- Can Security be granted to a foreign lender?
- Can banks take a mortgage over land and buildings on the land?
- What are the mechanisms for registering land and for registering and perfecting security?
- Can the Bank use a Security Trustee to hold security on trust for creditors?
- Does the landlord/borrower have control over changes in tenants if the tenant wants to transfer the lease to a new tenant and is the original tenant still bound by the lease?
- How can the Bank enforce security?
- Is there anything else that you would specifically point out to a UK lender as being unusual or particularly difficult?
- B. Security Over Shares
- C. Leases
1. Can Security be granted to a foreign lender?
Yes. In general, there are no restrictions on the ownership of land or the taking and enforcing of security rights by a foreign party.
2. Can banks take a mortgage over land and buildings on the land?
Yes. The German Civil Code (BGB) provides for two basic types of security interests over real estate, which again may appear in a number of variations and which allow the secured creditor to use the proceeds generated and/or the value represented by the real estate to discharge the secured liability. One is the accessory mortgage (Hypothek), the other is the abstract land charge (Grundschuld). Both concepts confer a right in rem to the secured creditor which allows him to enforce payment of a certain amount of money ‘out of the real estate’ in the case of the debtor’s default. The land charge represents the more popular and commonly used type of security over real estate as opposed to an accessory mortgage. The reason is that a land charge does not directly link the security right to the existence of a particular and defined claim and, therefore, gives more flexibility to the lender than an accessory mortgage. The connection between the ‘real’ right and the secured claim is made in a special security purpose agreement.
2.1 Distinction between mortgages on land and buildings on land.
There is no such distinction. A land charge is granted over a plot of land but the scope of the security interests extends to the economic entity established on the encumbered land as a whole. Buildings on the land are considered as belonging to the land (sec. 94 German Civil Code) and will automatically be encumbered by a land charge. Furthermore, the land charge generally encompasses accessories as well as fruits and produces of the land. In principle, a building cannot be separately encumbered by way of land charge.
2.2 Are mortgage certificates for a certain value issued? What is the cost? Are they transferable?
A security interest over land can take both the form of a certificated land charge/mortgage (Briefgrundschuld/Briefhypothek) or the form of a uncertificated land charge/mortgage (Buchgrundschuld/Buchhypothek). In both cases the costs are the same (cf. below 3.2).
A certificated land charge can be transferred by a written assignment and the delivery of the certificate whereas in case of non-certificated land charges the transfer requires a respective entry in the land register and the declaration of the parties needs to be attested be registerable with the land register.
A certificated land charge can be transferred by a written assignment and the delivery of the certificate whereas in case of non-certificated land charges the transfer requires a respective entry in the land register and the declaration of the parties needs to be attested by a German notary to be registerable with the land register.
2.3 Can second ranking security be taken? If so how is it registered?
Yes. The registration procedure is the same as in case of a first ranking land charge. The rank and priority of a land charge depends in principle on the sequence of its entry in the land register. The land charge which is registered first ranks prior to all subsequent land charges and other subsequent encumbrances. However, the ranking may also be changed after registration of the land charge by way of an agreement between the respective secured parties.
2.4 Can the real estate be transferred to a third party (being still subject to the mortgage) without the lender’s consent?
Yes. German statutory law does not require the mortgagee’s consent for any transfers since the registered mortgages and other encumbrances will remain in force so that the mortgagee’s legal position is not adversely affected by the transfer of the real estate to a third party.
2.5 Are there any preferred creditors (other than a prior ranking mortgage holder)?
In addition to mortgages which are registered in Section III of the German land register German law also provides for other encumbrances, such as easements (Dienstbarkeiten) like, for example, rights of way and rights of use, and annuity charges (Reallasten), which are registered in Section II of the German land register. The priority of these encumbrances depends on their time of registration so that all entries in Section II of the German land register which were registered prior to the relevant land charge in Section III will be prior in rank. In case of an enforcement the holders of such prior ranking encumbrances will be preferred creditors for an amount to be fixed by the court representing the value of their encumbrance which falls away as the result of the court auction.
