Judicial Sale of Real Estate in Germany: Law and Practice

Introduction and Statement of the Problem

Of all areas of the law, real estate is the one most often cited as having the greatest divergence between jurisdictions. Even within the European Union, where convergence of laws in some areas is a reality, a common land law regime remains a distant aspiration. While the United States and the United Kingdom share a heritage of the common law, Germany is a civil law jurisdiction rather than a common law jurisdiction. Under this civil law concept, the law is interpreted by the courts, which is especially true for the administration of real estate transactions such as the termination of leases for good cause or neighbourhood rights (Kock & Hosenfeld, 2007).

Under the German Civil Code, certain aspects of real estate are governed by other laws — for example, the proceedings regarding registration in the land register are governed by the Land Register Regulation, and proceedings regarding judicial foreclosure are governed by the Act on Judicial Foreclosure. Real estate may be owned by individuals as well as legal entities, including local authorities and foreign companies (Kock & Hosenfeld, 2007). According to Cranston and Goode (1997), "When the German Civil Code (Bürgerliches Gesetzbuch, or 'BGB') came into force on 1 January 1900, it not only coincided with the beginning of a new century but also marked the end of the long process of the unification of the German state" (p. 2). In reality, it also marked the beginning of a new era in the adjudication of real estate sales in Germany — a process that has created a convoluted but solid framework in which stakeholders can proceed to secure and protect their interests.

Since 1900, civil law has derived essentially from the Bürgerliches Gesetzbuch, the civil code devised during the Second, Wilhelmine, Reich. Over the course of a century, however, a number of additions and modifications have been made. According to Blacksell, Bohlander, and Born (1996), "Ironically, East Germany employed the same Bürgerliches Gesetzbuch until 1976, when its own civil code was introduced, which better reflected the reality of civil relationships in a communist state. After reunification, federal law — which, as far as civil matters were concerned, again meant the Bürgerliches Gesetzbuch — was extended to cover all of the new German state, though with numerous transitional exceptions in the new Länder" (p. 198). Some exceptions have gradually been eliminated; however, the law itself, including the Law of Property, has continued to change through government-sponsored additions and the normal process of judicial rulings, which have further complicated matters (Blacksell et al., 1996).

The adjudication of legal disputes over property restitution depends on the precise location in united Germany where the dispute took place, when it first occurred, and the current state of the law as interpreted by German federal courts. According to Blacksell and colleagues, "All of this amounts to a virtual quagmire for interpretation and to a potential source of endless litigation. For the most part, this potential has yet to manifest itself in property-restitution claims, but only because most of the more controversial and difficult cases have not reached the courts" (Blacksell et al., 1996, p. 199).

The key to establishing a legitimate claim to land or property is having title recorded in the Land Registry. The register goes back to the Second Reich, in the early years of the twentieth century, but for various reasons records are often incomplete and inconclusive, especially in the new Länder. Many records were lost during World War II and its aftermath, and after its first few years in power the government of the GDR allowed the register to lapse. The East German state apparatus saw little reason to legitimise the bourgeois concept of private property by keeping records current. Based on the foregoing, the joint declaration by Kohl and Modrow in 1990 had at its heart the creation of a hierarchy of Offices for the Settlement of Disputed Property Claims.

Even in a somewhat simplified form, the process of submitting a claim is exceedingly intricate. A basic distinction is made between residents of a property without any paper claim to title, and people who believe they have a legitimate claim on the basis of a formerly registered title. German residents may petition for title with the Land Registry provided they have received a certificate showing that the period allowed for registering a claim has elapsed and that there are no other outstanding claims from the Office for the Settlement of Disputed Property Claims. Title claimants must also establish the legitimacy and relative merits of their claim compared to any other claims relating to the same piece of property, and the claim must be lodged within the time period allowed (Blacksell et al., 1996). These formal steps are absolutely required before an application for title can be filed with the Land Registry. Importantly, nothing in the formal claims process limits the right of a claimant to go to the courts to resolve a claim, although in practice this has not been common — indicating a high level of acceptance of the formal German procedures involved in the administration of real estate sales (Blacksell et al., 1996).

