Under a law passed by parliament today, tenants will be protected against termination by landlords who will in many cases not receive such protection for their financing.
Amendment to German lease law
In view of the regulatory measures of German authorities reacting to the spread of COVID-19, many businesses will suffer significant losses of income. As a consequence, tenants may not be able to meet their rent obligations and will likely have no rights to rent reduction or termination for cause under German law. Only a right to amendment of, or withdrawal from, contract pursuant Section 313 of the German Civil Code (BGB) may potentially apply, however, on a strict case-by-case basis.
Therefore, the German legislator grants tenants protection against termination by their landlords for outstanding rent regarding the months of April through June 2020. The law passed the German Federal Parliament (Bundestag) on 25 March 2020, and was approved by the German Federal Council (Bundesrat) today. In essence, the law states that:
- A landlord cannot terminate a lease due to lease payments outstanding for the period between 1 April 2020 until 30 June 2020 if the failure to pay the rent is owed to the COVID-19 pandemic — for which the tenant is required to provide credible evidence (glaubhaft machen). The termination right due to non-payment of rent during the aforementioned three-month period is suspended until 30 June 2022. Thus, rent not paid during April, May, and/or June 2020 will have to be paid until 30 June 2022 at the latest, to avoid landlords being able to terminate leases for non-payment during such months after 30 June 2022.
- The German federal government is empowered to prolong, by governmental order, the period in which outstanding rent does not entitle the landlord to termination until 30 September 2020 should the impact of the COVID-19 pandemic require such a measure, or, upon prior approval of the German Bundestag, beyond 30 September 2020.
- The law is mandatory, e., it cannot be waived by mutual agreement between the parties.
- To the benefit of landlords, the rent is still due (fällig), and therefore the tenant will have to pay interest on any outstanding rent. If the lease agreement itself does not provide for a default interest rate, the statutory interest rate of nine percentage points above the German base interest rate (currently -0.88%) would apply if both tenant and landlord are merchants (Unternehmer). Therefore, it may be commercially more reasonable for tenants to finance rent payments through loans (g., through the financing program of the German state-owned bank KfW for companies with temporary financing difficulties due to the COVID-19 crisis (for further detail, see Legal Update – COVID-19: Immediate Measures to Gain State Aid Financing (KfW Credit et al)) instead of incurring interest for late payment of rent.
- Further, the law does not restrict a landlord’s termination rights that do not relate to outstanding rent payments for April through June 2020.
Impact on existing loan agreements
- To the detriment of commercial landlords, the law does not mirror the termination ban with respect to financings landlords may have in place regarding their properties. An initiative to mirror a similar moratorium to protect landlords, as debtors towards their creditors, was not successful for merchant borrowers but only for consumers. The law, however, provides for the possibility to extend the debt moratorium to small- and middle-sized enterprises by governmental order. Thus, while commercial landlords may face delays in or even a loss of rental income, they will be required to continue to service their debt.
- In case the landlord/borrower does not have other assets to maintain the debt service it should address this situation to respective creditors as early as possible.
- There may be situations in which, besides honoring paying obligations, the borrower is obliged to:
- Inform the lenders to provide certain frequent information updates or inform them about other issues that have a material and/or negative impact on the position of the borrower or the lenders and/or
- Cash-trap, e., not distribute (excess) cash, whereas excess cash is the difference between the rental income (received) after payment of operational and other agreed expenses, which then would be trapped in the structure and pledged as security for the lenders.
- Whilst in case of a payment event of default, the acceleration of the loan agreement is threatened instantly and hence will require a waiver from the lender(s), in case of other events of default the possibilities (if any) to cure such default should be elaborated if cure periods are permitted. Ultimately, for these types of default also, lender’s waiver of rights may need to be sought.
- Rent arrears will have a direct impact on financial covenants agreed, such as an interest cover ratio (ICR), debt service cover ratio (DSCR), or a debt yield (DY) covenant. If the situation continues or worsens, a devaluation of the property may also trigger a breach of the often agreed loan to value (LTV) covenant.
- A consequent Cash Trap may have a direct impact on the actual management of the properties since payments to asset and property managers very often may not be permissible anymore, or may be restricted to a certain amount.
- If a tenant is approaching a landlord to ask for an agreement to reduce rent beyond the statutory rent moratorium described above, there will be certain consents required from the lenders. In addition, rent most likely will be assigned to the lenders or the security agent, which will require additional consents as the landlord will no longer legally own the rent receivables.