When a decision is made to sell a business, many different factors and considerations play a role. For those businesses that operate from leased space, whether it be office space, restaurant space or any other form of commercial or retail space, the terms and conditions of the underlying lease will factor into the sales equation since the lease might be transferred in connection with the underlying sale. This will result in the buyer “stepping into the shoes” of the seller and becoming the tenant under the lease. Not only are the business terms, such as rent and the remaining duration of the lease important, but both seller and buyer will also need to consider whether the landlord has any approval rights over the sales transaction.
Leases generally provide that an assignment of the lease by the tenant is a transaction that requires the landlord’s approval. A business is generally sold through either a sale of the tenant’s equity or underlying ownership interests in the tenant entity (“Equity Transfer”) or through the sale of all or substantially all of the tenant’s assets (“Asset Transfer”). An Equity Transfer arguably does not require the landlord’s approval since no assignment of the lease occurred as the tenant entity does not change. However, an Asset Transfer would require landlord’s approval since the tenant entity did in fact change as part of the transaction. However, to prevent circumvention of the assignment provisions and to ensure that both Equity Transfers and Asset Transfers constitute an “assignment” of the lease, sophisticated landlords generally will insist that their leases include language that those types of transactions (as well as mergers, reorganizations, consolidation and other types of transfers) are deemed assignments for purposes of the lease and thus require landlord’s approval.
A landlord having approval rights over a sale of a business potentially creates competing interests. From a tenant’s perspective, a tenant does not want a landlord to prevent the sale by withholding their consent or by using their consent rights as leverage to obtain greater benefits than conferred by the lease (e.g., the landlord will approve the transaction provided the buyer agrees to pay increased rent or additional consideration), while, from a landlord’s point of view, it wants to ensure that the buyer / new tenant is reputable, experienced and has sufficient financial resources to succeed.
So how should those competing interests be resolved so the concerns of each party are fairly addressed? The answer lies in incorporating qualifications and conditions governing the sale of a business as it relates to landlord’s approval rights under the lease. If the sale involves a “one off sale”, meaning that only a single lease and leased location are the subject of the sale, as opposed to multiple locations, unless tenant is able to negotiate the most favorable scenario (from tenant’s position) that such transaction does not require landlord’s consent, the lease should provide that landlord will not unreasonably withhold, condition or delay its consent so long as the buyer satisfies certain conditions, the most important being that buyer has a sufficient net worth / liquidity and experience in the business being sold. The sufficient net worth / liquidity requirement that needs to be satisfied is usually (i) a stipulated dollar figure (e.g., buyer has to have a net worth greater than X dollars), (ii) by buyer having a net worth greater than the seller, or (iii) by buyer having a net worth sufficient to satisfy the remaining financial obligations under the lease. With respect to the requirement of experience, the lease might provide that the buyer must have a certain number of years of experience in operating the business being sold and must operate a certain number of other locations with such business. Those conditions will serve to address landlord’s concern that the buyer is not a “downgrade” from its current tenant while contemporaneously ensuring the seller that the landlord will not withhold its consent to transaction arbitrarily and in bad faith.
If the sale involves multiple locations, then the same conditions previously mentioned should need to be satisfied – however, unlike the “one off sale”, landlord’s approval to the transaction should not be required if the above conditions are fulfilled. This will ensure the seller that the landlord cannot jeopardize a larger multi-location sales transaction. From a landlord’s perspective, the new tenancy may be more beneficial since landlord will likely receive a larger tenant with more resources, financial, experience and otherwise, than the seller.
In addition to the foregoing, there are some additional lease provisions that should be considered in connection with the sale of a business:
- With respect to an Equity Transfer, it should be made clear that a transfer of ownership interest in the tenant only triggers the assignment provisions (and thus the requirement to obtain landlord’s consent) if more than a controlling interest in the tenant is transferred (e.g., more than 50% of the stock or other equity interests) or if, as a result of such transfer, the person that has the authority to run the “day to day” business of the tenant changes. The tenant should be able to freely transfer a non-controlling share of ownership interests without landlord’s approval to raise capital and for other purposes. Such a transaction should not be objectionable to landlord as long as the person(s) primarily responsible for operating the business does not change.
- Leases often include language where a landlord shares in the net profit received by a tenant in connection with an assignment of the lease. For a seller, this is objectionable since why should landlord benefit from all the hard work that the seller undertook to grow its business and why should the landlord profit therefrom? However, the landlord views the leasehold interest that is being transferred as being valuable and as a key component of the sale for which they should receive some profit, often justified due to the buyer also receiving a lower rental amount by assuming an existing lease as opposed to entering into a new lease where the rent would otherwise have been the higher fair market value rent.
Which equitable solution can address the diverging positions? A profit share should not apply in a context of a sale where the tenant has multiple locations since the real estate asset being sold/transferred does not solely consist of this specific leasehold interest. A seller might also make the reasonable argument that it should also not apply in a “one of sale” as well, especially if the use of the premises is not changing. However, if the landlord insists on a profit share in such circumstances, then a fair and equitable compromise is that the applicable percentage of net profits payable to the landlord is calculated on the amounts payable and allocable to the value of the leasehold estate being transferred, not the business as a whole. A landlord should not share in other aspects of the deal, such as the value of seller’s good will or inventory. - If a guaranty was signed in connection with the lease, it would be prudent for a tenant to request language in the lease that, upon an assignment of the lease, the guarantor is released from its obligations under the guaranty if a substitute guarantor executes a substitute guaranty. Otherwise, the guarantor might remain liable for the actions of the buyer under the lease following the sale since a guarantor is generally not released upon an assignment of the lease.
Contacts
| Florian Ellison fellison@golenbock.com (212) 907-7339 | Steven R. Hochberg shochberg@golenbock.com (212) 907-7343 |