EAST GERMANY: RESTITUTION OF EXPROPRIATED PROPERTY
VERSES INVESTMENTS - RELIEF OR A FIELD OF TENSION?

ECONOMIC BACKGROUND

The new German States which once formed the so-called German Democratic Republic are still in the middle of what is perhaps the most fundamental economic transformation possible.

For the East Germans, the hardships of this transformation can now be felt throughout the country, as the continued unemployment rate of 11.7% in October, 1991 demonstrates. Economic unity with West Germany immediately uncovered the weaknesses in East Germany's economy, primarily the lack of modernization and investment over the past decades, with the resulting productivity equivalent to only about one-third that of West Germany. Positive developments and new opportunities derived from the new union have been slower in presenting themselves.

However, due to certain improvements in investment-related laws, there are now clear indications that a reversal of this trend has started. The employment slump has recently become less severe than previously feared, sectors of the economy such as the construction industry and retail trade are now showing positive trends, and the Trust Agency, the governmental agency designated to privatize former State-owned enterprises ("Treuhandanstalt"), has developed clear and manageable internal structures and has so far sold more than 3,000 of the 8,000 formerly State-owned enterprises. However, since the State-owned enterprises were often huge conglomerates, the real figures of what has been sold and what is still available are much higher. Most of the legal and practical uncertainties of the early days have by now been solved. The companies now have Deutsche Mark balance sheets, and reliable information about an investment target is usually available in sufficient detail. Consequently, the East German GNP, which decreased sharply in 1990 and fell even lower in 1991, is expected to grow by more than 5% in 1992 and by more than 10% in each subsequent year.

It is therefore time for foreign investors, especially American investors, to reconsider their initial reluctance to step into a market where they have so far been significantly under-represented compared to the number of foreign investors in West Germany.

Investment in the five new German states became even more attractive after Parliament enacted investment incentive legislation and decided in favor of Berlin as the German capital. The subsidies, investment grants and tax advantages are substantial and promote foreign investments without any kind of discrimination.

There are available:

• Direct payments to investors by way of subsidies;
• Extraordinary depreciation of movable or immovable useable fixed assets (except automobiles and aircraft);
• Tax-exempted reserves leading to a tax deferral for investors;
• Investment grants within the budget limits; and
• Subsidized loans.

It should be noted that Germany imposed a 7.5% income tax surcharge in the period July 1, 1991 through June 30, 1992 in order to finance Unification and the transition of the former East German economy to Western standards. However, new investments in East Germany should be practically unaffected by the surcharge because the returns on such investments will not fall within the surcharge period.


RECENT LEGISLATION ON PROPERTY ISSUES

One of the most significant obstacles for a substantial flow of investments has been the absence of a functioning real estate market. Most pre-War private property was expropriated or confiscated under the Communist regime. The first wave of measures transferring private property into the Ownership of the people" (a more appropriate term would be government or State ownership) was the so-called "Land Reform" (instituted during the Soviet Occupation between 1945 and 1949. The East German Communist government installed in 1949 continued these expropriations and confiscations that ended with a comprehensive expropriation order in 1972 that resulted in most of the remaining privately held real property and businesses, which had until then survived, finally being expropriated or confiscated. Consequently, hardly any real estate was in private hands when the Berlin Wall came down on November 9, 1989.

To ease the tensions generated by the rapidly growing demand for land and to prepare restitution of Western constitutional order, on September 23, 1990, the then still-existing GDR enacted two laws in accordance with agreements with West Germany: The first, the Act Regulating Open Property Issues (Gesetz über Regelung offener Vermögensfragen, hereinafter referred to as the "Property Act") created claims for either the restitution of assets (including real property and businesses) which had been expropriated in East Germany, or for the compensation of their value. As a general rule, property confiscated or expropriated under the GDR regime shall be returned, whereas expropriations during the Soviet Military Government (the period between May 9, 1945 and October 6, 1949) shall not be reversed. In the case in which the actual property cannot be returned to the original owner or his/her successor, a monetary compensation for their loss will be made.

Second, the Act Relating to Special Investments in the German Democratic Republic (Gesetz über besondere Investitionen in der DDR, hereinafter referred to as the "Investment Act") provides that an investor can, under certain conditions, obtain an investment certificate entitling him to purchase or lease real property and thereby acquire or validly hold title with priority over restitution claims.

