Help for commercial tenants?

As of December 16, 2020, Germany is known to be in a renewed COVID-19-related lock-down. Numerous commercial tenants and lessees have been forced to close their businesses as a result, and it is impossible for us to predict when businesses will be allowed to reopen on a regular basis after the resolutions passed on January 5, 2021 and the development of contagion rates. Already during the so-called first lock-down in spring 2020, the legislator undertook to strengthen the interests (also) of commercial tenants and lessees with the Act on Mitigation of the Consequences of the COVID 19 Pandemic of March 27, 2020, by granting them protection against termination even in the event of non-payment of rent in the months of April to June 2020 until June 30, 2022. What was not clarified at the time, however, was whether tenants and lessees were entitled to a reduction in rent or lease as a result of the government-imposed restrictions on commercial operations – whether as a result of a reduction in rent or as a result of the application of the principles of disruption or cessation of business.

In the meantime, these questions have been answered differently by the courts, but predominantly in the negative on the grounds that the use of the leased property is within the tenant’s sphere of risk. Numerous tenants have since been ordered to pay outstanding rent arrears. Now the legislator wants to help tenants and leaseholders by a new regulation.

1. Supplementation of the regulations on the disturbance of the basis of the contract

In its session on December 17, 2020, the Bundestag passed a resolution lasting until the September 30, 2022 to Section 313 of the German Civil Code (BGB), which was adopted on December 31, 2020 has entered into force. Art. 240 § 7 EGBGB reads:

“(1) If, as a result of government measures to combat the COVID 19 pandemic, leased land or leased premises that are not residential premises cannot be used for the tenant’s business or can be used only with significant restrictions, it shall be presumed that, in this respect, a circumstance within the meaning of Section 313(1) of the Civil Code that has become the basis of the lease has changed seriously after the conclusion of the contract.

(2) Paragraph (1) shall apply mutatis mutandis to leases.”

According to the legislator’s intention, the new regulation is also applicable to cases that have been concluded at the time the new regulation enters into force but have not yet been legally decided. This also has significant relevance to closure periods or other impairments due to government restrictions on use during the initial lock-down.

• Section 313 of the German Civil Code grants the tenant or lessee a right to adjust the contract if there is a change in

1. circumstances, which have become the basis of the contract, have changed seriously after the conclusion of the contract,
2. the parties would not have concluded the contract or would have concluded it with different content if they had foreseen this change, and
3. one party cannot reasonably be expected to adhere to the unchanged contract, taking into account all circumstances of the individual case, in particular the contractual or statutory distribution of risk.

The foreseeable circumstances must be presented and proven by the lessee or tenant in the event of a legal dispute.

Following the amendment to Section 313 of the German Civil Code (Bürgerliches Gesetzbuch – BGB) passed by the German Bundestag, it is now presumed that the lack of usability or significantly restricted usability of commercial rental space as a result of government measures to combat the COVID 19 pandemic constitutes a circumstance within the meaning of Item 1 above. However, the statutory presumption of the existence of a serious change in circumstances that have become the basis of the contract does not automatically entitle the tenant to adjust the rent. It is true that in the event of a legal dispute, the tenant no longer has to present this factual requirement. However, the statutory presumption may be rebuttable, i.e. the landlord is free to prove the contrary. Such evidence is likely to be available, for example, if the lease was entered into at a time when a pandemic spread of the COVID-19 virus and a resulting lock-down were already foreseeable or existed.

Furthermore, in order for the tenant to have a claim to adjustment of the contract, the other requirements set out in Clause 2 and Clause 3 must also be met. Thus, the hypothetical question to be clarified is, on the one hand, whether the contracting parties would not have concluded the lease or would have concluded it with different content had they foreseen the COVID-19-related closures. The decisive factors in answering this question are the specific rental arrangements agreed between the parties, such as turnover-based rental arrangements, the amount of rent and the extent to which it is covered by sales revenues, incentives in relation to standard market arrangements, but also the relationship between supply and demand on the rental market and the resulting negotiating positions of the parties.

Furthermore, the normative element of Section 313 of the German Civil Code must be answered, as expressed in the factual element under item 3, i.e. whether it is reasonable or unreasonable for the tenant to adhere to the unchanged contract. As before, the decisive factor here is the circumstances of the individual case, whereby the following points in particular should be taken into account:

• What is the contractual distribution of risk in relation to the specific tenancy?

In this context, it must be taken into account – even after the most recent legal amendment – that, as a matter of principle, the tenant bears the risk of use with regard to the leased property. In the case of commercial leases, this primarily includes the risk of being able to generate sales and profits in the leased property. Such a distribution or assumption of risk regularly excludes the possibility for the party concerned – apart from extreme exceptions in which an unforeseen development occurs with possibly existentially significant consequences for one party – to invoke a disturbance of the basis of the transaction when the risk materializes. Accordingly, some courts have already considered a claim of the tenant for contract adjustment in accordance with the provision of § 313 BGB, but have rejected it in the result for the individual case. The justification for the amendment to the law, on the other hand, assumes that without corresponding contractual provisions, burdens resulting from government measures to combat the COVID 19 pandemic are regularly attributable neither to the risk sphere of the landlord nor of the tenant.

• How much do government restrictions affect the tenant’s operations?

An indication of a severe impairment may be a significant decline in sales compared with the previous year, for example. In this context, the duration of the impairment and the question of whether the tenant’s existence is endangered by this also play a role.

• What efforts have been made by the tenant or its owners, partners, shareholders, etc. to mitigate the risks posed by the COVID-19 pandemic?

