Germany: Real Estate – Recent Developments And Decisions - Spring 2015

Keywords: real estate, insolvency notation, land register, power of disposal

POWER OF DISPOSAL AFTER DELETION OF A INSOLVENCY NOTATION IN THE LAND REGISTER

By Elmar Günther

Higher Regional Court (OLG") Naumburg 12th Civil Division, Decision of November 12, 2013 – 12 Wx 43/13

Head note

Deletion of an insolvency notation in the land register does not in itself result in the debtor who is the registered owner regaining power of disposal.

The land registry can therefore require proof of withdrawal of the property from the insolvency estate prior to execution of the debtor's transfer of land ownership.

The trustee must provide a declaration of release to this end, which is required to be in the form provided for under Sec 29 of the German Land Register Code (GBO").

Facts

Two private persons were registered in the land register as owners. Consumer insolvency proceedings were opened regarding their assets and a trustee appointed. A insolvency notation was registered in the land register in July 2012 and then deleted in December 2012. The decision does not specify whether the deletion was done at the request of the insolvency court or the trustee. With notarial deed of April 2013, the owners sold the property. To secure the buyer's right to transfer ownership, the owners approved registration of a corresponding priority notice. The land registry did not carry out the registration applied for and requested proof – in official or officially authenticated form – that the owners had regained their power of disposal. To this end, they were requested to produce both the declaration of release itself as well as proof that the debtor had received this document in the form required for the land register. The owners lodged an appeal against this with the OLG.

Content and subject of the decision

The OLG ruled in favour of the land registry in agreement with previous decisions. It ascertained that the insolvency notation and the power of disposal were to be kept strictly separated. When insolvency proceedings are initiated, the property owner's power of disposal as debtor passes to the insolvency administrator. However, the insolvency notation is a purely declaratory entry in the land register that destroys the good faith in the registered owner's power of disposal. It is generally accepted that registration of the insolvency notation and – where the entry is missing – the land registry's sure knowledge of insolvency proceedings having been initiated, ruin the land registry's presumption of the owner's power of disposal and it may not register transfers of ownership by the owner without proof of latter's (restored) right of disposal. In the opinion of the OLG, neither the registration nor the deletion of the insolvency notation provided information on the substantive legality of the power of disposal, i.e. whether the property is (still) part of the insolvency estate or not. The OLG argued that in on-going insolvency proceedings, the existence of a restriction of the power of disposal must always be assumed and the debtor therefore has no power of disposal. The deletion of the notation only reflects the view of the insolvency court, as mere declaration of knowledge. Neither does an application by the insolvency administrator himself render proof that the prohibition of disposal has been cancelled. Because of the principle of legality, the land registry is strictly prohibited from participating in good faith acquisitions. Instead, proof of cessation of the insolvency administrator's power of disposal and of restoration of that of the owner must be proven in the form provided for under Sec 29 GBO – i.e. with an official or officially authenticated document. This proof includes both the insolvency administrator's declaration of the release of the property from the insolvency estate as well as receipt of this declaration by the property owner.

This reasoning follows in the tradition of the landmark decision of the OLG Rostock (decision of January 18, 2012 – file no. 5 Wx 114/11) and decisions of the OLG Jena, and is in line with the prevailing opinion. As far as can be seen, this has only been criticised by the German notarial institute, as well as in a recent decision of the OLG Hamm (decision of March 20, 2014 – file no. I-15 W 392/13, 392/13 15 W). Although the notation itself is merely declaratory, the fact as to how and by whom the deletion is effected would, however, have an influence on the sure knowledge of the restriction of the power of disposal, as required by the principle of legality. Since in the event of a request by the insolvency court or the insolvency administrator the proceedings are either concluded or stopped, or the property is released or sold by the insolvency administrator, the restraint on disposal also would have ceased – as with initiating insolvency proceedings –outside the land register, and the land register would therefore become inaccurate. The reasoning of the criticism is that in the event of a request by the insolvency court there would in fact remain no basis for doubt as to the owner regaining power of disposal. The land registry should therefore no longer infer continued restriction based only on insolvency proceedings that may be on-going.

