As the Dallas-Fort Worth economy picks up steam, many companies are taking advantage of pricing and other market-related opportunities to acquire other businesses, purchase assets of other companies and in some cases, merge with other companies. One consequence of these transactions is the leases “inherited” by the purchaser.
In most acquisitions and mergers, a target’s existing leases are merely a blip on the radar screen. They are generally not the issue driving the decision of whether to close the business transaction. Due diligence reviews of leases generally focus on the most obvious provisions—lease term, rental rate, etc. But once the transaction is closed, it’s imperative that a tenant quickly get up to speed on less obvious but nonetheless important terms of inherited leases.
As an aside, although the provisions are in all likelihood non-negotiable—except in connection with an extension or expansion amendment—the old adage that “knowledge is power” certainly holds true in the inherited lease scenario: Here are a few pointers:
• Ancillary Rights. This refers to expansion rights, renewal rights, and the like. Often these ancillary rights terminate upon an assignment of the lease. Review each of the specific ancillary rights provisions in the lease (as well as the assignment and subletting provision) to make sure that you retain the rights that you think you have. By reviewing any landlord estoppel obtained in connection with the transaction, the successor tenant can at least know the landlord’s position on the status of the rights.
• Insurance. A tenant needs to make sure that there’s no gap in coverage between the insurance required from the landlord and that required from the tenant. Under some leases, the landlord must insure only the building “shell”; in other leases, landlords insure the building “as built.” Some leases require tenant’s insurance to cover “improvements and alterations”; does that mean everything other than building shell or only those alterations made by the tenant after the date of the lease? Although no tenant wants to double-pay for insurance (through pass-through of landlord’s premiums and the cost of the tenant’s own coverage), it’s an even worse problem to find out—after a casualty—that there’s a gap in the coverages.
• Allowance. In leases where an allowance was to be provided, tenants can sometimes find “coins in the sofa cushions.” Review allowance disbursements to see if there is any remaining balance that has not yet been spent—and is not waived per a deadline in the lease. In some cases, a tenant may be able to apply it to rent but in any event, may get some additional “free” improvements.
• Non-curable Defaults. Leases often include defaults that cannot be cured by a tenant; the landlord can exercise its remedies upon the occurrence of any of them. A few examples include a breach of hazardous material provisions, failure to deliver evidence of insurance, an assignment without consent, bankruptcy/ insolvency of the tenant, abandonment or failure to occupy the premises, etc. It’s critical that tenants stay focused on avoiding these defaults since there’s no right to cure them. This is especially true for tenants whose rent is “below market,” where it may be in a landlord’s best interest to terminate a lease in order to increase its return.
In the world of inherited leases, tenants often find themselves in situations not of their own making. But a careful review of less obvious lease terms goes a long way in helping to avoid potential pitfalls.
Kathleen “Kitty” O’Connell Henry has worked with institutional commercial property owners in numerous lease transactions involving more than 100,000 square feet of space. She also frequently represents purchasers and sellers in sales transactions. Contact her at email@example.com.