Analyzing the Seller’s Operations:Leases
August 9, 2007
A thorough examination of the seller’s lease should be high on your list of priorities. The lease may contain some news (including news the seller isn’t even aware of) that may be so bad as to prevent the business from being sold on any terms.
Let’s assume Houston Sash & Door leases its plant and office space from a local real estate company. Houston tells you what the monthly rent is and it sounds favorable. The plant is located close to a major highway; consequently you’d like to stay in this location after you buy the business. You ask Houston how long the lease has to run, and he tells you it expires in three years. With three years left on the lease, you could buy the business and take your chances on what’s going to happen when the lease expires. Either you’ll be able to negotiate a new lease on favorable terms or you’ll have to move. But what if the lease has only eight months (or eight weeks) to go? Whatever you do, don’t take the seller’s word that the landlord will agree to a new lease or to extend the existing lease. Before you commit to buy, make sure the landlord will sign a new lease. If you can, get the landlord to sign a new lease with you, which should take effect only if and when you close the sale.
Even if the existing lease has a long time to run, the lease may not be assignable. If the lease has a provision prohibiting an assignment of the lease or says the landlord’s prior consent is required, you must check with the landlord to find out if the assignment is okay. Get the landlord to put the consent in writing. Your attorney should prepare a waiver of the nonassignment provision for the landlord to sign.
In some situations the seller won’t even be a party to the lease. The lease may have been drawn up between the landlord and the owner of the business rather than the business itself. In this case the seller technically won’t be able to assign the lease to you, even if such an assignment is permitted. What’s worse, the seller may be a subtenant, so that the consent of the primary tenant, as well as the landlord, may be required. In all cases your attorney must be satisfied that a proper assignment of the lease can be made. If it can’t be, you probably can’t buy the business unless you’re willing to move it to another location and the seller is willing to make payments on the lease despite no longer conducting any business there.
The assignability of the lease isn’t the only topic you need to discuss with the landlord. If the seller is behind in the rent or has in some way damaged the premises, the landlord probably has the right under the terms of the lease to collect these sums from you should you take over the lease. Find out if the landlord has any outstanding claims against the seller. If not, your attorney should have the landlord sign an estoppel certificate, whereby the landlord agrees there are no claims pending against the seller on the lease.
You and your attorney should read the lease carefully. Houston may tell you his rent is $5,000 a month. When you read the lease, you find, sure enough, the rent is $5,000 a month. But keep reading! You may find that the lease allows for an increase in rent. The increase may be a specified dollar amount or based on a percentage, such as the increase during the preceding year in the consumer price index (CPI). The lease may even provide for a pass-through of the tenant’s share of the landlord’s maintenance costs, taxes, and insurance. (If the lease is a net lease, you’ll be liable at the start for all these expenses, whatever they are, with the landlord receiving a fixed amount.) You may even find the landlord has the option to forget about the fixed rent and instead collect from you a percentage of your gross sales-a percentage lease. Your seller may not have had sufficient sales to activate the percentage rent clause. But if you’re planning on having greater sales than your seller, a percentage lease will increase your rent. It will also require you to turn over your records to the landlord for inspection so that the landlord can verify you’re turning over a proper amount of rent.
Most leases also have a blank where the tenant and the landlord fill in what the premises will be used for and prohibit the use of the premises for any other purpose. For example, the lease may state: “The premises shall be used for the purpose of selling shoes and other footwear apparel at retail and for no other purpose.” Adding a line of jogging shorts and shirts may constitute a breach of the lease. Once again, you should check with the landlord to see whether a change in the purpose clause is permitted; if it’s okay, get it in writing.
The standard commercial lease is very long and has the world’s smallest type. Reading it produces eyestrain and brain damage, but there’s just no substitute for having you or your attorney read it thoroughly before you sign.
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