By Danielle Stephens and Justin Borrowdale
Transactional attorneys play a key role in guiding their clients through various aspects of the sale of a business. Many clients operate their business from property that they do not own, but instead lease from a third party. In that case, when your client is preparing sell its business, you will need to contemplate how to transfer your client’s rights and obligations under the lease to the new business owner and limit any future liability under the lease for your client. Most leases provide that a tenant must obtain the landlord’s consent to any assignment of the lease or sublease of the premises. There may be exceptions in the lease to the consent requirement that allow for a lease to be assigned or the premises to be subleased to a successor in interest to a tenant’s business (i.e., in the event of a sale of all or a substantial portion of tenant’s assets) without landlord consent. Unless the lease was heavily negotiated by tenant’s counsel at the inception of the lease, the lease most likely provides that your client will remain liable under the lease (including any exercised options to extend) even after an assignment of all rights and obligations under the lease to the assignee/buyer. Although such continued liability is often an unwelcome surprise to clients, there are several strategies for reducing a client’s liability.
- Ask the buyer to negotiate their own lease with the landlord
If the buyer is successful at negotiating their own lease with the landlord, the landlord will terminate your client’s lease which will eliminate any risk of future liability under the lease for your client.
- Assign all rights under the lease to the buyer except for the options to extend
If you advise your client to assign all rights under the lease to the buyer except for any options to extend, your client’s liability under the lease would terminate at the end of the then-existing lease term. At the end of the then-existing lease term, if the buyer desired to remain at the same location, the buyer would have to negotiate its own lease with the landlord.
- Sublease the premises to the buyer
By electing to sublease the premises to the buyer instead of assigning the lease, your client retains more rights under the lease and more control. With a sublease structure, your client (i) can oversee the payment of rent by the sublessee and the delivery of the rent to the landlord to avoid monetary defaults under the lease, (ii) will be informed of tenant defaults because the landlord remains obligated to deliver notices to your client, (iii) has the opportunity to cure sublessee defaults, and (iv) can terminate the sublease in the event of a default and gain possession of the premises once again. As a sublessor, your client would also control the exercise of any options to extend during the lease term. This structure may not be ideal for a client who wants to ensure that the landlord and tenant are in privity of estate so as to permit the landlord to collect rent directly from, and enforce the lease directly against the buyer.
- Negotiate with the landlord
You could negotiate with the landlord for an immediate release of your client from liability under the lease, or a release after a certain period of time after the assignment (e.g, 3 years). In exchange for this release, your client could offer to (i) increase the security deposit, (ii) pay a fee for the early release, or (iii) extend the lease term thereby providing the landlord with a longer rent stream.
- Request the buyer/assignee to provide security for its indemnification of seller/assignor
Your assignment agreement (pursuant to which the seller assigns the lease and the buyer assumes the lease) should include language whereby the buyer/assignee indemnifies seller/assignor from any claims for a breach of the lease or otherwise related to the property arising after the effective date of the assignment agreement and the closing of the purchase and sale of the business. Depending on the situation, the following assurances may be combined in myriad ways to further secure the buyer’s indemnity obligation: (i) require the buyer to pledge its assets, (ii) require the buyer’s shareholders to pledge their shares, (iii) require the buyer’s principals to indemnify seller and secure that indemnity through a deed of trust on the principals’ real property, and/or (iv) require that the buyer provide a security deposit or letter of credit.
There are many ways to deal with a lease when a business is sold. While the best strategy for reducing a seller’s future liability under a lease depends on the parties involved, the circumstances surrounding the transaction and the nature of the business, the strategies listed above are worth considering.
Danielle Stephens is a partner at Diepenbrock Elkin Gleason, LLP in Sacramento, California. Her practice focuses on real estate and environmental law.
Justin Borrowdale is an associate at Diepenbrock Elkin Gleason, LLP in Sacramento, California. His practice focuses on commercial and industrial real estate transactions.