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The Berlin government’s envisaged five-year rent cap on residential properties has caused significant uncertainty among investors in housing portfolios.

By Constanze Kugler and Christian Thiele

On 18 June 2019, the Berlin Senate published a position paper specifying details of an envisaged five-year rent cap on residential properties in the German capital. The cap would significantly strengthen current restrictions on rent increases, which can only occur subject to certain rules and within certain limits. Berlin’s government aims to pass the statute later this year and enter it into force no later than January 2020.

Key Provisions

The position paper outlines the following key terms of the rent cap:

Federal Ministry of Finance publishes draft tax bill outlining new measures effective 1 January 2020.

By Tobias Klass

The Federal Ministry of Finance has released its first draft tax bill on the contemplated real estate transfer tax (RETT) reform, setting out the general framework to which market participants must conform. German political debate has focused on strengthening German RETT laws for some time. The Conference of the German Ministers of Finance added weight to this political debate in June 2018, requesting that tax department heads of the federal and state ministries of finance transfer the resolution into a draft bill. Consequently, market participants have structured transactions to account for considerable uncertainties as regards RETT consequences.

The proposed draft measures are consistent with those outlined in June 2018, however, for the first time, market participants are gaining more clarity about when the new rules likely will apply. Generally speaking, the new rules will only apply to transactions as of 1 January 2020.

While a shareholders’ resolution is still required, the FCJ left open the question of whether notarization of the resolution is necessary.

By Christian Thiele and Otto von Gruben

The German Federal Court of Justice (FCJ) decided on 8 January 2019 that Section 179a (1) of the German Stock Corporation Act (AktG) does not apply mutatis mutandis to a German GmbH (II ZR 364/18). The decision contradicts the prevailing view in legal literature so far, pursuant to which a notarized shareholders’ resolution approving the sale and transfer of all or substantially all assets of a GmbH was required.

Background

Section 179a (1) AktG provides that an agreement, pursuant to which a German stock corporation undertakes to transfer all of its assets requires an approving shareholders’ resolution. If a respective agreement is executed without such resolution, it remains provisionally invalid until it is approved by way of a shareholders’ resolution in accordance with Section 179a (1) AktG. If the shareholders refuse to approve such agreement, it becomes permanently void.

Sellers may be liable for damages if actual rent is lower than stated in the rent roll, despite contractual exclusion of liability for defects.

By Christian Thiele and Patrick Braasch

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.

Background

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.

Ruling finds that parties may make informal modifications without notarization after the conveyance has become binding.

By Christian Thiele

The German Federal Court recently ruled that parties may informally modify a property purchase agreement if the conveyance has become binding — thereby confirming prior case law. The Court further held that the parties may also make such informal modifications if they have granted fiduciary instructions to the notary not to file the conveyance with the land register until the purchaser has paid the full purchase price.

The case

On 4 May 2011, the defendant bought three apartments from the plaintiff by virtue of a notarial purchase agreement at a price of €309,692. The parties declared the conveyance and applied for the entry in the land register. In the purchase agreement, the parties instructed the notary to file the conveyance only when the purchaser paid the full purchase price. On 24 July 2012, the defendant demanded a €27,100.76 reduction of the purchase price. The plaintiff accepted the reduction in writing, and the defendant paid the reduced price. However, the plaintiff then requested the payment of the full purchase price, arguing that the reduction of the purchase price was invalid because the amendment had not been notarized.

Proposed reforms to the Mietpreisbremse aim at strengthening and solidifying restrictions on steep rent increases in German urban areas.

By Christian Thiele and Eun-Kyung Lee

After intense discussions within the ruling coalition, the German government this week adopted a draft bill regarding the reform of German tenancy law.

What is the Mietpreisbremse?

The Mietpreisbremse (literally “rental price brake”) introduces a considerable element of rent control into the German legal system and is one of the largest political projects in the German rental market in recent years. Adopted in 2015, the measure allows the governments of the 16 German federal states to cap landlords’ rental price raises for new rentals by way of regulation. The main purpose is to prevent landlords of apartments in urban areas from significantly increasing rents following a change of tenant. According to Section 556d of the German Civil Code, the rental price in a new residential lease contract must not exceed the local comparable rent by more than 10% if the regulations have declared the relevant region as part of an area with a strained residential market. Of the 16 federal states, 11 states, including Berlin, Hamburg, and metropolitan areas in North Rhine-Westphalia and Bavaria, have so far passed such a regulation.

Real estate investors with their corporate seat and management outside of Germany may be subject to German taxation on capital gains from share deals. Non-resident individuals (investing directly or through partnerships or funds) will primarily be affected.

By Tobias Klass and Verena Seevers

According to a German draft tax bill, the sale of shares by foreign-based shareholders of foreign-based companies primarily holding real estate in Germany will trigger a new capital gains exit tax as of 1 January 2019. This change may signal a need for alternative exit strategies.