To date, over a million restitution claims for assets in East Germany have been filed. Yet these filings have caused great uncertainty as to whether disposal of an asset was thereby blocked or whether it still could be purchased or leased for the purpose of a priority investment. The filings thus created a major obstacle in a great number of acquisitions. The Investment Act, although designed as a relief to the blocked real estate market, has proved insufficient. The same has been true with priority rules regarding enterprises which were set forth in the Property Act itself. Difficulties in the handling of the laws, as well as unresolved problems regarding the determination of who exactly, i.e., which entity, was entitled to dispose of a particular asset and apply for the investment certificate, resulted in an on-going lack of availability of real property. Similar problems have affected investment in existing enterprises.

In response to such concerns, the "Act for the Removal of Impediments to the Privatization of Enterprises and for the Promotion of Investments" was enacted on March 29, 1991, which significantly amended the Property Act and the Investment Act. It has greatly expanded the opportunities for an investor to purchase or lease an asset by excluding any restitution claims to such asset.


Scope of the Property Act

The Property Act as amended on March 29, 1991 covers all assets and claims to assets that were:

1. expropriated without sufficient compensation (indeed, it does not include expropriations effected during the Soviet Occupation between May 9, 1945 and October 6, 1949; this exclusion has been held constitutional by the German Federal Constitution Court in its decision of April 23, 1991. The German Parliament will decide on compensation for those expropriations);
   
   
2. expropriated with compensation lower than what citizens of the former GDR were entitled to;
   
   
3. sold by official administrators to third parties either directly or after having been transferred first into State property;
   
   
4. transferred into State property pursuant to a resolution of the Presiding Committee of the Council of Ministers of February 9, 1972, or related regulations;
   
   
5. real estate assets conveyed into State property by waiver of ownership, disclaimer of inheritance or gift if the waiver, disclaimer or gift was motivated by overindebtedness caused by such asset resulting from insufficient rent collected;
   
   
6. taken by the government or a third party by way of abuse of power, corruption, coercion or deception;
   
   
7. under one of the following compulsory governmental measures which shall be repealed: (i) state administration of assets owned by citizens who left East Germany without permission; (ii) preliminary administration of assets owned by citizens of West Germany or Berlin through governmental bodies on a statutory basis; and (iii) the administration of "foreign" assets by the government;
   
   
8. assets formerly owned by individuals prosecuted for racial, political, religious, or other reasons during the period between January 30, 1933 and May 8, 1945 (this applies, most importantly, to expropriated or seized property of Jewish persons), and assets seized as a consequence of, or in connection with, unfair administrative or criminal proceedings.

Covered Assets

The Property Act applies to real properties, buildings and other constructions, rights to use real property and similar rights, movables (including art work, jewelry, etc.), intellectual property rights, account balances, and participations in or title to enterprises with their business seat in East Germany, including East German branches of foreign companies.


Nature of Claim/Principal Rule

In principle, assets which had been transferred into State property or sold to third parties shall be returned if a legally recognizable claim has been filed. Instead of claiming restitution of an asset, applicants may elect to claim monetary compensation, unless the loss resulted from the transfer of real estate into State property by way of gift or waiver of ownership or inheritance rights. If applicants are only able to claim an asset jointly, they also need to exercise their election rights jointly.

Decreases or increases in value of assets or property since the conveyance into State property due to improvements financed by the State shall be compensated (value adjustment). Special regulations apply to the determination of increases and decreases in value and/or compensation claims for enterprises (basis: West German law balance sheets).

Purchase prices, redemption or compensation payments are taken into consideration on a two-to-one ratio (East German Marks to Deutsche Marks). Lost profits will not be compensated. Procedural details will be regulated separately. Pursuant to the Property Act, the person or entity which has the power to dispose of an asset must refrain from disposing of or encumbering the asset or from entering into long-term agreements with regard to the asset without the consent of the applicant if an application pursuant to the Application Decree (see below) has been filed, except for such transactions that are necessary to fulfill legal obligations or to maintain the asset.

In addition to reconveyance of expropriated property, the Property Act provides for the termination of compulsory public administration in the situations where this was the manner in which the State controlled an asset.

Special Rules for Business Enterprises (Secs. 6 and 6a of the Property Act)

The Property Act also includes restitution claims for enterprises. However, title in an enterprise may be claimed only if the enterprise in its present status is comparable to the expropriated enterprise. The Property Act assumes comparability

"if the products and services of the enterprise remained basically unchanged considering the technical and economic developments, or if earlier products and services have been replaced by new products and services."

