Commercial Lease Law: Dispute about Rent Payments in Times of Corona
A glance at the legal history and the legal concept of "major business basis" - risk distribution, between lessee and lessor
1. Initial situation
In response to the corona crisis, all German state governments took measures to slow down the spread of the new corona virus, mainly in March 2020 on the basis of the Infection Protection Act. In Berlin, for instance, numerous regulations were put into force by the legislator for this reason from mid-March 2020. The Regulation on Measures Required to Contain the Spread of the Coronavirus SARS-CoV-2 (SARS-CoV-2 EindmaßnV), section 3a (1) of the Berlin Regulation, issued on 22 March 2020 and amended several times, ordered the closure of all "outlets/points of sale within the meaning of the Berlin Shop Opening Act of 14 November 2006" and in particular excludes the retail trade for beverages and food in (2) thereof. Since mid-March 2020 therefore, among other things, all retail outlets had to close unless they were covered by the exemption. In the meantime, the rules have been relaxed although distances must be kept, allowing for fewer customers, and wearing mouth-nose protection is mandatory.
Due to the official closure order of shops, some well-known major lessees of business premises in Germany have publicly announced to suspend the payment of all or part of the rent for the closed shops (Immobilienzeitung of 16 April 2020, p. 15 "The majority of chain stores suspend rent"). The legal concept of the discontinuation of the basis of business, which has been codified in section 313 German Civil Code (BGB) since 2002, is now regularly discussed with regard to the impact of the corona crisis on contracts between enterprises. In the announcement of the rent payment freeze, too, the discontinuation of the business basis was stated as an argument in addition to force majeure.
2. Risk distribution to date
Upon the verification of rights arising under the legal principle of discontinuation of the business basis, it is asked whether a circumstance has become a business basis and whether insofar a serious change did occur which justifies an adjustment of the contract. A change is serious if, at least, one party had not concluded this contract or had not concluded the contract with such contents if it had been aware of the change. If only a risk is realised which has to be borne by one party, then the application of section 313 BGB is excluded. This can be the case in the event of a contractual assumption of risk or in the event of a normative risk allocation.
As a rule, the risk of usability of the purchased objects rests with the purchaser. The lessee of business premises regularly bears the operating risk. This is often even deemed to be explicit if - which is not unusual - the entrepreneurial lessee is obliged to take out and maintain business shutdown insurance, which is intended to cover the loss of turnover resulting from officially ordered business shutdown and the associated risk of no longer being able to pay the rent (Note: business interruption insurance in a dispute, it presupposes material damage as the trigger for the business interruption, business closure insurance as a special form is required; Link).
When applying the "small" business basis, which involves the circumstances affecting the respective, that is, singular contract, previous case law has regularly considered the business risk to be borne solely by the commercial lessee.
Thus, for instance, the commercial lessee has to bear the risk of vacancies around him, relocation of roads, incorrect turnover expectations and also the risk of official orders which have an effect on the rented object. Case law does not give the commercial lessee the right of reduction and, at present, the commercial lessee is also not entitled to adjustment due to disruption of the business basis. Only a termination of the lease could be considered in the event of impossibility to let.
In principle, rights based on discontinuation of the business basis only exist if the unchanged performance of the contract is unreasonable and unacceptable for the other party. According to a common phrase of case law unreasonableness is given if adherence to the contract would ensue intolerable results which cannot be reconciled with the idea of justice and law. This requires a comprehensive weighing of interests taking into account all circumstances, also advantages accruing to a party besides the disadvantages.
3. Suitability of the previous legal institute and historically equivalent concepts
The question is whether the concept of the "small transaction basis" is appropriate to find legal consequences reasonable in the corona crisis for a great number of contracts between commercial lessors and lessees. If the parties had known that the corona crisis was coming and with it numerous (lasting for how long?) official shop and business closures, what would the parties have agreed? This question can hardly be answered. Questions of general distress and hardship can hardly be answered properly by merely referring to civil law and current case law on the "small business basis". In view of the rapid development of the corona virus and the constantly new counter-measures of the legislator and the authorities and their unforeseeable duration, cascade effects may occur even at short notice which are interrupting supply chains, triggering off a great number of insolvencies and incurring viability problems for the banks.
