Real Estate Law Newsletter: Developments in commercial tenancy law in times of COVID-19

Please find an update here: Update in Commercial Tenancy Law

As early as the beginning of last year, the onset of the coronavirus pandemic in Germany and the associated official closure orders (behördliche Schließungsanordnungen) created the need for landlords to accommodate commercial tenants, who were hit hard by the crisis; popular tools included the deferral, reduction or complete abatement of rent owed under the lease. We all remember the uncertainty surrounding the so-called “coronavirus deferrals” (which were not, in fact, deferrals) and similar issues.

Now, lawmakers are making a second attempt to provide legal assistance to commercial tenants and somewhat alleviate the existing legal uncertainty, particularly with respect to possible frustration of contract pursuant to Sec. 313 of the Civil Code (BGB). Landlords’ right to terminate the lease for non-payment of rent was restricted in spring 2020, and now the new Sec. 7 of Article 240 of the Introductory Act to the Civil Code (Einführungsgesetz zum Bürgerlichen Gesetzbuch – EGBGB) is raising new questions.

Both commercial tenants and their landlords are once again confronted with many questions, even though the law has not really changed.

Summary

The new statute merely establishes the refutable legal presumption that, as a result of the government measures which were taken in response to the coronavirus pandemic, a circumstance which represented a foundation of the lease in terms of Sec. 313(1) of the Civil Code (BGB) was significantly altered after conclusion of the contract (the purely factual aspect). This does not change the fact that the tenant continues to bear the burden of proof and explanation for the other conditions of an adjustment.

Moreover: Those who have already reached mutually acceptable arrangements with tenants in the past, such as amendments to the lease agreements, still have reason to hope that such arrangements will be upheld by the courts in case of dispute.

We also do not see any real risk that this statute will be applied retroactively to cases in the period of the first lockdown, from April to June 2020.

Therefore, as far as the legal consequences are concerned, this does not necessarily mean that each tenant has a right to adjustment, let alone termination, of the lease. The courts which have already dealt with the new law have hardly questioned this fact. Rather, whether or not the tenant can be awarded a claim under Sec. 313 of the Civil Code (BGB) depends on an examination of the individual case, in which the court is required to weigh the interests of both parties to the lease. In such an examination, it is likely that a claim to adjustment of the lease will still be denied in most cases.

In detail

Being aware of the various publications which have already appeared, we would like to provide you with this newsletter a brief explanation of the current legal situation, as well as answering the question of whether tenants are (still) required to pay rent without reduction, and therefore maybe furnishing an initial framework for resolving the questions which may arise in the future from the viewpoint of both parties of the lease agreement.

Specific provisions of tenancy law

Many have asked us whether rent can be reduced based on a material defect in the lease premises, which can no longer be operated, after all.

Based on provisions of tenancy law which are specific, and which therefore take precedence over other provisions (Sec. 535 of the Civil Code (BGB) and subsequent sections), a reduction in rent in favor of the tenant is excluded.

Based on the definition of “material defect” established by the Federal Supreme Court (Bundesgerichtshof – BGH) (BGH, Judgement of 13 July 2011, Case No. XII ZR 189/09; BGH, NJW 2011, 3151; BGH, Judgement of 2 March 1994, Case No. XII ZR 175, 92; BGH, Judgement of 22 June 1988, Case No. VIII ZR 232/87), nearly every court which has examined the question has denied the existence of a material defect in the case of coronavirus-related official closure orders. Hindrances and restrictions on use in public law could theoretically result in a defect, according to the Federal Supreme Court, but this would only be the case if the cause of the restriction lies in the condition of the lease premises and its relationship to the environment, not if the restriction is caused by the tenant’s personal or operational circumstances (BGH, ibid.). The Federal Supreme Court found that, if the lease premises remains suitable for use and only the tenant’s profits are affected, the restriction falls entirely under the tenant’s use risk and that the risk relating to provision of the lease premises for use, which falls within the landlord’s sphere, is not affected (BGH, Judgement of 16 February 2000, Case No. XII ZR 279/97).

Cancellation of the duty to pay rent due to inability

Possible cancellation of the duty to pay rent as a consequence of inability in accordance with Sec. 326(1) and 275(1) of the Civil Code (BGB) has also been discussed by the courts in many cases, but such a possibility must be denied in the end because the general provisions relating to disturbances in performance no longer apply after delivery of the lease premises to the tenant.

Frustration of contract: Sec. 313 of the Civil Code (BGB)

This leaves only the possibility of adjustment of the rent by applying the principles of frustration of contract in accordance with Sec. 313 of the Civil Code (BGB).

As already stated in the introduction to this newsletter, the newly enacted Sec. 7 of Article 240 of the Introductory Act to the Civil Code (EBGBG) (taking effect as of 31 December 2020) merely represents an interpretive aid or basic presumption, which tenants can now use to argue that Sec. 313 of the Civil Code (BGB) applies due to significant alterations in the foundation of the contract, and to seek adjustment of the rent.

The fact remains that, in accordance with Sec. 313(1) of the Civil Code (BGB) as amended, adjustment of the lease would only be possible (i) if the circumstances which have become the foundation of the contract were significantly altered after conclusion of the contract and (ii) if the parties would not have concluded this contract, or if the terms of the contract would have been different, if the parties had foreseen this change. In addition, an adjustment is only possible (iii) if at least one contracting party can no longer be reasonably expected to adhere to the contract unchanged, with due regard for all circumstances of the individual case, particularly the contractual or legal distribution of risk.