No-PE Structures

In classic No-PE structures (i.e. a structure avoiding a permanent establishment in Germany), foreign-based companies investing in German real estate are subject to German corporate income tax (at a rate of 15.8%) with respect to the company’s rental income and sale proceeds in case of asset sales of German real estate. Neither rental income nor capital gains are subject to German trade tax (generally ranging from 7-17%) if neither a company’s corporate seat nor permanent establishment is situated in Germany.

Share deal exits from No-PE structures are currently not taxable in Germany, i.e., capital gains from share deals with the target being a foreign-based real estate company (for example a Luxembourg S.à.r.l with non-German based shareholders) are not subject to German corporate income or trade tax. The draft bill aims to change that from January, 1, 2019.

FCJ decision finds that mere suspicion of contamination resulting from a sold property’s past use constitutes a defect.

By Patrick Braasch and Christian Thiele

The German Federal Court of Justice (FCJ) has ruled that an abstract suspicion of contamination resulting from a sold property’s past use already constitutes a material defect — irrespective of the actual existence of any contamination. A seller’s failure to disclose the known usage history — which objectively gives rise to the suspicion of contamination — constitutes fraudulent conduct. As a consequence, the seller cannot invoke any contractual limitation of liability.

Case background

The FCJ’s judgment, dated 21 July 2017 (V ZR 250/15), involved a case in which the plaintiff had acquired from the defendant several plots of land that had been developed as a business park. In the notarized sale and purchase agreement, any liability of the defendant was excluded, with the exception of intent and fraudulent conduct. The defendant was aware that an asphalt mixing plant for regional road construction, as well as a sewage sludge retention basin, had been operated on the property from the 1960s until the 1980s. When the defendant acquired the property in 1989, the seller at that time represented that he was not aware of any soil contamination.

The Conference of the German Ministers of Finance has announced measures against so-called share deal structures following the conclusion of the respective technical federal-state working group.

By Tobias Klass

Background

So-called share deal structures have been the focus of German political debate about real estate transfer tax (RETT) for some time. The coalition agreement already contains the governing parties’ political letter of intent to end allegedly fraudulent tax structurings regarding RETT through share deals. The background of said structures are transactions in which land or real estate is not sold directly, but indirectly, by selling the shares of the property holding company. Provided that a purchaser acquires less than 95% of the shares, RETT is not triggered under current law. If a corporation is involved in these structures, a co-investor typically will acquire the remaining shares of more than 5%. Alternatively, if a partnership is involved, the shares remain with the seller, as the mere change of shareholders in the amount of at least 95% of the partnership interests would already trigger RETT. As market participants have merely adapted to the current legal situation, referring to fraudulent structures is generally inaccurate. However, these structures became the focus of tax authorities, rendering them politically targeted.

As a first step, the current resolution of the Conference of the Ministers of Finance dated June 21, 2018 has substantiated the political discussion. The Conference asked tax department heads of the federal and state ministries of finance to transfer the resolution into a draft bill that the federal government will submit to the legislative procedure.

Increased competition among insurers and improved policy terms suggest the German W&I insurance market is becoming more favourable to investors.

By Christian Thiele

In real estate transactions, buyers and sellers naturally pursue conflicting interests when negotiating a sale and purchase agreement. On the one hand, sellers will strive to achieve the highest possible purchase price, and will also want to keep their liability exposure low. Private equity investors in particular will try to achieve a “clean exit” when selling real estate directly or indirectly, so that they can dissolve the selling entity quickly. On the other hand, buyers will want to minimize the purchase price. At the same time, they will know the asset only from their due diligence. Therefore, buyers will try to obtain a comprehensive set of representations and warranties from the seller. However, even if the seller gives such representations and warranties, asserting claims will often be unsatisfactory for the buyer because the selling entity lacks assets. The buyer will therefore insist on a security for his claims. These conflicting interests often put a significant burden on contract negotiations and can even turn into a deal-breaker.

Sell-and-buy-side W&I policies

Parties to a deal can secure the buyer’s claims in different ways, such as a purchase price retention or escrow accounts. In the current seller’s market, however, such structures are becoming increasingly rare. So-called warranty and indemnity insurances (W&I insurances), however, are becoming an increasingly popular method of securing the buyer’s claims. Either the seller or the buyer can take out such W&I insurances. If the seller takes out the insurance, the insurer reimburses the seller — similar to a liability insurance — for claims asserted by the buyer. Such policies have risks for the buyer, e.g., if the seller acts intentionally or violates his obligations under the insurance policy and the insurer refuses to reimburse the damage. Sell-side W&I policies, therefore, have almost no practical relevance, at least in real estate private equity transactions. The buyer’s preferred option is the buy-side W&I policy. Such policy grants the buyer a direct claim against the insurer in case of a damage. The buyer, therefore, does not have to assert any claims against the seller. Such policies also cover instances in which the seller has not disclosed the relevant facts and has therefore acted with gross negligence or even intentionally.