“Buying doesn’t mean renting” – or does it?

In the first half of 2016, the Federal Court of Justice and the Higher Regional Court of Saarbrücken issued informative decisions on the interpretation of Section 566 of the German Civil Code (BGB) and on the question of what consequences the sale of a rental property has for the parties involved.

Most people involved in real estate law are probably familiar with the principle of “purchase does not cancel rent” in accordance with Section 566 BGB. According to Section 578 (2) BGB, this principle also applies in commercial tenancy law. If a rental object is sold by the landlord to a third party after it has been transferred to the tenant, the purchaser enters into the tenancy in place of the landlord. With the entry of a purchaser in the land register of the property on which the leased property is located, the purchaser takes the place of the landlord. In practice, this is often referred to as a legal transfer of the tenancy – in contrast to an equally possible legal transfer of contract between the seller, purchaser and tenant.
However, the transfer of ownership does not completely release the seller from the tenancy: if the purchaser does not fulfill his obligations under the tenancy agreement, he is liable for the tenant’s claims for damages or reimbursement of expenses against the purchaser in accordance with section 566 (2) sentence 1 BGB, like a guarantor who has waived the defence of foreclosure. However, the former landlord is released from this liability in accordance with Section 566 (2) sentence 2 BGB if he notifies the tenant of the transfer of ownership, unless the tenant terminates the tenancy agreement at the earliest possible date.

In the first half of 2016, the Saarbrücken Higher Regional Court and the Federal Court of Justice issued interesting decisions on the requirements and legal consequences of Section 566 BGB.

Saarbrücken Higher Regional Court, judgment of 27.01.2016 – 2 U 71/14

In a legal dispute before the Saarbrücken Higher Regional Court, the main issue was whether a rental agreement that had not already been bindingly concluded could be transferred to a purchaser of real estate by applying Section 566 BGB accordingly.
In the case to be decided – in simple terms – the owner had submitted an irrevocable, conditional and limited offer to a subtenant of his main tenant in order to conclude a tenancy agreement with the subtenant for the space already provided to him by the main tenant. The new tenancy agreement offered was to take effect upon termination of the current main tenancy. The new tenancy agreement was enclosed with the offer letter already fully executed and signed on one side by the owner. The property was subsequently sold by the landlord. The subtenant accepted the offer in due time after the transfer of ownership and sent the signed tenancy agreement to the purchaser.
The Saarbrücken Higher Regional Court qualified the offer to conclude the tenancy agreement as the granting of a “justification option”. This is characterized by the fact that, unlike the usual extension options in tenancy agreements, it does not extend an existing tenancy, but rather creates a new tenancy in the first place. The so-called justification option is therefore a contractual offer with an extended binding effect. What it has in common with the renewal option is that it is solely up to the tenant to submit the declaration of acceptance within a certain period of time.
In the opinion of the court, such unilaterally binding offers are to be treated in the same way as a tenancy agreement subject to a condition precedent, the condition of which has not yet been fulfilled at the time of the acquisition of ownership. In these cases, the purchaser enters into the tenancy concluded under the condition precedent. Nothing else can apply to the option to establish a lease, as the seller has also made a binding declaration in this case.

BGH, decision from 05.04.2016 – VIII ZR 31/15

The decision of the Federal Court of Justice was primarily concerned with the question of what requirements are to be placed on the constituent element of the transfer of the leased property within the framework of Section 566 (1) BGB.
The far-reaching effect of Section 566 (1) BGB makes it necessary for the purchaser to be able to determine from the ownership situation which tenancy he is entering into upon transfer of ownership. The prerequisite for the applicability of Section 566 BGB is therefore that the rental object has been transferred to the tenant and that the tenant exercises actual control over the rental object at the time of the transfer of ownership.
In the case on which the BGH decision is based, this actual control of the tenant was interrupted. At the time of the transfer of ownership, the tenant had no longer exercised the possession that had been transferred to him. The court ruled that at the time of acquisition of ownership by the purchaser, the tenant had to be in actual possession. If the actual control of the property is interrupted or no longer exists at this time, Section 566 BGB does not apply, even if a tenancy continues.

Practice Notes

In order for the purchaser of a property to be able to recognize at an early stage what obligations he is entering into towards tenants under Section 566 BGB, Section 550 BGB requires the written form for long-term tenancies and Section 566 (1) BGB requires that the tenant has already received the rented property, i.e. that it is “visible” there.
According to the ruling of the Higher Regional Court of Saarbrücken, special attention must now also be paid to so-called justification options when examining existing tenancies. Otherwise, the purchaser could be surprised by the fact that a former subtenant demands the handover of a rental property that the new landlord considers to be vacant space.
Conversely, a purchaser who has calculated his purchase price on the basis of the continued existence of long-term tenancies must, according to the decision of the Federal Court of Justice outlined above, make sure during the due diligence that the tenants have obtained and actually still exercise their direct possession. In addition, a prudent purchaser will have the selling landlord ensure or guarantee that the respective rental property will still be in the tenant’s possession at the time of handover and that the tenant will not relinquish this possession until the transfer of ownership. Otherwise, § 566 BGB would not be applicable according to the case law of the BGH and thus the basis for a certain capitalized earnings value of the property would be shaken.