Furthermore, the German Law on Compulsory Enforcement (ZVG) provides for certain privileged security interests. For the purpose of the distribution of enforcement proceeds the following claims have priority in the following order: (i) certain interests incurred in connection with a compulsory administration (Zwangsverwaltung) of the respective real estate property; (ii) certain claims of a receiver (Insolvenzverwalter) if the forced execution takes place in connection with an insolvency proceeding; (iii) certain claims in connection with a compulsory execution regarding commonhold property; and (iv) claims in connection with public easements, recurring benefits, particularly without limitation real estate tax, interest, surcharges or pension benefits.
It is noteworthy that under German law certain encumbrances on the real estate property, such as in particular public easements, are not shown in the land charge register. However, most of the federal states provide for registers with respect to such public easements.
2.6 Can “all monies” mortgages be taken?
The granting of an “all monies” mortgage, i.e. a mortgage securing an unlimited indebtedness which is not determined at the time the mortgage is created, is not possible under German law. However, in case of a land charge (Grundschuld) the parties only need to specify the maximum amount without linking it to particular claims so that by entering into a respective security purpose agreement (cf. answer 2 above) the parties can agree that – up to the maximum amount of the land charge – “all monies” owed by the mortgagor to the mortgagee presently or in the future in connection with their business relationship shall be secured by the land charge.
2.7 Can a landlord’s right to receive rent be charged, assigned or transferred to a lender by way of security? If so, how?
Yes. Under German law the landlord’s rights to receive rent can be assigned by an assignment agreement. It needs to be noted, however, that in case of an insolvency of the landlord rent assignments will only be valid for the rent falling due up to and including the month in which insolvency proceedings are opened, while the assignment of rent for later time periods ceases to be effective.
2.8 It is customary/possible for a lender to take a charge/security over bank accounts of the borrower? Is it usual for lenders to contractually restrict rights to withdraw funds in accounts until the scheduled interest and capital repayments are made?
Under German law the borrower may grant a pledge over his bank account in favour of the lender. It is also possible to make contractual arrangements for blocked accounts, such as e.g. debt service reserve accounts. In case of German account pledges it needs to be noted that the standard terms and conditions of German banks provide for an account pledge of all accounts opened so that a respective waiver of the account bank is required for the lender’s account pledge to become prior in rank.
3. What are the mechanisms for registering land and for registering and perfecting security?
3.1 Consequences of failure to register
A land charge is not perfected and does not exist as long as it has not been registered in the land register. In particular, until the time of registration, the chargee will not be protected by the publicity rules of the land register (sec. 892 German Civil Code) so that third parties can acquire the property without the still unregistered land charge (or other encumbrance).
3.2 Formalities for execution of security and costs?
3.2.1 Formalities for execution of security
The creation of a land charge requires a notarially certified consent in respect of the registration of the land charge from the owner of the property and registration of the land charge in the relevant local land register.
The costs associated with creating a security interest on German real estate include the notary’s fees and the fees of the land register. The notary is entitled to notarial fees in connection with the attestation (Beglaubigung) of the mortgage deed and the notarial recording (Beurkundung) of the submission to immediate forced execution by the property owner which is generally required by German banks. In order for the land charge to be immediately enforceable, i.e. without the necessity of the chargee to obtain a court judgement first, the owner of the property has to execute a notarial deed whereby the owner submits itself to immediate forced execution. Since not only the signature of the owner is notarially certified but the whole deed is notarially recorded, the notary fees for the submission to immediate forced execution can be substantial. The land register charges a fee for the registration of the land charge. Both the notarial fees and the registration fees depend on the amount of the land charge and the amount to which the owner submits itself to immediate forced execution and will be calculated on the basis of an official German legal cost statute (Gerichts- und Notarkostengesetz).
4. Can the Bank use a Security Trustee to hold security on trust for creditors?
Under German Law, there is no concept of trust similar to English law. However, it is possible for a security trustee to hold non-accessory security interests such as land charges (but not accessory security rights such as mortgages and pledges) in its own name but for the account of the secured lenders. A parallel debt structure may be used to enable a bank to act as security trustee also in respect of accessory security rights. In case one bank acts as security trustee the secured lenders might bear the insolvency risk of the security trustee.
