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Purchasing Property with a Lease

Often when purchasing a company, certain assets pose issues not easy to discern. For example, a Purchaser can buy real estate through a purchase contract and perhaps even personal property such as furniture and furnishings, fairly easily. When purchasing real estate, title insurance can be ordered, surveys re-dated, and abstracts renewed. Information on mortgages can be obtained from a County Clerk’s office and assurances can be given of non-default status.

One major asset exists, however that is not so easy to determine currently–the status of Leases. But there are tools that can help, as follows; and requiring them in a Purchase Offer can be essential. These are some, but by no means all of such tools.

1.  Past Breach of Lease. If a purchaser is taking a Lease amongst other assets it is critical to know that the Lease is not in breach, and that there will be no future Landlord or Tenant action. But how to find this out? There would be no public filing regarding a breach particularly if no law suit has as yet been brought by or against either party.

The tool here, is an Estoppel Letter where the Seller, Tenant, and the Landlord each state, under oath or not, that there has not now nor ever been a breach. Having given such assurance, the assuring party is then estopped from asserting a current breach into the future. Of course, it would have been astute for the Purchase Contract to require an Estoppel Letter if and when demanded during the Lease Term. Careful drafting of Leases may even attach a sample Estoppel Letter in acceptable form, as an exhibit.

2.  Assignment of Subletting Clause. A purchaser must also study a Lease to determine what rights the Landlord has with respect to assignment or subletting. There are many variations of this so the Assignment and Subletting consents need to be carefully examined. For example, it is possible that if this is a store in a chain of branch stores, that there may be a lease clause simply stating that if all or a significant number of related locations are to be sold, the Landlord need only be given notice and its consent is unnecessary. Other typical such clauses may or may not require that Landlord consent, be reasonable or not and prompt or not. The number of days when Landlord consent is required to an assignment or sublet might also be stated.

3.  Use Clause. A purchaser must study the Use Clause in every lease. I was once confronted with a purchaser who wanted to open a car dealership. The lease prohibited car dealerships because the Landlord had also been a car dealer. Often, Leases require only that any Use be permitted by zoning. Sometimes a non-compete clause will determine prohibited competitive users even in an extended geographic radius.

4.  Attornment Clause. For a person purchasing a Landlord position, it’s important to determine if the Lease contains an Attornment Clause requiring the current Tenant to be governed by the new Landlord (Purchaser) as the original Landlord had been.

5.  Internal and External. Every provision in each lease must be examined including, for example, whether or not the Landlord’s approval of a new Tenant as an Assignee rather than as a sub-tenant excuses the current Tenant from further liability.

If so, or if not, a Purchaser of the Landlord’s position should request updated financials of all successor tenants. Hopefully, when the Lease was first drafted or in the purchase contract provision was made for requiring financial statements on demand. Otherwise, the current Tenant (or Landlord) may not be compelled to provide one. Knowing what items of equipment and personality go with the departing tenant or remain after the sale are often referenced in the Lease.

6.  Physical Examination. Purchasers are benefited by a physical examination not only by the Purchaser itself, but also by a building engineer or inspector. It may be that costly repairs need to be made for safety or government compliance, which might be used to offset the purchase price. It would be helpful to check with the applicable zoning or building department to determine if the building qualifies or perhaps has ever been cited under environmental, federal, state, and local legal and administrative guidelines.

All told, there are a number of important leasehold analyses which need to be examined when purchasing property that includes a lease. The tools to discover problems prior to purchase may not be obvious but they exist in your attorney’s lexicon.

I received an unexpected offer to purchase my business. What do I do now?

Many business owners have been caught off guard by the receipt of an unexpected offer from a third party to purchase their business. Here are six immediate steps that you should consider taking if this happens to you.

1) Request a letter of intent. If you haven’t received a signed letter of intent (LOI) from the prospective purchaser, you should request one. The LOI should indicate the purchase price and the other material terms of the transaction. The LOI should also indicate the structure of the transaction (i.e., stock sale or asset sale), the expected timing of the transaction and whether the prospective purchaser will need to raise funds from a third party to pay the purchase price. LOIs are also helpful in fleshing out whether there will be an “exclusivity period” during which you will be prohibited from shopping your business to third parties. LOIs are typically non-binding (except with respect to exclusivity as described above), but they are useful in establishing the parameters of the transaction and in identifying the key issues that will need to be resolved.

2) Request the execution of a confidentiality agreement. You should not discuss the possibility of selling your business to any party that has not executed a confidentiality agreement for your benefit. In addition to covering business and financial information about your company, the confidentiality agreement should restrict the prospective purchaser from disclosing the fact that discussions are taking place concerning the sale of the business or the status of any such discussions.

3) Commence seller due diligence. You should begin to identify, with the help of legal counsel, the “diligence issues” that may complicate the transaction. In broad terms, diligence issues are those transaction issues that can be identified by reviewing the seller’s business records and contracts. Examples include (i) the need to obtain the consent of third parties to consummate the transaction and (ii) the existence of actual or potential liabilities that may be significant in amount. The prospective purchaser will engage in extensive due diligence prior to signing a definitive agreement to purchase your company, and will seek to resolve any diligence issues that it may identify either through a reduction of the purchase price or through contractual mechanisms. It is advisable for a seller to identify and attempt to address any such diligence issues before they are identified by the prospective purchaser.

4) Discuss the offer with your tax advisor. It is impossible to determine whether an offer to purchase your business is attractive without an understanding of the tax liability that you will incur as a result of such transaction. Keep in mind that the structure of a sale transaction can be important in determining the tax consequences of the transaction. Accordingly, it may be desirable to make a counteroffer with a more tax-efficient structure after discussing the offer with your tax advisor.

5) Consider whether to conduct a formal auction for the business. Sellers often seek a “market check” to determine if the offer that is on the table is truly the best offer. As a seller, you may be able to conduct a formal auction process where additional prospective purchasers are identified and competing bids are solicited from such parties. You should be mindful that conducting a formal auction process is time-consuming, and the ensuing delay may cause the party that made the unexpected offer to withdraw such offer. If you plan to conduct a formal auction process, it may be desirable to engage an investment banker to assist you with that process.

6) Be mindful of fiduciary duties. If you don’t own 100% of the business, you will need to be mindful of fiduciary duties you may owe to the other owners of the business. In general terms, fiduciary duties require persons to act in good faith, exercise due care, and refrain from pursuing self-interest at the expense of other shareholders. If a sale of the business is imminent, your fiduciary duties may require you to obtain the highest possible price for the business. You should navigate any fiduciary duty issues with the assistance of legal counsel.

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