In order to assess the geographical importance of the judicial process used for property restitution since German reunification, it is necessary to consider the scale of the problem and how it has evolved. According to Blacksell and colleagues:

"By the end of 1995 the several Offices for the Settlement of Disputed Property Claims across former East Germany had received a total of 1,228,598 separate claims. A distinction exists, though, between the number of claims lodged and the actual number of individual items at issue: a single formal claim may include several properties or other elements. The number of items at issue — 2,463,077 — is more than twice the total number of claims and comprises more than 120,000 businesses and more than 2.3 million buildings and plots of land. If it can conservatively be assumed that a minimum of five persons are affected for each business and a minimum of two persons for each building, then some 5 million people are directly involved in property-restitution claims — nearly a third of the population of the new Länder." (Blacksell et al., 1996, p. 200)

Since December 1991, the number of claims filed with the courts has not been significantly greater, with the exception of fluctuations experienced in Brandenburg and Berlin; such fluctuations were attributed to different methods of computer-based data collection in those two areas and to the subsequent standardisation of the system throughout the new Länder (Blacksell et al., 1996). In reality, 92% of all claims for property restitution were timely filed within the first 15 months following reunification (Blacksell et al., 1996). The administrative burden placed on the Offices for the Settlement of Disputed Property Claims was enormous, particularly since the offices only became active after October 1990, with no existing precedents concerning how they should be administered (Blacksell et al., 1996). These researchers report that "The huge volume of claims in their first year of operation, intimidating enough in itself, also created an expectation that the final number would be even larger than it has turned out to be, because there was no way of knowing that the vast majority of claims would be registered so quickly" (Blacksell et al., 1996, p. 200).

The differences in the number of claims among the five Länder and Berlin — ranging from 122,981 in Mecklenburg-Vorpommern to 281,473 in Brandenburg — suggest significant differences in area and population, but also reflect differences in the scope for actually making such claims due to specific socioeconomic conditions in each region (Blacksell et al., 1996). Berlin, as the future capital of unified Germany, was quickly seized upon by investors because of the high level of interest in reclaiming property there; this investment interest also affected the surrounding state of Brandenburg, where cities such as Potsdam are effectively part of the greater Berlin metropolitan area. By contrast, Mecklenburg-Vorpommern is more isolated and rural, with a smaller population engaged in agriculture rather than industry. Fewer property claims have been experienced there, largely because much of what is being reclaimed in that northernmost Länder consists of individual farms rather than housing and urban businesses (Blacksell et al., 1996).

If the claims are divided into subgroups, regional variations are even more marked. Claims involving property and land range from 89% of all claims in Brandenburg to only 63% in Mecklenburg-Vorpommern and Berlin. Although the total number of businesses subject to a claim is little more than 5% of the total, the regional distribution is notable, with Mecklenburg-Vorpommern in the vanguard. These events suggest that a large number of farms are being reclaimed and withdrawn from the collective farms of the communist era (Blacksell et al., 1996). "In comparison with the five Länder," the authors advise, "fewer claims involve property and land, and proportionately more involve money. The reason for this is the peculiar conditions stemming from Berlin's status as a divided city, which made it easier to resist straightforward state requisition by the East German regime, so that most claims are for financial compensation for an inadequate purchase price" (Blacksell et al., 1996, p. 201).

By 30 June 1995, 95,715 (52.9%) claims involving businesses and 1,351,459 (51.4%) of all other claims had been adjudicated. Furthermore, the rate at which claims are being settled has shown a steady improvement of about 3% per quarter, with a notable spike in the rate at which claims involving land and property are being resolved most recently (Blacksell et al., 1996). The authors conclude that "The end appears to be in sight, despite the marked regional variations. The overall figures on the settlement of claims are somewhat misleading because, as we have already pointed out, each claim may incorporate several distinct elements and because the range of outcomes is wide" (Blacksell et al., 1996, p. 198).