4.1. What happens if the lenders change later on e.g. on a transfer? Does new security have to be signed?
If the concept of the security trustee is used, no new security document needs to be signed. Otherwise it depends on the type of security: Accessory security rights (such as e.g. pledges) will automatically be transferred together with the secured claims while non-accessory security rights (such as e.g. land charges) need to be transferred by a separate agreement.
5. Does the landlord/borrower have control over changes in tenants if the tenant wants to transfer the lease to a new tenant and is the original tenant still bound by the lease?
In general, a transfer of the lease to another tenant requires the consent of the landlord. However, a tenant of a residential lease may sublet part of the premises if he has a legitimate interest to do so. In this case, the original tenant will still be bound by the lease and be liable vis-à-vis the landlord under the lease agreement.
6. How can the Bank enforce security?
6.1 Can a foreign jurisdiction (either a court or arbitral tribunal) be chosen to settle disputes and under what circumstances may such a choice not be recognised?
In general, under German domestic law and under the Council Regulation (EC) No 44/2001 on jurisdiction and the recognition and enforcement of judgements in civil and commercial matters, the parties to a contract can chose a foreign jurisdiction to settle disputes. However, disputes relating to land securities and disputes relating to lease agreements can only be settled by the (locally) competent German court.
6.2 Does the local law allow for the enforcement of arbitral awards or foreign judgements without review?
German domestic law generally allows the enforcement of domestic arbitral awards without review. The enforcement of foreign arbitral awards is governed by international treaties (such as e.g. the New York Convention).
Based on European law foreign judgements or payment orders issued in other EU Member States may be enforceable in Germany without a review of the merits of the case (cf. e.g. Council Regulation (EC) No 44/2001 on jurisdiction and the recognition and enforcement of judgements in civil and commercial matters, Regulation (EC) No 805/2004 creating a European enforcement order for uncontested claims, Regulation (EC) No 1896/2006 creating a European order for payment procedure).
Other foreign judgements may be also recognised and enforced in Germany without such review if the requirements of sec. 328 of the German Code on Civil Procedure (ZPO) are met (in particular reciprocity of recognition, no violation of public policy or due process of law, no contradiction with other judgements).
6.3 How can that security be enforced? Can it be sold to a third party? Is it possible for a secured party to appoint receivers/liquidators and if so how and what are their powers? Can security be enforced directly without recourse to the courts and are private sales of security possible? Does it have to be sold by auction?
The enforcement of a land charge can be achieved by an application for execution after the chargee has obtained an enforceable judgment. Furthermore, the chargee may, at the time the land charge is granted, request the notary to issue an immediately enforceable copy (vollstreckbare Ausfertigung) of the land charge that enables the chargee to enforce the land charge immediately by applying for enforcement proceedings without having to first obtain an enforceable title by initiating separate legal proceedings.
The German law on Compulsory Enforcement (ZVG) provides for two main possibilities of enforcement;
Either the chargee may apply for a compulsory court sale in which case the real estate will be auctioned through respective court proceedings following which the proceeds of the auction will be distributed to the chargee and other preferred creditors in the order of their priorities. A private sale would only be possible if the lender/chargee and the borrower/charger jointly agree that the borrower sells the property by way of a private sale.
The second possibility for the chargee is to apply for a compulsory administration (Zwangsverwaltung) in order to benefit from the income of the real estate property. The competent court will in that case appoint an administrator who will administer the real estate property and distribute the income from the real estate to the secured creditors in the order of their priorities.
Under German law, land charges are assignable and can be sold and transferred to third parties.
6.4 Is the lender responsible for maintenance and insurance of the real estate after default until sale?
Pursuant to the German law on Compulsory Enforcement (ZVG) the administration and use of the real estate remains with the debtor within the limits of due management of the property unless these duties are transferred to a court appointed administrator in case of a compulsory administration.
6.5 Is there a method of foreclosure (lender obtaining good title to the real estate in satisfaction of all or part of its debt)? If so, does this require a court order and is it only automatically used when the real estate is not sold at public auction?
In case of a compulsory court sale (cf. answer 6.3 above) the lender can submit bids and thereby acquire the property for himself.
7. Is there anything else that you would specifically point out to a UK lender as being unusual or particularly difficult?
Under German law the enforcement of land charges whether by a compulsory court sale or by a compulsory administration follows strict and complex rules which are administered and/or monitored by the competent German court. Only in rare cases can a land chargee be authorised by the court to appoint its own administrator.
