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Commercial Lease Assignment Problems
As part of selling your business, the lease can be one of the most overlooked barriers to completing the deal. The buyer and seller may have a “meeting of the minds” when it comes to the lease, but if it isn’t assigned they have nothing to buy or sell.
Let’s explore a few of the common issues that come up related to a lease in the sale of a small business.
Inadequate Time Remaining on the Lease
Ideally a tenant should sell a small business with more than three years left on the lease. The takeaway here is the longer the better.
It’s not uncommon for me to meet a seller who is going “month-to-month” on a lease and proud of it. In their mind they’ve reduced their commitment to the business, but in the buyer’s mind one of the largest expenses of the business is unsecured and at risk of inflation. The buyer’s ideal scenario is a monthly rent price that is known and set into infinity, and for this reason many buyers ask if there is an option to buy the real estate.
When sellers go month to month, the lease negotiation with the landlord is shifted further towards the advantage of the landlord/property management firm.
Landlord Approval is often a Condition to Close in Asset Purchase Agreements
When a business is sold the buyer must be approved by the landlord to be granted an assignment or a new lease. The seller normally only cares if the buyer has the funds to pay for the business, but the landlord doesn’t want the buyer “squeaking in” with nothing left in the bank account, or even worse bringing debt into business.
Landlords want to see reserves for a buyer to be able to pay the rent for up to six months, and they will ask for a “PFS” or personal financial statement to judge the rent worthiness of a tenant. Much like an SBA loan, they may also want to see some experience from the tenant that’s relevant to the business they are buying.
While the landlord can’t tell an owner how to run a business if they pay the rent and follow the rules of the lease, they can make it difficult to get in.
Assignment Fees From a Landlord may be Excessive
It’s not uncommon for a landlord or property management group to ask to see the contract for the sale of the business before considering a new tenant. They do this because they want to know how much the seller will make when they sell the business, and they may want a piece of the action. This is called an assignment fee.
For the right to transfer a lease, or what is often justified as “attorney’s fees,” an assignment fee is demanded to release the current tenant from their obligations. The fee is normally between $2K-$5K, but in one case I’ve seen a landlord ask for 10% of the contract price, which was $33,000. Assignment fees are negotiable, and a good broker and/or business attorney can assist a seller in negotiating this amount.
It also highlights the value of having a good relationship with the landlord.
Security Deposits on Commercial Lease Assignment may be Necessary
While the assignment is typically the responsibility of the seller, the landlord can and will also ask for a security deposit from the buyer. A reasonable security deposit is one month’s rent, but this too is subject to negotiation. I’ve seen up to six months requested, and again it’s highly negotiable. Both the term and how long it’s held can be negotiated.
While the seller of the business may think this isn’t his or her problem, it can be a problem if the security deposit makes the acquisition prohibitive for the buyer.
Landlords may ask for longer term security deposits as a deterrent to acquiring the space if they’re not trusting of buyers. Having a strong personal financial statement and experience to run the business is the best defense against an unreasonable security deposit.
Assignment Conditions may Surprise Everyone
Just when you think it couldn’t get any worse, there’s more. Landlord’s often don’t like letting the original tenant off the hook. If a seller gets his or her lease assigned, the landlord will most likely insist that the seller stays on the lease as back up in case the buyer doesn’t pay the rent.
Why have one “throat to choke” when you can have two?
The best defense here for a seller is to negotiate the removal of a personal guarantee when renewing a lease years before selling the business. If the business is strong and long lived, and the landlord likes you, renewing for a long term but removing your personal obligations will best position you to exit your business without the associated liabilities attached.
Conclusions
Some things like the “month to month” phenomenon of sellers are counter-intuitive. A final example are below market rents. While below market rents can be great for a seller for cash flow, it’s all the more reason to expect a landlord to “correct” the rent when a new tenant arrives. Market rates are what you want to be paying to avoid any unpleasant surprises when it’s time to sell the business.
When it comes to leases, the landlord has most of the cards. Even when neighboring spaces are unrented, landlords see a small business sale as their opportunity to make some money and adjust market prices to current levels.
Here again we see the difference in the renter versus owner perspective; the renter thinks “they need my business because these other units are unrented, so I’m going to get a great price” while the landlord thinks “this tenant needs to pay market rate or higher because these other units are unrented.”
Neal’s strengths include matching buyers and sellers, pricing businesses, and negotiating deals.
He is an MBA, CBI, ABI and serves on the boards of the Carolina Virginia Business Brokers Association (CVBBA) and the Better Business Bureau of Eastern NC. He’s lived in Garner for 15+ years and is an active member of the Garner Chamber of Commerce. He enjoys cycling and spending time with his wife Vivian.
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We are about to sign a lease for a restaurant space, but found a clause in the fine print that the landlord is to have 50% of the premium sales price if and when the tenant sells the business. It already seems unfair that the landlord wants any portion of the business owner’s transaction of his own business, let alone 50% of the premium. What should I do?
Daniel:
Before signing ANY lease, consult your attorney! Thinking you are saving $1000 by not using an attorney is a poor business decision.