Given the enormous changes resulting from the reunification of the two German states, as well as the need to better understand how precedential cases and the current applications of the German Civil Code in an increasingly Europeanised environment will affect the interests of stakeholders, this study was guided by three research questions:

1. What types of judicial sales of real estate are currently practiced in Germany?
2. How are these judicial sales typically adjudicated?
3. What are the current and future trends for the judicial sale of real estate in Germany?

Today, Germany represents one of the most important economies in the world and has assumed a new leadership role in European affairs that will likely continue to guide the European Union from legal, military, social, and political perspectives. Because all European nations have their own — and sometimes unique — types of laws to administer the sale of real estate through the courts, and because these laws are frequently complicated and convoluted, sifting through the morass of legalities has assumed new importance. According to one authority, compliance with the formalities for assuming an obligation to transfer real estate under section 313 of the Civil Code is required both to provide proof of the obligation and to caution the parties, because real property is regarded as an extremely important asset (Gordley, 2001).

Because many real estate laws are designed to help people protect their rights and interests, it is important to determine what occurs when international investors and German consumers alike are confronted with the complex laws surrounding the adjudication of real estate sales in general, and in Germany in particular. In this regard, differences in judicial sales of real estate represent a matter of considerable importance "when major domestic investors in one jurisdiction look beyond their own borders to expand their portfolios and spread risk, as they now do almost as a matter of course" (Fordham & Wiemann, 2006, p. 13).

Civil law. The "body of law which every particular nation, commonwealth, or city has established peculiarly for itself; laws concerned with civil or private rights and remedies, as contrasted with criminal laws" (Black's Law Dictionary, 1990, p. 246).

Execution sale. A sale by a sheriff or other ministerial officer under the authority of a writ of execution that has been levied on the property of a debtor (Black's Law Dictionary, 1990, p. 568).

Foreclosure sale. A sale of mortgaged property to obtain satisfaction of the mortgage out of the proceeds, whether authorised by a decree of the court or by a power of sale contained in the mortgage (Black's Law Dictionary, 1990, p. 646).

Judicial sale. A sale conducted under a judgment, order, or supervision of a court — as in a sale under a petition for partition of real estate, an execution, or a foreclosure sale. Such sales must be based upon an order or decree of a court directing the sale. A sale in a bankruptcy proceeding is also a "judicial sale," as distinguished from a foreclosure sale or execution sale (Black's Law Dictionary, 1990, p. 849).

German Civil Code and Rights Over Land

The body of research concerning the return on real estate investments suffers from a number of constraints when compared to return series for stocks and bonds. In particular, stocks and at least some bonds trade in continuous auction markets characterised by large volume, many informed traders, and low transaction costs (Grauer & Hakansson, 1995). The paucity of these factors in real estate transactions, and the necessary reliance on appraisals, are widely regarded as resulting in smoothed returns data that understate the risks associated with real estate investment. Grauer and Hakansson (1995) estimate that real estate risk, as measured by the standard deviation of annual returns, lies "between that of stocks and bonds, in the 9% to 13% range" (p. 117).

Today, asset securitisation is used primarily with regard to obligations owing to the debtor, including accounts receivable, mortgages, student loans, credit card receivables, and commercial loans. Empirical evidence emphasises that any income-producing asset can be securitised, including, as Lopucki (1996) suggests, "office buildings, shopping centers and other commercial real estate [as well as] computer, automobile, equipment, and other leases" (p. 91). Lopucki adds that "previously constructed and operational infrastructure projects such as power plants" can also be securitised, and notes that securitisation techniques have even been applied to assets such as inventories that do not themselves produce a cash flow but will be converted later into assets that do (Lopucki, 1996, p. 90).

To illustrate the practical implications, Lopucki (1996) provides an example in which property with a market value of $100 would sell for only $70 in a judicial sale. "By granting a mortgage against the property in the amount of $75, the debtor creates a judgment-proof structure. That is, if judgments are later entered against the debtor, the alliance of debtor and secured creditor can control the property by purchasing it at sale for $75.00" (p. 91).