Therefore, the concept of the "major business basis" comes into consideration. This means the expectation that the fundamental political, economic and social basic conditions of the contract will not be changed by revolution, war, expulsion, hyperinflation or a (natural) catastrophe and that the social existence and livelihood will not be shattered.
However, such a natural catastrophe might be given with the corona crisis. The global spread of COVID-19 was declared a pandemic on 11 March 2020 by the WHO. The German legislator has established the existence of a pandemic with the law to mitigate the consequences of the COVID-19 pandemic which was passed on 27 March 2020. The official measures, such as the closure of shops and businesses, serve to avert the threat of pandemic risks.
What applies in the event of a frustration of the "major business basis"? Primarily, the law applies. In the post-war period the contract assistance law was enacted for the protection of debtors and for the avoidance of corporate collapses. Today, the Law on the Mitigation of the Consequences of the COVID-19-Pandemic applies. The suspension of rental payments without replacement cannot be justified by this Law, since, presently, it allows only the temporary deferral of rental payments (Article 240, section 2 Introductory Law to German Civil Code (EGBGB); moratorium).
Thus, the "major business basis" becomes relevant. In the post-war period the courts had chosen a rather pragmatic approach for the settlement of legal disputes and, in so doing, had taken the circumstance into account that the risk of the occurrence of such events cannot be attributed to none of the parties. According to a ruling of the Federal Court of Justice (BGH) of 26 February 1957, the landlord was not subject to a full maintenance obligation in the event of exorbitant war damage. According to a ruling of the Hamburg Higher Regional Court (OLG) of 24 June 1947, each party had to bear half of the damages caused by a destruction of leased premises by an air raid although the lessee had to bear the risk of the loss of the object by contract. These examples of case law show one way of dealing with the question of commercial rentl payments in case of officially ordered closures of shops and businesses due to the COVID-19 pandemic:
If there are no special circumstances advocating a transfer of the risk to one party, the risk will, in principle, be shared.
In other words, risk means having to pay the full amount of rent and bear the costs incurred for the leased object, even though there is no or only a reduced usage advantage due to opening and sales bans.
4. Considerations on risk distribution
The following considerations can be made on the question of the ratio in which risk should be distributed:
4.1 Scope of the limitation of use
First of all, the percentage of the limitation of use of the leased premises must be determined. If the activity of the lessee agreed in the lease agreement is not possible at all (e.g. currently still fitness salon, tanning lounges, wellness facilities), the limitation of use affects the full consideration in terms of value, i.e. the entire rent. If the leased spaces are only partially usable, for example in a restaurant the guest rooms are covered by the prohibition but an off-premises sale is possible, the first step is to establish the proportion of the reduction in use or the corresponding proportion of the rent. In doing so, one could refer to a comparison of turnover, for example the last three months before the period of restriction or the same period of the previous year.
Although the turnover is certainly also based on individual and special circumstances (weather in the catering trade with a large open-air area), a certain general approach is probably unavoidable.
If turnover in commercial premises has dropped to zero, a review should be carried out to see whether there was another opportunity for turnover which was not taken into account (e.g. zero turnover for off-premises sales).
The burden of proof could then be placed on the lessee as to why no turnover was generated (e.g. in a three-star gourmet restaurant, an off-premises sale is generally not possible because the quality of the prepared menus does not allow delayed or remote consumption).
It should be noted that only limitations of use caused by official regulations are taken into account in the distribution of risk. A special topic is for example if revenues are reduced despite the lifting of restrictive measures. However, this has not yet occurred because - as far as can be observed - no area will remain without restrictions for an unforeseeable period of time due to existing distance rules and obligations to protect the mouth and nose. After relaxation, therefore, different times and scopes of limitations of use must be ascertained.