You can negotiate ANY terms the landlord offers. You can establish your business across the street and the landlord gets nothing!
Hi Daniel,
I’ve had clients run into this situation when negotiating a lease.
I told them to RUN AWAY. There are other places to lease with a landlord who wants to be in the real estate rental business and not in your business. Why would you reward your landlord for selling your successful business?
I couldn’t agree more with Randall, seek legal advice regarding any lease you sign!
Good luck Daniel!
I agree with Holly and Randall’s response Daniel.
I’ll also add that just because a lease doesn’t include a clause that enables a landlord to take a portion of the business owner’s sale price doesn’t mean they may not ask for one.
I had this happen and the landlord asked for 20% of the sale price to assign where the lease was silent. The outgoing tenant negotiated the fee down, and the incoming tenant negotiated a defined, reasonable fee to avoid it happening to them when they exited.
as a director of a business and 50/50 owner of the business am i allowed to see the lease even if its only in my husbands name ? this is for information for divorce settlement
Jane: In most states, a partner of a business is legally allowed, “with reasonable notice”, to review the books and records of the business. A lease signed by the business would be a record that all partners should be able to review. Please consult with your attorney.
Thanks for your question Jeff.
You should ensure that the lease is properly assigned.
In addition to “who pays what,” lease spells out all of the responsibilities of both parties, so you want to ensure the chain of responsibility is transferred to the new business owner/tenant.
I’d encourage a conversation with the new tenant to learn why they want to pre-pay; there could be a solid business reason but it’s possible there’s something nefarious as well… Be sure not to ask any questions that could be considered discriminatory, but try to get to the reason why they don’t want a credit check.
As always, consult with a real estate attorney for legal advice.
Lastly, in regards to the deposit… In most of my deals, the business buyer pays the business seller directly for the real estate security deposit, and the closing attorney reflects to all parties that the deposit has shifted from the previous to the new tenant. This way it doesn’t go from previous owner/tenant to the landlord and then back to new owner/tenant.
Hi Mr. Isaacs,
We recently leased out a commercial facility to a Trucking company. The lease is for 2 years and we are 6 months in.
The existing tenant is now selling (asset sale) and the new proposed owner/tenant is wanting to pay the 18 months up front instead of going through the process of completing a credit check.
The rent is $7,000 per month, so the upfront payment would be $126,000 plus a deposit (current tenant has paid a $7K deposit).
What, if anything, should we be wary of in this situation?
If we forego the credit check, should we still demand a background check? Anything else vitally important if we get the 18 months up front?
I’m buying a pizzeria/ restaurant and there are 21/2 years left on the lease is it better to assume the lease or negotiate a new lease
In my experience as a business broker landlords generally prefer to have new tenants assume leases to save on legal costs and to recoup fees they paid in when they negotiated the original lease, such as lease up contributions.
From your perspective you would want to assume it if the terms are favorable, or negotiate for a new one if you think you can do better on terms. It may be worth having a commercial real estate agent research what favorable lease terms are in your market.
A new lease could include perks such as a grace period for the first few months and/or a new tenant improvement budget, but would likely be higher in cost.
Review the current lease for any assignment fees due and who is responsible for paying it.
Lastly, that’s a long time for a lease, chances are those are options; dig into if they are “market based rent” options or fixed rent.
I bought the business of operating a gas station from the original tenant with the consent of the landlord .
Now the lease is expired.Can the land lord force me out without any payment.
Hey Cyrus,
If the lease is expired, he can force you out without any payment.
When you say “with the consent of the landlord,” that consent needs to be documented by an official document such as a lease assignment or new lease. Written agreements support both parties cases for rights of usage. If the consent is verbal you won’t have much to defend.
If you don’t have a written agreement it’s not too late to create one with your landlord.
Consult with a qualified real estate attorney for legal advice, the advice above is from my experience as a practicing intermediary.
I hope these answers provide you clarity for your current situation.
Dear Mr. Neal Isaacs,
Thank you for your answer.following to my question,please be advised that the assignment that I had with the original tenant has been signed by the land lord.Although the assignment is expired, the landlord neither extends it ,nor is willing us to go. So how should we proceed?
The gas station is losing money and we are ready to make some changes to make it profitable,but wondering what to do
Best regards
Thanks for explaining Cyrus.
It may be that your landlord is considering selling the property for some use other than a gas station. I’m just guessing at why a landlord wouldn’t want to sign a lease with an existing tenant. It’s worth discussing with him or her.
Either way I would recommend a candid conversation with your landlord because any investment you make in the property could be at risk if you haven’t secured the space through a valid lease. It may make more sense to invest in another space if your landlord won’t co-operate with you.
Hi-
If a lease is being reassigned from Seller to Buyer and extended for a few years, who should be paying the Landlord’s attorney’s fees (buyer, seller or landlord)? Landlord as asking the Buyer to pay. I would think since the landlord is getting years added, he should pay for his own attorney fees — I assume he would pay if this was a brand new lease. Thank you.
Hi Henry,
The existing lease may address this situation. You may find in the lease agreement a section addressing assignment and it may define the party who shall bear the legal expenses when assigning the lease.