In the opinion of the OLG Rostock, the evidentiary value of the court's request provided in due form (signed and sealed) only concerns the fact that declarations were made by the court but does not, however, extend to the content of the declaration. In contrast, it is argued that the request pursuant to Sec 38 GBO in fact replaces the usual application (Sec 13 GBO), the authorisation (Sec 19 GBO) as well as the evidence (Sec 22, 29 GBO) by signature, stamp or seal of the authority. The OLG Hamm in this context also refers to the explanatory memorandum of the (in this case) identical predecessor provision to the Insolvency Code, the Bankruptcy Code. Pursuant to this memorandum, the legislator in fact wanted to relieve the land registry of difficult substantive assessments and re-establish the protection of good faith of a purchaser in accordance with Sec 892 of the German Civil Code (BGB). If the land registry refuses entries because it assumes the continued existence of the power of disposal outside the land register despite the insolvency notation having been deleted, this would contradict the intention of the legislator.

What is unclear in the discussion is whether the contents of the insolvency courts' requests in question include merely the deletion or also the reason for the deletion, for example conclusion of the proceedings or release of the property by the current insolvency administrator. In the latter case, it probably argues in favour of the critics of the prevailing case-law.

Impact on day-to-day business

Despite noteworthy criticism of the decisions, it is not foreseeable that the dissenting voices will prevail. The prevailing case-law must therefore be respected in practice. This involves a risk that quite some difficulties may arise in transactions.

Firstly, in exercising due diligence, attention should be paid as to whether a insolvency notation was registered and deleted during the ownership period of the seller. In this case, the buyer must insist on being provided with original documents providing corresponding evidence of the regained power of disposal in the form required for the land register.

Secondly, obtaining such documents in the required form could be problematic. Under substantive law, the insolvency administrator's declaration of release is for example sufficient in simple written form. Depending on how long ago the deletion was made, the seller may not be able to obtain the documents due to, for example, the insolvency administrator's mandate having been terminated in the interim. Even the alternative of providing possible insolvency court decisions, as considered in the case-law, may also assist in revocation or closing of insolvency proceedings, but not in the event of mere release from the insolvency estate. On the owner's side, for the purpose of safeguarding the marketability of a property in such a case, in the event of release care must be taken that the documents obtained are in an official form or officially authenticated.

Thirdly, up to now the case-law has not taken into consideration the problems involved in providing proof of the (continued) capacity of the insolvency administrator in this context. That means that the documents to confirm continued capacity upon release should also be requested as a precaution. However, the significance of presenting the insolvency administrator's certificate of appointment, together with a certificate issued by the insolvency court regarding continuing appointment, is restricted to the time of presentation. That is, the existence of the original document must be documented at the same time as the release statement. Whether this is actually feasible with every insolvency administrator is doubtful.

The problems usually only arise when the property is released despite ongoing insolvency proceedings. However, experience has shown that transfers by the debtor then take place relatively close to the time of release. The documentation should therefore be easier to generate than in the case of transfers that only happen years later. Nevertheless, it would be desirable for the established barriers to the practice to be eliminated by the critics' opposite view being adopted in the case-law.

REGISTRATION OF A CONSTRUCTION LIEN AFTER SALE OF A PROPERTY

By Annika Baut

Federal Court of Justice (BGH") Seventh Civil Division, Judgment of December 18, 2014 – VII ZR 139/13

According to the legislative provision of Section 648 of the German Civil Code (BGB"), a contractor who has been tasked with construction of a building or part thereof may demand registration of a construction lien against the client's building site to safeguard his claims arising from the works contract. Whether such an entitlement for the contractor to register a construction lien still exists if the property to be encumbered has in the meantime been sold, the BGH was now required to establish in its decision of December 18, 2014.

Head Note

In principle, Section 648 Paragraph 1Sentence1 BGB does not protect the contractor from the client selling the property on which the contractor has to perform the contractually agreed building works. The contractor can therefore only be granted the right in exceptional cases to register a construction lien against a third party who acquires the property from the client.

Facts

The decision handed down by the BGH was based on a works contract. In December 2008 and October 2009, defendant 2 contracted the plaintiff to perform various construction works (plumbing, heating and ventilation works, supply and installation of a pellet boiler etc.). At the time of awarding the contract, defendant 2 was the owner of the freehold apartments where the works were to be carried out. Defendant 1 is the sole managing director of defendant 2 and at the same time CEO of the sole shareholder of defendant 2.

After the contract was awarded, the plaintiff performed a portion of the contracted services. In December 2009 he ceased his work. The plaintiff billed defendant 2 for supply and installation of the pellet boiler by invoice of December 2009, which defendant 2 settled. In addition, the plaintiff subsequently billed further construction works to a total amount of about EUR 25,000. However, defendant 2 did not make corresponding payments.

With notarial deeds of February and April 2010, defendant 2 sold the freehold apartments to defendant 1. In order to meet the agreed purchase price, defendant 1 took on loan liabilities from defendant 2, which the latter had taken out to finance the building project. Defendant 1 was entered as the owner in the land register in May 2010.

