Does the owner bear the risk in case of bankruptcy?

Due to the tense situation in the hotel industry, various lessees are currently approaching their lessors asking for deferral or abatement of rent payments for the period ahead. There are many suggestions for possible compromises - but the insolvency law situation must always be taken into account in order not to create any risks for lessees or lessors. The comments in this article apply equally to hotel lease agreements.

Currently discussed compromises

All suggestions made in this text, underlie the lessee's concern to pay no or reduced rent for the period ahead (currently two to six months are being considered). The draft law to mitigate the consequences of the COVID 19 pandemic in civil, insolvency and criminal proceedings, which was passed in the Bundestag on 25 March 2020, provides that lessors may not terminate the lease due to non-payment of the rent, which is due in the period from 01 April until 30 June 2020, as a result of the effects of the corona virus. However, the obligation to pay the rent continues to exist (the rent is therefore not deferred by law). In the event that the lessee does not pay the rent without a deferral agreement with the lessor, he will be in arrears with the rent payment and will owe default interest at 9% points above the statutory base rate (currently 8.12%).

Some lessees would like to obtain a direct waiver on the rent for those months concerned. This does not meet the approval of most lessors, as it would shift the risk distribution between the lessor and lessee completely to the lessor in the current situation. Compromises such as a pro-rata reduction of the rent (e.g. 50%), are also discussed topics.

To defer the rent for the months ahead is probably the most common suggestion.

There are many possible solutions for compensating deferred rent:

• The most common approach currently discernible is to agree to pay the amount deferred from the rent at a later time. The periods for subsequent payment range from the entire remaining term of the lease agreement to a subsequent payment still in 2020. The majority of lessors waive default interest on the deferred sum, at least if repayment will be made within a rather short period (one to two years).
• Alternatively, suggestions have been made to include a turnover or profit rent component for the time ahead into lease agreements in addition to the current fixed rent. Those agreements can be made in different variants - for the entire remaining term of the contract, for a limited period only, or until additional payments in the amount of the deferred sum (plus default interest if appropriate) have been made to the lessor.
• Also discussed is the possibility of extending the fixed term of a lease agreement to effectively repay the deferred sum during the extended period. This variant is also proposed in connection with the abatement of rent. In the case of a deferral, this is certainly a very abstract possibility of default payment, which involves financial evaluation of advantages of a possible extension of the agreement on the lessor's side (since payment in addition to the agreed fixed rent is de facto not made).
• Another option possible to compensate deferred rents (or at least parts) is the extraordinary indexation of the agreed rent at an earlier date or beyond the indexation already agreed on in the lease agreement. Depending on the specific content of such an agreement, the likelihood of the acceptance of such an agreement on the lessor's side is based on estimation, as a guaranteed additional payment in the amount of the deferred rent is not mandatory.

For both parties to the lease agreement, the advantage of an amicable settlement lies in the legal certainty it provides. The lessee does not thrust ahead the arrears of rent, on which interest accrues, but which must be paid back as quickly as possible. The lessor has planning security as to how and when the unpaid rent will be repaid to him by the lessee. This is particularly important because the lessor regularly has to service a financing which is also due despite the upcoming change in the legal situation as there is no protection against termination or deferral of payment (except for consumer loan agreements).

Insolvency law aspects

Within the framework of a law to mitigate the consequences of the COVID 19 pandemic, the Bundestag also adopted the draft already announced in a press release on 16 March 2020 on the temporary suspension of the obligation to file for insolvency and to limit the liability of organs in the event of insolvency caused by the COVID 19 pandemic (COVInsAG). In particular, this includes a provision for the suspension of the obligation to file for insolvency until 30 September 2020 (suspension period) in order to give companies affected by the Corona pandemic more time to obtain state aid and implement further restructuring measures. According to COVInsAG, the suspension of the obligation to file for insolvency until 30 September 2020 only does not apply if the insolvency maturity is not based on the consequences of the Covid 19 pandemic or if there are no prospects of eliminating the existing insolvency. For debtors who were not yet insolvent by 31 December 2019, it is assumed that the debtor's insolvency maturity is based on the effects of the pandemic and that there are prospects of eliminating his insolvency.

In addition, the uncertainties and obstacles that creditors normally face in continuing business relations with the debtor are to be countered by relaxing the relevant insolvency avoidance rules accordingly. For example, congruent and certain incongruent cover transactions (e.g. payments made during the suspension period or the granting of payment facilities such as deferrals) are excluded from the challenge unless the creditor was positively aware that the debtor's restructuring and financing efforts were not suitable for eliminating an insolvency that had occurred. In addition, the avoidance of the repayment of a loan newly granted during the suspension period is excluded from the insolvency avoidance until 30 September 2023. This also includes trade credits and other forms of service provision, which is why there are good arguments for the deferral also being understood as a granting of credit within the meaning of the provision.

These regulatory measures are appreciated and will hopefully help to ease the situation for many companies.

Even after the COVInsAG comes into force, however, lessees should first of all pay attention to the presentation of their current financial situation when making their inquiries for a rent deferral to the lessor. Formulations are prematurely chosen which might indicate, that the debtor has been insolvent for some time. Regardless if or if not insolvency has already occurred (for a longer period of time), it should be in the debtor's interest to document in a letter to the lessor as well as in the subsequent contractual arrangement that any financial difficulties of the debtor are due to the effects of the Corona pandemic.

It is recommended that the lessee should always examine solutions, which provide for a (partial) abatement of the rent, concerning any tax disadvantages that might occur.

From the lessor's point of view, it is also important to ensure that the chosen arrangement of rent deferral agreements and in particular its wording does not give rise to any insolvency avoidance risks in the event of the lessee's subsequent insolvency. First of all, it is also relevant for the lessor that the wording of the contractual agreement between him and the lessee does not give the impression that the debtor was insolvent independently of the pandemic or even before its spread, in particular not before 31 December 2019, and that the lessor knew of this as in this case the exclusion of contestability would not apply.

With regard to deferral provisions, lessors could also benefit from the relaxation of the rescission provisions regarding the repayment of loans granted during the suspension period after the end of the suspension period. There are good arguments that the deferral of rent payments can be understood as granting loans in the sense of the new regulations and thus rent arrears up to 30 September 2023 are possible without being contested.
With regard to the further proposed structuring options, it is advisable to first carry out a new risk assessment with regard to the debtor's financial situation at the end of the suspension period. If the rent payment is arranged as a cash transaction, i.e. the rent is paid immediately after the leased property is put at the lessee's disposal or after the rent is due, this should in any case significantly reduce the remaining risks of avoidance. In particular, the indexation model described above or the solution of amortizing lost rent over an extension of the lease term would have the advantage that it could be arranged as a cash transaction.

Conclusion

So far a great understanding of the situation of operators has been shown by the lessors. The parties are working together to develop common solutions and are aware that hotel lease agreements establish long-term partnerships enabling both parties to survive. When drafting such agreements, some of the legal framework conditions of insolvency law as well as civil law (e.g. the written form requirement) must be taken into account. Furthermore, both parties should also consider any existing financing agreements, which often contain specifications on deferral agreements regarding payments owed (operator side) or assigned (lease) claims (owner side).

In addition to the question of suspending or deferring the rent, other legal issues for operators and owners also arise in connection with the corona virus, such as the effects on the obligation to pay rent or the possibility of a reduction, the right to suspend operations and the classification of the corona virus as "force majeure". If you are interested, take a look at our other blog posts and the FAQ from our webinars on 24 and 25 March 2020.

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