Real estate co-publishing Admissibility of Triple-Net Lease Contracts 1 by Raphael Söhlke, P+P Pöllath + Partners, Berlin Content of Triple-Net Lease Contracts sistent understanding of what characterizes the operation of the property, as far as these a triple-net lease contract, however, still are not to be borne by the lessee. In order Origin and Economic Significance does not exist. Currently, the examination to exclude this risk, a second component of Triple-net lease contracts aim to exempt is regularly broken down into individual the triple-net lease contract should provide the lessor from the costs of the leased pro- questions: for the lessee to bear all incidental and ope- perty, in order to thus secure yield realized rating expenses. The (usual) clause which from the lease payments. While such con- In financial terms, the most important cri- determines that the lessee shall be respon- tracts are quite common in Anglo-Saxon terion for a triple-net lease contract is the sible for the operational expenses pursuant countries, in Germany there is (still) some shifting of liability for maintenance and to sec. 2 of the Operating Expenses Ordi- uncertainty on both the conceptualisation repair to the lessee. According to statu- nance (Betriebskostenverordnung – Be- as well as the validity of such contracts. tory provisions, the lessor is obliged to trKV) does not, however, cover various The term “triple-net” implies that a “three- maintain the lease object in a condition other costs. Thus costs expended for the fold net” lease payment can be collected which complies with the requirements of commercial and/or technical administrati- by the lessor, i.e. without (calculated) de- the lease contract. They thereby bear the on, for instance, are not operating expenses ductions concerning tax, insurance and maintenance expenses, in other words they within the meaning of the BetrKV. maintenance. When concluding a triple-net must carry out all maintenance and repair In order to ensure that all operating ex- lease contract, the lessor/investor has two measures, including interior redecoration, penses are borne by the lessee and therefore aims in mind: firstly, to procure the lease which are necessary to ensure the use of the do not reduce the stipulated lease income, income without cost items which reduce property by the lessee according to the con- it should be agreed that the lessee shall the yield. All operating and administrative tract during the entire term of the lease. bear all further operational and incidental expenses in connection with the property expenses in addition to those pursuant to (in the broadest sense) are shifted to the les- However, when leasing business spaces sec. 2 BetrKV, and preferably also those see, eliminating the need for a (calculated) it is common to impose a broad range of which are incurred in the future. reduction from the expected regular lease maintenance and repair obligations on the income. Secondly, the point is to minimize lessee (e.g. maintenance and repair of all By the same consideration, the lessor/inve- the amount of work done on the property areas exclusively used by the lessee). Ne- stor will also wish to ensure that the lessee by the lessor during the term of the contract vertheless, part of the maintenance and re- shall bear the costs of the necessary (or as much as possible, by making the lessee pair obligations remains the responsibility pre-agreed) insurance policies. responsible for the entire maintenance, i.e. of the lessor. This applies in particular to upkeep, repairs and, as far as possible, the the maintenance of the roof and the sup- By referring to sec. 2 no. 13 BetrKV (“co- administration of the property. porting structures of the building, often sts of property and third-party liability in- referred to as “Dach und Fach” (“roof and surance”) on the obligation to bear costs, For the lessee, this at least results in the structure”). considerable progress may be made. Ac- possibility of a cost reduction: in return for cording to this provision, the lessee shall bearing the higher costs and risks associa- Consequently, the lessor is obliged to ful- at least bear the costs of insurance for fire, ted with a triple-net lease contract, they pay fill maintenance and repair obligations and storm, water and other elemental damages. a (in some cases significantly) lower rent. It arrange for the necessary measures to be is then up to the lessee to take advantage of taken. This can lead to a significant cost A further aspect is the question of which the difference to bear expenses on the pro- burden for the lessor. In addition – parti- party to a triple-net lease contract shall perty and to insure against risks resulting cularly with long-term lease contracts – it bear the risk of (accidental) loss of the pro- from their maintenance obligation. is almost impossible to reliably predict in perty, or which mutual obligations exist if advance what maintenance/repair requi- the