Although triple net leases (known as “full repairing and insuring leases” in the UK) are common practice internationally, in Germany they cannot be agreed under standard form contracts. Nevertheless, there is broad economic interest in agreeing in a lease the rent is calculated triple net, that is without taking account of taxes and special charges, nor insurance premiums, maintenance, repair or replacement costs nor the costs of upkeep, and this would be just as attractive in Germany as elsewhere. Landlords using debt capital to fund their purchase of real estate, real estate funds and institutional investors who have to consider internal risk profiles are particularly reliant on stable and calculable returns.
In Germany, lease agreements in the form of “General Terms and Conditions” (GTCs) are legally not permissible, even if landlord and tenant have equal bargaining power. Even though triple net rents can in fact be negotiated individually, this entails enormous time and effort for the landlord.
Contracts under German law
A landlord is obliged to keep the rental property in suitable, contractually compliant condition (section 535, paragraph 1, sentence 2 of the German Civil Code, BGB). However, the principle of freedom of contract generally allows the parties to deviate from this statutory model.
Scrutiny of GTCs
The party introducing clauses in a standard form contract typically has greater economic power and can impose its GTCs on the other contracting party, so that the principle of freedom of contract finds its limits where it would unreasonably disadvantage that party. Even contracts between experienced businesspeople are subject to such GTC scrutiny in Germany.
Transferring property-related taxes and special charges to the tenant is not a problem, even in the form of GTCs. Insurance costs can also be passed on to the tenant insofar as they meet the need for cost efficiency and are beneficial at least partially to the tenant or the rental property.The cost of insuring against terrorist acts can only be passed on if the property faces a concrete risk. Furthermore, operating costs can generally be allocated to the tenant if the respective contractual stipulations are precise enough, for example, by referring to the German Operation Cost Ordinance (Betriebskostenverordnung) in an annex to the contract.
A more difficult matter is imposing all repair and maintenance costs on the tenant in a standard form contract. If the tenant is made responsible for the upkeep of an entire building, this would also include roof repairs, where costs can quickly shoot up.This would present an incalculable risk for the tenant and cause him to be unreasonably disadvantaged. Therefore, to determine whether particular costs can be transferred, it is essential to be very specific about the exact burdens and risks this entails for the tenant.
A foreseeable risk for the tenant is constituted by those maintenance and repair obligations caused by the tenant’s use of the premises or arising from his own sphere of risk. This means that the tenant can be made responsible for the maintenance of the rented premises themselves, but not the maintenance of communal areas, the roof or supporting parts of the building (known as “roof and framework”). In case of doubt, maintenance clauses must be interpreted restrictively, presupposing that the rental property was in perfect condition at the beginning of the lease. Also, the transfer of maintenance obligations is calculable and thus acceptable if the relevant costs are capped. Maintenance costs for communal areas can be passed on to the tenant under standard form contracts (that is, in GTCs) subject to a ceiling of 10 per cent of the annual rent. It is unclear whether “single-tenant” leases, where one tenant rents the entire property, need to provide such a cap for maintenance and repair costs allocated to the tenant. Although such properties do not have communal areas, not all maintenance work is caused by the tenant’s use or falls within his sphere of risk.As a precaution, a cap should be agreed even for “single-tenant” leases.Another matter on which courts have not yet handed down a final ruling, is whether maintenance of roof and framework can— as an exception—be passed on to the tenant if a cap is agreed.The obvious approach would be to classify roof and framework as being part of the communal areas. However, the Federal Court of Justice has not yet decided on this, so for the time being, it would be prudent to avoid allocating these maintenance costs to the tenant in GTCs.
Furthermore, the tenant’s maintenance obligations do not include the obligation to bear the costs of replacement—at least not without express provision. If the tenant does indeed replace elements of the building and thereby increases the value of the landlord’s property, this must be explicitly agreed on between the parties.
No scrutiny of GTCs
General Terms and Conditions are assessed on whether the party who has not drafted the GTCs suffers an unreasonable disadvantage compared to the party proposing them. In triple net leases it is only the tenant who takes on additional obligations so only he could suffer such an unreasonable disadvantage. If the tenant proposes the triple net clauses, this would, in fact, be advantageous for the other contracting party—the landlord.
Proposing triple net clauses is often attractive to the tenant, as it can ask for a lower rent in return for taking on these obligations.When undertaking maintenance works the tenant can also negotiate more beneficial contracts with builders and is only required to pay if damage actually occurs. Ultimately, this may be cheaper for the tenant than paying a monthly, fixed lump sum to the landlord to cover potential maintenance costs in addition to his rent.Tenants with a strong market position in particular have enough bargaining power to impose such provisions on the landlord, for instance, financially strong tenants such as supermarket chains.They are also common in the context of sale and lease-back transactions. However, the tenant must necessarily be the party drafting and proposing the GTCs. If the tenant only pretends to introduce the clauses himself but actually acts for the landlord, the landlord will be considered to be the party drafting the GTCs.
