Sellers may be liable for damages if actual rent is lower than stated in the rent roll, despite contractual exclusion of liability for defects.
The Higher Regional Court of Cologne (HRC Cologne) has ruled that a property seller is liable for the difference between the rent shown in the rent roll attached to a property purchase agreement and the actual rent — irrespective of the general exclusion of warranty claims in a purchase agreement. As a consequence, a seller may have to compensate a purchaser for all future losses resulting from such lower actual rent for up to 30 years. The decision highlights the high commercial relevance of rent rolls and the legal risks resulting from rent rolls in the context of real estate transactions.
The HRC Cologne’s judgment, dated 29 November 2018 (3 U 24/18), involved a case in which the plaintiff had acquired from the defendant a residential building with 14 rental units. The sale and purchase agreement (SPA), which excluded the defendant’s statutory liability for material defects as seller, stated that the plaintiff was aware of the lease agreements. An exhibit listing all leases (names of tenants, location of and rent for the respective rental units) was attached to the SPA, which also stated the annual net rent for the entire building.
After closing the transaction, the plaintiff discovered that the actual annual net rent was significantly lower than stated in the SPA exhibit. The plaintiff demanded damages from the defendant for the loss of rent. Furthermore, the plaintiff sought a declaratory relief regarding the defendant’s obligation to compensate the plaintiff for any future differences between the actual rent and the rent shown in the SPA exhibit.
The Court’s Ruling
The HRC Cologne decided that the defendant was fully liable for all current and future losses resulting from the difference between the actual rent and the amount stated in the rent roll. The ruling addresses several key legal questions that arise in real estate transactions:
When does the rent listed in a rent roll constitute a binding description of the sold property?
According to the court’s ruling, attaching a rent roll as an exhibit to the SPA can be sufficient to qualify the information contained in the rent roll as a binding description of the sold property. The SPA does not need to qualify explicitly the rent roll as a property description. If the rent roll lists the net rent for individual rental units or the entire building, there is a strong assumption that the parties intended for such rent amounts to constitute binding qualities of the sold property.
What are the legal consequences if the actual rent is lower than the rent stated in the rent roll?
The shortfall in the rent constitutes a lack of conformity (as defined in Article 2 of Directive 1999/44/EC and transposed into German law), allowing the purchaser to reduce the purchase price, claim damages (if the lack of conformity cannot be fixed), or rescind the purchase agreement. In the case at hand, the seller was required to compensate the purchaser for the difference between the “agreed” rent as stated in the rent roll and the actual rent. The declaratory relief granted by the HRC Cologne effectively requires the seller to pay compensation for the next 30 years, if and to the extent the actual rent is lower than the agreed rent (subsequent rent increases will presumably narrow down or close the gap).
Can liability risks resulting from rent rolls be limited by generally excluding the seller’s liability for defects in the purchase agreement?
The court found that if an SPA provides for both a binding description and the exclusion of the seller’s liability for defects, the scope of such exclusion will not apply to liability relating to lack of conformity with a binding description. This interpretation is based on the wording of the SPA in the case, which did not address the relationship between binding descriptions and the exclusion of liability. The court did not clarify whether the parties could have explicitly agreed to exclude the seller’s liability regarding binding descriptions. In marked-standard real estate investment SPAs, the statutory liability regime for defects is usually fully excluded and replaced by specific representations and warranties.
In the context of a German law real estate purchase agreement, including the amount of rent owed under a lease agreement in a rent roll poses several risks, including:
- The sellers may be liable, as in the case at hand, if the amounts stated in the rent roll are incorrect due to calculation or copy-and-paste errors.
- The rent the tenants owe may be lower due to defects allowing for an automatic rent reduction.
- The tenants may be entitled to rent-free periods not reflected in the rent roll.
- The leases may be invalid for legal reasons, and therefore no rent may be owed at all.
If rent amounts must be listed at all, sellers may try to limit the information provided to rent payments actually received. However, even these figures occasionally turn out to be incorrect. Other information included in rent rolls, such as size of rental units or lease terms, give rise to similar risks. Buyers, on the other hand, will be encouraged by the HRC Cologne’s judgment to demand extensive rent rolls including as much commercially relevant information as possible, as such information will effectively provide additional warranties. Therefore, all parties to real estate purchase agreements should consider carefully information to be included in rent rolls.