property is completely or predominant- Individual Questions rements may arise during the term of the ly destroyed, without this being the respon- Tenancy rules (Mietrecht) in the German lease. This uncertainty is at odds with the sibility of the lessor or the lessee. Civil Code do not recognize the triple-net financial goals of lessors/investors, who lease contract as a separate type of con- rely on calculating the future revenue and According to statutory provisions, in the tract. Until now, the standard commenta- expenditures as accurately as possible upon case of the lease object being destroyed, ry and textbooks on tenancy law scarcely conclusion of the lease contract. the lessor is released from their obligation mention triple-net lease contracts; only the to relinquish the lease object (sec. 275 Ger- literature apart from commentary and text- In addition to the costs for maintenance man Civil Code); the lessor is not obliged books has already dealt with this in more and repair, lease income will be reduced to rebuild or repair the property2. In case of detail. A conclusively reinforced and con- primarily by expenses in connection with a partial destruction of the lease object, the 1 The present article is an abbreviated version of an article which the author published in Transaktionen, 2 BGH v. 13.12. 1991 – LwZR 5/91, ZMR 1992, 140, 141; LG Berlin v. 28. 5. 1998 – 62 S 401/97, Vermögen, Pro Bono - Festschrift zum zehnjährigen Bestehen von P+P Pöllath + Partners, Beck Verlag, WuM 1998. January 2008, pg. 197 - 210 2 2008 handbook co-publishing Real estate lessor is only obliged to rebuild or repair if in the general terms and conditions (AGB) is invalid in any case. With reference to this this is possible during the lease term and if has been the object of countless individual judgment, the specialist literature thus takes costs do not exceed a (financially) reasona- court decisions. Case law in many areas is the view that a transfer of liability for “Dach ble limit (Opfergrenze)3. On the other hand, however still in flux. For the clauses/ele- und Fach” is also in principle invalid in the the lessee is released from their obligati- ments of triple-net lease contracts as men- general terms and conditions (AGB)10. on to make the stipulated lease payments tioned above, the following principles may (sec. 275 para. 4, 326 para. 1 German Ci- be recorded: In 2005, the Federal Court of Justice (BGH) vil Code). So in effect, the lessor prima- The question of whether general terms and decided that the obligation for maintenance rily bears the risk of (accidental) property conditions (AGB) may permissibly ob- and repair may only be shifted to the lessee loss. Until conclusion of rebuilding, they lige the lessee to carry out comprehensive as far as it extends to damages attributable to receive no lease payments and also bear the maintenance and repair (including “Dach use of the lease object or the lessee‘s sphere risk of not having (sufficient) insurance for und Fach”) has not been conclusively an- of risk11. The Federal Court of Justice’s the damages incurred. In addition, they are swered. Based on two decisions of the Hig- decision pertained to a case in which the responsible for rebuilding the lease object her Regional Courts (Oberlandesgerichte lessee had only leased a part of the pro- (including the conclusion of building and – OLG) of Cologne4 and Naumburg5, a perty. However, the principle as stated by planning contracts), for which financial in- comprehensive transfer of the maintenance the Federal Court of Justice should also be vestors are not normally equipped. charges to the lessee in the general terms valid for the case which almost exclusively The statutory provisions in turn do not cor- and conditions (AGB) is in essence inva- occurs in triple-net lease contracts, where respond with the financial interests of the lid. The lessee would be burdened with an the entire property is leased. On areas and lessor/investor regarding unreduced lease incalculable cost risk which could not be facilities which are exclusively used by the income. The lessor/investor will therefo- predetermined and the lessee could be held lessee – in particular if the entire property is re be anxious to shift the risk of acciden- liable irrespective of any fault (verschul- leased – the (complete) transfer of liability tal property loss as far as possible to the densunabhängige Haftung) and would have for maintenance and repair should thereby lessee, e.g. with the following provision: to bear the expenses of any damages and be admissible in the general terms and con- firstly, that the lessee is obliged to arrange wear and tear already present prior to con- ditions (AGB), as far as it results from use for the rebuilding or necessary repairs. For clusion of the contract. of leased property or is within the lessee’s this purpose, they are either assigned any sphere of risk. insurance claims of the lessor or the lessee In both decisions, the