Negotiation

Non-binding agreements

Are non-binding preliminary agreements before the execution of a definitive agreement typical in real estate business combinations, and does this depend on the ownership structure of the target? Can such non-binding agreements be judicially enforced?

The use of preliminary agreements, such as LOIs, is standard practice in Germany and usually does not depend on the ownership structure of the target.

After reviewing the investment memorandum and before entering in-depth negotiations regarding the purchase of real estate, the potential buyer typically signs an exclusivity agreement with the seller. An estate agent often facilitates this. The exclusivity period usually lasts between four weeks and three months, at the end of which the buyer needs to make a binding offer. Although the LOI is not binding and enforceable regarding the conclusion of a purchase agreement, the parties typically aim to agree on the framework conditions of the real estate business combination.

The preliminary agreement should clearly state which provisions will be binding to avoid leaving enforceability open to court interpretation. While terms covering commercial issues are usually non-enforceable, terms regarding the confidentiality, exclusivity and duration of the preliminary agreement are enforceable.

Typical provisions

Describe some of the provisions contained in a purchase agreement that are specific to real estate business combinations. Describe any standard provisions that are contained in such agreements.

A purchase agreement must contain, at a minimum, the identity of the parties, the structure of the sale, the object of purchase and the purchase price. In relation to a real estate business combination, the target company (as the direct object of purchase) must be described precisely, as must the real estate acquired indirectly via reference to its registration in the land register. Regarding the purchase price, the payment mechanism, due date and closing conditions must be agreed upon. Frequently, a preliminary purchase price is fixed but is later adjusted as the calculation of the purchase price generally depends on the rental income of the property.

Essential provisions further include the date of transfer of possession, the deletion of encumbrances and repayment of loans secured by those encumbrances, representations and warranties (R&Ws) and remedies for breach of contract.

The standard R&Ws for the acquisition of real estate cover leases and other third-party agreements, environmental matters, litigation, payment of taxes and other public fees and charges, compliance with building permits and zoning regulations.

Stakebuilding

Are there any limitations on a buyer’s ability to gradually acquire an interest in a public company in the context of a real estate business combination? Are these limitations typically built into organisational documents or inherent in applicable state or regulatory related regimes?

There are no legal restrictions on a buyer’s ability to gradually acquire an interest in a public company in the context of a real estate business combination in Germany. Furthermore, these limitations cannot be specified in the articles of association of the company. However, there might be tax consequences if certain shareholding thresholds are exceeded (eg, if a shareholder directly or indirectly acquires 95 per cent of the shares in a company that owns real estate). In this case, real estate transfer tax will, generally, be incurred.

Certainty of closing

Describe some of the key issues that typically arise between a seller and a buyer when negotiating the purchase agreement for a real estate business combination, with an emphasis on building in certainty of closing. How are these issues typically resolved?

The parties to a purchase agreement typically agree on certain termination or rescission rights if closing conditions (eg, a certain percentage of the property is leased) are not fulfilled by a fixed longstop date. Depending on the party’s negotiating power, contractual penalties might be negotiated. If a certain matter (eg, the granting of a building permit) is key to the transaction, the parties can agree for the matter to be a condition precedent for the entire agreement.

Additionally, provisions dealing with the transfer of the companies’ properties, securities and potential warranty rights against contractors should be incorporated in the agreement. The parties may also agree on the termination of maintenance, service and employment contracts to optimise the combined businesses.

Environmental liability

Who typically bears responsibility for environmental remediation following the closing of a real estate business combination? What contractual provisions regarding environmental liability do parties usually agree?

Under the German Federal Soil Protection Act, the polluter, the current owner, the current user and all former owners and users of a property may be subject to mandatory decontamination measures by order of the relevant authorities. Should any contamination of a property render decontamination measures necessary, the relevant authorities will not necessarily charge the polluter, but look for the most financially sound party that is or has been the owner, or has been in any other way in possession of the property. The German Federal Soil Protection Act grants specific rights to any party that may be charged to recover payment from any other party whose liability for the particular contamination can be proven.

The local authorities maintain cadastres in which all available information on possible contamination of soil or ground water by existing or former use of the property or as a result of warfare is registered (the Cadastre for Contaminated Sites). These cadastres are an important source of information for any investigation prior to the acquisition of a property. If the property is not registered or no issues are referred to in the cadastre, this does not necessarily mean that the property is free from contamination. It is therefore highly advisable to undertake an environmental investigation prior to any acquisition of property.

In standard sale-and-purchase agreements, the term ‘environmental damage’ is defined to include contamination under the German Federal Soil Protection Act, and also, for example, hazardous materials in the building, warfare agents and waste. In the market-standard provision, the seller states that it is not aware of any contamination and that the buyer will indemnify the seller in case authorities should request decontamination measures from the seller in the future, unless the seller is responsible for the environmental damage. If there is any suspicion of environmental damage, environmental experts should investigate the matter further so the parties are able to agree on liabilities.

Other typical liability issues

What other liability issues are typically major points of negotiation in the context of a real estate business combination?

The parties will typically agree on a time of transfer regarding the risk associated with the property; for instance, the ownership and right of use of the property, duties of care, accidental deterioration or impairment of the property. The seller should keep in mind that by selling the property its liability is not automatically excluded; but the purchaser should note that he or she might need to fulfil duties connected to the property prior to its purchase.

It is market standard that the liability for defects of the property are limited or excluded.

Sellers’ representations regarding leases

In the context of a real estate business combination, what are the typical representations and covenants made by a seller regarding existing and new leases?

Generally, the sale of a property does not affect existing leases, regardless of whether the transfer is made by a share deal or an asset deal. The new owner is bound by the existing leases (including its benefits and liabilities) and enters into the lease as the legal successor of the seller.

Therefore, typical representations of the seller include the existence and validity of the lease agreements, rent payments, rent securities (including the transfer of these securities) and ongoing or pending legal disputes with tenants.

Market-standard covenants may concern:

  • a promise to perform outstanding repair and maintenance works;
  • the obligation not to terminate or amend existing lease agreements without the prior approval of the other party; or
  • a commitment to enter into new lease agreements between closing and the final transaction.