Germany: The exercise of the municipal right of first refusal found inadmissible if based on a forecast

Judgment of the Federal Administrative Court (4 C 1/20) of 9 November 2021

The ruling by the Federal Administrative Court (BVerwG) on 9 November 2021 came as a bombshell not just for investors, but also for cities and municipalities. The court had ruled that the practice of numerous cities and municipalities in Germany of exercising their pre-emption rights in areas covered by a preservation statute (Milieuschutzsatzung) is unlawful. The cities cannot exercise their pre-emption rights solely on the basis of the forecast that the purchaser of the property will in future pursue intentions of use contrary to the preservation statutes.

What did the Federal Administrative Court actually decide?

The subject matter of the action was the exercise of the municipal right of first refusal by the district of Friedrichshain-Kreuzberg for a plot of land which was built on with a building dating from 1889, comprising 20 rented flats and two commercial units. The property was located within the scope of an ordinance that serves to protect the preservation of the composition of the residential population for special urban development reasons (Milieuschutzsatzung). In this area, the district was entitled to a right of first refusal pursuant to Section 24 (1) no. 4 alternative 2 Town and Country Planning Code. However, the exercise of the pre-emptive right was excluded by law if, among other things, the property is actually built on and used in accordance with the objectives or purposes of the urban development measures.

The lower courts had assumed that indications showing how the prospective user intended to use the property in the future were to be taken into account. It should be sufficient, according to the lower courts, if the municipality only forecast the danger that the purchaser would displace parts of the residential population from the area by upgrading the flats, increasing rents or converting them into owner occupied flats.

The BVerwG has now put a stop to this interpretation: It considers the requirements of the ground for exclusion of Section 24 (1) no. 4 alternative 2 Town and Country Planning Code as relevant, since the wording of the provision clearly refers to the actual circumstances at the time of the last decision of the authorities on the right of first refusal. The examination carried out by the lower courts as to whether it is to be assumed in future that the intention to use the property is contrary to conservation was held to be inadmissible.

What impact does the ruling have on exercised rights of first refusal?

In the past, numerous cities in Germany (e.g. Berlin, Frankfurt) have exercised the municipal right of first refusal in areas subject to preservation protection in order to bring the corresponding properties under the ownership of the cities themselves or their housing associations. The BVerwG ruling rules out, at least in the future, the possibility of the cities relying on forecasts of the purchaser’s future behaviour regarding use. However, with regard to pre-emptive rights already exercised in the past on this basis there have been far-reaching consequences.

In principle, the judgment of the BVerwG only has effect in favour of the claimant in a legal dispute. The exercise of municipal pre-emption rights in other cases initially remains effective, even if it should be unlawful (cf. Section 43 Administrative Procedures Act). However, it can be revoked again by the authority. But the person concerned has no claim to the revocation of the decision by which the right of pre-emption was exercised. Whether such a revocation takes place is at the sole discretion of the authority.

However, in view of the BVerwG’s landmark decision, cities and municipalities are both subject to an increased duty of review. Municipalities that have exercised the right of first refusal in the past in cases similar to the one on which the BVerwG’s landmark decision was based have to deal in a particular way with the interpretation recognised as law by the BVerwG. The more similar the cases are, the more likely it is that the authority’s discretion to decide positively to revoke the administrative act will be reduced.

If one arrives at the conclusion that the municipality is obliged to revoke the administrative act concerning the exercise of the pre-emptive right, the legal basis for the land purchase agreement with the municipality would consequently also cease to exist. The purchase agreement would then have to be rescinded: The municipality would have to transfer the property back to the former seller and would be reimbursed the former purchase price. Any costs incurred by the seller in connection with the reversal would have to be borne by the municipality in the form of damages.

What are the implications of the judgment for avoidance and submission agreements?

Using the municipal right of first refusal as a means of exerting pressure, municipalities have concluded avoidance and submission agreements with purchasers as an alternative to exercising the municipal right of first refusal. In these agreements, the purchasers undertake, for example, not to establish freehold ownership or partial ownership of the purchased property and the flats located in it without the written consent of the municipality, not to leave flat vacant for a certain period of time without a justifiable reason, or only to pass on the cost of modernisations in the form of rent increases up to a certain percentage (usually 30 percent of the net household income). In the event of a breach, there is the threat of contractual penalties, some of which can be considerable. In return, the city undertakes to refrain from exercising its right of first refusal.

The purchaser may now have a claim for adjustment and termination of these avoidance and submission agreements concluded in similar constellations in the past. In individual cases, such agreements may also have to be considered void irrespective of the recent case law of the BVerwG.

Termination

Termination is possible, for example, if the circumstances that were decisive for determining the content of the contract have changed so significantly since the conclusion of the contract that one of the contracting parties cannot reasonably be expected to adhere to the original contractual provision and an adjustment is not possible or reasonable. A change of the legal circumstances can be a common legal error about the legal situation or a common error about the continuance of a certain jurisdiction. In the present case, this could be seen, for example, in the fact that both parties assumed the continued existence of the legal admissibility of avoidance and submission agreements, which, in view of the BVerwG’s ruling, is now likely to be doubtful.

Nullity

Avoidance and submission agreements concluded in the past are not generally null and void due to the ruling of the BVerwG. However, independently of the current ruling of the BVerwG, nullity could result from the circumstance that an avoidance and submission agreement was concluded as a settlement agreement in order to eliminate “an uncertainty existing in a reasonable assessment of the facts or the legal situation by mutual compromise” (cf. section 55 Code of Administrative Court Procedure). Such an agreement can be void pursuant to Section 59 (2) no. 3 Administrative Procedures Act if the prerequisites for the conclusion of a settlement agreement did not exist and an administrative act with corresponding content would be unlawful.

The prerequisite for the conclusion of a settlement agreement pursuant to Section 55 Administrative Procedures Act is an existing legal or factual uncertainty which is to be eliminated by the settlement agreement. The avoidance and submission agreements known to us were generally concluded because of an alleged uncertainty concerning the facts of the case. For example, the cities claimed that there was insufficient factual documentation, such as information on currently existing leases, to allow for the consideration of the exercise of the right of first refusal. In direct connection with this, the conclusion of an avoidance and submission agreement was offered.

In such a situation, however, the conclusion of a settlement agreement is in any case not possible if the cities have only omitted to further clarify the facts or have even only claimed to have done so in order to precisely thereby maintain a state of actual uncertainty, which is a prerequisite for the conclusion of a settlement agreement. The uncertainty of a factual situation does not release an authority from its obligation to investigate the facts sufficiently and conclusively ex officio. The principle of official investigation prohibits an authority from failing to give a clarification of the facts that is possible and necessary with reasonable effort in order to be able to conclude a settlement agreement solely for reasons of saving work.

If, however, the preconditions for the conclusion of a settlement agreement were not met, the agreement is in any case null and void, since a corresponding administrative act with the content of an avoidance and submission agreement would be unlawful. With regard to the obligations and contractual penalties contained in the avoidance and submission agreement, there is no basis for an administrative act. It is true that the declaration of avoidance and submission is modelled on Section 27.1 Town and Country Planning Code, which opens up the possibility for the purchaser to avert the right of first refusal by means of a declaration of obligation. However, the provision only grants the purchaser a right to avert the right of pre-emption and does not contain any further authorisation for the cities and municipalities to issue administrative acts - a fortiori not subject to ancillary provisions in the form of requirements and conditions, such as those made with regard to rent levels or the conversion of residential property in the avoidance and submission agreements.