Because of the outstanding claims for compensation for work of around EUR 25,000, the plaintiff initiated legal proceedings against defendant 1 for approval to register a construction lien with respect to both freehold apartments. He claimed payment of compensation for the work from defendant 2. The claim was successful in both the courts of first and second instance. With the appeal permitted by the BGH, defendant 1 sought dismissal of the complaint against him.

Content And Subject Of The Decision

The BGH upheld the appeal submitted by defendant 1. It set aside the contested decision and referred the case back to the appeal court for a new decision as far as the latter had dismissed the appeal of defendant 1. The BGH explains that the conditions under which a contractor could request being granted a construction lien under Section 648 Paragraph 1 Sentence 1 BGB were not met with regard to defendant 1. The right to be granted a construction lien is fundamentally directed against the person ordering the work (client") and presupposes that this client is also the owner of the property on which the work is to be performed. However, defendant 1 is neither the client who ordered the work performed by the plaintiff, nor was he the owner of the property on which the contractually ordered work was to be performed at the time that the work was commissioned.

Defendant 1 also need not be treated as if he were the client who had ordered the plaintiff's work. In this respect, the conditions are not met under which, in accordance with BGH case-law, a departure from the principle of client and owner being the same person would come into consideration. The BGH has only recognized such a departure from this principle in one situation where the client was not also the owner of the property affected by the work at the time that he commissioned the work. Such circumstances evidently were not present in the case to be decided.

The contractor is generally also not protected by Section 648 Paragraph 1 Sentence 1 BGB from the client selling the property on which the contractor is required to perform the work specified by the works contract. The client can have a legitimate interest in selling the property for various reasons, especially if the sale of the property could mean recovery of the costs incurred by him in respect of investments made in the property. Such a legitimate interest may also not be denied from the outset on the grounds that defendant 2 had sold the property by way of self-dealing (Insichgeschäft") to its sole managing director, who is also the sole CEO of the sole shareholder.

Furthermore, neither is the BGH required to determine definitively whether and under what conditions a contractor may demand that the purchaser of the property on which the works were performed should allow him to secure a construction lien in an exceptional case because of his claims arising from the contract with his client. Such an exceptional case could indeed be recognized in circumstances where, with regard to the purchaser, the requirements of Section 826 BGB were met, for example if he purchases the property in fraudulent cooperation with the client or in the knowledge of the intention to disadvantage a creditor. A claim against defendant 1 as managing director of defendant 2 could also come into consideration under the principles of the representative's own liability pursuant to Section 313 Paragraph 3 BGB. However, as yet the appeal court has reached no findings as to whether the conditions for an exceptional case are met in the case under consideration. The BGH itself could therefore not decide in the matter, which is why the decision had to be set aside and referred back to the appeal court.

Impact On Day-To-Day Business

Consistent with its earlier case-law, the BGH emphasizes with this decision that the right to be granted a construction lien under Section 648 BGB generally requires that the client who commissioned the works and the owner of the property are the same person. If the property to be encumbered is therefore sold, the contractor usually cannot assert a claim against the new owner to be granted a construction lien in order to secure the claims for compensation to which he is entitled. A different assessment can only be considered in exceptional cases, such as fraudulent collaboration between client and contractor.

Thanks to this decision, potential purchasers may breathe a sigh of relief for the time being. As a rule they need not be concerned that a contractor can register a construction lien against the acquired property. However, it should be noted that the findings of the BGH are very vague on whether and in what circumstances a contractor can request a registration of a construction lien in the event of a sale. Furthermore, the exceptional cases referred to by the BGH are merely examples and do not represent an exhaustive list of all the exceptions to be taken into consideration. In this respect, it cannot be excluded that the BGH also recognizes a right of the contractor to be granted a construction lien against a potential purchaser in other cases. Some residual risk therefore remains in this context.

In view of this decision, contractors are advised to assert their right to be granted a construction lien immediately if they become aware of an intended sale of the property to be encumbered. To avoid the property being sold before registration of a construction lien, contractors should include an obligation in their works contract for the client to inform them in good time of an intention to sell.

For clients, the decision means primarily that, in the event of a planned sale, they should expect a possible short-term registration of a construction lien. This should be taken into consideration particularly where schedules are tight, in order to avoid any processing issues during the sale.

