Obligation to pay rent
Business interruption insurance
The covid-19 pandemic has raised the question of whether franchisees and franchisors, as tenants, could reduce their rent in line with government-ordered closings (for more details, see “Do franchisors and franchisees still have to pay rent during a government-ordered shutdown?”).
The Federal Court of Justice has now ruled on the question of rent reductions(1) and whether an insured, on the basis of the agreed insurance conditions, can claim on his business interruption insurance policy for closings related to covid-19.(2)
This article explores these recent decisions and examines their implications for franchisees and franchisors.
Obligation to pay rent
The Federal Court of Justice has confirmed that it is possible for a tenant (for example, a franchisee or franchisor) to reduce their rent due to government-ordered closings based on breach of contract law.(3) However, the Court rejected the idea of a lump sum reduction of 50% of the rent. Instead, the effects of closing the business on the tenant and landlord must be weighed in detail in each case.
The defendant, a discount clothing retailer, had leased retail space from the plaintiff. The regional government issued a general decree to contain the covid-19 pandemic, forcing the defendant to close his store from March 19, 2020 to April 19, 2020 inclusive. While the plaintiff demanded payment of the full rent for this period, the defendant refused, arguing that the government-ordered closure was outside of its sphere of risk.
While the Chemnitz Regional Court, the competent court of first instance, ordered the tenant to pay the rent in full, the Court of Appeal, the Higher Regional Court of Dresden, overturned this decision and ordered the tenant not to pay only 50% of the rent. The appeals court ruled that none of the contracting parties caused the pandemic or could have foreseen it. The Federal Court of Justice has now overturned that ruling, saying a blanket reduction of 50% was wrong.
Official closing orders do not constitute a defect of the rented premises
The Federal Court of Justice first confirmed that government-imposed business closures did not constitute a defect of the rented premises(4) and that a legal rent reduction was therefore excluded. The rental property was available for the agreed rental purposes for the duration of the closure order.
Contract modification due to breach of contract?
The Federal Court of Justice has also confirmed most of the court decisions published to date that a change in contract resulting in an adjustment of the rent was possible via the law on breach of contract.
The Federal Court of Justice then focused on the question whether, taking into account all the circumstances of the case, in particular the contractual or legal allocation of risks, it was reasonable for the contracting parties to adhere to the unmodified contract . The Court considered that the covid-19 pandemic ultimately constituted a general life risk not covered by the risk allocation in the lease unless the contracting parties had provided for such a risk in the lease. As a rule, the associated risk cannot be attributed to a single contracting party. Therefore, the Federal Court of Justice, unlike the Higher Regional Court in Dresden, rejected an overall reduction of 50% of the rent. Instead, to determine whether honoring the unmodified contract was unreasonable, thereby requiring an adjustment of rent, the interests of the tenant and landlord in the particular case had to be weighed in detail. When weighing them, the following elements had to be taken into account in particular:
- What specific disadvantages has the tenant suffered as a result of the closure of the business and the duration of the closure?
- What actions did the tenant take (or could reasonably have taken) to reduce impending losses during business closures and/or what financial benefits did it obtain as a result of the closure?
- Has the tenant obtained any financial benefits through government grants or commercial insurance?
This is not an exhaustive list. What was essential were the specific financial effects of the business closures on the tenant and whether they had been of such magnitude that a modification of the lease was necessary.
In the case at issue, the Federal Court of Justice left open the outcome of the case-by-case assessment and did not comment on whether the tenant had the right to reduce the rent. Instead, he sent the case back to the court of appeal, the Higher Regional Court in Dresden, to make such an assessment.
Business interruption insurance
In another judgment, the Federal Court of Justice decided that, on the basis of the insurance conditions agreed between the parties to the litigation, the insured parties (for example, the franchisors or the franchisees) cannot claim their insurance against losses operations following a business closure related to the covid-19 pandemic.
The plaintiff, who operated a restaurant, held a business interruption insurance policy with the insurer against whom he brought the action. Because the regional government issued a general order to mitigate the covid-19 pandemic, the plaintiff had to close his restaurant in April 2020 and claimed compensation from the insurer based on this policy due to the closure of his restaurant. The insurance conditions listed certain diseases and pathogens within the meaning of the German Infection Control Act for the establishment of an insurance claim. The list did not specifically mention covid-19, severe acute respiratory syndrome (SARS) coronavirus (SARS-CoV) or SARS-CoV-2.
Both the Regional Court of Lübeck, the competent court of first instance,(5) and the court of appeal, the Higher Regional Court of Schleswig-Holstein(6), rejected the plaintiff’s claim for payment. This has just been confirmed by the Federal Court of Justice.
Covid-19 and SARS-CoV-2 are not covered by insurance
The Federal Court of Justice first upheld the lower courts’ interpretation of the insurance terms, finding that a business closure to prevent the spread of covid-19 disease or the SARS-CoV- 2 was not covered by the insurance policy.
Under the express terms of the policy, coverage only extended to business closures imposed to prevent the spread of reportable diseases or pathogens. Notifiable diseases or pathogens were named in an exhaustive list, which did not contain the covid-19 disease or the SARS-CoV-2 pathogen. The meaning and purpose of the clause also supported the view that the list was exhaustive, according to the court. The Court said the average insured cannot assume that an insurer is willing to provide coverage for unlisted diseases and pathogens. Moreover, as illnesses can occur years after the conclusion of a contract (such as covid-19), due to the imponderable nature of the risk to be insured, the insurer would not be able to calculate appropriate premiums.
No violation of the law on the general conditions of sale
The Federal Court of Justice also confirmed that the insurance conditions did not violate the General Terms and Conditions Act, in particular the principle of transparency. From the wording of the insurance conditions, it was clear that notifiable diseases and pathogens were definitively defined. An average insured person would not feel that every business closure on the basis of German infection control law was covered by the relevant policy or that the insurer would be liable even for diseases and pathogens not listed which appeared only after the conclusion of the contract.
These decisions of the Federal Court of Justice specify that in matters of commercial leases, the closures of companies linked to covid do not constitute a defect of the rented premises, although a reduction in rent remains possible. Whether such a reduction is possible and, if so, to what extent, must be carefully considered on a case-by-case basis. It will be interesting to see how the Higher Regional Court in Dresden, and other courts for that matter, further elaborate the guidelines set by the Federal Court of Justice for making such an assessment.
With particular regard to franchise law, it remains to be seen how the courts will carry out a case-by-case assessment as required by the Federal Court of Justice – for example, what criteria will be used to decide whether of a rent reduction and whether other franchise-specific factors will also need to be considered beyond the standards imposed by the Federal Court of Justice.
It is now also clear that, depending on the exact terms of the relevant business interruption insurance, there is no entitlement to reimbursement for losses due to official closure orders during the covid-19 pandemic. Although this decision concerns only one case, it can be considered as a historical decision: the insurer is not liable for unlisted diseases and pathogens that only arise after the conclusion of the contract. The Federal Court of Justice, like the lower courts, therefore clearly ruled in favor of the protection of insurers.
In view of these two decisions, franchisees and franchisors, as tenants, would be well advised to find an amicable solution with the owners. In fact, this has been the case quite often in practice so far.
For more information on this subject, please contact Karsten Metzlaff Where Jasmine Schulzweida at the office of Noerr LLP in Hamburg by telephone (+49 40 300 3970) or by e-mail ([email protected] Where [email protected]). Otherwise, contact Tom Billing at the office of Noerr LLP in Berlin by telephone (+49 30 20 94 20 00) or by e-mail ([email protected]). The Noerr LLP website can be accessed at www.noerr.com.