Proposed German Legislation Would Clarify Termination Rights for Long-Term Lease Agreements

Real estate investors, tenants and financing banks in Germany have long faced legal uncertainty related to the risk of premature termination of long-term lease agreements due to alleged written form defects. On 20 December 2019, the German Upper House (Bundesrat) released a draft legislative proposal regarding a complete revision of termination rights in case of written form defects. If finalized, this proposal would bring much-needed clarity to the scope of termination rights in relation to written form defects.

Background

Long-term commercial lease agreements in Germany must be concluded in written form in order to provide for a fixed term of more than one year. The German courts have developed a very strict interpretation of this written form requirement. If the parties violate this requirement, the lease agreement can be terminated by either party with a notice period of six months. The earliest that notice may be given is one year after the start of the lease term.

The objective of this scheme was to protect the purchaser of the property, which automatically assumes all rights and obligations under the lease agreement by operation of law upon acquisition of the property. The purchaser therefore should have the ability to evaluate the scope of the assumed rights and obligations by reviewing the written lease agreement.

In order to comply with the written form requirement, all essential contractual provisions must be recorded in writing as part of the lease agreement or by clear reference in the lease agreement. However, the exact scope of this requirement is not clearly defined in German case law. In practice, there is a significant risk that material provisions may be omitted from the form, either when the lease agreement is concluded or in the event of any later amendments. For example, provisions may be omitted in the case of verbal arrangements or email communication between landlord and tenant.

Premature termination often has substantial commercial consequences for a party. For example, it can affect property financing for the landlord or cause business interruptions for the tenant.

Draft Legislative Proposal

The German Upper House draft legislative proposal includes the following new regulations:

• Only the purchaser of a property (i.e., the landlord) may terminate the lease agreement in case of written form defects. The new regulation will apply to existing and newly concluded lease agreements.
• The right to terminate the lease agreement because of a written form defect can only be exercised within a period of three months after becoming aware of the written form defect.
• The tenant has the right to object to the termination within two weeks following receipt of the notice of termination. In this case, the tenant must agree to continue the agreement only in accordance with the terms that comply with the written form requirement. In other words, the tenant must waive the non-written parts of the agreement for the future.
• A termination due to violations of the written form requirement after the respective acquisition is excluded.

Outlook and Assessment

These proposed changes are welcome. The draft legislative proposal is in line with the main purpose of the written form requirement, i.e., the protection of the purchaser of the property. If finalized, this proposal will result in a considerable gain in legal certainty for real estate investors and long-term tenants.

Certain portions of the legislative proposal would benefit from some refinement, however. There is a particular need for clarification regarding the tenant’s right to request continuation of the lease agreement after the tenant has objected to the termination. The draft proposes that all parts of the agreement that do not comply with the written form requirement must be waived, and that only those conditions that have been agreed in written form will apply. It remains unclear how this provision would work in case of incomplete or unclear provisions that resulted in the written form defect. In such cases, it would not be practicable to waive the parts of the agreement that violated the written form.

If this legislative proposal is finalized, the previous regulations would remain in force for terminations of lease agreements that occur before the new law goes into effect. The written form requirement itself remains unchanged and must be observed to avoid the possibility of termination in the event of the sale of the property. Therefore, careful preparation of the lease agreement and all amendments remains important. Should the draft law come into force in its current form, purchasers should also keep in mind the three-month period and use it to check for written form defects.

The draft law will now be submitted to the German Bundestag. We will closely monitor and report on the progress of the legislative process in the following months.