In this regard, it is necessary to consider, for example, whether the tenant is entitled to mitigation grants for the COVID 19 pandemic and whether it has applied for and received them. Furthermore, it must be questioned whether the tenant saves, for example, expenses in connection with short-time work or the discontinuation of purchases of goods with which it can at least partially compensate for the loss of sales as a result of government restrictions.

2. possible adjustment of the contract as a legal consequence

In the event that all of the aforementioned requirements are met, the contractual adjustment must take into account not only the individual circumstances of the tenant, but also the circumstances on the landlord’s side. The contract adjustment must be reasonable for both contracting parties. For example, the extent to which the landlord himself is dependent on the rent payments, among other things to repay real estate loans for the rented property, but also independently of this the remaining term of the lease and the solvency of the tenant in other respects, must be taken into account. The landlord cannot reasonably be expected to adjust the contract if he must expect that the tenant will have to file for insolvency in the foreseeable future despite the reduction in rent. In addition, contractual arrangements can also be considered in which the tenant – despite the effects of the pandemic-related closures – is in a significantly better economic position overall than the landlord, so that an adjustment of the contract would be unreasonable.

Moreover, the legal consequence of a contractual adjustment is not necessarily a unilateral reduction in the amount of rent. Also possible (as before) are

• an interest-bearing or interest-free deferral of rent,
• the combination of a temporary rent reduction with an extension of the lease term that includes a subsequent increase in the rent,
• a reduction in the rental space or even
• a cancellation of the entire lease agreement.

Therefore, the circumstances of the individual case will continue to be decisive in the future, so that general statements such as those that have already been read (“Landlords must now tremble again”) are prohibited.

• Consequences for practice

As a result of the above, despite the addition of Section 313 of the German Civil Code, tenants are not advised to reduce the rent without further ado, as this can quickly lead to a rent arrears that is relevant for termination. Rather, tenants must seek a discussion with the landlord and explain to him the specific circumstances on the basis of which a contract adjustment appears necessary from their point of view in the individual case. In this context, we advise tenants to also focus on the interests of the landlords and to explain to them specifically – taking into account the above statements – that and why, even taking into account the circumstances of the case with the landlord, as far as is known, it appears to them to be unreasonable to adhere to the contract on unchanged terms. Tenants must take into account that many landlords can only make a decision to adjust a long-running lease on a secure decision-making basis, taking into account corporate governance requirements and the Business Judgement Rule that exist for them. In this respect – despite the new statutory presumption rule, the associated change in the distribution of the burden of proof with regard to the existence of a basis for the transaction and its serious change and a negotiating position that is thus certainly improved overall for tenants – tenants are nevertheless subject to considerable requirements for presentation.

Conversely, landlords cannot be advised to do anything other than sit down at the negotiating table with their tenant if a contract adjustment pursuant to Section 313 of the German Civil Code is not already ruled out at first glance, and to look for a mutually agreeable solution. On the one hand, this can help to secure the tenant’s liquidity and retain him as a tenant in the long term. On the other hand, it must be noted that parallel to the amendment of Section 313 of the German Civil Code (BGB) as of December 31, 2020, the Code of Civil Procedure was also amended. Thus, Section 44 of the Introductory Act to the Code of Civil Procedure (EGZPO) now instructs the courts to give priority and expedited treatment to actions relating to an adjustment of rent under Section 313 of the German Civil Code (BGB) and to set a first hearing date within one month of service of the statement of claim. Whether this is practically feasible – also from a pandemic perspective – remains to be seen. In any case, however, in the event of a legal dispute, considerable costs and, if necessary, the obtaining of expert opinions are to be expected in order to ascertain the respective circumstances of the individual case and to sound out the reasonableness of adhering to the contract for both parties. This can and should be avoided through a well-prepared landlord-tenant conversation, if possible.

For individual landlords, the tax consequences of a rent reduction may also need to be taken into consideration, namely the possibility of a partial waiver of property tax. From a basic tax point of view, the main cases of application of a partial remission within the meaning of Section 33 of the Real Estate Tax Act in the case of leased commercial real estate are either vacancy or insolvency of the tenant. The landlord must not be allowed to justify the reduction in income as the basis for the partial remission, i.e. it must be based on circumstances beyond his control. In the literature, the loss of harvest due to natural events such as floods, drought, hail, etc. was considered as a non-justifiable circumstance in the case of an agricultural and forestry business as an example. A pandemic and its impact on commercial users could be treated in the same way, although no decisions exist on this yet. If there is a loss of income to be taken into account, partial remission will only be granted if the reduction or loss of rent exceeds 50% of the originally agreed rent. This refers to a calendar year. In individual sector-related cases for single tenants, for example in the hotel, gastronomy or retail sectors, as well as in shopping centers, it may therefore be possible to apply for a property tax waiver with prospects of success.

KPMG LAW and the experts at KPMG AG Wirtschaftsprüfungsgesellschaft will be happy to assist you with

• the assessment and determination of whether the constituent elements of Section 313 of the German Civil Code (Bürgerliches Gesetzbuch – BGB) are present and thus whether a claim for adjustment of the contract can be considered, in particular in obtaining the information required for this purpose by making specific inquiries of the tenant and/or conducting its own investigation of the tenant’s financial and other business situation,
• the negotiations on an adjustment of the lease agreement,
• the preparation of an addendum to the lease agreement as a result of the negotiations, and
• reviewing the tax implications of any lease adjustments.