The world of commercial real estate—and the contracts that drive it—are fraught with risks to both the transaction at-hand and the wider interests of the business. Today, let’s talk about one of the common points of negotiation, complication, and sometimes seriously adverse implications for businesses, the commercial lease assignment.
Almost every commercial lease contains language pertaining to lease assignments. Quite simply, a lease assignment outlines the procedure and approval process for assigning the leasehold interest from the tenant to another party. The lease assignment should provide for a smooth transition without a renegotiation of the original lease terms.
As you can imagine, when businesses change ownership, whether by selling the assets or transferring ownership interest in the company, the transaction triggers the provisions of the lease assignment section of the commercial lease. Often, the location of a business can play an important part of the valuation of the business and its likelihood of post-transaction success. For example, a restaurant or retail shop in leased space typically carries a lot of locational value due to customer goodwill, foot traffic, and surrounding businesses. If you’re selling a business, whether by transferring only assets or ownership interest in the company, it pays to have thought ahead about a potential exit when you’re negotiating the provisions at the outset of the lease.
Regardless, the lease should contain very specific procedures that all parties—the landlord, selling tenant (known as the assignor), and buying tenant (known as the assignee)—must follow in order to expeditiously assign the lease. Essentially, the landlord needs to have the right documents and time to evaluate the viability of the buyer as a replacement tenant, while buyers and sellers need the landlord evaluation expedited in a way that doesn’t interfere with or improperly delay the transaction.
As a protection for the event of potentially selling your business or no longer needing the space you have leased, you’ll want to put a short, but reasonable amount of time in place for the landlord to evaluate the assignee. We see these time frames at multiple durations, but you’ll want to limit this to about two weeks or 10 business days to keep momentum for your sale transaction. You’ll want to also clearly define the information that the landlord wants to see regarding the assignee’s financial position and not just assume that they’ll go with the health of the business their assignee is purchasing. The assignee may have a riskier debt ratio, lower net worth, or other key financial factors that creditors use to evaluate potential customers.
In addition, if you believe it is likely that your business may merge or be acquired by another company, it is important to add language to the lease that allows you to assign the lease without the landlord’s prior approval as long as the transaction falls within certain “permitted transactions”.
Many leases often have renewal options to give peace of mind and flexibility to both the landlord and tenant. Don’t assume that these options will transfer to a new tenant without explicitly stating this procedure in the lease assignment provisions.
You’ll also negotiate a lease assignment fee, since the due diligence required by the landlord is akin to a bank underwriter evaluating risk for a loan. While some landlords forego such a fee, many expect as much as $1,000 or more. Make sure this cost isn’t prohibitively high for affecting the value of your future transaction.
I think an improperly negotiated lease assignment provision is one of the more surefire ways to put a business exit in jeopardy, cause acrimony, or even worse, cause a sale to fall through to an otherwise great buyer. As with many aspects of business law, commercial real estate transactions must be approached with the goals of the business—current and long-term—in mind. If you take a strategic view of each transaction and work with your advisors, you’ll be able to significantly lower the likelihood of a less-than-stellar transaction.
To learn more about our services for commercial real estate purchasing, selling, and leasing, as well as strategies for exiting your business, contact me at the Forrest Firm today.