Germany: No realisation of rental collaterals due to contested claims during ongoing residential tenancy

29 October 2014

Dr. Vera Meyer

In its decision of 7 May 2014 (VIII ZR 234/13) the German Federal High Court of Justice (Bundesgerichtshof, BGH) was concerned with the extent of a landlord’s right to realize the rental collateral provided by the tenant. The BGH dealt with the question whether the landlord was entitled to realize the rental collateral during current residential tenancy due to claims which are a matter of dispute between the parties.

I. Purpose of rental collateral

Rental collaterals serve the purpose to provide security for the landlord in case the tenant does not fulfil his contractual obligations. At the same time, the tenant shall be protected from the landlord utilizing the rental collateral as he likes. In order to balance these interests appropriately sec. 551 of the German Civil Code (Bürgerliches Gesetzbuch, BGB) contains several provisions which need to be observed in case of residential tenancies: According to sec. 551 para. 1 the amount of a rental collateral shall not exceed the amount of three monthly rents. According to sec. 551 para. 2 a tenant is entitled to pay the rental collateral by instalments. According to sec. 551 para. 3 a landlord is obliged to invest the rental collateral at interest. The investment has to be separated from the landlord’s assets to ensure that the rental collateral is not accessible for the landlord’s creditors. The tenant shall receive the interest. According to sec. 551 para. 4 agreements which deviate from the aforementioned provisions to the detriment of the tenant are void.

II. Facts

The plaintiff was tenant of an apartment owned by the defendant. According to a provision of a side letter to the lease agreement the defendant was entitled to satisfy claims due during the tenancy realizing the rental collateral and the plaintiff was obliged to replenish the rental collateral so it would have its original balance.

In the course of the tenancy the plaintiff claimed for rent reduction. The defendant had the rental collateral paid out to him during the current tenancy due to the contested claim which led to the rent reduction. By means of the application the plaintiff claims for credit and reinvestment of the rental collateral’s amount separated from the defendant’s assets.

III. Decision of the BGH

Pursuant to the decision of the BGH the plaintiff is entitled to claim replenishment and reinvestment of the rental collateral’s amount according to sec. 551 para. 3 BGB. The BGH considered the parties’ agreement deviating from statutory regulations to the detriment of the plaintiff invalid.

As the BGH states in the grounds of its judgment, the defendant was not entitled to realize the rental collateral during the ongoing tenancy due to a tested claim because during tenancy a landlord holds the tenant’s (and thus another party’s) assets in trust. Realizing the rental collateral during the current tendency would be contradictory to the trust relationship between landlord and tenant with regard to a rental collateral as indicated in sec. 551 para. 3 BGB. A landlord is only entitled to realize a rental collateral during the current tendency in case of uncontested claims or claims determined legally valid by a court or in case realization of the rental collateral is in the interests of a tenant. If a landlord was entitled to realize a rental collateral during the ongoing tendency due to contested claims or claims not determined by a court there would be a huge number of lawsuits requiring indirect examination whether alleged claims are substantiated and due.

Furthermore, the BGH clarifies that a landlord’s need to be protected against a tenant not fulfilling contractual obligations is not limited by restricting the right to realize a rental collateral because the rental collateral granted in favour of the landlord remains in the landlord’s hands. Rental collaterals do not serve the purpose to allow landlords to realize the granted amount immediately in order to satisfy their claims during the ongoing tenancy. By imposing the obligation on landlords to invest the rental collateral separated from their own assets according to sec. 551 para. 3 BGB, the legislator intended to enable tenants to receive an undiminished repayment of the amount granted as rental collateral after termination of the tenancy in case the landlord is insolvent insofar as no uncontested claims of the landlord exist. This objective would be disrupted if the landlord was entitled to realize the rental collateral during the current tenancy due to contested claims.

IV. Practice Notes

The BGH provides clarity for cases as the one at hand: A landlord is not entitled to realize the rental collateral during ongoing tenancy due to contested claims. Agreements between a landlord and a tenant entitling the landlord to realization are void. Landlords shall only be entitled to realization if their claims are uncontested or determined by a court or realization is conducted in favour of the tenant, e.g. the landlord is not entitled to terminate the lease agreement any more since realization of the rental collateral results in satisfaction of the landlord’s claims.

The BGH does not decide on the question whether a landlord is entitled to realize the rental collateral due to contested claims after the tenancy was terminated. The landlord’s entitlement is indicated by the fact that after termination of the tenancy rental collaterals do not only serve security purposes but also realization purposes. These realization purposes may lead to the conclusion that in case of proper invoicing a landlord is entitled to realize the rental collateral due to contested claims after the tenancy was terminated. However, caution is advisable when utilizing rental collaterals after termination of the tenancy because the landlord’s obligation to invest the rental collateral at interest continues to exist even after the tendency was terminated.

Furthermore, the BGH does not expressively state whether in case of a commercial tenancy a landlord is not entitled to realize the rental collateral due to contested claims as well. Since sec. 551 BGB which protects tenants from inappropriate utilization of rental collaterals by the landlord is not applicable to commercial tenancy, the decision of the BGH might not be applicable to commercial tenancy accordingly. Section 551 BGB only applies to residential tenancy. However, landlords of commercial properties are obliged to hold a rental collateral in trust for tenants, although sec. 551 BGB is not applicable to commercial tenancy. They are also obliged to keep the amount they received separated from their own assets in order to prevent their creditors from accessing the tenant’s money. As the decision of the BGH refers to these obligations of a landlord, it is possible that the BGH might restrict the right of landlords to realize rental collaterals during the ongoing tenancy due to contested claims. A final decision by the BGH dealing with this question in the context of commercial tenancies remains to be seen. Until then, it is recommendable for landlords to include a clause in a commercial lease agreement stating that the landlord is entitled to realize rental collaterals during the ongoing tenancy due to contested claims and the tenant is obliged to replenish the rental collateral to its original balance. There is a residual risk that such a clause would fail a judicial review with respect to general terms and conditions.