Holds Reduction of Rent in Accordance with the Principles of Frustration of Contract Only After Comprehensive Weighing of the Individual Circumstances

On 12 January 2022, the German Federal Court of Justice (Bundesgerichtshof, BGH) ruled (XII ZR 8/21) that a tenant who was prohibited from operating its retail store due to general orders issued to contain the Coronavirus pandemic may be entitled to reduce the rent. However, the rent shall not just be reduced by half under a lump sum approach; instead, a comprehensive weighing of all the circumstances of the individual case is required. For this purpose, the concrete economic effects of the closure of the tenant’s business in relation to the respective business premises must be determined. The rent shall be reduced only if the resulting disadvantages, taking into account any advantages, rise to the level of requiring an adjustment to the lease agreement. A threat to the economic existence of the tenant due to the closure order is not required, but it has to be taken into account, whether the tenant was able to take measures to reduce his losses.

With this decision, the BGH has decided the long-disputed question of how closure orders for retail businesses issued as a result of the Coronavirus pandemic affect the obligation to pay rent.

Facts and Course of Court Proceeding

 The tenant operates several retail stores for various textiles and goods for daily use. Due to the general orders issued in spring 2020 by the Saxon State Ministry for Social Affairs and Social Cohesion (Sächsische Staatsministerium für Soziales und Gesellschaftlichen Zusammenhalt) to contain the Coronavirus pandemic, according to which all stores had to be closed with a few exceptions, the tenant was required to close its store from 19 March 2020 to 19 April 2020. Thereupon, the tenant ceased to pay rent. As a result, the landlord sued the tenant for payment of the outstanding rent for the month of April 2020. While the regional court (Landgericht) largely upheld the landlord's claim, the Higher Regional Court (Oberlandesgericht, OLG) of Dresden awarded the tenant a reduction of the rent by half referring to the principles of frustration of contract (Störung der Geschäftsgrundlage).

Ruling of the German Federal Court of Justice

In its decision, the BGH rejected a reduction of the rent under warranty law but affirmed the existence of a frustration of the contract and referred it back to the OLG. The OLG is now required to determine the concrete economic effects of the store closure and examine whether and to what extent the disadvantages require an adjustment of the lease.

No Reduction of Rent Under Warranty Law

 The BGH decided the tenant is not entitled to reduce the rent under warranty law. They reasoned that a general order for the purpose of containing the Coronavirus pandemic, which orders the closure of retail stores, does not result in the rental object having a defect. The resulting restriction on use is not directly related to the specific quality, condition, or location of the rental object. The reason for the closure order is not the concrete condition of the rental object or the building, but the public traffic resulting from the use, which creates the risk of an increased spread of the Coronavirus. However, the general order does not prohibit the tenant from using the rented premises, nor does it actually or legally prohibit the landlord from letting the rented premises.

The decision of the court was also not altered on the grounds that the parties agreed in the lease agreement that the premises shall be used “as sales and storage premises of a retail store for textiles of all kinds as well as goods for daily use and consumption”. The agreement of the specific rental purpose does not mean that the landlord assumes an unconditional obligation to accept responsibility even in the event of a government order prohibiting store opening in the event of a pandemic.

Reduction of the Rent Due in Accordance with the Principles of Frustration of Contract

The BGH held that a closure order issued as a result of the Coronavirus pandemic constitutes a frustration of the lease. In individual cases, this may give rise to a claim by the tenant to a reduction of the rent.

In this case, the general orders issued to combat the Coronavirus pandemic, which ordered the closure of retail businesses, led to a so-called major frustration of the contract (Störung der großen Geschäftsgrundlage). This means that the lease parties’ expectation that the basic political, economic, and social conditions of the lease would not change, and that the social existence would not be shaken was disturbed. This is also in line with the statutory presumption created in December 2020 in Article 240 § 7 of the Introductory Act to the German Civil Code (EGBGB). The disadvantages for the tenant resulting from the closure of the business due to general orders go beyond the usual risk of use of the tenant. The economic disadvantages are not based on entrepreneurial decisions or the disappointed expectations of the tenant but are a consequence of government intervention in economic and social life to combat the pandemic. None of the parties to the lease agreement can be held responsible for this. Ultimately, a general risk of life is realized which is not covered by the distribution of risk under the lease agreement without a corresponding contractual provision and thus cannot be assigned to any contracting party alone.

However, a reduction of the rent also requires that the tenant, after comprehensive weighing of all circumstances of the individual case (Section 313 (1) German Civil Code), cannot reasonably be expected to continue with the rental agreement unchanged. The OLG’s lump sum reduction of the cold rent by half does not take this into account. Rather, a comprehensive and case-by-case weighing is required, in which the disadvantages suffered by the tenant as a result of the closure of the business are to be considered. In the case of a commercial tenant, these may primarily consist of a concrete drop in sales for the period of the closure. However, this is only to be based on the specific rental object and not on a possible group turnover. It may also be necessary to take into account what measures the tenant has taken or could have taken to reduce the impending losses during the closure of the business. Contrarily, financial advantages of the tenant must be taken into account, too. These may be, for example, in the form of government assistance, but also benefits from a business insurance policy of the tenant that may be liable to indemnify. Loans granted as support shall not be considered because they do not provide the tenant with final compensation for the loss of sales suffered. An actual threat to the economic existence of the tenant, however, is not required. Finally, the interests of the landlord must also be taken into account in the required weighing.

Evaluation and Outlook

The BGH has now issued its long-awaited decision on the question of whether a retail tenant affected by a closure order issued as a result of the Coronavirus pandemic is entitled to reduce the rent. The BGH decided that such a closure order does not constitute a defect of the rental object. In its ruling, it also confirmed, once again, that a rental defect must have a direct connection with the specific quality, condition, or location of the rental object. In the future, this assessment may also be relevant for other situations involving official orders or legal changes that are only related to the tenant's use or operation but have no direct connection to the rental object.

By not making a lump sum reduction of the rent, but instead requiring a comprehensive weighing of the individual case, the BGH has given priority to case-by-case justice over fast decisions. As a result, decisions may be less predictable in individual cases, and court proceedings may also be longer and more costly as a result. For the parties to the lease, this may make out-of-court settlements more attractive. This is also true since the BGH has stated in a recent press release that the interests of the landlord are to be taken into account as well, but has not provided any more detailed information on this. It may be appropriate to take into account the landlord's interest in operating the rental property in a way that covers its costs, taking into account its financing and other costs, and not to reduce the cold rent by more than 50 percent.