The written form requirement regarding commercial lease agreements will be abolished – now it is for real!

The draft bill on a law to reduce bureaucracy which was passed by the German Parliament on 26 September 2024 stipulates among other items the abolishment (more specifically the relaxation) of the written form requirement as per section 550 of the German Civil Code. In the past, the strict written form requirement has repeatedly led to doubts regarding the fixed term of commercial leases, resulting in substantially increased due diligence time and effort in real estate transactions and uncertainty as to whether the cash flows that purchasers anticipated would be generated by the acquired properties are truly sustainable. This often resulted in extensive provisions in purchase agreements, oftentimes relating to purchase price retentions where the releases were tied to the seller succeeding to remedy the non-compliance with the written form requirement. The new regulation has already been the subject to extensive discussion and criticism when the corresponding draft bill was first published on 11 January 2024. Its recent adoption by the German Parliament provides an opportunity to take a sober look at the reform proposal and its effects in practice without getting lost in all the specific legal ramifications. Rather, in the following the matter shall be analysed deliberately in a simplified way for the sake of clarity and comprehensibility for non-lawyers.

How is the written form requirement being changed?

The simplicity of the draft bill has a certain elegance to it. In the future, the conclusion of a commercial lease for a fixed term of more than one year will no longer require the physical embodiment of the agreement of the parties (on paper) with a handwritten signature. Rather, in the future the compliance with "text form" as per § 126b German Civil Code, i.e. electronic embodiment on a durable medium will suffice which makes simplified speaking all non-verbal agreements potentially compliant. The previous strict formal requirements will hence be relaxed considerably. In particular, compliance with the electronic form as per § 126a German Civil Code will suffice for compliance with the written form requirement.

In which way is the relaxation of the written form requirement problematic?

An essential purpose of the written form requirement is the protection of the interest of a purchaser of the property. Since rental agreements are assumed by a property purchaser by operation of law in accordance with § 566 para 1 of the German Civil Code in such form as they were concluded between the original landlord and tenant, the purchaser has a vital interest in having comprehensive knowledge of the content of the lease agreements. If one accepts that in many cases the purchaser is not primarily interested in acquiring the substance of the property, but rather the cash flows generated from the rental agreements, it is obvious that the sustainability of these cash flows is of essential importance to the purchaser. Due to the resulting right of termination for the parties to the lease agreement, in the event of a breach of the written form requirement this interest is negatively affected.

In any case, the protection of the acquirer's knowledge of the entire content of the lease is potentially negatively affected by the reform. Such knowledge is easier and for the acquirer to obtain if the entire contractual agreement is embodied in one or more cross-referenced physical documents. If agreements entered into in part by exchange of e-mail or whatsapp-messages now also fulfil the written form requirement, it will become more difficult to obtain reliable knowledge of the content of the entirety of the contractual agreement as part of a legal due diligence. However, it seems doubt whether the scenarios put forward by the critics of the reform are realistic. Professional landlords and tenants will both stick to the proved and tested means of physical or electronic signing.

Then why the reform?

The written form requirement in its current strict form has developed a certain life of its own over time, and even when interpreted formally correct by the relevant courts, has produced some bizarre bloopers that were simply no longer explainable to landlords and tenant alike. E.g. there was a time during which the letting of undeveloped premises with the intended fixed lease term did not seem possible because the handover date could not be included in the original lease agreement. It is also worth recalling the time when a rental agreement that may have been validly concluded and whose content was 100% consistent with the parties' agreements was deemed not to comply with the written form requirement due to a long period of time between the signature of the tenant and landlord on the document. It was only in 2010 that the Federal Court of Justice remedied this flaw after years of uncertainty.

Even today, spaces left blank in the signature block of a written lease agreement can lead to violations of the written form requirement, even though the lease was signed by individuals with sufficient signing power. None of these examples serve the interest of a purchaser of a property. It is the expectation that many of these case group will be resolved, that provides the reform with legitimacy. Details remain to be sorted. In particular the question what the future requirements regarding cross-reference will be in the event of multiple separate agreements of the parties, potentially via various electronic and non-electronic means.

How will purchasers be protected for the rest?

The criticism voiced regarding the draft bill largely relates to potential weakening of the protection of purchasers. This would best be prevented by retaining the current strict written form requirement.

1. International context

A glance outside the box shows that Germany, with its strict requirement regarding the written form of lease agreement, is an exception internationally. Other jurisdictions are also familiar with the concept of the purchaser assuming existing lease agreements in the course of an acquisition. How are the interests of the purchaser protected in such jurisdictions? One means of choice, for example, is a declaration of conformity issued by the tenant (e.g. in the USA: Estoppel Certificates).

2. Lease Agreements

German commercial lease agreements already often include, in various forms, an obligation of the tenant to issue a declaration regarding the completeness and correctness of the lease documentation provided to the tenant by the landlord in the event of a sale, which the landlord may bring to the attention of the potential purchaser. In the future, increased attention will be paid to these declarations when drafting lease agreements and when conducting a real estate due diligence. With regard to the contractual negotiation of lease agreements, particular care will have to be taken to ensure that the agreement of the corresponding provision does not constitute a violation of the relevant statutory provisions relating to general terms and conditions (allgemeine Geschäftsbedingungen, AGB).

3. Purchase Agreements

The reform will likely also have significant consequences for the drafting of purchase contracts. Here, too, it is possible to increase the protection of the purchaser. Until now, sellers have usually been able to avoid having to provide a guarantee relating to the compliance of the lease agreements with the written form requirement, oftentimes with reference to the corresponding legal uncertainty. This may change with the upcoming relaxation of the written form requirement, which should result in a substantial simplification. A buyer may be able to insist on corresponding guarantees.

Electronic Signing

One major advantage of the revised law will be that the signing of commercial lease agreements using electronic procedures (keyword: DocuSign) will satisfy the written form requirement. Under the current regime, lease agreements were already sometimes entered into using electronic procedures. The consequences of the fact of the evidence that the electronic signatures are genuine is not embodied in the physical lease agreement (i.e. the paper copy) on the compliance with the written form requirement was, however, not entirely clear. Now, it is safe to assume that electronic signing procedures in itself do not constitute a breach of the written for requirement.

Grandfathering Provisions

The relaxation of the written form requirement shall apply also to commercial lease agreements concluded before the law came into force, provided that the parties agree accordingly. In case they do not, a transitional period of 12 months starting with the law coming into force shall apply, during which the written form requirement in its current form continues remains in force. Critics have rightfully pointed out that these grandfathering provisions may lead to a certain degree of uncertainty. In general, this seems, however, to not have a material detrimental impact on the reform.

Summary

In general, the effects of the reformation of the requirements regarding the written form of commercial leases appear to be positive. As with any change in legislation, there are questions of doubt. However, the facilitations and likely simplifications appear to be more significant.