Purchasing a Business – The Lease
Many purchasers looking to buy an existing business are aware that it is important to include in the agreement of purchase and sale that the transaction is conditional on landlord’s consent. If the transaction is structured as an asset sale, landlord’s consent will be for the assignment of the existing lease to the purchaser. If the parties are proceeding with a share sale, many leases require the parties to obtain landlord’s consent if the sale results in a change in the effective voting control of the corporation (though sometimes it is simply a change of ownership!).
While purchasers are often only focused on the numbers under the lease (i.e. minimum rent and TMI), it is equally important to ensure that the lease condition includes satisfactory review of the lease by the purchaser’s solicitor. Here are a few things to look out for:
Demolition or Renovation Clauses
Tenants are entitled to quiet enjoyment of the premises provided that they are not in default of their obligations under the lease. However, some leases contain a demolition clause and/or a renovation clause which provides that the landlord may terminate the lease by providing a predetermined amount of notice if the landlord intends on demolishing all or part of the building or renovating the building such that it renders the premises unusable by the Tenant for a certain amount of time. This is problematic for purchasers if the location is an important part of the business and it also causes interruption to the operation of the business since the purchaser will have to relocate.
Depending on the type of business, it may be beneficial to review whether the lease contains an exclusive use provision which restricts the landlord’s ability to lease units in the shopping center to other tenants proposing to operate the same or similar business. This will provide you with assurance that a competitor will not be opening shop next door. The wording of the exclusive use provision is important as landlords will prefer the wording to be as narrow as possible to avoid unnecessarily restricting its ability to lease to other tenants. Tenants on the other hand would prefer the language to be as broad as possible to cover a wider range of uses. If the existing lease does not contain an exclusive use provision, it doesn’t hurt to ask especially while you have the landlord’s attention.
“The Tenant will not effect or permit a Transfer without the consent of the Landlord which consent shall not be unreasonably or arbitrarily withheld”.
The assignment provision is the reason why purchasers and sellers need to obtain landlord’s consent in the first place. Here is an example of how this provision may be worded:
Note: “Transfer” is a defined term that usually includes, but without limitation, assigning the lease, subleasing the premises, and a sale which results in a change of the effective voting control of the corporation.
The words “consent shall not be unreasonably or arbitrarily withheld” is important because it means the landlord cannot deny the proposed transferee for no particular reason. The landlord will usually ask the purchaser for financial details, background information (e.g. business experience), and references to determine if the purchaser is likely to default on its obligations under the lease.
The lease will often indicate that the tenant will be responsible for the landlord’s administration and legal fees in connection with the request for consent. This can be upwards of thousands of dollars. This is a cost that purchasers and vendors often forget about until the assignment agreement provides that the landlord’s consent is conditional on this being paid.
Some leases provide that the landlord, as a condition of providing its consent, may increase the rent to fair market value as of the date of assignment. Less tenant favourable leases may even allow the landlord to change the terms of the lease. This causes uncertainty for both purchasers and vendors.
In conclusion, purchasers should view the lease as more than a financial obligation but more so an asset of the company. While the landlord may not end up exercising its rights under these clauses during your ownership, it is something that may concern prospective buyers if you were to sell the business down the road. What is important in a lease will vary depending on the nature of the business.
– Felix Ng, Associate Corporate Counsel
© Kalfa Law 2020