4.2 Leasing obligation to be compared
Once the magnitude of the risk has been established this way, the question arises as to which parts of the rent are to be included, merely the so-called basic rent or also the ancillary costs. However, since ancillary costs incurred by the lessee for the leased premises are also included in the rent (Palandt-Weidenkaff, section 535 BGB marginal 72), these are also included. If the ancillary costs include consumption-related costs, such costs are likely to be lower than usual in the case of limited use, which in turn benefits the lessee.
4.3 Risk distribution
In the absence of special circumstances, the distribution of risk can be as follows:
Half of the percentual limitation of use, measured in terms of loss of turnover, leads to a corresponding reduction in rent. Hence, if there is a 100 percent limitation of use, this leads to a 50 percent reduction in rent. A 60 percent limitation of use would lead to a 30 percent reduction in rent.
4.4 Special circumstances
When determining the distribution of risk, it must also be ascertained whether there are any of the above-mentioned special circumstances that influence the economic risk on one side or the other.
4.5 COVID Mitigation Act
The above-mentioned law to mitigate the consequences of the COVID-19 pandemic cannot be such a circumstance, for example at the expense of the lessee. Although it contains in Article 3 section 1 as new Article 240 section 2 of the Introductory Law to the German Civil Code - EGBGB - "contractual provisions in the event of the COVID-19 pandemic", also as an intervention in rental and lease agreements, section 2 merely contains a prohibition of termination in the event of non-payment of rent for the period 1 April to 30 June 2020. However, the provision does not remove the leasing obligation and does not affect its maturity, so that even default interest is additionally incurred. And in fact it must be fulfilled by 30 June 2020 because then the prohibition of termination expires (Article 240 section 2 (4) EGBGB).
4.6 State aid
In addition, attention should be drawn to state support, such as the "Corona emergency aid", a subsidy programme of the Federal Government and the Federal States, which, for instance, supports micro-enterprises, self-employed persons and freelancers with up to five or more employees ten full-time employees respectively "to overcome an economic situation that threatens their existence", calculated according to the "verifiable liquidity shortage of the applicant for the next three months" (Investitionsbank Berlin, Link) with up to EUR 5,000 (state funds) and EUR 9,000 for up to 5 employees or 15,000 for up to 10 employees (federal funds). In this context, it is stipulated that the federal funds are to be used exclusively for operating costs such as rent (Investitionsbank Berlin, op. cit. /FAQ corona emergency aid (rescue aid and subsidy)).
Moreover, with regard to the state funds, removal of the liquidity shortage probably means being placed in a position to use the aid to settle liabilities that cannot be met out of operating funds, including rental obligations (e.g. when determining the liquidity shortage, an estimate of income for the next three months must be compared with the current material and financial expenditure for this period, whereas under costs/payments there is an explicit item rent and lease payments for commercially used premises and, remarkably, there is talk of a possible rent reduction which, if it reaches at least 20 per cent, can even be set for five months, Investitionsbank Berlin, loc. cit.). It should be pointed out that in this respect too, among other things, "insurance benefits due from insurance against business interruption or loss of business, etc., must be given priority and taken into account when calculating the liquidity shortage" (Investitionsbank Berlin, loc. cit.).
If such support has been granted, it may be assumed that it was sufficient to eliminate the liquidity shortage, i.e. also to settle the leasing obligation for the business premises. In this case, a special circumstance would then have led to the fact that the risk of the leasing charge, which in principle is to be shared by way of the major business basis, is not to be shared here but rather affects the lessee. Should the lessee argue that the assistance was sufficient to fulfil the leasing obligation, the burden of proof ought to lie with the lessee who submits his business documents to prove that and why the assistance was not sufficient to put the lessee in a position to fulfil the leasing obligation during the limitation period.
In the foreseeable large number of disputes in the corona crisis between lessees suffering economic losses and their lessors on the question of whether and to what extent the crisis will affect leasing obligations, the concept of the large business basis can be a useful compensatory point to start from. In the practical application, some effort in identifying circumstances cannot be avoided which sometimes affects the lessee to a larger extent. Nevertheless, this is not unreasonable as it is a matter of tying the extent of the lessee's losses to the extent of the distribution of the risk of its leasing Obligation.
Dr Thomas Jilg
Lawyer, Notary - registered office Berlin