Introduction
Case law up to 31 December 2020
New legislation
Impact of new legislation
Implications for franchise industry in particular
Comment
The effects of the COVID-19 pandemic are still omnipresent in Germany. The courts have yet to resolve some legal issues, including the issue of payment of commercial rent. One example is whether franchisees and franchisors as tenants can reduce or even suspend their rent payments due to widespread government-ordered shutdowns. More than 20 court decisions have been handed down on this subject, and the opinions expressed vary widely. Even the German law that entered into effect on 31 December 2020 via an expedited legislative procedure does not provide final, generally applicable clarity on this issue. This article presents a brief summary of the current situation and sets out the implications for the franchise industry in particular.(1)
Case law up to 31 December 2020
Government-ordered shutdowns do not constitute defect in leased premises
The Munich Regional Court I was the first court to rule that the widespread government-ordered shutdowns in response to the COVID-19 pandemic constituted a defect in leased premises which entitled tenants to reduce their rent payments (22 September 2020, Case 3 O 4495/20). A few courts initially followed this opinion, including the Pinneberg Regional Court (17 November 2020, Case 81 C 18/20) and the Kempten Regional Court (7 December 2020, Case 23 O 753/20).
However, most courts by far reject the opinion that the shutdowns constitute a defect in leased premises (see, for example, Mannheim Regional Court, 23 July 2020, Case O 22/20, BeckRS 2020, 26351; Heidelberg Regional Court, 30 July 2020, Case 5 O 66/20, BeckRS 2020, 19165; and Frankfurt am Main Regional Court, 7 August 2020, Case 2-5 O 160/20, BeckRS 2020, 20149).
The courts' reasoning for this is that a government-ordered shutdown is a circumstance outside the scope of a rental contract which does not directly affect or alter the leased premises (similar to the prevention or restriction of use under public law) that, in principle, does not constitute a defect. The courts stated that the only exception would be if circumstances affecting the leased premises were directly caused by the specific characteristics, condition or location of the leased premises as set out in the contract. According to the courts, this is not the case with government-ordered shutdowns or other restrictions because these measures serve to protect the public from general health risks and are unrelated to the specific characteristics of any leased premises.
Lease amendment due to frustration of contract?
Most of the courts believe that amending a lease to reduce the rent would be possible only, if at all, according to the law on contract frustration (Section 313 of the Civil Code). So, in their opinion, a lease can be amended only if the fundamental facts on which the contract (lease) was based have subsequently and unexpectedly changed due to a government-ordered shutdown in response to the COVID-19 pandemic.
The initial discussion in this respect centred on whether the rules that apply to contract frustration can be applied to the government-ordered shutdowns in response to the COVID-19 pandemic. Some courts have assumed that the laws passed so far in connection with the COVID-19 pandemic (particularly Article 240, Section 1(4), Number 1, Section 2 of the Introductory Law to the Civil Code) make it impossible to apply provisions on contract frustration to such cases (see, for example, Regional Court Munich II, 6 October 2020, Case 13 O 2044/20). According to these courts, the new provisions stipulate that a tenant's obligation to pay rent is not suspended during the shutdowns or use restrictions (Article 240, Section 1(4), Number 1 of the Introductory Law to the Civil Code). Rather, if a tenant cannot meet its obligation to pay rent, the landlord is only prevented from terminating the lease (Section 2 of the Introductory Law to the Civil Code).
Most courts have rejected subsequent amendments of leases according to the rules of contract frustration (see, for example, Mannheim Regional Court, 23 July 2020, Case O 22/20, BeckRS 2020, 26351 and Heidelberg Regional Court, 30 July 2020, Case 5 O 66/20, BeckRS 2020, 19165).
The reason given is that, taking into consideration all of the circumstances on a case-by-case basis – particularly the contractual or statutory risk distribution – tenants can be reasonably expected to continue to adhere to the contractually fixed (full) lease. The courts believe that, in a lease, the tenant basically bears the risk of all operational circumstances (in particular, the risk of exercising its right to use the rented premises), while the landlord is subject to an obligation to grant use. While the parties can contractually change this risk distribution or stipulate that the landlord assumes all or part of the tenant's use risk, the courts have observed that most leases do not contain such a clause. Finally, they have determined that the COVID-19 pandemic cannot be seen as grounds for a general reversal of risk distribution (see, for example, Mannheim Regional Court, 23 July 2020, Case 23O 22/20, BeckRS 2020, 26351).
