Impact of the corona crisis on the obligation to pay rent
The corona crisis has forced many tenants to close their shops, with devastating financial consequences. Many tenants have notified their landlords that they will unilaterally reduce their rent payments, citing this situation. Are they allowed to do that?
Under the authority granted in sections 28 and 32 of the German Infection Protection Act of 20 July 2000 (German Federal Law Gazette Vol. I p. 1045), many official orders to contain the spread of the disease (SARS-CoV-2) caused by the novel coronavirus (COVID-19) are being issued within a short period of time. In every German state the legal foundation has been laid for closing shops. As a rule, the only exceptions are businesses that provide the public with supplies to meet their basic needs. The different rules in various states present a strong challenge to not only landlords but also tenants – from retail chains to individual shop proprietors. The main focus is on keeping the business open, but if this is not legitimately possible, how to distribute the costs due to the adverse circumstances. Tenants are already beginning to contact their landlords to negotiate on rent reductions.
More and more retailers and restaurants that are completely or partially exempted from the official orders are also deciding to close their businesses voluntarily for financial reasons. In such cases as well, tenants are demanding that their landlords bear a portion of the financial losses in the form of payment deferral, rent reductions and temporary contractual amendments. Are they allowed to do that?
Obligation to pay rent
Tenants that are exempted from an official order to close businesses generally remain contractually obliged to pay the contractually stipulated rent, even during the corona crisis (section 535(2) German Civil Code). The exceptional circumstances caused by the COVID-19/novel coronavirus have already resulted in strongly reduced numbers of retail customers in the past few days. However, fewer customers and visitors alone do not automatically entitle a tenant to unilaterally reduce rent payments or to claim a rent reduction. However, different rules may apply in a specific situation depending on the distribution of risk provided in the lease.
This situation is already moot for tenants affected by an official order to close their businesses. The official order to close retail businesses other than those that serve to cover the public’s urgent daily needs has now brought up even more issues regarding rent payments:
Unilateral rent reduction
Voluntary closing for economic reasons
The prerequisite for a unilateral rent reduction is that there is a defect in the leased premises (section 536(1) first sentence, Civil Code). The principle is that if the tenant closes its business voluntarily and for economic reasons, there is no such defect and the tenant must continue to pay the full rent.
- Officially ordered closing
If a business is forced to close due to an official order, the decisive factor for a unilateral rent reduction is whether this constitutes a defect in the leased premises. According to current case law, official hindrances and restrictions to the use of leased premises only constitute a defect if they apply to the specific characteristics, condition or location of the leased premises (see, for example, German Federal Court of Justice judgment dated 13 July 2011 – XII ZR 189/09). On the other hand, use restrictions that are caused by the tenant’s personal or commercial circumstances are not to be classified as defects. In short, if the closing is caused by the fact that certain premises are no longer permitted to be open for business, a unilateral rent reduction may be permissible. This does not apply if the order refers to a certain type of business. This means that the tenant bears the risk of the ‘type of business’.
The purpose of the business closures ordered to date as a result of the corona crisis is to reduce the number of retail customers and the accompanying risk of infection. The official orders usually differentiate based on type of business. It is expressly to remain permissible to keep open businesses that are necessary for local supply, which include food retailers, beverage shops, banks, pharmacies and post offices. Conversely, this entails a discretionary decision by the authority as to whether to close businesses whose range of products include only items that are not indispensable in the current exceptional circumstances. This means that the sovereign interventions are purely business-related and have no direct connection to the leased premises. Tenants subject to such closure can continue to use their leased premises, for example for internal purposes such as inventory, decoration, etc. Official permission to re-open the shop to the public is thus equivalent to a decision regarding a business licence. Thus, based on the current legal situation, tenants must continue to pay rent.
- Rent reduction due to restriction of use
According to the current legal situation, landlords should avoid premature restriction of use without an official order addressed to them. This applies not only to the leased premises themselves but also to common areas (e.g. due to closure of some businesses in a mall or a retail park). Otherwise, the tenants affected by this could – depending on the circumstances – cite a de facto negative impact on the use of the leased premises and find cause to assert a claim for rent reduction or compensation.
Right to claim amendment of contract
If, upon entering into a lease, a tenant and landlord did not foresee unusual circumstances that result in a drastic change in their business relationship, a legal correction can be necessary according to principles of good faith. Therefore, in certain exceptional cases, there is an option to amend the lease according to the principles of frustration of contract, section 313(1) Civil Code). Up to now, legal precedents in commercial rent cases have rejected recourse to these principles. This means that, even considering the legal instrument of frustration of contract, according to current case law, it is to be assumed that the obligation to pay rent continues to exist. However, due to the historic magnitude of the corona crisis and the attendant duration and intensity of the financial burden tenants must bear, case law could develop in a different direction which is not currently foreseeable.
However, even if the principles of frustration of contract are applied, the risk distribution stipulated in the lease is to be taken into account.
It appears that tenants will only have the right to claim damages from their landlords in exceptional cases. Such claims usually require culpability on the part of the landlord, which is probably not given in this case. However, damages claims would be conceivable if the landlord – e.g. of a mall or retail park – decides to close leased premises without the corresponding official order or an official closing order is addressed to a specific landlord (e.g. for failure to comply with hygiene standards)
According to the current legal situation in Germany, it is the tenant that generally bears the financial risk if an official order is issued to close the shop. In exceptional cases, the tenant might have the right to a rent reduction or damage claim from its landlord. Nevertheless, not only the risk distribution as provided in the lease but also the relevant official order must be examined on a case-by-case basis. It remains to be seen whether the courts will begin to apply the principle of frustration of contract, with the result that landlords will share their tenants’ long-term financial burden.
We will keep you updated!
Any questions? Please contact: Annette Pospich, Dirk Lentfer, Enno Stange
Practice group: Real Estate Investment Group