Article

Envisaged amendments to Section 550 BGB

Check Mate for the “Termination due to violation of the written form”?  

The German Bundesrat is attempting to put a stop to the improper invocation of the lack of written form by amending the law. The amendment could contribute to eliminating existing legal and planning uncertainties.

Recently, the Federal Government has received a legislative initiative from the Bundesrat, the upper house of the German parliament, according to which the written form requirement of § 550 BGB or the right of termination of the contractual parties resulting from a violation of the written form requirement is to be reduced to its original purpose - the protection of the purchaser of a leased property. If the Bundestag were to pass a corresponding law, this would mean that in the future only the purchaser of a property would be able to invoke a written form violation - and only for a limited period of time. Attempts to walk away from agreed terms by claiming an alleged violation of the written form requirement would be stopped.

The purchaser of a leased property has a legitimate interest in knowing the content of the rental agreements that on the basis of the provision of § 566 BGB - "Purchase does not break rent" - he becomes a party to at the time of the transfer of ownership in lieu of the selling lessor. The provisions of the rental contract, in particular the agreed fixed term, are often decisive for the purchaser's decision to acquire the property. For this reason, more or less extensive due diligence checks are usually conducted prior to the acquisition of rented properties in order to uncover any risks with regard to existing rental agreements as a key asset. In the case of commercial leased properties, considerable importance is attached to determining the WA(U)LT (Weighted Average (Unexpired) Lease Term), i.e. the average remaining term of the lease contracts as a significant KPI.

But how often does it happen that a lease agreement submitted by the seller in the course of due diligence or in the course of sales negotiations is incomplete or that an amendment has taken place in the meantime which has not been properly documented? Experience shows that this affects a large number of lease relationships per transaction. However, provisions in the lease agreement unknown to the purchaser, e.g. subsequently agreed construction obligations of the landlord, rent reductions, etc., may have significant financial consequences for the purchaser.

This, i.e. protecting the purchaser from unpleasant surprises, was originally the purpose of the written form requirement in § 550 BGB, the non-compliance with which gives the purchaser a special right of termination.

Over time, however, the written form requirement developed more and more into a provision which - independent of any specific transaction - led to considerable legal uncertainty. This was and still is due to the fact that the case law requirements regarding compliance with the written form requirement were and are very high and the willingness of contractual parties to take (alleged) violations as a reason for an early withdrawal from agreed terms has steadily increased over time - at least in the opinion of many market participants. In practice, the provision of § 550 BGB has increasingly been used by landlords and tenants to terminate "unwelcome" longer-term lease agreements by giving notice. Since, according to the highest court rulings, subsequent amendments that had not been made in writing or had not been made the subject of the "uniform deed" were in many cases sufficient for a violation of the written form requirement, the search for a reason for termination often led to success.

Even the "healing clauses" developed in practice could no longer cope with the accompanying legal uncertainty due to the opinion taken by the Bundesgerichtshof in that regard.

The German Bundesrat (the representation of the Federal States at national level) has now taken this as an opportunity to introduce a legislative initiative aimed at eliminating the existing legal uncertainty and limiting the legal consequences of a breach of the written form requirement.

 

1 The written form requirement

According to the written form requirement regulated in §§ 550, 126 BGB, for a rental agreement with a term of more than one year, all elements essential to the contract must be recorded in writing. By reference to § 578 BGB, the written form requirement applies not only to residential property but also to commercial tenancies.

Failure to comply with the written form requirement results in any fixed term agreed in the rental contract not being valid, instead the rental contract is deemed to have been concluded for an indefinite period of time and the rental relationship can be terminated by either party to the contract observing the statutory notice periods, provided such termination is not contrary to good faith. In all other respects, the contract which is not in conformity with the formal requirements remains fully effective, even if the parties did not want a contract for an indefinite period of time and would not have concluded such a contract. Non-conforming commercial lease agreements can be terminated with a notice period of six months to the end of the respective quarter. The legal consequences mentioned above occur regardless of whether a change in ownership and/or the persons of the parties involved in the rental relationship has occurred.

This legal consequence, which is expressly prescribed by law, can have consequences that are pleasant or unpleasant for both parties, depending on the market situation and interests. For example, the tenant of a retail property that is no longer profitable may, by citing the lack of form, release himself from his obligations long before the end of the originally agreed term - which was the basis for the landlord's profitability calculations. A landlord might be inclined to terminate a lease before the end of the agreed term in order to achieve a higher rent when re-letting. This, of course, under the condition that in the above-mentioned cases the contractual partner cannot prove the unfaithfulness of the termination or is not willing to have it established in court.