On 31 December 2020 new legislation on commercial rent entered into effect which assumes that a government-ordered shutdown or restriction of use of leased premises constitutes a serious change in circumstances within the meaning of the contract frustration rule (Section 313 Abs 1 of the Civil Code in conjunction with Article 240, Section 7 of the Introductory Law to the Civil Code). The new regulation makes it clear that the shutdowns or other governmental restrictions basically constitute contract frustration. However, the legislature did not answer the key question of whether and for what amount and for the benefit of which party (ie, tenant or landlord) the lease is to be amended. Hence, the legislature left the question open to further debate by the courts.
More court decisions have been handed down since 31 December 2020 (eg, Munich I Regional Court, 25 January 2021, Case 31 O 7743/20; Munich II Regional Court, 28 January 2021, Case O 2773/20; and Munich I Regional Court, 12 February 2021, Case 31 O 11516/20, BeckRS 2021, 1762). In all of these decisions, the courts assumed that the situation corresponds to contract frustration, but rejected the amendment of the lease in favour of the tenant, with the result that the cost risk is borne in full by the tenant.
A Munich I Regional Court decision (12 February 2021, Case 31 O 11516/20) received significant attention in the German media, not only because the value of the matter was more than €1 million, but also because the case concerned a lease for premises in which a well-known German fashion chain operated a retail shop.(2) The tenant had not paid any rent for April 2020. The national and regional COVID-19 regulations applicable at the time included a shutdown of retail shops. According to the court, the landlord was nonetheless entitled to payment of the full rent for April 2020.
The Munich I Regional Court first rejected the assumption of the existence of a defect in the leased premises. It found that the shutdowns due to the COVID-19 pandemic were the result of neither the condition nor the characteristics of the leased premises in dispute. The court stated that they were caused solely by the risk of employees and customers contributing to the further spread of COVID-19. In the next step, the court found that there had been a frustration of contract due to the government-ordered shutdown in response to the pandemic. However, the court excluded an amendment to the lease in this particular case. The court stated that the sales figures and financial report submitted by the tenant did not justify a rent reduction. Conversely, the results from the previous three financial years showed that it would have been reasonable to expect the tenant to create reserves equal to one month's rent.
The decision is not yet final.
Two further recent decisions by German higher courts illustrate that the differences of opinion among the courts continue unresolvedly and that a ruling by the German Federal Court is awaited. Both decisions are dated 24 February 2021 and were heavily reported on in the German media. The claimant in both decisions was a well-known German textile and fashion retailer which operates retail outlets in many German cities and refused to pay rent in April 2020 due to the government shutdown.
Whereas the Dresden Higher Regional Court ruled that the rent should be reduced by 50% for the months during which a government shutdown was in place and shops were hence closed to the public (24 February 2021, Case 5 U 1782/20), the Karlsruhe Higher Regional Court assumed that an adjustment could be considered only in the event of a threat to the company's economic existence (24 February 2021, Case 7 U 109/20). However, such an economic threat was not given in regard to the claimant (ie, the fashion retailer).
Implications for franchise industry in particular
As many of the business sectors affected by the COVID-19 pandemic are structured as franchises (eg, food, retail and consumer services), franchises have been hit particularly hard by the ongoing restrictions. Also, both franchisors and franchisees may act as tenants of commercial premises and, as such, bear the risk of use towards the landlord. In addition, franchisors and franchisees may be equally affected as tenant and landlord. The entire franchise community is therefore looking at the decisions of the higher regional courts and is eagerly awaiting a clarifying ruling from the Federal Court of Justice.
It remains to be seen what position higher-instance courts (ie, the higher regional courts and the Federal Court of Justice) will take on this issue. It is good to see that the legislature has passed a law requiring that courts expedite proceedings on claims to payment of rent for commercial premises relating to government-ordered measures to combat the COVID-19 pandemic (Section 44 of the Introductory Law to the Code of Civil Procedure). However, due to the continuing lack of legal certainty, in practice, tenants and landlords in dispute are advised to direct their efforts to reaching a settlement from the beginning.
For further information on this topic please contact Karsten Metzlaff or Jasmin Schulzweida at Noerr LLP's Hamburg office by telephone (+49 40 300 3970) or email ([email protected] or [email protected]). Alternatively, contact Tom Billing at Noerr LLP's Berlin office by telephone (+49 30 20 94 20 00) or email ([email protected]). The Noerr LLP website can be accessed at www.noerr.com.
Endnotes
(1) This article examines the impact of the COVID-19 pandemic on commercial rent. For further information on how the pandemic has affected the franchise industry, please see "What legal impact has the COVID-19 pandemic had on the franchise sector so far?".
(2) Further information is available here.