respective clauses themselves must take out the (building) in- were, however, each restrictively interpre- In argumentum e contrario, this means firstly surance. Secondly, provisions are made to ted so that in effect the lessee only had to that the lessee may not be held liable for de- ensure that the obligation to pay the rent carry out maintenance and repair work ne- fects already existing upon the surrender of shall only be discontinued until the point cessitated by their use of the leased proper- the leased premises to the lessee. Secondly, in time at which the rebuilding work could ty6. However, it is doubtful whether this re- no liability for maintenance/repair measures have been concluded if the lessee had pro- strictive interpretation of general terms and may be transferred to the lessee arising from perly fulfilled these obligations. conditions (AGB) is valid against the back- accidental loss of property (e.g. through a ground of sec. 305 c para. 2 German Civil fire which is not the fault of the lessee)12. Admissibility of Triple-Net Lease Code (doubts on the interpretation shall be These principles should also be valid wi- Contracts to the detriment of the user of the respective thout exception for the maintenance and The question of the legal admissibility of term or condition) and the principle that an repair of “Dach und Fach”. In its 2005 deci- triple-net lease contracts is currently an- invalid provision may not be reduced to its sion, the Federal Court of Justice did not ex- swered on a case-by-case basis (Einzelbe- permitted content (Verbot der geltungser- pressly comment on respective provisos on trachtung), namely whether the clauses ty- haltenden Reduktion)7. The OLG Dresden8 “Dach und Fach”. However, there should be pical for this structure are admissible. It is and the Higher Regional Court of Berlin no room for such a proviso after the Federal important to understand this individual ex- (Kammergericht)9 have also determined Court of Justice’s decision in 2005. Firstly, amination before deliberating whether an that the (complete) transfer of liability for in its decision the Court gives no indication overall examination (Gesamtbetrachtung) maintenance and repairs is not admissible that its stated principles should not be valid might lead to different results. in the general terms and conditions (AGB). for the maintenance of “Dach und Fach”. Similarly to the decisions of OLG Cologne Secondly, this conclusion results from the Individual Examination According to and OLG Naumburg, this is justified on the following consideration: the decision refers the Requirements for General Terms grounds that the lessee would be burdened expressly to the transfer of responsibility for and Conditions (Klauselrechtliche with incalculable expenses. From the wor- maintenance and repair of jointly used areas Einzelbetrachtung) ding of the judgment, one could argue that and facilities. Against this background, there Whether, and to what degree, the parties according to the opinion of OLG Dresden is no reason the (jointly used) roof should be may deviate from the statutory distributi- and Kammergericht Berlin, the transfer of treated differently than, say, a (jointly used) on of risks to the detriment of the lessee liability for maintenance of “Dach and Fach” heating system. 3 BGH v. 20. 7. 2005 – VIII ZR 342/03, NJW 2005, 3284. 8 OLG Dresden v. 17. 6. 1996 – 2 U 655/95, NJW-RR 1997, 395 (396). 4 OLG Köln v. 17. 12. 1993 – 19 U 189/93, NJW-RR 1994, 524. 9 KG Berlin v. 23. 5. 2002 – 20 U 233/01, NJW-RR 2003, 586. 5 OLG Naumburg v. 12. 8. 1999 – 2 U (Hs) 34/98, NJW-RR 2000, 823. 10 Schmidt-Futterer, Mietrecht, ninth ed. 2007, § 535 para. 80; Schlemminger/Tachezy, NZM 2001, 416 6 Cf. also Wolf/Eckart/Ball, Handbuch des gewerblichen Miet-, Pacht- und Leasingrechts, ninth ed. 2004, (416 et seq.). para. 370. 11 BGH v. 6. 4. 2005 – XII ZR 158/01, ZMR 2005, 844 (846). 7 Heinrichs, in: Palandt, BGB, sixty-sixth ed. 2007, „vor § 307“, para. 8. 12 BGH v. 25.2.1987 – VIII ZR 88/86, NJW-RR 1987, 906. handbook 2008 3 Real estate co-publishing The allocation of the operating expenses results in a (substantial) reduction in the primarily justified with the following consi- itself requires a defined and unambiguous rent. This should later put the lessor in the derations: the lease object is often purchased agreement in the contractual provisions. position to argue that the assumption of the or installed by the lessor according to the The lease contract must define the ope- maintenance and repair obligations is part of specifications of the lessee, so that the main rating expenses to be borne by the lessee. the agreement on the rent, which is not sub- interest in the property and its use may in The lessee should be able to at least appro- ject to the proviso control pursuant to sec. fact be attributed to the lessee22. The calcu- ximately determine which additional costs 305 et seq. German Civil Code. This proce- lation of the consideration