An improvement or deterioration of the asset or profit status after expropriation must be compensated by taking into consideration general economic developments. In the absence of comparability, or in the case of applicants who opt for compensation rather than restitution, applicants may claim compensation in an amount equal to the value of the enterprise at the time of expropriation, including 1% interest per annum. The same applies to movables, if they cannot be returned.

If an applicant claims title to an enterprise now forming part of a larger entity and restitution would require a spin-off, the applicant may claim an interest in the larger entity. The value of such interest must also reflect the changes in the value of the enterprise.

If assets were grossly mismanaged, applicants may claim damages pursuant to the law on government liability.


Parties Involved in the Restitution Process

The restitution process affects a number of parties, the configuration of which often gives rise to confusion. Basically, there is one party which has become the victim of the confiscatory measure; there is another party in whose possession or ownership the item of property actually is (prior to the potential reconveyance); there might be an investor trying to claim priority over a pending restitution claim; and there are administrative authorities which might have to approve a transaction. Beyond the question of who is entitled to the asset and may therefore claim restitution, a particular source of problems appears to be the determination of the party which is legally entitled to dispose of the asset in question.


Potential Claimants

Restitution and compensation claims may be asserted by the original owners, i.e., individuals and entities, and their successors and assignees. If more than one individual suffered from an illegal act, the applicant who suffered first in time may assert the claim. If an applicant claims co-ownership in an enterprise, the results of adjudicating the claim will apply to all other co-owners.


Power of Disposal

Items of property which were affected by confiscatory measures were either converted into State property or given to third parties (e.g., party activists). As a standard rule, the person or entity now owning an item of property or in the position to dispose of it is regarded as having power of disposal under the Property Act. Difficulties arise in the case of State-owned property. Under Western legal order, title registers for real property and enterprises would tell who was considered to have power of disposal. In East Germany, registers were often inappropriate for determining the power of disposal of State-owned property since the registers did not always indicate specific administration authorities to have power of disposal. In addition, problems have arisen from the re-structuring of local authorities and municipalities causing "old" administration authorities to cease to exist. For that reason, a law has been enacted (Vermögenszuordnungsgesetz) to assign the power of disposal over an asset of State property to the public administration body on a community or state level. Special rules apply to the Trust Agency (Treuhandanstalt), the governmental agency designated to privatize the former State-owned enterprises. Ownership rights in these enterprises have passed, directly or indirectly, through holding companies to the Trust Agency, which in these cases exercises power of disposal by virtue of law.


Exceptions to the Principal Restitution Rule

To reduce hindrances in economic reconstruction and development and with respect to certain general considerations, exceptions from the principal restitution rule are provided for. The most important ones (most of which have been incorporated into the Property Act itself) are as follows:

1) Special Investment Purposes (Sec. 3a of the Property Act, and Sec. 3.VI of the Investment Act)

To enhance pursuit of specific investments, particular assets needed for such investment shall no longer be blocked by pending applications for restitution. Therefore, the provisions discussed below may be regarded as the heart of the March, 1991 amendments. By law, there are basically two levels of rules after these amendments granting priority for investments:

First, there is Sec. 3a of the Property Act, which is most comprehensive and therefore unofficially referred to as the "Super Investment Priority Rule" covering both immovables and enterprises. It is limited in time to contracts entered into prior to December 31, 1992. Second, there are Secs. 3.6 - 3.8 of the Property Act, the "Ordinary Investment Priority Rule" covering enterprises only, and the Investment Act covering immovables, both of which expire by December 31, 1993. Therefore, until the end of 1992, the subsequent "Super Investment Priority Rule" overlays the "Ordinary Investment Priority Rule" enacted earlier.

Under either Rule, an asset may be sold or leased irrespective of pending applications for restitution if the investor provides a detailed investment plan that demonstrates qualifying investment purposes.

Once the potential investor is granted permission to invest with priority in the form provided for in the specific Act, i.e., a contract under Sec. 3a of the Property Act, an administration approval under Secs. 3.6 - 3.8 of the Property Act or an Investment Certificate under the Investment Act, he enjoys protection from restitution claims filed by victims of expropriation or
confiscation.

