Germany: Is The Reliance On Long-Term Lease Agreements In Germany Built On Sand?

In recent years foreign investment in real estate in Germany has steadily increased. In 2006 about 50 billion Euros were invested in supermarkets, office buildings or other commercial property. This purchaser friendly environment is due to relatively low purchase prices as a result of the economic stagnation during past years. Further, it is also advantageous for investors that lease agreements are very often concluded for a fixed term of 10 or 15 years. The new owner steps – by force of law – into the rights and obligations as lessor. The lessee has no right to terminate the lease agreement upon a change of ownership. The security of a foreseeable long-term income is not only one of the reasons for the purchase but also an important asset when negotiating loan contracts or other means of financing.

However, often the expected long-term income remains theory. If the lessee looses interest in the leased property he might terminate the lease agreement prior to the expiration of the fixed term.

How is such premature termination of long-term lease agreements legally possible?

The reason is a specific provision of the German law on lease agreements, i.e. sec. 550 of the German Civil Code. Pursuant to this provision lease agreements concluded for a lease term exceeding one year require the written form. Lease contracts, not concluded in writing are not invalid, but could be terminated in compliance with the statutory termination period, provided the lease has lasted for more than one year.

At first sight, the provision seems harmless as it is common practice to conclude lease contracts on commercial property in writing. However, German statutory standards as to the written form are fairly high. They are only complied with, if certain formal requirements are met and if all essentials are explicitly specified in the contract. This enables a purchaser of a shopping mall, hotel etc. to evaluate the contents of the existing lease contract he is going to enter into by purchase.

The problem is often overlooked in due diligences as only the small number of real estate experts among German lawyers knows this peculiarity and thus, the consequences.

As described above, the essentials are to be clearly specified in the lease contract, either in the main document itself, or in the respective supplements. If the contract contains of more that one page, they must be tacked together or visibly connected by either a consecutive numbering of the provisions or of the pages, as per a uniform design, a textual coherency etc..

Attachments and supplements to the main contract are the major source of error.

As to attachments, the written form requirement is met only if all agreements are contained in one entire document. Thus it is essential that both, the main contract and the attachment are solidly combined, either physically or by clear reference.

The same standards apply to subsequently agreed supplements. If they are not physically combined, there must at least be an explicit reference to the main document. Furthermore, the supplement must clearly indicate that all previous agreed provisions, although not mentioned in the supplement, shall remain unaltered and in full effect. If only one of these requirements is not met, a long-term lease contract may from then on be terminated at any time with the statutory notice period of three to nine month.

All essentials like contractual parties, lease object, term of the contract and rent must be contained in one document in writing. If e.g. according to the contract the location of the real estate is to be set out in a site plan, the final plan must be firmly affixed to the main document. Further, terms like "the lease commences upon the transfer of the object" are found in lease contracts entered into while the object was still under construction. As the exact commencement of the lease is not fixed in the contract the purchaser is unable to clearly identify the expiration of the lease period. Thus, the legal requirements are not met and the lease agreement may be terminated with the statutory notice period.

Considering the severe consequences for the lessor, some German courts found that the statutory written form requirement is still met if e.g. the location of the lease object could visually be identified or if the date of transfer can – retrospectively – be ascertained through witnesses or other means of evidence. Other courts set high standards as to the written form requirement and herewith enable the lessor and the lessee to terminate the contract ahead of schedule.

Hence, prospective buyers are well advised to get professional advice in order to verify whether the existing lease contracts are in compliance with the written form requirements. Those who have already purchased a real estate and stepped into the rights and obligations as lessor should – in case the form requirement was not met – seek remedy.

This at first requires a thorough analysis of the existing lease agreements. If legal imperfections are discovered, joint efforts of the lessor and the lessee to solve the problem are advisable. If the lessee is interested to continue the tenancy he might be willing to find a mutual solution as the legal uncertainty is also to his detriment since he also bears the risk of a termination of the lease agreement prior to the expiration of the fixed term. In cases where the lessee obviously seems not interested to continue the tenancy, hopefully he will not discover the legal deficits.

How to cure a deficient lease agreement?

Copy the entire agreement, add missing parts and have the new document signed by both parties. This, however, does not only constitute a lot of work but makes it also necessary that both parties carefully re-read the whole agreement in order to rule out any differences between the new and the old lease agreement. Further, the lessee might make his signature subject to an amendment of certain provisions.

Therefore, it is advisable to draft a supplement to the existing lease agreement which clearly refers to the original document. Here, all essentials not complying with the written form requirement should be explicitly stipulated and also that, apart from the amendments, the original lease agreement remains in full force.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.