The Situation: A decision by the German Federal Court of Justice has made null and void written form defect-curing clauses in lease agreements.
The Result: It is likely that more tenants and landlords will attempt to terminate lease agreements prematurely based on an alleged written form defect.
Looking Ahead: Actions resulting from the ruling could both jeopardize investors' cash flows or present an opportunity to replace unprofitable leases.
The German Federal Court of Justice (Bundesgerichtshof, "BGH") recently published a decision from September 27, 2017, ruling that the so-called written form defect-curing clauses agreed to in lease agreements are null and void. By such clauses, the parties undertake to cure violations and to refrain from an early termination on the grounds of a violation of the written form. Under German law, a lease agreement with a binding term of more than one year has to comply with the written form. If violated, the lease generally can be terminated by a six months' prior notice with effect from the end of a calendar quarter (commercial leases)—irrespective of the agreed term. Parties will not be entitled to damages because of such termination. We expect to see more tenants and landlords trying to terminate lease agreements based on an alleged written form defect. This could be both a significant threat to investors' cash flows or an opportunity to replace unprofitable leases.
Background of the Ruling
Until the recent decision by the BGH, it was an open question whether the written form curing clause would actually allow the parties to rely on the agreed term as some courts ruled in favor and some against the clause. Agreeing to such a clause should have protected parties against the harsh consequences of a written form violation and the threat of an early termination. Under the clause, parties to a lease were obliged to carry out all actions and take all measures necessary to cure such written form violation and not to terminate the lease agreement on the grounds of a written form violation.
Now the BGH has decided that written form curing clauses are null and void and cannot prevent parties from terminating a lease agreement suffering from a written form defect. The court referred to the purpose of the written form requirement set out in Section 550 of the German Civil Code (Bürgerliches Gesetzbuch). In particular, the written form should protect the buyer of a real property who will assume all existing lease agreements by operation of law. Such buyer should be in a position to identify from written documents all material arrangements with the tenant that will be binding for him. The BGH considered the written form curing clause a circumvention of the law.
After the new ruling, landlords and tenants alike can seek protection only if a termination by the other party violates the principles of good faith. As the courts will decide this on a case-by-case basis, in most circumstances the outcome is hardly predictable. In the case at hand, the BGH still ruled that the landlord was not entitled to terminate the lease agreement. The court found the landlord's termination to be against good-faith principles—solely the landlord had benefitted from the amendment to the lease and the violation of the written form.
Written Form Requirement for Leases under German Law
To comply with the written form, it is not only necessary to document the agreement in writing, but much more detailed requirements apply that are frequently not complied with. For a lease with a binding term of more than one year, all material terms must be included in a single written agreement signed by both parties in original form. Material amendments must be documented in a written amendment with additional specific requirements applying. There is no conclusive guidance as to what has to be considered material. If in doubt, parties should enter into a formal written amendment to avoid violation of the written form.
What Landlord and Tenants Need to Do
More landlords and tenants will consider using a potential written form issue as a tool to get rid of or to renegotiate lease agreements. Landlords and tenants are advised to review their lease agreements to ensure that they do not bear risks of violations. If this is the case, it is advisable to cure the written form issues through an amendment agreement.
Most importantly, parties should be most diligent when agreeing to future leases or amendments to lease agreements. It has become even more important to refrain from oral arrangements, side letters, and agreements in emails and to insist on written form compliant amendment agreements.
Two Key Takeaways
- Parties to lease agreements should carefully review these agreements to ensure that they are not in risk of violations.
- Oral agreements, side letters, and agreements arrived at via email should be avoided in favor of written, compliant leases.