INEFFECTIVENESS OF COLLATERAL AGREEMENT DUE TO OVERCOLLATERALIZATION RESULTING FROM TAKING OUT CONTRACT PERFORMANCE AND WARRANTY BONDS WITH OVERLAPPING DURATION

By Anja Giesen

The Federal Supreme Court (BGH"), Judgement of January 22, 2015 – VII ZR 120/2014

Providing advance payment, performance and warranty bonds (Bürgschaften) or appropriate guarantees is a common means of collateral in construction projects of all sizes. Even with large project developments, contracts are not always comprehensively negotiated down to the last details and there are instances where certain parameters are not addressed, for example in the course of a bidding process. In no time at all you find yourself within a legal framework that can be classified as general terms and conditions of business. The case-law on general terms and conditions of business has also developed in such a way that despite intensive contract negotiations, individual clauses can constitute general terms and conditions of business. Once a legal dispute has arisen, it may be problematic to demonstrate and proof that the disputed clause was actually negotiable. Against this background, it is important to know the boundaries of the general terms and conditions of business within which one can manoeuvre.

Facts

The client (Plaintiff) had instructed the contractor to construct new floodlighting for a stadium and is demanding payment out of a performance bond from the defendant bank (Defendant).

In accordance with the provisions on collateral security in the special contractual terms and conditions (BVB) and in addition to the provisions of the current German Construction Tendering and Contract Regulations Part B (VOB/B"), the contractor had to hand over a performance bond in the amount of 5 percent of the contract price, No. 6.1 BVB. Furthermore, the contractor had to provide a warranty bond in the amount of 3 percent of the contract price, No. 6.2 BVB. In the additional contractual terms and conditions (ZVB") it is stipulated under No. 33.1 ZVB that the contract performance bond shall cover claims for the performance of all obligations arising from the contract including warranty claims.

Even before acceptance, one of the lighting columns that had been erected, snapped. Elimination of the defect was pre-financed by the client. Liability was resolved in court and the contractor was ordered to pay a total of EUR 492,807.43 (EUR 191,400.00 of which he was jointly and severally liable for with the designer, who settled this amount). The contractor paid only EUR 10,000.00 before insolvency proceedings were initiated against the contractor's assets.

Content and subject of the decision

The BGH ruled that the defendant does not have to pay and was able to successfully plead an ineffective collateral agreement pursuant to Sec 768 Para 1.1, Sec 821 German Civil Code (BGB").

The BGH based its decision on an unreasonable disadvantage of the contractor pursuant to Sec 9 Para 1 of the law regulating general terms and conditions of business (AGBG") in the old version (now Sec 307 Para 1 BGB) due to overcollateralization for warranty claims on the part of the client. What was decisive for presuming overcollateralization was the interaction of the aforementioned Regulations No. 6.1 and 6.2 BVB in conjunction with Regulation No. 34.6 of the additional contractual terms and conditions (ZVB), pursuant to which the deed of the performance bond is to be returned only after unconditional acceptance of final payment and under the further requirements that the contractor has performed the work stipulated in the contract, satisfied any claims and provided an agreed security for the warranty. This regulation allows the client to keep the performance bond for an extended period after acceptance, namely as long as there are still disputes on outstanding bills of the contractor. Any warranty claims arising up to this time would also be covered by the performance bond. Thus the situation could ensue that warranty claims would for a significant period be covered by the contract performance bond that has not been returned due to unconditional acceptance of final settlement not having taken place yet on the one hand and by the warranty bond that already had to be provided with acceptance on the other hand, in other words by a total of 8 percent of the contract price.

The BGH had already decided by judgment dated October 1, 2014 (VII ZR 164/12) that overcollateralization and thus unreasonable disadvantage would exist if the contractor has to pay a collateral in the form of an absolute bond in the amount of 7 percent of the contract price for what is at all events a significant period of time beyond acceptance. This decision follows this ruling and here, too, the BGH finds an ineffective collateral agreement. The BGH also points out in its decision that amending the clause by deleting the passage after unconditional acceptance of final payment" would be ruled out, since the regulation would be changed too much with regard to the intent of the user of this clause.

Impact on Day-to-Day Practice

In order to achieve an effective safeguard, overcollateralization should in any case be avoided in a warranty agreement and in the framework of general terms and conditions of business when drafting the collateral agreement. This must be taken into consideration in addition to the mere amount of a collateral in the interaction of various bonds and the respective conditions of return. Overlaps – for example by conversion of deeds of bonds or a concurrent exchange against return of the performance bond – must be avoided. The fact that the guarantor may invoke objections on the part of the debtor under the collateral agreement results from the principle of accessoriness of the bond to the principal amount owed. From the client's point of view, it is therefore also advisable to require independent guarantees instead of bonds.

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Originally published March 19, 2015

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