Security for leases during the coronavirus pandemic
a lifeline for landlords?
Landlords are coming under increasing financial pressure as retailers suspend their rent payments due to official orders to close their stores during the coronavirus outbreak. Many tenants decided to take this step from 1 April 2020, as they no longer have to fear termination for cause in connection with certain pandemic-related payment arrears under the new legal situation (see our news). For landlords, this has exacerbated the already tense situation.
To be able to meet their own liabilities to banks, utilities and service providers, landlords are increasingly seeking to realise the security for claims under the lease provided to them. It is therefore crucial for them whether the new legal situation also permits the realisation of the security and whether the tenant is subsequently obliged to top it up. Apart from this, the question arises whether the landlord would be entitled to give notice on the lease for cause if the tenant breached such an obligation to top up the security provided.
Legal starting point
Up to now, only the German Act to Mitigate the Consequences of the Covid-19 Pandemic under Civil, Insolvency and Criminal Procedure Law of 27 March 2020 (“Covid-19 Act”) contains special legal provisions for the coronavirus crisis in relation to tenancy law. Where the Covid-19 Act does not provide special provisions, the general statutory rules and terms of lease are authoritative in individual cases.
A key provision of the Covid-19 Act in relation to leases is a restriction on terminations by landlords. By way of exception, landlords may not give notice on leases because of payment default if the tenant fails to pay rent in the period from 1 April 2020 to 30 June 2020 despite being it due and this failure is due to the effects of the Covid-19 pandemic (see Article 5 Covid-19 Act in conjunction with Article 240 section 2(1) of the new version of the Introductory Act to the German Civil Code). Apart from this restriction on terminations, the Covid-19 Act does not provide for any other modifications to tenancy law, meaning that for the most part the general legal provisions and contractual provisions continue to apply.
Therefore, despite the restriction on terminations contained in the Covid-19 Act, the tenant’s obligation to pay the rent owed under the contract fundamentally continues to apply. If the tenant defaults on payment, apart from the right of termination that would otherwise potentially exist the landlord is essentially still entitled to the general statutory and contractual rights and claims.
Realising rent security deposits and guarantees
The Covid-19 Act does not contain any specific provisions on realising rent security deposits and guarantees. Therefore, the same applies here: if a tenant defaults on payment due to the coronavirus crisis, the landlord is still entitled to realise the security in accordance with the general statutory provisions or terms of lease. Whether such a right to realise actually exists in individual cases must be assessed on the basis of the specific circumstances and contractual arrangements. It must also be taken into account above all whether the lease permits realisation of the security during the term of the tenancy as well and whether the claims asserted by the landlord have been disputed by the tenant. The landlord is only allowed to realise the security if the legal and contractual requirements for this are met in the specific case.
In many cases, in the current situation the parties to leases are looking for an amicable financial solution, as the consequences of the Covid-19 pandemic were ultimately not the fault of any of the parties involved. However, it is difficult to reach an agreement if both landlord and tenant lack the necessary liquidity, which is urgently needed by both parties in the current critical situation.
Against this background, it can help to free up the otherwise unused financial reserves of the security in the short term. If security for the lease was provided in the form of a bank guarantee, the guarantor bank often has pledged funds in an account of the tenant as security. If this can be liquidated at short notice with the involvement of the guarantor bank, this can result in additional funds which can then be put on the negotiating table and used to bring about a solution.
Claim to replenishment of the security for the lease
In practice, the value of the rent security deposit agreed is often equivalent to the sum of three months’ rent in commercial leases. In these cases, the security will exactly cover the time frame from 1 April 2020 to 30 June 2020, during which in the tenant’s protection from termination under the Covid-19 Act applies. Replenishment of the security plays an important role for the landlord to ensure that it is not without security afterwards.
If the landlord justifiably falls back on the security during the tenancy, it is basically entitled to have it topped up again. This does not require an express agreement in the lease. The new provisions of the Covid-19 Act do not change this: the right to have the security topped up even exists if it is used to cover payment arrears for which the landlord cannot terminate the lease due to the restriction on terminating leases in the Covid-19 Act. If, however, the security is used in breach of general statutory provisions or terms of the lease, the landlord is not entitled to replenishment. The landlord then has to replenish the unlawfully used security themselves (for example by crediting the amount realised to the rent depositsecurity account).
Right to terminate due to breach of obligation to top up
Contractual and statutory right of termination
Commercial leases typically contain a right on the part of the landlord to give notice for cause mirroring the tenant’s right if the tenant does not meet its obligation to top up the security in accordance with the contract. In principle, such a provision should also be permissible in the form of general terms and conditions (GT&Cs), as long as the contractual provision is sufficiently transparent and precisely worded.
Even if the contract does not expressly provide for such a right to give notice on the lease, there are strong arguments to support the idea that the landlord is entitled to it by law: the starting point does not differ from situations where the tenant does not even pay the contractually agreed security for claims under the lease at the beginning of the lease. In such a case the landlord is also entitled to give notice of termination under commercial tenancy law according to the case law of the highest courts (see German Federal Court of Justice judgment BGH NZM 2007, 400). Due to the comparable interest of the landlord in holding security, there are strong arguments for applying this case law to the tenant’s breach of its obligation to top up the security.
Right to terminate leases limited by the Covid-19 Act?
The Covid-19 Act does not contain any explicit limitation of the right to give notice on a lease if the tenant fails to replenish the agreed rent security deposit properly. Can the landlord therefore also terminate the lease in accordance with the above principles if the landlord’s demand for replenishment was directed at parts of the security it has called in because of rent arrears arising in the time from 1 April 2020 to 30 June 2020? This would mean that although the landlord would not be entitled to terminate the lease directly on the basis of the payment arrears from this period due to the restriction on terminations in the Covid-19 Act, it would be entitled to terminate the lease on the basis of a breach of the obligation to top up the security. It remains to be seen whether case law will also allow such a right of termination during the coronavirus crisis.
The Covid-19 Act does not contain any special legal provisions on the realisation of security provided for claims under leases and the tenant’s obligation to top up. Therefore, the general statutory provisions and terms of lease between the parties continue to apply in this context. However, if a tenant defaults on the replenishment, the landlord’s right to terminate could be restricted by case law in certain circumstances due to the protective motivations underlying the Covid-19 Act.
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Any questions? Please contact: Dr Dirk Lentfer or Dr Enno Stange
Practice group: Real Estate Investment Group