Squaring the circle – a balanced protection for tenants and purchasers

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Martin Butzmann
Rotthege Wassermann, Düsseldorf
m.butzmann@rotthege.com

Tenant protection v purchaser protection

Most if not all legal systems aim to protect tenants from negative repercussions in the sale of a premises. At the same time there is an acknowledged need to protect purchasers from undisclosed lease agreements. Balancing this conflict of interests poses a major challenge in many jurisdictions. In some legal systems, only publicly registered agreements, agreements with usual content or agreements entered in a certain form or for a certain time are binding for the purchaser. Others grant termination rights for either the purchaser or the tenant. However, to our knowledge no comprehensive comparative law study has been carried out regarding this topic.

Written form according to the German Civil Code

In Germany the purchaser becomes party to the lease agreement instead of the seller where the seller was the lessor.

Lease agreements do not need to be entered in written form. But the term of a lease agreement not entered in written form is indefinite according to section 550 of the German Civil Code (GCC). This rule is not subject to the disposition of the parties.

An indefinite lease agreement can be terminated with the statutory periods of notice. The provision historically aims to protect purchasers from agreements unknown to them. However, the rule also applies for the original parties.

According to the German Federal Court of Justice, written form requires all the essential information to be in writing.^[1] If the lease agreement consists of separate documents or agreements (including attachments) these must either all be physically linked or must have an intellectual context by referring to each other.

Abuse of the rule

In practice, it has become a veritable ‘trend’ to terminate unpleasant lease agreements with reference to a lack of written form. This especially applies to commercial lease agreements since residential tenants are protected by special provisions even in indefinite lease agreements.

For the terminating party this is a welcome and easy way out of the lease agreement. In view of the unclear legal situation terminating parties are willing to take the risk of being sued afterwards. Especially for a tenant the (financial) benefit of terminating the unpleasant agreement and simply vacating the rental space is mostly deemed higher than continuing the agreement. For the other party those terminations bear high risks concerning investments in the lease property, especially if the remaining term is long. Tenants will lose their operating site. Lessors will have costs filling vacancies. They must also expect banks to withdraw credit from them.

Amendment proposal

The abuse of section 550 of the GCC has led to massive criticism among academics and practitioners for years. Now, a bill to amend the legal consequences of a lack of written form is in the process of being submitted to the Bundestag.^[2]

According to the bill only the purchaser of the rental property shall have the right to terminate the agreement. The lack of written form must result from an agreement before the acquisition of the property. Also, the purchaser must terminate the agreement within three months of obtaining knowledge of the agreement lacking written form. The termination shall become ineffective if the tenant objects to it within two weeks and agrees to continue the lease contract without the agreements lacking written form.

On coming into effect, the new rule shall apply to all lease agreements that have not yet been terminated regarding the lack of written form.

Evaluation

At first sight the amendment promises to be a balanced and reasonable solution for the practiced abuse of the requirement of written form.

Right of termination for purchaser

By reserving the right of termination for the purchaser and limiting it to pre-purchase agreements the rule fulfils its original purpose of protecting the purchaser from agreements unknown to them. At the same time, the deadline of three months for termination after obtaining knowledge provides a certain legal security for the tenant. The tenant themselves may notify the purchaser of such agreements.

From a purchaser’s point of view, it would be desirable to clarify that the deadline begins at the earliest with the purchaser becoming owner of the property. A tenant could otherwise possibly claim that the deadline has already ended after economic transfer but before transfer of ownership.

Tenant’s right of objection

However, the tenant’s right of objection creates several problems. First, if the tenant objects to the termination there must be a way to define the terms of the continuance of the lease agreement. A solution could be to implement the obligation to enter an addendum to the lease contract. The addendum should name all those agreements fulfilling written form.

Second, in many cases it will not be practically possible to continue the lease contract without the agreements lacking written form. If the rental object is not defined or it is unclear who really is party to the contract, this is a lack of written form. How can the contract be continued with these agreements when there is only the original contract without amendments? If the contract was transferred five years ago via amendment and the transfer amendment does not fulfil written form, would the previous party enter back into the contract? If the rental space has been changed via amendment not fulfilling written form, will the rental space now be the original one even if this rental space has been rented by another tenant in the meantime? These examples show that the tenant’s right of objection and the consequence of its exercise are not a viable solution.

Solution

The tenant’s right of objection should be removed. This way the purchaser is protected according to the original aim of section 550 of the GCC. There is also no disadvantage for the purchaser when selling the property since the termination right will again apply for the new purchaser.

The tenant is sufficiently protected by the three-month termination deadline. It must not be forgotten that the lack of written form results from agreements that both parties have reached by mutual consent while not paying attention to the requirements of written form.

When addressing the outlined conflict, one should bear in mind not to overthrow the main concepts of the respective legal system. A comprehensive change in the legal framework might not have the desired effect but lead to even more uncertainty.