher Regional Court of Karlsruhe (OLG Karlsruhe, decision of 24 February 2011, 7 U 109/20). For this purpose, it is relevant:
- to what extent revenues have declined,
- which commercial compensations have been possible for the lessee e.g. through online trading,
- to what extent the commercial lessee has obtained state aid,
- which expenses were saved through short-term work or through a reduced purchase of goods as well as,
- whether reserves were built up.
In addition, the lessee also has to submit relevant documents. In particular, they include:
- (monthly) economic analyses,
- balance sheets,
- turnover sheets,
- tax returns,
- tax statements,
- profit and loss statements,
- purchase books,
- documents concerning the application for and granting of state aid (grants).
Pursuant to the decision of another court, such as the Higher Regional Court of Berlin
(KG Berlin, decision of 1 April 2021, 8 U 1099/20) a concrete threat to the existence for the lessee, however, does not have to be positively determined on the basis of his business data. Rather, the threat to the existence already has to be assumed if an ordered closure lasts for one month or longer.
If an adjustment of the agreement is not possible, section 313 BGB additionally provides for the (unilateral) termination of the agreement as a further consequence. The prerequisite is that the termination of the lease agreement is the only option to avert the threat to the lessee's existence. However, alternative measures previously have to be taken in order to improve the economic situation of the lessee. The following measures may be considered:
- the waiver of individual elements of the rent (e.g. administrative expenses),
- the reduction of (total) rent by a certain percentage, whereby in this case a provision should be made for the accounting of operating costs due by the end of the year because of the reduced advance payments.
- maintaining the advance payments for operating costs and reduction of base rent.
4. Case law on the commercial lease law in the Covid-19 Pandemic
There are nearly 25 current decisions of the regional courts and higher regional courts which have dealt with coronavirus-related closure orders during the Covid-19 Pandemic and the interests of the commercial leasing parties. After coming into force of the new regulation of Article 240 section 7 EGBGB, however, there were only six crucial decisions of the German courts which carried out a different application of section 313 BGB as well as consideration in the individual case. Five of the six courts decided in favour of the lessor and refused an adjustment of the agreement. As justification of the decisions favourable to lessors, the five courts essentially stated that it was only unreasonable for the commercial lessees on the basis of frustration of purpose to pay full rent if their claims destroyed their existence or at least seriously impaired their economic progress, and also the interests of the lessor allowed an adjustment of the agreement. For this purpose, the circumstances would have to be examined in detail. For the balancing of interests in the individual case, it had to be taken into account whether a decrease in sales, possible compensations through online trading or through public benefits, saved expenses, e.g. through short-term work as well as persistent assets through goods available for sale further on had taken place.
In all five of the proceedings, this has no been demonstrated and proven by the lessee.
A fundamental decision by the Federal Supreme Court (BGH) would be desirable in view of the extremely opposing arguments of the higher courts concerning the application of the legal concept of frustration of purpose in the course of coronavirus-related closures of operations. It is not yet possible to forecast whether and when such a fundamental decision will come.
5. Our approach
The parties of commercial leases have to live with a legal uncertainty with respect to the assessment of the amount of rent after coronavirus-related closures of operations until a decision has been made by the Federal Supreme Court. In any case, we advise the parties to cooperate with each other at first and to find an amicable solution. In this context, we advise and assist the parties with the preparation of supplements, deferral agreements or instalment payment agreements.
If the parties agree on a reduction of rent, this has to meet the written form requirement pursuant to section 550 BGB and has to be documented in a respective supplement if the term of the adjustment of the agreement shall last longer than one year, or if other obligations or changes to the lease agreement are regulated which should continue to exist for the duration of more than a year. In case of supplements and new lease agreements, it is advisable for the lessor to include a standard "coronavirus clause" in the agreements. This clause can ensure the necessary flexibility in case of dispute.
The new regulation of Article 240 section 7 EGBGB quickly reveals, as a result, that furthermore many questions remain unanswered since it has to be clarified in each individual case whether all factual requirements of section 313 BGB are met for an adjustment of the agreement pursuant to the principles of the interference with the basis of the transaction.
Furthermore, we advise all lessors - in particular such lessors with current debt financing of the commercial properties concerned - not to prematurely agree to a request for a rent reduction of their commercial lessees, especially since the coronavirus-related economic disadvantages are often not substantiated in sufficient detail by the lessees. Nevertheless, we also recognise that the case law is not consistent and that legal disputes may entail risks for our clients, since some regional courts and higher regional courts also have rendered judgments in favour of lessees. To date, there is also no high court decision of the Federal Supreme Court on this matter. (31 May 2021)
Rechtsanwalt, Notar - registered office Frankfurt/Main
Dr Angela Kogan