Even if the United States were to modify its rules to make shareholders liable for the debts of their corporations, at least some other countries would decline to do so. Assuming, for example, that Germany retained shareholder limited liability, strategic investors in Germany could invest in U.S. companies without exposing their assets to tort liability. "German law would control the relationship between the German corporation and the German investor, and that law would not impose shareholder liability" (Lopucki, 1996, p. 91). This strategy would effectively create a class of foreign investors in U.S. corporations who would not be subject to shareholder liability, allowing them to outbid U.S. investors for the shares of U.S. corporations (Lopucki, 1996).

As noted above, Germany is a civil law jurisdiction in which the law is interpreted by the courts. Under the BGB, certain aspects of real estate are governed by other laws, including the Land Register Regulation and the Act on Judicial Foreclosure. Real estate may be owned by individuals as well as legal entities, including local authorities and foreign companies (Kock & Hosenfeld, 2007). There is no bar to foreign individuals or foreign companies acquiring property in Germany. The recognised rights over land are as follows:

(a) Title/ownership — including co-ownership by more than one person.

(b) Heritable building right — a property may be encumbered by a heritable building right; the beneficiary is entitled to have a building on the property owned separately. Where the building is commercially the essential part of the property, this right functions similarly to a contractual lease, with the specific characteristic that the building belongs to the beneficiary.

(c) Easements, including: (i) Land servitudes — encumbrances in favour of the owner of another property, granting the right to use the encumbered property in a specified way or prohibiting certain acts on it; (ii) Restricted personal easements — encumbrances in favour of specific persons or partnerships; and (iii) Usufruct — a right entitling a person other than the owner to the beneficial use of a property.

(d) Pre-emption rights.

(e) Ground rent — an encumbrance in favour of specific persons or a legally capacitated partnership, providing for recurring benefits that must be convertible into money claims (e.g., payment of rent, delivery of food or water).

(f) Mortgage, land charge, and rent charge: (i) Mortgage — the beneficiary is entitled to payment of a certain sum for the fulfilment of an underlying claim; the mortgage is accessory to that claim and cannot be enforced if the claim ceases to exist. (ii) Land charge — the beneficiary is entitled to payment of a certain sum, but unlike a mortgage, the land charge is not accessory to a specific claim. (iii) Rent charge — a specific sum payable on a regular recurring date.

These rights are rights in rem. Pre-emption rights may also be agreed in purely contractual form. Leases are purely contractual, though they may be safeguarded by an accompanying easement. Title is transferred to the new owner upon registration in the land register. There are no significant current reform plans; however, Germany has been discussing the introduction of REITs (Real Estate Investment Trusts), and there is a likelihood that changes to the VAT rate and to the taxation of gains upon disposal of property may be introduced (Kock & Hosenfeld, 2007).

The typical lease provisions for German business premises are summarised in Table 1 below.

Table 1. Typical provisions for leases of German business premises today.

Length of term. A business lease is usually provided for an initial fixed term with certain extension options for the tenant. The maximum fixed term for the tenant is 30 years. Irrespective of any other provision in the lease agreement, either party may terminate the lease after 30 years within the statutory termination period.

Rent increases. It is common to agree on an adjustment of rent according to changes in the cost of living index issued by the Federal Statistical Office. The adjustment may be upwards or downwards.

Tenant's right to sell or sub-lease. A lease agreement cannot be sold by the tenant under German law. The parties may only agree to a third party entering the existing lease as tenant. The tenant is not entitled to sub-let the premises without the prior consent of the landlord, though it is not unusual for the landlord to consent to sub-letting to certain third parties, such as another company within the same group.

Change of control of the tenant. In the absence of any change of control clause, the lease remains with the tenant as the legal identity does not change. In the event of a corporate restructuring such as a merger, if the new entity is the legal successor of the tenant, the lease agreement remains with the new entity.

