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04.07.2017 | KPMG Law Insights

A side letter is not a solution

A side letter is not a solution

Typically, a side letter contains ancillary agreements of contracting parties that they do not wish to include in the main contract. However, side letters are concluded with very different contents and for different purposes. The use of a side letter may have an impact on the associated main contract.

A side letter is usually a supplementary agreement under the law of obligations to a main contract. The content of such an agreement is not subject to any constraints, as there is neither a legally binding, legally characterizing nor even typical content for a side letter. In addition to the confidentiality interests of the contracting parties, freedom of content is often the decisive reason for wanting to conclude a side letter. The law also does not contain any express formal requirement for supplementary agreements under the law of obligations. The fundamental freedom of form and the associated cost advantages (in avoiding notarization, public certification or recording of a settlement) can also motivate contracting parties to want to record supplementary agreements in a side letter in addition to a main contract.

Notarization of real estate purchase contracts

However, these supposed advantages are only valid to a very limited extent in connection with real estate transactions: according to § 311b para. 1 sentence 1 of the German Civil Code, a contract by which one party undertakes to transfer or acquire ownership of a plot of land requires notarization. The purpose of the standard is to draw the attention of the contracting parties to the significance of the legal transaction and to protect them from hasty decisions, whereby the formal requirement has a warning function. In addition, disputes are to be avoided by providing the parties with expert advice prior to entering into what is regularly a material transaction.

Invalidity of the entire legal transaction

Insofar as a side letter now complies with the form requirement of Section 311b para. 1 sentence 1 of the German Civil Code (BGB), its informal conclusion pursuant to Section 125 sentence 1 of the German Civil Code (BGB) leads to the invalidity of the agreements contained in the side letter. In addition, the invalidity of a side letter can lead to the invalidity of a property purchase agreement that is in itself validly notarized as the main agreement. This is because, according to Section 139 of the German Civil Code, the entire legal transaction is void if a part of the legal transaction is void and if it cannot be assumed that it would have been made even without the void part. The decisive factor here is whether, according to the intention of the contracting parties to the land purchase agreement, the various agreements are to depend on each other in such a way that they “stand or fall with each other”. Due to the diverse content of a side letter, this can only be decided on a case-by-case basis.

Will to include

The requirement of form of a contract for the purchase of real property pursuant to § 311b para. 1 sentence 1 of the German Civil Code (Bürgerliches Gesetzbuch – BGB) shall include all agreements which, according to the intention of the contracting parties, are to make up the sale transaction. In this respect, it is sufficient if one party wishes to make the agreement an integral part of the contract.

Accordingly, the purchase agreement and the side letter may form a single sale transaction, a legal unit. A legal unity exists if, according to the will of the contracting parties, the agreements do not apply on their own but are dependent on each other, whereby a unilateral dependence of the land purchase agreement on the side letter is also sufficient.

Explanations

In addition to declarations within the scope of a real estate purchase agreement that are directed at bringing about a legal consequence, such agreements also require notarial certification that describe and specify the content and scope of the services. Sometimes it can be difficult to distinguish such agreements from mere explanations. A side letter that merely contains explanatory notes to a contract for the sale of real property is not subject to the formal requirement of Section 311b of the German Civil Code (BGB). An explanation is regularly given if only that is illustrated which is regulated by the land purchase agreement to be notarized. However, the boundary is to be drawn where the content of the contract itself only becomes apparent or comprehensible from the explanation or in connection with the explanation.

Agreements with a third party

It is also conceivable that a side letter is entered into between the contracting party to a land purchase agreement and a third party who is not involved in the purchase as a selling or purchasing party. Even in this constellation, however, the necessity of a notarial certification in accordance with § 311b Para. 1 sentence 1 BGB and depends on the content of such a side letter. In this respect, the same principles apply as in the case of a side letter between contracting parties. The decisive factor here is also the intention of the contracting parties to the purchase agreement to make the agreement contained in such a side letter an integral part of the purchase agreement. If at least one party would not want to conclude the land purchase agreement or would not want to conclude it in such a way if the side letter with the third party did not exist, this proves the necessity to also make the side letter the subject of the notarial certification of the purchase agreement.

Practice note

In real estate transactions, utmost caution is always required when concluding a side letter, because with an informally concluded side letter, the contracting parties risk the nullity of the entire legal transaction. Therefore, a precise examination of the intended content of the side letter in the respective individual case is always required.

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Dr. Rainer Algermissen

Partner
Head of Construction and Real Estate Law

Fuhlentwiete 5
20355 Hamburg

tel: +49 40 3609945331
ralgermissen@kpmg-law.com

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