B. Security Over Shares
In Germany, real estate is regularly held by single purpose vehicles incorporated as limited liability companies or limited partnerships. We therefore highlight the specific issues that arise in the context of enforcing a security interest taken over the shares of a German limited liability company and a limited partnership.
1. Can security be granted to a foreign lender?
Security over shares in a German limited liability company or a limited partnership can be granted to foreign lenders.
2. Can second ranking security be taken? If so, how is it registered?
Second ranking plegdes over shares in a German limited liability company or a limited partnership can be taken. The granting of a pledge over such shares does not require registration (but notification to the company). The rank of multiple pledges over one share is determined by the chronological order in which the pledges were created.
3. What are the mechanisms for registering and perfecting security?
3.1 Consequences of failure to register?
Neither the granting of security over shares in a German limited liability company nor over shares of a limited partnership requires registration.
3.2 Formalities for execution of security and costs?
The pledge of shares in a German limited liability company (GmbH) is done in the same way as a transfer of shares in such company: pledgor and pledgee have to conclude a notarised share pledge agreement. In addition, depending on the articles of association of the company the consent of the shareholders’ meeting or the other shareholders of the company regarding the pledge of a share may be required. Furthermore, the pledge needs to be notified to the company.
The pledge of an interest in a German limited partnership (KG) only requires the conclusion of an agreement between pledgor and pledgee and the consent of the other partners, if any. The agreement between pledgor and pledgee does not have to meet any formal requirement; in particular, no notarisation or registration is required. However, a notarisation of the pledge agreement is required in case the pledge of the interest in the limited partnership is combined with the pledge of the shares in the general partner of the partnership that is a limited liability company (GmbH & Co. KG).
The costs for the notarisation of a share pledge agreement regarding shares of a German limited liability company depend on the lower of (i) the value of secured obligation or (ii) the market value of the pledged share. Depending on the relevant values the notarization costs which are calculated on the basis of an official German legal cost statute can be substantial.
4. Do the shares need to be transferred into the name of the lender or its nominee?
A transfer of shares is not required for the granting of an interest in the shares.
5. How can the lender enforce its security?
5.1 Can it be sold to a third party? Is it possible for a secured party to appoint receivers/liquidators and if so how and what are their powers? Can security be enforced directly without recourse to any courts and are private sales of security possible? Does it have to be sold by auction?
In principle, the enforcement of a pledged share requires an executory title pursuant to the German Code of Civil Procedure, e.g. a court decision, but pledgor and pledgee may agree on waiving the requirement of an executory title.
When the requirements for the enforcement of the pledge (Pfandreife) are met, the court competent for execution may, upon application by the pledgee, issue an attachment order regarding the pledged share. The attachment order has to be served upon the shareholder and the company.
Only the court competent for execution decides on the procedure of the realisation of the pledge. The pledged share may be realised by public auction or a private sale. The private sale is usually carried out by the bailiff, but the court may also appoint a third person.
As it is often difficult to realize a share pledge successfully through a public auction, the pledgee may request the court to decide on a private sale through the pledgee or a direct transfer of the share to the pledgee. However, the parties of the share pledge agreement cannot agree on a certain procedure, the decision remains with the court competent for execution.
The aforementioned procedure basically applies to the enforcement of a pledged interest in a limited partnership accordingly. However, the sale of the interest in a limited partnership through a public auction or a private sale is only possible if the sale of the interest is generally permitted by the articles of association or if the other partners of the partnership agree to the sale in the individual case.
If the sale is not possible, the pledgee may terminate the partnership. To avoid the termination of the partnership, the articles of association of a limited partnership often provide that the issuance of an attachment order regarding a share in the partnership results in the exclusion of the respective partner. In these cases the pledgee is entitled to a settlement payment.
As a pledge is a security instrument of strictly accessory nature, the pledge of a share of a company cannot be transferred separately but will automatically be transferred to a third party in case of a transfer of the secured claims.
5.2 Are loans from shareholders subordinated? If so, how is it done? Is it customary for such loans to be waived or written off contractually as part of an enforcement of a share pledge should a default occur?