Repairs. Repairs are subject to negotiation. It is common for the landlord to provide for repair of the roof and structure, while the tenant takes responsibility for any other repairs of the leased premises. Business leases are usually terminated by lapse of time, default, or mutual agreement. Extension options are regularly included. Statutory law provides for a lease of unlimited time which may be terminated by either party within the statutory termination period. Where an initial fixed term is agreed, the landlord may only terminate for good cause — for example, if the tenant fails to pay rent or is not granted the contractual use of the premises.

Source: Kock & Hosenfeld, 2007.

Unjustified Enrichment in Real Estate Transactions

Concerns over unjustified enrichment from the sale of real property arise in relation to the general principle set out in section 812(1), first sentence, of the German Civil Code: "Someone who obtains something without legal ground through performance by another or in another way at his expense is bound to make it over to him" (Wer durch die Leistung eines anderen oder in sonstiger Weise auf dessen Kosten etwas ohne rechtlichen Grund erlangt, ist ihm zur Herausgabe verpflichtet) (quoted in Johnston & Zimmermann, 2002, p. 240). According to Johnston and Zimmermann, this conceptualisation introduces constraints to equitability because it is excessively broad: "It is not the case that everything that one has without a legal ground as a result of performance by some other or in another way at his expense can be recovered. The task for German jurisprudence was to identify cases falling within the general principle where the claimant actually did have a cause of action" (Johnston & Zimmermann, 2002, p. 377).

The four following cases, identified from the wording of the first sentence of section 812(1), are now widely accepted:

1. The claimant rendered a performance (Leistung) to the defendant which was without a legal basis;
2. The defendant encroached on the claimant's property (Eingriff);
3. The claimant incurred expense in improving the defendant's property (Verwendungen); and
4. The claimant paid the defendant's debt (Rückgriff).

German law has refined and confined its broad principle so as to cover only particular situations in which enrichment occurs. Of these four types, the first is based on the words "through performance" (durch die Leistung), while the remaining three are sub-categories of enrichment "in another way" (in sonstiger Weise). It is worth emphasising that category (2) specifically addresses real estate cases involving enrichment by wrongs: "Clearly, different considerations may arise in that case from those that do where no wrong is involved" (Johnston & Zimmermann, 2002, p. 240).

In some cases, it should not be a major concern that the defendant is not enriched, because "he may have purchased the plaintiff's goods from a third party, committed a wrong, or voluntarily accepted plaintiff's performance, or voluntarily hired a third party for whom he should be responsible." In other cases, however, the plaintiff has done none of these things, and courts should resist the temptation to allow the plaintiff to recover (Johnston & Zimmermann, 2002, p. 240).

By way of illustration, these authors cite an American case in which the plaintiff delivered a carload of coal to the wrong recipient, who consumed it. The market value of the delivery was $6.85 per ton, but the defendant had a contract with another supplier to purchase coal at $3.40 per ton. The plaintiff was permitted to recover only $3.40 per ton. This case is notable because "a mistake like this carries one beyond the realm of contract, even the illusion of contract. In other words, the defendant never decided to acquire coal at such a price, and so it mattered, to this court, whether he was actually enriched" (Johnston & Zimmermann, 2002, p. 240).

The purpose of this example is to illustrate a fundamental difference between U.S. and German practice that may affect the adjudication of real estate through judicial sale. In another American case, the defendant hired the plaintiff to build a Turkish bathhouse. Due to an architect's error, the defendant expected to pay about $23,000 — approximately what the bathhouse added to the value of his land — while the fair value of the work was approximately $33,000. The American court permitted the plaintiff to recover the higher figure, but the authors suggest that this decision would not have been reached under German law.