Qualifying investment purposes under the "Super Investment Priority Rule" include:

1. regarding the sale or leasing of real estate or buildings:
   the creation or securing of jobs through the formation of a commercial establishment or an enterprise in the service sector; the satisfaction of a substantial housing need of the people; or the creation of infrastructural measures for such projects.
   The granting of priority to the investor over pending restitution claims must be appropriate and reasonable; furthermore, the investor's ability to pursue his/her stated investment purposes must be contingent upon the granting of this priority;
   
   
2. regarding the sale or leasing of enterprises:
   the creation or securing of jobs or enabling investments that improve competitiveness; the absence of a warrant to continue operating the enterprise by the applicant for restitution.
   

In the context of the "Super Investment Priority Rule", the Trust Agency also has the power of disposal with regard to all enterprises that it owns indirectly, wholly or partially.

Within the framework of the sale of shares in an enterprise (as opposed to a sale of its assets) for investment purposes, problems may exist regarding assets, in particular, real estate, that belong to the enterprise. Such assets may, in turn, be subject to separate restitution claims, especially where the enterprise assumed or was assigned title to such assets through confiscation or expropriation. The assets of a company are not protected from restitution claims regarding the company itself. In order to also obtain such protection for single assets, the investor would have to be granted an Investment Certificate with respect to the particular item. However, the possibility of obtaining Investment Certificates for assets in addition to the granting of priority for the investment in the enterprise itself is not addressed in the law. Still, it is the common belief of the Trust Agency that this is legally possible.

Within the framework of this "Super Investment" rule, the law does not prescribe a separate administration procedure. It is left to the entity having power of disposal to decide whether an eligible investment purpose is being presented. Consequently, the application of the rule is restricted to those assets whose control is assigned to the official local authorities or the Trust Agency. Before the asset can be sold or leased to third parties, the applicant who has filed restitution claims has to be heard (mainly to determine whether the applicant is willing and able to make a comparable investment by himself). If the asset has been sold or leased pursuant to this Rule, and the applicant's restitution claim turns out to be justified later on, a monetary compensation shall be paid to him in the amount of the revenues of the sales or, if higher, at fair market value.

To be valid, a purchase contract for expropriated assets under the "Super Investment Priority Rule" must contain a provision obliging the acquiror to return the asset if he does not comply with the investment plan during the first two years following the purchase, unless unforeseeable business reasons force him to deviate from the plan.

Under Sections 3(6) - 3(8) of the Property Act (the "Ordinary Investment Priority Rule", regarding enterprises only, see above), the conditions are more limited as far as procedures are concerned; whereas the entity having power of disposal decides by itself on the qualifying investment purpose under Sec. 3a, Secs. 3(6) - 3(8) of the Property Act require a separate administration procedure and decision by the local district administration (Landratsamt bzw. Kreisfreie Stadt). On the other hand, Secs. 3(6) - 3(8) are also eligible for investment projects not involving a public authority or the Trust Agency exercising control of the enterprise.

Finally, the Investment Act sets forth the rules for the "ordinary" treatment of immovables until the end of 1993, as opposed to the more short-term-oriented "Super Investment" provisions. Under the Investment Act, the material requirements are stricter than under Sec. 3a of the Property Act. In addition to the conditions of Sec. 3a of the Property Act, the investment project must be urgent in nature. A deadline on the realization of the investment will be set forth in the specific Investment Certificate, which must be issued by the local district administration pursuant to the Investment Act. Where limited real property rights are sufficient to pursue the investment, those rights may be granted instead of transferring full ownership rights by selling the asset (German law provides for certain types of limited real property rights). Notwithstanding the principal restitution rule, the Investment Act further stipulates the right of the entity having power of disposal of the asset to enter into long-term lease contracts, to encumber the asset or to invest by itself, provided that a qualifying investment purpose is given (self investments).

A party that would be entitled to restitution but has been deprived of this right under the Investment Act may claim monetary compensation in the amount of the sales revenues or fair market value. If the asset has only been leased, restitution will be granted and the applicant becomes party to the lease agreement.


2) Unfeasability of Reconveyance (Sec. 4(1) and Sec. 5 of theProperty Act)

The Property Act also excludes the re-transference of assets whose dedication had been changed materially and entirely, i.e., property rights in real estate or buildings that have been changed at material cost and then brought into public use, such as schools or streets, and real estate or buildings in commercial use or forming part of an enterprise, if the real estate cannot be re-transferred without material detrimental effects on the enterprise.

An applicant may demand either revenues of the sale or, if higher, the fair market value if a re-transference of real estate is excluded because of special investments (see above).