to be paid to the may be incurred13. Therefore, the statutory dure may be possible if the parties seriously lessor usually also results from the concrete requirement of certainty (Bestimmtheits- discuss the difference between a “normal” purchase and credit costs (financing func- erfordernis) applying to general terms and rent associated with restricted maintenance tion of the lease). conditions is not fulfilled by such formulati- obligations for the lessee and a reduced rent ons as “the lessee shall bear all operating ex- associated with a shift of all maintenance The considerations which justify the “spe- penses” or even “... the customary operating obligations to the lessee. In this case, there cial handling” of leasing contracts are ap- expenses”14. Similarly, a provision by which is also the question of whether the contrac- plicable in the same way to triple-net lease all newly resulting operating expenses are tual regulation finally agreed upon qualifies contracts, in any case on agreements which allocated to the lessee is invalid pursuant to as a general term/condition (and is thereby are very similar to leasing. An example sec. 307 German Civil Code15. subject to certain restrictions governing the thereof may be sale-and-lease-back arran- use of these AGB) at all. In all other cases, gements: companies try to capitalize on Insurance premiums in addition to sec. 2 significant doubts are raised about whether the liquidity tied up in their real property Nr. 13 BetrKV may also be assigned to the the parties may successfully argue that the by selling and utilizing the revenue more lessee. The expenses for special insurance respective contractual regulation is part of profitably in their actual core business. In policies such as, for example, glass insu- the agreement on the rent. In its decision of order to be able to continue to use the real rance, insurance for damages to telecom- the year 200518, the Federal Court of Justice property, it is simultaneously re-leased. In munications, alarm and fire alarm systems, determined that supplementary agreements practice, triple-net lease contracts are often other electrical and electronic systems, which deviate from ”non-compulsory” sta- seen in this connection. are only transferable to the lessee if at the tutory provisions may not be part of the same time he is the beneficiary of such in- agreement on the rent. In all other cases The economic reasoning behind such trans- surance policies16. Moreover, as to unusual which solely serve to revoke the provisions actions is thereby primarily a financing insurance policies the respective contractual on proviso controls pursuant to §sec. 305 ff. transaction (“repayment of the purchase provisions may be regarded as a “surprising German Civil Code, the risk is relatively price by lease payment”) and not exclusi- provision” (überraschende Klausel) within high that – given the actual motives of the vely the surrender and use of the property the meaning of sec. 305 c para. 1 German parties – the courts will deny the validity of for a period of time which characterizes Civil Code, and thereby be invalid17. such clauses. the lease contract. Based on this particular proximity to leasing (if classification as a The transfer of the risk of accidental pro- Overall Perspective leasing agreement cannot be considered), perty loss may also be problematic from Unlike the case of the individual exami- tenancy contracts in this constellation may an “AGB perspective” based on the state of nation, an overall examination (Gesamt- be treated in the same way as an atypical current case law. As previously mentioned, betrachtung) of this contractual configu- tenancy contract, also such as a leasing the OLG Naumburg and the OLG Cologne ration, in particular a comparison with the contract. The particular proximity of this have determined that a transfer of the main- case law on leasing, may lead to a different contractual constellation to leasing justi- tenance and repair obligations is limited at conclusion. fies the handling of such tenancy agree- the point at which the danger of (accidental) ments in the same way as leasing contracts loss (Sachgefahr) is transferred to the les- Although (real property) leasing may in as far as the admissibility of certain regu- see and the burden of the maintenance and principle be attributed to tenancy law19, the lations in the general terms and conditions repair obligations therefore represent an in- Federal Court of Justice has deemed sub- is concerned. The fact that this may gene- calculable cost risk to the lessee. stantive deviations from statutory provisions rally be valid for triple-net lease contracts of tenancy law to be valid20. It has thus seen however, is not yet self-evident from this Taking into account the aforementioned le- the shifting of the risk of accidental loss argument. gal risks relating to general terms and con- and the risk of paying the rent (Sach- und ditions (AGB), an array of approaches is Gegenleistungsgefahr) in the general terms However, the triple-net lease contract, as recommended in order to validly agree upon and conditions (AGB) to be admissible21. In can be seen from the aforementioned, de- the respective provisions. In particular, it is addition, for the area of leasing of goods the monstrates a particular peculiarity as oppo- recommended that the contractual parties (complete) transfer of maintenance liability sed to a normal lease contract which justifi- document that the assumption of all main- to the lessee in the general terms and condi- es its privileged treatment in the same way tenance and repair obligations by the lessee tions (AGB) is deemed to be valid. This is as the leasing contract. 