Signed lease agreement not binding

11 May 2010

Introduction

The German Federal Court of Justice (Bundesgerichtshof) ruled on November 4, 2009 that a commercial lease agreement, which was concluded by the parties for a ten-year-period and which was signed on the behalf of the tenant by one of the two board members (Vorstand) of a public limited company (Aktiengesellschaft), did not meet the written form requirements (the signing director had no right to sole representation) and was therefore concluded for an indefinite period of time, i.e. could be terminated by either party on short notice.

 Outline of the Problem of the Written Form Requirement

Pursuant to German law, a lease agreement, residential or commercial, entered into for a fixed term of more than one year, has to be in writing. Otherwise, the lease is valid but may be terminated by either party with the statutory notice periods (in case of commercial leases: until the third working day of a calendar quarter year with effect as of the following calendar quarter year, i. e. approx. six to nine months). Even commercial lease agreements concluded for a ten- or fifteen-year-period could be terminated within the statutory period before the lease's contractual end.

The primary purpose of this regulation is that a purchaser, who acquires a property for which such a long-term lease exists and who will, if the statutory requirements are met, enter into same lease as the landlord, shall be able to gather all necessary information from the written lease agreement.

Often tenants try to get rid of their contractual obligations based on non-compliance with the written form requirement, even if they themselves had previously caused this insufficiency.

From the landlord's perspective, in particular from the perspective of an investor (whose protection the written form requirement actually intended), this can lead to the loss of the basis of his investment, since in most cases, the long term income from a lease is the economic reason for the decision to acquire a property (asset deal) or a company which holds a property (share deal).

 What is Written Form?

Written form means that all material provisions of the lease have to be included in one joint document, and by competent representatives of the parties have to sign them. The lease agreement has to refer to all existing annexes and a sufficient link between annexes and the main lease agreement is required. Later addenda must distinctly refer to the relevant lease agreement.

Hence, the German Federal Court of Justice ruled that all agreements that shape the content of the lease agreement have to be made in written form. As an example, the German Federal Court of Justice ruled that if the parties orally agree on a change of the maturity (from a quarterly to a monthly payment), this amends an essential stipulation of the agreement and leads to non-compliance of the written form requirement and, therefore, entitles both parties to termination on short notice. According to the German Federal Court of Justice's jurisprudence, a lease agreement can be terminated before its contractual end even if only one annex (out of many) does not meet the written form requirement.

Additionally, in order to comply with the written form requirement, the time between the offer and its acceptance must not exceed a certain number of days. This obligation tends to cause problems in practice when lessor and lessee do not sign the lease agreement simultaneously, but send it via post. Moreover, the agreement may not be concluded at all, if the delay between offer and acceptance is too long. The jurisprudence of the Higher Regional Courts (Oberlandesgericht) in Germany is not consistent in this matter (it ranges from five days to three weeks; there are even court decisions which qualify this question not at all as a question of written form), investors who rely on a long-term lease should have clarified not only that duly authorised signatories have signed all documents that have been paginated and attached, but also whether the parties of the lease have signed the agreement within a relatively short period of time. They should also have checked whether there have been recent changes in the relevant jurisprudence before acquiring the target with the lease agreements as a major asset.

 Multitude of Decisions in the Last Years on the Subject

Almost more than any other area of tenancy law, the subject of written-form requirements has been shaped by numerous judgments on a case-to-case basis from the German Federal Court of Justice and the Higher Regional Courts during the last years.

 However, for investors it is not always easy to determine what applies. Some examples:

  • The German Federal Court of Justice has ruled that in case of an Aktiengesellschaft (public limited company) the signatures of all directors in case of joint representation are required or that the single signing director has to clarify that he acts by proxy of the other directors.
  • In case of a GmbH (limited liability company), the German Federal Court of Justice ruled that the signature of a person acting on behalf of the company, but not being one of its directors, could meet the written form requirements (the question of whether the same person has the power to represent the company is not a question of written form, but of the validity of the entire agreement).
  • Conversely, if one individual has signed on behalf of another one (e.g. his or her spouse), this may be in line with the written form requirement according to the German Federal Court of Justice, even if the signing individual does not state that he acts as a proxy. This may also apply to a Personengesellschaft (partnership), whereas in case of a Gesellschaft bürgerlichen Rechts (civil law partnership), all partners have to sign, unless one of them has sole representative powers, in such case, he would need to add a respective note to his signature.

In summation, close monitoring of the jurisprudence is necessary in order to ensure the long-term peace of mind for real estate investments.

 

Sebastian Schmid, Counsel Salans LLP

Anna Dost, Freelance Associate

 

FAF International have developed cover for this situation, by protecting the lender against any shortfall in debt service resulting from the premature termination of a lease due to a breach of the written form requirements. This type of insurance is more cost efective than a bank guarantee as that would have to be repaid if it was ever called in.

Click here to contact our Western Europe team.