Good Faith Acquisitions (Sec. 4(2) of the Property Act)

Individuals, churches or charitable foundations having bought assets in good faith before October 18, 1989 need not re-transfer those assets, provided that the authorities had legally granted the necessary approval pursuant to the Application Decree (Anmeldeverordnung, see below) of July 11, 1990. In the case of real estate, the authorities may grant compensation to the claimant in the form of other real property of equal value. The Property Act defines bad faith acquisitions as purchases violating valid East German law or based on corruption, abuse of power, malicious use of constraining situations or deceit of previous owners.


Legal Consequences of the Restitution

When assets have been re-transferred to the applicant, he becomes party to all rights and obligations connected to the asset. Leases or other use agreements are only affected if the lessee or user holds his position because of corruption, abuse of power, coercion or deceit. Encumbrances registered at the time of the conveyance of a piece of property into State-owned property are re-entered in the Land Register. Mortgage claims of the State-owned banks against State-owned pieces of property are extinguished and must be settled with the successor of these institutions. Lessees and users may claim compensation for improvements of the property. In limited circumstances, lessees and users have a pre-emption right.


Procedure

Newly created authorities on the local level will handle the restitution and compensation claims. Applications must be filed with the appropriate local authority. In addition, a supporting and supervising authority on the federal level (Bundesamt) shall be established. An application filed with an authority which is not competent shall be forwarded to the appropriate authority by the original inappropriate addressee. Any application pursuant to the Application Decree of July 11, 1990 is deemed to be an application for the restitution of assets.

Applicants may request information from the authorities when providing prima facie evidence of a claim. They may elect between restitution and compensation until the authority has rendered a decision.

The authority must render a written decision and inform the Applicant of his/her legal rights to challenge the decision. The decision becomes res judicata within one month if no objection is filed. Once it is res judicata, title to the assets is automatically transferred to the Applicant. If necessary, the authority arranges for the correction of the Land Registers.

The Applicant is not charged for any administrative proceedings, except for the cost of counsel. However, the authority must reimburse the cost of counsel, if reasonably necessary to assert a justified claim.


Deadlines Pertaining to the Application Decree

The Application Decree of July 11, 1990 set a "deadline" to assert claims by October 13, 1990. However, neither the Application Decree nor the Property Act exclude claims after the expiration of the deadline; they only exclude a right to claim restitution of title if title (especially in real estate) has passed to third parties. If title has so passed, applicants may only claim compensation. The "deadline" for claims based on expropriations in the period between January 30, 1933 and May 8, 1945 had been extended to March 31,
1991.


OUTLOOK

To date, the various district administrative authorities have primarily been occupied with registering the restitution claims filed and entering them into their computer system. Now it seems that this initial phase of merely taking stock is coming to an end and that the second phase involving decision-making regarding pending applications has begun. However, the duration of the decision-making process regarding an individual case may take months, if not years, especially if court procedures follow. Therefore, for the time being and for the near future, the availability of assets needed for investment will continue to depend on the application of the laws discussed herein.


LAST MINUTE NOTE

Pursuant to a press article in the Frankfurter Allgemeine Zeitung dated December 5, 1991, the German Government and the Secretary of Finance presented proposals for the calculation of monetary compensation. Apparently, they propose that a lump sum in the amount of the rateable value (Einheitswert) of 1935 multiplied by 1.3 without interest be paid; however, it is proposed that payments made to applicants in the past for the equalization of burdens of World War II and its consequences (Lastenausgleich) will be deducted, which would result in a net multiplier of about 0.7. There will be a percentage decrease for compensations above DM 100,000.00. To offset any disproportionate advantages of applicants who are granted restitution of their expropriated property, such applicants, according to the proposal, will be required to pay a "property compensation" (Vermîgensausgleich) in the amount of 30% of the rateable value, but at a much higher multiplier. For example, the multipliers for housing rental real estates shall be 3, for business real estate 9, for vacant real estate 15. In the case of enterprises, the 30% figure will be based on the equity of the enterprise as shown on its Deutschmark opening balance sheets.

Although these are just preliminary proposals, they indicate the basic format of what to expect.

Lex Mundi World Reports
Supplement No. 15, May 1992

Thomas O. Verhoeven, Esq., Peter Erbacher, Esq.
and Walther H. Nuessel, Esq.
Boden Oppenhoff Rasor Raue
Olympic Tower, 19th Floor
645 Fifth Avenue
New York, NY 10022
Tel: 212-752-2900
Fax: 212-752-3009