Shutdown of hotel operations due to COVID-19 "Corona Virus" - Force Majeure?

The COVID-19 "corona virus" pandemic keeps almost the whole world in suspense. The effects on the global economy are not yet foreseeable. At least the hotel industry is heavily affected due to the strong decrease in bookings. Many hotel operators are therefore considering a temporary shutdown of their businesses, hoping to at least reduce running costs.

Tenets of shutting down hotel operations

In general, lessees are not obligated by German law to actually use their leased property. The shutdown of an operation is the sole discretion of the operator – given that there are no deviating stipulations agreed upon in the lease agreement. The remarks in this article also apply accordingly to lease agreements.

Obligation to operate in the lease agreement

Regardless of the general legal situation, the landlord may be interested in ensuring the continuous use of the leased property. (This might be the agreed on to avoid impact on the property value, for example unused or empty rooms might give the wrong impressions.). To satisfy this interest, many hotel lease agreements stipulate the lessee's obligation to operate the hotel at all times; this can be contractually agreed on, under the consideration of certain principles.

As long as there is no official injunction issued by the authorities – mandating an immediate shutdown of hotels (e.g. for public health measures) – even a severe decrease of guest numbers does not qualify as a reason for impossibility to fulfil his contractual obligation to operate. To date, a large number of federal states and cities have issued ordinances and general rulings prohibiting, for example, "overnight accommodation for tourism purposes" or restricting the operation of "hotels, other accommodation facilities and the provision of all types of accommodation". The wording of these orders therefore covers hotels and serviced apartments equally. Comprehensive official closure orders (such as those issued by the City of Cologne), however, naturally take precedence over a contractually stipulated duty to operate.

Exemption from obligation to operate due to interference with the basis of the transaction

In certain individual cases come into consideration where an exception from a contractual agreed obligation to operate might be justified according to the principles of "interference with the basis of the transaction" (sec. 313 of the German Civil Code) due to force majeure. If circumstances which became the basis of a contract have significantly changed since the contract was entered into, adaptation of the contract may be demanded by either party. This applies if one of the parties cannot reasonably be expected to uphold the contract without alteration given the changed circumstances and if the parties would not have entered into the contract or would have entered into it with different content if they had foreseen this change.

Hence, the following must be assessed:

• Would the parties have made a different contractual arrangement if they had foreseen the outbreak of an epidemic with the current effects?
• Can it be reasonably expected from the lessee to adhere to the current contract (and therefore to the obligation to operate)?

To fully comprehend the principles of "interference with the basis of the transaction", it is vital to be mindful of the relevant case law: The Bundesgerichtshof (German Federal Court of Justice) re-emphasizes that in commercial lease agreements it is part of the lessees sphere of responsibility to assess the prospects of success of the undertaking on the chosen business location.

Regarding the question whether a different contractual agreement would have been made concerning lease payments or terms thereof, circumstances of the individual case and the negotiation history need to be considered first and foremost. In general the stipulation of an obligation to operate indicates that it is important to the lessor to prevent ceasing shutdown of the hotel operation at the lessee's discretion. That implies that the operator shall bear the risk of being obligated to operate even if the operation is not profitable. Due to this implicit distribution of risks, it excludes the lesse's option to invoke its rights according to the principles of interference with the basis of the transaction. It must be assessed whether the COVID-19 pandemic is going far beyond the usual business risks that the parties would have stipulated an exception from the obligation to operate if they had foreseen the corona crisis. This question can only be answered by reviewing the specific contractual arrangement of the lease agreement. Other circumstances that could cause revenue decline have to be taken into consideration (e.g. natural disasters, terror attacks). If none of those special cases were considered regarding the obligation to operate the assumption is justifiable that the parties would not have agreed on an exception for the COVID-19 epidemic. The fact that the operation of multiple hotels might be affected by the corona crisis cannot lead to any other result because each lease agreement has to be considered individually.

Assuming the parties actually would have agreed upon an exemption from the obligation to operate in case of a corona pandemic – it has to be assessed whether the operator can reasonably be expected to adhere to the current contract. The Bundesgerichtshof (German Federal Court of Justice) applies criteria of whether the adaptation of the contract appears unavoidable under the principles of law and justice. Both parties' interests (lessee and lessor) have to be taken into consideration. , For an evaluation the terms and conditions of the lease agreement have to be reviewed and – according to the (to this extent incoherent) case law – an estimation whether the existence of the operation is threatened if the lessee must adhere to the current stipulations has to be given. An important aspect for this evaluation will be the agreed upon type of rent. If the parties stipulated a fixed rent, an unreasonable disadvantage to the lessee is more likely to be concluded than if the parties agreed upon a turnover-based rent. Assuming a turnover-based rent, the lessee's operational risk has already been partly shifted to the lessor because not only the lessee is affected by sudden revenue decline – as the turnover-based rent reduces accordingly. Those circumstances could lead to the assessment that further amendments to the lease agreement are not necessary because the existing lease agreement is not unreasonable for the operator.

Conclusion

The question whether hotel operations are allowed to shut down their business cannot be answered sweepingly. As the stipulations in hotel lease agreements may deviate significantly from case to case, only individual assessments are possible. Tenants should always bear in mind that a shutdown of the operations might be a breach of contract that in worst case can lead to termination of the lease agreement. To eliminate legal uncertainties while planning a temporary shutdown of business an examination of the relevant provisions of the lease agreement is recommended, if possible an amicable agreement with the landlord should be seeked.

In addition to the question of the obligation to operate, other legal questions for hotel operators and owners arise in regarding the corona virus, such as effects on the obligation to pay rent, the possibility of deferral agreements or the effect on existing financing.

Please also take a look at our other blog posts as well as the FAQ from our webinars on this subject dated 24 and 25 March 2020.

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