Pursuant to German insolvency law the repayment claims of shareholders in respect of loans granted to a company are subordinated by law in case of an insolvency of the company (i.e. they rank inter alia behind claims of normal third party creditors).
In addition, contractual subordination agreements are sometimes concluded between the shareholders, lenders and the company to provide for a subordination of the shareholder loan already prior to an insolvency situation. Finally, if the subordination by the shareholder meets certain criteria, it can also avoid the commencement of insolvency proceedings due to an over-indebtedness since in case of a “qualified subordination” by the shareholder the repayment claims will no longer have to be taken into account as indebtedness.
We usually would expect the lease to be an operating lease and therefore the lessor would not be required to obtain a financial services license in accordance with the German Banking Act (KWG). In case of a financial lease, the details need to be assessed taking into account the individual circumstances.
Legal issues that would be likely to impact upon the valuation and the security of income from an investment perspective.
1. Lease Structure
1.1 Typical lease length?
The length of the lease is determined by the parties in accordance with their economic needs, subject to the comments below. Many commercial leases have a fixed term of 5 to 10 years. Tenants are often granted options to extend the leases (2 to 5 years).
1.2 Maximum/minimum lease length if any?
The fixed term of the lease is 30 years at most. After the expiration of 30 years, the lease can be terminated by either party. So called “chain leases” are permitted, if the new agreement is an independent expression of the parties’ intent. Thus, the parties can agree on consecutive lease agreements with a fixed term amounting to more than 30 years (if e.g. they agree on a new lease with identical conditions with a fixed term of 30 years after 7 years of the initial 30-year-term have already expired, the parties can virtually agree on a 37 year term). However, the parties can also agree on a registered permanent lease (Dauernutzungsrecht) under the German Condominium Act (Wohnungseigentumsgesetz), should they desire a term of more than 30 years.
1.3 Statutory controls and obligations re renewal/termination of leases (does tenant have automatic right to renewal or can they apply to the courts for a new lease); also does some form of notice have to be served to terminate a lease to avoid renewal?)
A fixed term lease expires automatically at the end of the term, unless the parties have agreed on an extension option or an automatic extension. A lease created for an indefinite period of time is subject to ordinary termination by either party and expires at the end of the respective contractual or statutory notice period.
However, if after termination of the lease the tenant is still using the property with the approval of the landlord the lease is deemed to be extended for an indefinite period of time and can be terminated by either party within the statutory notice period.
1.4 Any overriding statutes concerning the ability of the tenant to break a fixed term lease (whether or not included as a term of the lease)?
Either party may terminate the lease agreement for good cause with immediate effect (i.e. in case of material default of the other party), if under the circumstances of the individual case and consideration of the parties’ interests a continuation of the lease cannot be expected from the terminating party. This can be, inter alia, the case, if the landlord does not hand over the leased property or does not warrant the contractual use vis-à-vis the tenant, e.g. if the leased property is defective in a way that is preventing the tenant from using the property in the contractually stipulated way.
1.5 Any other security of tenure provisions available to a tenant that would frustrate possession or prevent receipt of market rents?
Any limitation of the contractually stipulated use (e.g. road blocks, noise and so on) that is not unsubstantial may entitle the tenant to reduce the rent or even to claim compensation for damages.
2. Rent/Rent Reviews
2.1 Rental income receivable quarterly/monthly in-advance/in-arrears?
Usually, rent of a fixed sum per month or per year is agreed upon. For shopping centres or other retail properties, hotels and restaurants payment of a turnover rent is widespread, sometimes in addition to a fixed (base) rent. Rent is usually paid monthly in advance. Quarterly payments in advance are rarely accepted.
2.2 Periodicity of reviews?
Usually, rent is adjusted every two or three years. It is also usual practice for the rent to be adjusted according to changes of the consumer price index on an annual or permanent basis. Automatic changes of the rent in accordance with changes of the consumer price index require that the landlord be bound by the lease for 10 years at least.
2.3 Basis of review (upwards-only or variable, indexation or market rent)?
It is usual practice for the rent to be adjusted according to the changes of the consumer price index (up or down). In market practice the rent is often adjusted if the index changes by more than 10 index points or percent. In many cases the adjustment to be made is not identical to the adjustment of the index, but is a certain percentage of this change (e.g. 80%). Instead of an indexation of the rent, the parties may also agree on a progressive rent which increases in a fixed quantum.