(i) Real element

The change in the law merely anticipates the first element (i) of frustration of contract (the real element) in Sec. 313 of the Civil Code (BGB) and establishes the presumption that the government measures are the reason why the use of the lease premises is restricted. In other words, it places the burden on the landlord to demonstrate that the opposite is the case, which would be difficult to accomplish in the case of the relevant closures (and the change only applies to closures, not if customer traffic is down for other reasons, such as if consumers are concerned or reluctant to spend). One could try to address allocation of the operating risk based on the ability to obtain official permits, even if this would be no more than grasping at straws. If this is attempted, the parties would be forced to conclude, by way of supplementary contractual interpretation, that the operator risk allocated to the tenant by the parties includes not only implementation of the risk at the approval level, obtaining the operating permit, but also the risk of operating the premises itself, so that Sec. 313 of the Civil Code (BGB) does not even apply.

But since the new law does not affect the other elements, it is still up to the tenant to demonstrate that these elements have been met and it must do so in light of the fact that Sec. 313 of the Civil Code (BGB) has been subjected to a very restrictive interpretation as a result of its interference with contractual fidelity (this may change based on the recent legislative trend, but that remains to be seen).

(ii) Hypothetical element

As a result, the burden is (still) on the tenant to demonstrate that (ii) the tenant’s misconceptions about the circumstance of the crisis prior to conclusion of the contract were so significant that it would never have concluded the lease in this way if it had foreseen the crisis (the hypothetical element).

Whether this element has been met must be determined on a case-by-case basis and is not easy to prove, especially if the landlord was not familiar with the tenant’s sales. But if the rent was based in large part on the tenant’s sales, or if documentation of the tenant’s sales was presented to the landlord at the time, one might certainly consider whether the hypothetical element for frustration of contract has been met, given that both parties were familiar with the sales expectations and frequently calculated these expectations using appropriate models. In such a case, it can be argued that they would have hardly entered into the same lease if they had foreseen the pandemic-related closures.

(iii) Normative element

According to the Federal Supreme Court, the tenant is also required to explain that (iii) an adjustment to the contract is necessary to prevent an intolerable result inconsistent with principles of law and justice which the tenant cannot, in good faith, be reasonably expected to bear; the “normative element” (BGH, Judgement of 11 October 1994, Case No. XI ZR 189/93 in NJW 1995, 47, Marginal No. 4b).

Is this the case? The legislative intent to Sec. 7 of Article 240 of the Introductory Act to the Civil Code (EGBGB) provides no help in this question, as it makes no allocation in favor of either party. Accordingly, the question as to whether the normative element has been met still has to be examined on a case-by-case basis, with the tenant bearing the burden of proof.

In accordance with the present case law, for example, all benefits derived by the tenant (lower costs, government aid for employees working shorter hours) as well as benefits which the tenants negligently failed to take advantage of (such as online sales, sales incentives through reduced prices, etc.) are counted against the tenant. Reductions in operating costs and government aid (extraordinary economic aid) also count against the tenant. Accordingly, in order to be able to assess the extent to which the tenant was actually affected by the crisis in each case, it would be beneficial for the landlord to at least obtain an explanation as to what aid may have been requested and granted in each specific case, while keeping a watchful eye on other rules and issues which may apply in an extraordinary situation like this one.

Procedural matters

Caution is required in the event of possible litigation. In accordance with Sec. 44 of the Introductory Act to the Civil Procedure Code (Einführungsgesetz zur ZPO) , the courts are required to assign top priority to and expedite proceedings relating to rent or lease adjustments for land or non-residential premises as a result of government measures to combat the COVID-19 pandemic and, pursuant to Sec. 44(2) of the Introductory Act to the Civil Procedure Code (EGZPO), a hearing must be granted at the earliest possible date in such cases, no later than one month after service of the complaint.

Retroactive effect

Finally, although the case has often been presented otherwise, this change likely will not have a retroactive effect on cases from April to June 2020. The tenant continues to bear the burden of proof and explanation in those cases. There is no exceptional case where this change will have a truly retroactive effect with associated legal consequences. However, the courts will likely orient themselves based on the general legislative trend.

Those who have already reached mutually acceptable arrangements with tenants in the past, such as amendments to the lease, still have reason to hope that such arrangements will be upheld by the courts in case of dispute, and are therefore ‘’watertight”.

For example, if the parties reach a conclusive contractual arrangement for the period of the pandemic which takes into account the altered economic circumstances, the precedence of the contractual agreement would likely mean that Sec. 313 of the Civil Code (BGB) would not even apply, despite the change in the law. In such a case, the parties would have made a new adjustment to the contract based on the elements presented above ((i) through (iii)) which takes precedence over Sec. 313 of the Civil Code (BGB), in our view, since the concrete risk of (additional) official closures is fully covered by the contractual arrangement.

Conclusion

In conclusion, such an intolerable result to the tenant can be assumed only in rather extraordinary cases, so that a claim to adjustment of the lease under Sec. 313 of the Civil Code (BGB) will be awarded only in extremely limited cases. Moreover, landlords may also be able to argue that such an adjustment is out of the question because it poses an existential threat to the landlord, given that the latter is still required to pay principal and interest, especially in cases where the restrictions are of a temporary nature, but the adjustment in rent would be of longer duration.

Accordingly, the question must still be decided on a case-by-case basis. Individual court decisions have shown that, in certain extreme cases, such an examination may result in adjustment claims entitling the tenant to reduction of the rent by 50%.

For this reason, it would be advisable for parties to include a type of pandemic clause in future leases in order to address existing legal uncertainty as far as possible in advance and eliminate the grounds for discussion about the hypothetical element of frustration of contract. In such a case, the hypothetical element would no longer exist, since the circumstance of the crisis would have become a real element which was taken into account by the parties and which is reflected accordingly in the contract.

For more Update in Commercial Tenancy Law, click here.