One might think that the transfer of such maintenance obligations is not a deviation from what the law terms “non- mandatory legal provisions”, because a lower rent can be charged as a quid pro quo and therefore the arrangement appears to be a matter of performance and consideration. Whether performance and consideration are proportionate is always the responsibility of the contracting parties and is generally not subject to scrutiny by the courts. However, in addition to being a mere “price agreement” (lower rent in exchange for additional obligations) the imposition of extensive maintenance obligations diverges from the landlord’s statutory duty to maintain the rental property’s condition in accordance with section 535, paragraph1, sentence 2 of the German Civil Code (BGB).Therefore, it is a side agreement subject to judicial scrutiny.
The safest way to agree on a triple net lease is by individually negotiated contract. If the clauses are actually negotiated by the contracting parties, neither of them needs to be protected from a disproportionate disadvantage via scrutiny of GTCs. However, even in these circumstances two problems need to be considered. First, the landlord has to prove that the clauses were in fact negotiated and second, the individual negotiations are immensely laborious. It can be prove that the contract was individually negotiated if the maintenance obligations were clearly taken on in exchange for a lower rent. In such a case the tenant had the choice of either agreeing to a higher rent or taking on maintenance obligations. Providing lists of local comparative rents or an expert’s opinion on the local rent is sufficient evidence in this regard. Furthermore, as a precaution, a record of the entire correspondence (emails, etc.) should be kept.A confirmation from the tenant stating that the agreement was individually negotiated is not enough, because in assessing the GTCs the actual negotiations need to be comprehensible and accessible. However, landlords owning several properties are faced with an enormous amount of work when entering into individual negotiations with each and every tenant and the relevant documentation process. This may also make property management more difficult as all leases contain different stipulations.
Particularly interesting are sale and lease-back transactions where the owner releases the capital tied up in an asset by selling his property to an investor and then immediately leasing it back. Here, the tenant is in a situation comparable to the owner.The rental property derives from the tenant’s own portfolio so he is in a better position to judge the risks than the landlord, who merely is a financial investor. Since the tenant’s interests are similar to those of an owner, triple net leases are widespread in this type of transaction.
The fact that in the context of a sale and lease-back the lease agreement itself is notarized does not exempt its GTCs from scrutiny by a court.The only decisive factor in subjecting the GTCs to legal review is whether the terms and conditions of the contract were pre-formulated within the meaning of sections 305 et seq. of the German Civil Code.The decisive factor in sale and lease-back transactions is whether the tenant is unreasonably disadvantaged by assuming unlimited maintenance obligations for the rental property contrary to the statutory provisions included in standard lease agreements (section 535, paragraph 1 sentence 2 of the German Civil Code, BGB).
Sale and lease-back transactions could for example be subject to the basic statutory principles of asset leasing agreements (German law differentiates between agreements for the letting of real property and asset/business leasing agreements which are deemed to be a combination of tenancy and financing). In leasing agreements, the lessee, who selects and later possesses the leased asset and thus causes the lessor to purchase it, is closer to the asset than the actual owner. Such “atypical” lease agreements are evaluated differently from “normal” lease agreements in terms of GTCs; both the risk of accidental loss, destruction or deterioration and the price risk, as well as any and all maintenance obligations can be allocated to the tenant in a standard form contract. However, the lessee is usually assigned the lessor’s warranty rights in return. So ultimately the lessee is in a better position than the tenant as a party to a sale and lease-back transaction. Also, there is no case law drawing such a comparison in the context of GTCs. So simply calling a standard form contract aa “asset/business leasing agreement” does not create an effective triple net lease.
Therefore it is debatable whether triple net leases in sale and lease-back transactions are classified as atypical lease agreements. Some argue that, according to the general legal principles governing these situations, the imposition of all maintenance obligations without any restrictions is allowed.Although this view accords with standard practice and meets the needs of many parties in the real estate market, this legal classification of triple net leases in sale and lease-back transactions has not been recognized by the courts.
Consequently, agreeing on triple net leases by way of alternative types of contract should also be avoided.
It is extremely doubtful whether German case law will be aligned with common law jurisdictions in the near future, making of triple net leases acceptable without restriction in commercial tenancy law. Compared to other countries, German tenants enjoy very broad protection. In addition to his rental income, the landlord—as the owner of the property—also draws a long- term benefit from this asset.This is why it may be argued that in German law, all maintenance with long-term effects and potentially high costs, such as roof and framework repairs, should remain with the landlord. Whether the legislature will allow triple net leases in special cases such as sale and lease-back transactions (where the tenant is in a similar position to that of an owner) remains to be seen.