For various reasons, the written form requirement is of only limited significance for residential tenancies. For example, the limitation of tenancies for residential space is subject to the strict requirements of § 575 BGB anyway and termination by the landlord is only possible in compliance with the relevant tenant protection provisions.

The situation is different for commercial tenancies. Here, fixed-term - and often long-term - tenancy agreements, often paired with renewal options in favour of the landlord or the tenant (such as a 10 years' term with renewal options of 5 years each), are the order of the day and, much more so than is the case with residential property, are the basis for investment decisions and a factor determining value.

At the same time, commercial tenancies involve a significantly higher risk of intentional or unintentional, recognised or unrecognised non-compliance with the written form requirement. This is because, according to the jurisdiction of the Bundesgerichtshof, the written form requirement is not only about the fact that the lease agreement must be signed by both parties. It must also comply with the requirements for uniformity of the contractual document, the "uniform deed" requirement. This means that attachments - such as the floor plan of the rental property - must also either be incorporated into the text of the contract or firmly attached to the contract as a whole. The same applies to amendments, supplementary agreements, modified annexes, etc. Not only in the case of the establishment of new tenancies, especially with regard to newly constructed or newly erected rental space or rental space to be provided with conversions or installations, there is a considerable risk involved.

This has led and continues to lead to considerable legal uncertainty and often to an - in the opinion of market participants - abusive use of the right of termination originally granted by the legislator for other purposes.

 

2. Invalidity of clauses on the "healing" of written form

Since the written form requirement is mandatory, i.e. cannot be effectively waived by the parties to the contract, contractual practice has in the past attempted to remedy this by means of so-called "written form cure-all clauses". In summary, these are contractual provisions according to which the parties undertake to cure any defects of form and/or to not terminate the lease agreement due to a breach of the written form requirement. However, in its landmark decision of 27 September 2017, the Federal Court of Justice (BGH ruling, 27.09.2017 - VII ZR 114/16) declared such written form healing clauses to be inadmissible, as they are inconsistent with § 550 BGB.

 

3. Reform efforts

In view of the legal uncertainty brought about by the provision of § 550 of the Civil Code, it is hardly surprising that repeated calls were made to the legislature.

Now the German Bundesrat has made the issue the subject of a legislative initiative, which aims to soften the requirement of the written form and the special right of termination and to reduce it back to its original purpose - the protection of the purchaser of a leased property.

To this end, the state of North Rhine-Westphalia submitted a bill to the Bundesrat in September 2019, according to which the right of termination based on a violation of the written form requirement would only be available to purchasers of leased property, i.e. it would only apply following transactions.

According to the bill, the new regulation should only apply to residential and commercial leases concluded after the law has come into force. Moreover, the termination shall only be possible within three months after the acquirer becomes aware of the agreement reached without observing the required written form. In addition, the draft also provides for a further restriction of the right to terminate residential rental agreements. Finally, the tenant should be able to prevent termination by agreeing to continue the lease agreement under the conditions agreed in writing.

The reform aims to create more legal certainty for the parties involved in the tenancy and to prevent abuse of the right of termination due to a lack of written form.

The Central Real Estate Committee (ZIA) e.V. - as one of the most important interest groups in the real estate industry - has announced that it expressly supports the legislative initiative. According to its position paper of 17 December 2019, however, the association would welcome an even more comprehensive solution - namely the (complete) abolition of the written form requirement for commercial leases. As can be seen from the explanatory memorandum of the bill, the State of North Rhine-Westphalia had also considered this, but had then come to the conclusion that an abolition of the written form requirement in commercial tenancy law would not be compatible with the legitimate information interests of an acquirer with regard to existing tenancies.

On 20 December 2019, the Bundesrat decided to introduce the bill into the Bundestag. A key change compared with the proposal submitted by the State of North Rhine-Westphalia is that, according to the draft submitted by the Bundesrat, the new rules will also apply to non-cancelled rental agreements concluded prior to the law coming into force.

Pursuant to Art. 76 (3) of the German Constitution (Grundgesetz), the Federal Government must now first comment on the Bundesrat's draft bill. Such a statement is expected in the coming weeks. After that, the Bundestag will have to deal with the draft law.

The legislative initiative of the Bundesrat appears to be welcome, as it is suitable to put a stop to the "undesirable developments" not intended by the legislator, to help the agreements made by the parties to take effect, and to enable the parties to stick to their statements and thus contribute to legal certainty without disregarding the legitimate interests of a potential purchaser in sufficient and reliable information on existing rental agreements.

It remains to be seen how the legislative process will proceed - we will keep you informed of further developments.

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