13 OLG Köln v. 4. 12. 1990 – 15 U 75/90, WuM 1991, 357. 19 Cf. BGH v. 30. 9. 1987 – VIII ZR 226/86, NJW 1988, 198 (199). 14 Cf. OLG Jena v. 16. 10. 2001 – 8 U 392/01, NZM 2002, 70. 20 Cf. BGH v. 30. 9. 1987 – VIII ZR 226/86, NJW 1988, 198 (200). 15 Cf. Kinne, GE 1999, 1540 (1544). 21 Mörtenkötter, MittRhNotK 1995, 329 (339). 16 Langenberg, Betriebskostenrecht der Wohn- und Geschäftsraummiete, third ed. 1999, Part A, para. 102. 22 Cf. BGH v. 30. 9. 1987 – VIII ZR 226/86, NJW 1988, 198 (200); Wolf/Eckart/Ball (cf. footnote no. 6) 17 Schmid, Handbuch der Mietnebenkosten, ninth ed. 2005, para. 5531. para. 1675. 18 BGH ZMR 2005, 844 (845). 4 2008 handbook co-publishing Real estate The starting points in the leasing contract Even if individual questions on the deter- undertakes such a comprehensive transfer and in the triple-net lease contract are mination/description of triple-net lease of risk from the lessor to the lessee may not different, however. The leasing contract contracts are still open to discussion, their thereby be satisfied. is def ined by the fact that the lessor first economic aims are nevertheless explicit: purchases the property – according to the unlike a “normal” lease contract, a compre- In order to comply with the statutory re- specif ications of the lessee – in order then hensive transfer of risk to the lessee shall quirement for transparency (Transparenz- to grant use to the lessee. This “purchase take place. This type of contract is quite gebot) which applies to general terms and act” does not normally take place in tri- common in some business circles (e.g. lea- conditions (sec. 307 para. 1 sentence 2 Ger- ple-net lease contracts. Incidentally – as sing of large-scale real property) and is a man Civil Code), it is certainly necessary with the leasing contract – the contrac- common contractual construct, particularly to expressly designate the triple-net lease tual constellation of the triple-net lease in international contexts. Through its assi- contract as such in order to identify the de- contract follows an overall economic gnment of risk, which thereby reduces the viating risk assignment and its peculiarity. concept. The triple-net lease contract is rent payments, it fulfills the respective ex- not only a lease contract for business pre- pectations of fairness of the participating With this in mind, much speaks for the reco- mises which deviates from the statutory parties and, at the same time, the existing gnition of the triple-net lease contract as a guiding principles in certain provisions need for security with regard to calculations separate type of contract, thus withdrawing and thereby constitutes an unreasona- of particular investors. it from the “normal” test as regards com- ble disadvantage to the lessee. Such an pliance with the requirements for general examination is reduced too much to the When looking at the leasing, there is no ob- terms and conditions. individual provision to be examined and vious compelling reason why the economic disregards the intended overall economic (and practically relevant) need for a con- For further information see the law firm concept. tractual model which, outside of leasing, profile at the end of the Handbook. P+P Pöllath + Partners Raphael Söhlke is a lawyer in the Berlin office of P+P Pöllath + Partners. P+P is a law firm with a strong specialization in legal and tax advice on: I M&A transactions with the focus on private equity and venture capital; I structuring and placing of private equity, venture capital and other closed-end or public funds; I real estate transactions and project development; and I asset management, including trusts and foundations, particularly for family offices, entrepreneurs and investors. Raphael Söhlke focuses on real estate M&A and real estate private equity transactions, as well as project development. Raphael Söhlke joined P+P in 2000 after working for an international law firm in Frankfurt. He studied at the Universities of Trier and Aix-en- Raphael Söhlke Provence/France; he graduated from the University of Trier. He is a lecturer for the postgraduate course “Real Estate” at the University of Münster. For more details, please visit www.pplaw.com. handbook 2008 5
"triple net leased"