If not, it’s a negotiable matter.
It’s been my observation, when dealing with assignment situations, that most Landlords feel they have the upper hand and are generally reluctant to pick up any costs — even if the situation may be very beneficial to them in the long run. Just what I’ve observed…
And it’s not unusual for the landlord to ask for a separate assignment fee from the seller/buyer for their ‘trouble’.
The financial strength of the buyer should help when negotiating with the landlord. That said, I’ve been involved with deals when that doesn’t even matter.
The lease assignment is almost always a dicey situation to overcome when selling a business.
All the best…
Hi:
I sold my business in March 2016, it was an assignment. My lease at the time would end in August 2017. In the assignment, the revised lease term was extended to February 2021. But it is also written that my liabilities to the landlord would end in August 2017. My questions are A) am I still liable for paying rent if the current tenant defaults and when does my PG really end? B) if the current tenant renews the lease for another 5 years, am I liable for that renewal also?
Hey RT.
Your answers should be in the lease and the personal guarantee.
If your assignment has language that your liabilities ended in Aug 2017 you have documentation to protect yourself. As always I’d recommend consulting a real estate attorney for legal advice.
The personal guarantee may be included in the lease but it could survive the lease’s expiration so read it carefully. It should have the date of expiration included. Often the personal guarantee is at the very end of the lease .
Lastly, your assignee’s actions shouldn’t further your obligations if the lease was truly assigned.
Hi! I’ve signed my business lease for 5 years, but I’ve sold (sublease) the business after I’ve been there for first 3 years. The buyer finished the 2 years that I’ve left them, then Signed addition 2 more years. Then sublease to another new owner(3rd owner after me) after that, then the business got sold again to the 4th owner. Over all, it’s been 10 years that since I signed that lease, and my original lease expired 5 years ago. Now 4th owner of the business not paying rent, landlord are going after me for the rent balance, it is legal to do that?
Hey Molly,
Thanks for your question.
I don’t have all the details needed for a comprehensive answer, but since you used the word Sublease, it sounds like you may still be the principal on the lease.
Yes, a landlord could come after you directly if you are the principal on a lease, even if your sublease tenants don’t pay you your rent. This is where an Assignment is a better solution, as it would put you one step behind in the line for who pays first (assuming your landlord keeps the personal guarantee).
What doesn’t make sense is that it also sounds like your original term has expired, and only you should be able to extend your lease, so your landlord shouldn’t be able to “come after” you if your lease term has ended, unless there were unpaid bills/fees during the time of your lease.
I would recommend reviewing your lease and consulting with a real estate attorney to discuss the best plan to defend yourself. Sorry to hear that it’s been a challenge for you.
I sold my deli and new owner kept me on as a manager because the landlord would give him a lease with out me. The buyer was fully aware at the time of purchase. The new contract had seller and buyer on the year to year lease. I was recently fired for asking for unpaid wages & the lease was up the following month in which the landlord did not want to renew unless the orignal seller ( me) was on the lease again. But i was fired. The buyer then took an old lease forged dates/ rent amount and more with handwritten white out obvious not a real lease. The landlord contacted me to see if i would like the space because he gave a written notice to the current tentant. I accepted and was given a new 2 year lease at a higher rent amount of 600 more. At the time of his 2 week notice the current lease holder closed the shop stating maintence issues but yet told his lawyer he was sick. Now i have the space new name new menu new brand. My attorneys now are telling me to forfeit the space or pay the old tentant for loss of profits etc. What do i do?
Hey Yusuf,
There’s a lot to unpack here and I don’t know that I can add much value as I don’t totally understand the situation as it’s written. The fact that you’re attached to a transaction with forgery and what sounds like an individual who is not acting ethically is concerning.
Unfortunately this sounds like a legal issue more than a lease issue, and your attorneys, or an attorney on this platform should be guiding your decision. Outside of that, it sounds like you like the space and you have invested in it, but you don’t like the terms of your current lease; if appropriate I would also recommend explaining your situation to your landlord and imploring for their consideration to the special circumstances. I hope this helps.
Hey, I have a restaurant in which I own for over 7 years. I just signed an extension and I currently have 7 years left plus option. The landlord did not want to remove my personal guarantee or place a cap on it prior to extension. When I purchased the business, the previous owner was forced to sign a PG for 5 years (now released).
I’m planning on possibly selling the business in 3-4 years. I know this is a very difficult business to run with high rate of failure.
My question is if I sell in 3 years, I will have 4 years left. I doubt that the landlord will release me from the PG. If my buyer fails say within 3 years left with me on it, am I liable for all 3 years? Do they go after him personally first and then me? Will I be able to put a clause in the contract that if they come after me, I can go after his personal assets? It’s a large space and the rent is very high, so it would be a lot of money.
Greetings Mike,
You’ve asked a lot of great questions, and all of the answers are yes.
As far as who they come after first, the triggering event is what they call a “default” by your assignee; essentially when he or she stops paying they will be looking at you. The avenues for legal recourse they may chose will be based on their degree of letigiousness and how deep they believe your pockets to be.
Sounds like you already signed the extension so your option to negotiate will be reduced.