For example, Johnston and Zimmermann cite a German case in which an officer, immune from suit, seized and sold goods belonging to the plaintiff rather than the judgment debtor, to satisfy a judgment. When the plaintiff sued the judgment creditor who had received the proceeds, the creditor was allowed to deduct the costs of the judicial sale (Johnston & Zimmermann, 2002). In another German case, the lessee of the plaintiff's land, without authority, agreed to sell the defendant a right of way to build a private railway. "When the owner sued for unjust enrichment, the defendant was allowed to set off its expenses constructing and maintaining the railway. The results would be different in the United States" (Johnston & Zimmermann, 2002, p. 377). American courts have generally not applied the defence of change of position unless the defendant altered his position after being enriched — a point on which the authors agree with the German approach: "I do not see why the defendant should be held for more than he ever agreed to pay unless he was enriched by that amount" (Johnston & Zimmermann, 2002, p. 240).

A defendant in a German cause of action over real estate that is required to buy or sell at a price fixed by an appraiser will not be left indifferent by a liability in restitution. Johnston and Zimmermann suggest, however, that any such accounting must not exceed adjudged benefit, while also taking into account the transaction costs of the remedy. As these authors emphasise:

"Liability in respect of non-money benefits often requires the defendant to pay on the basis of an appraisal. Nor are the forced-exchange remedies unique in their potential requirement that an innocent recipient reach into his pocket to pay cash for unrequested benefits conferred. A vendor of land may be obliged to pay for the purchaser's improvements when the transaction is later set aside. An owner who recovers land previously conveyed under an invalid judicial sale may be liable for improvements by the purchaser. The contract doctrine of 'substantial performance' disguises a claim in restitution that may likewise require an innocent recipient to pay for something he did not want." (Johnston & Zimmermann, 2002, p. 378)

Moreover, contracts for real property under the German Civil Code that are binding for a very long time can offend common decency and therefore be void according to section 138(1); common decency is defined as "the beliefs of those whose thinking is proper and just. For common decency to be violated, there must be an extreme limitation of a person's economic liberty" (Gordley, 2001, p. 291).

There has also been a discernible lack of differentiation between property and possession in German law. As Steiger (2006) explains, focusing on the use of land as a resource, "'having' all property rights in the land is not necessarily the equivalent of being entitled to till a parcel of land. This can only be explained by the fact that some persons 'own' the rights to land as a common set while others only 'own' a subset of these rights" (p. 183). The right of property (including the right to encumber and alienate) and the right of possession (the right to physically use the land) can be assigned to the same person or to different persons. When the proprietor rents to a tenant, possessory rights inure to the tenant while the proprietor retains ownership. Steiger (2006) concludes: "The example also reveals that no possessory right can exist that is not related to a property right. Therefore, the right to change the form and substance of an asset, a possessory right, can always be restricted by the proprietor" (p. 183).

To illustrate differences and similarities among European jurisdictions, Gordley (2001) provides the example of a fictitious company, "Realty," competing in the real estate industry and seeking a site for a new building. Realty advised a property owner, "Simon," that it might be interested in purchasing a lot he owned, but required additional time to conduct a study. Simon promised without charge that he would sell his land to Realty at a fixed price under several different conditions, including an option for Realty to withdraw if, in its sole and absolute judgment, it found the economic prospects unsatisfactory. Under the German Civil Code, such a promise is not binding without compliance with the formalities for assuming an obligation to transfer real estate under section 313; contracts that require one party to transfer or acquire real property must also be recorded by a notary, though the absence of this formality is immaterial if the real property has actually been transferred (Gordley, 2001).

Because Realty can choose freely whether to buy or not, the contract is an option. An option is not deemed to be a gift and is valid under the German Civil Code even if nothing was paid for it. The question of what Realty wants to do with the land concerns only Realty's motives, which are not part of the contract unless the contract explicitly prohibits immediate resale. According to Gordley (2001), "It would not be a violation of good faith even if Realty did not tell the truth about its motives since under section 495 of the Civil Code the buyer is not even obliged to disclose his motives" (p. 292). Therefore, Realty can legally refuse to purchase the real estate if it finds the economic prospects unsatisfactory; and the increase in market price remains irrelevant provided it is not explicitly included in the contract.