2.4 Are rents/reviews subject to statutory control in regard to quantum or increase (i.e. rent control)?
A provision whereby the rent is automatically adjusted will only be regarded as valid if it falls into one of the exemptions stipulated in the German Price Clause Act (Preisklauselgesetz). Such an exemption applies if the term of the lease from the tenant’s point of view (i.e. extension options in favour of the tenant are included) is at least 10 years and the rent is adjusted both upwards and downwards in accordance with a price index fixed by the German Federal Statistical Office (Statistisches Bundesamt). In case of an infringement of the German Price Clause Act, however, the relevant provision is valid until the infringement of the relevant statutory regulations is determined by a court with binding effect.
3. Lease obligations: who has responsibility for:
3.1 Internal maintenance, decoration and repair?
Under the provisions of the German Civil Code, the landlord is generally obliged to maintain and repair the let property, including interior decoration and repairs. In practice, however, these obligations are usually passed on to the tenant to a large extent except for the maintenance of roof and structure of the buildings (Dach und Fach).
3.2 External maintenance, decoration and repair?
Pursuant to German law, the landlord is generally obliged to keep the leased premises in a condition suitable for the agreed use and maintain them in such condition throughout the period of the lease. In practice, however, these obligations are usually passed on to the tenant. The costs for the maintenance of commonly used spaces and outside areas are also usually passed to the tenants as ancillary costs to a certain extent.
3.3 Structural repairs?
Whereas the responsibility for the internal and external maintenance may – at least in commercial leases – be passed on to a wide extent to the tenant, the landlord remains regularly responsible for structural repairs, i.e. repairs of the roof and structure of the building.
Whereas insurance is not obligatory, the landlord normally takes out insurance for basic insurance risks (Elementarschäden) against fire, storm, hail, flood water etc., while the tenant usually takes out operational liability insurance which covers any damage caused by the tenant’s operations. The full cost of property insurances taken out by the landlord will normally be passed on to the tenant as part of the service charge.
Under leases for commercial use, the landlord has the option of choosing to add the VAT to the rent or not, if the tenant’s business transactions conducted in the lease premises are subject to VAT as well. Otherwise, the landlord may not be able to recover VAT.
In addition to the service charge, the parties normally agree that the tenant must pay other ancillary costs, such as public charges (in particular, real estate tax) and premiums for insurance taken out by the landlord.
3.7 The ability to recoup any landlord outgoings (including management costs) by way of service charges?
In order to charge any costs to the tenant, the lease agreement must precisely state each type of costs. Generally, a large part of landlord’s outgoings are charged to the tenant, including – under commercial lease – management costs. There are, however certain restrictions to be observed if the lease agreement is used repeatedly and thus subject to a higher standard of scrutiny which under German law applies for general terms and conditions (AGB).
4.1 Are terms of leases/contracts recognised and supported by case law in the jurisdiction?
Unless specific clauses are deemed invalid pursuant to the German standard terms and conditions (AGB) regulations incorporated in the German Civil Code, contractual stipulations and terms of leases are, in general, enforceable and supported by the German courts as long as they do not conflict with obligatory statutory provisions.
5.1 To be recognised in the courts, does an appraisal have to be prepared by some domestically regulated/qualified party or is an RICS (Royal Institution of Chartered Surveyors)-qualified appraisal report accepted and recognised in each jurisdiction?
To be recognised by a court, a property valuation must be made by a domestically regulated and qualified expert.
5.2 Is it possible to obtain environmental reports from a local government agency or a qualified, insured environmental professional?
The German municipalities keep registers in which environmental dangers or findings are recorded and which are open to public review. However, the registers show only information that has become known to the public authority and there may be other environmental damages on the property that are not publicly known.
5.3 Is it possible for liability in respect of past or present breaches of environmental laws to attach to a lender by it holding or enforcing a mortgage over real estate?
No, unless the lender has used the property by itself or becomes the owner of the property as successful bidder in the auction when enforcing the mortgage. Statutory environmental liability is only possible for former and present owners and users of the property as well as for the person responsible for the environmental damage.