Table of Contents
1. Introduction
In commercial transactions, it is crucial to be aware of the potential pitfalls that can arise when buying the shares or assets of a business which operates at a premises with an existing commercial lease. The intricacies of lease agreements can significantly impact the success and profitability of your newly acquired business. Based on my experiences with commercial transactions in Vancouver and Victoria, BC, we will explore some common pitfalls that buyers should be mindful of during the business purchase process. By understanding these pitfalls, taking proactive measures, and obtaining strong legal counsel, you can navigate the complexities of lease transfers to safeguard your interests.
2. Inadequate Commercial Lease Assessment
One of the primary pitfalls when purchasing a business with an existing lease is failing to conduct a thorough review of the lease agreement. It is important to recognize that commercial leases and residential leases differ significantly in terms of purpose, legal protections, and the rights and responsibilities of the parties involved. It is essential to review the lease terms, conditions, and obligations to identify any potential risks or unfavorable provisions. Some key aspects to consider include:
(a) Commercial Lease Expiration and Renewal Options
The location of the premise or characteristics of the surrounding neighborhood may be important factors in your decision to purchase the business. Evaluate the remaining lease term and ascertain whether there are renewal options available. An impending lease expiration or limited renewal options could jeopardize the viability of the business. Typically, a renewal option must be exercised by the previous tenant in accordance with a specific timeline. If the renewal option was not exercised, the landlord is no longer obligated to renew the terms of the lease. As a result, you may be forced to relocate the business, earlier than you expected.
(b) Assignment and Subletting Clauses in Commercial Leases
When you buy an existing business, you are hoping to improve, or at the very least maintain the profitability of the business. However, sometimes, the costs of the lease outweigh the profitability of the business. One way to reduce your costs is to find a new premise with more affordable lease costs. A common issue for tenants is that most commercial leases prevent tenants from easily relocating their business and terminating the lease without incurring significant additional costs.
(i) Assignment of a Commercial Lease
An assignment clause in a commercial lease allows the tenant to transfer their lease rights and obligations to another party, known as the assignee. This transfer effectively replaces the original tenant with the assignee, who becomes responsible for fulfilling the lease terms and conditions. Most commercial leases require the landlord’s consent prior to assigning the lease to a new tenant. Obtaining the landlord’s consent can pose challenges during the transfer process and your exit. Upon a successful assignment, the original tenant is usually released from their obligations under the lease. However, it is crucial to note that some leases and some landlords may include provisions that continue to hold the original tenant or a director of the tenant liable in the event of default by the assignee, ensuring that the landlord’s financial interests are protected.
(ii) Sublet of a Commercial Lease
A subletting clause in a commercial lease permits the tenant to lease part or all of the leased premises to a subtenant. Unlike assignment, where the original tenant transfers all lease rights and obligations, subletting allows the tenant to retain some responsibility as the head tenant. The subtenant becomes responsible for paying rent to the head tenant, who, in turn, remains liable for the rent owed to the landlord. Typically, in a subletting arrangement, the head tenant retains liability for the lease obligations, including rent payments and maintenance responsibilities.
(c) Maintenance and Repair Obligations in a Commercial Lease
If you a buying a business with an existing lease, be sure to assess your responsibility regarding maintenance and repairs to ensure they align with the condition of the premises and your future plans. Most leases in Vancouver and Victoria are referred to as triple net leases. A triple net lease is a type of commercial real estate lease in which the tenant is responsible for, among other costs, paying all or a proportionate share of the building’s operating expenses, in addition to the base rent each month. Operating expenses can include costly expenses including property tax, security fees, structural or architectural maintenance, repair, and replacement, and plumbing maintenance, repair, and replacement. You may even be responsible for maintenance of an elevator for which your business does not use. Before buying a business with an existing lease, it is also important to understand that the amount reflected as the base rent is the minimum amount per month that you will pay to the landlord. The maximum amount is often an undetermined variable cost based on the tenant’s proportionate share of the total operating expenses of the premises, common areas, and building.
3. Failure to Notify the Landlord
Another potential pitfall is neglecting to notify the landlord about the change in ownership or failing to seek their consent as required by the lease agreement. Failing to adhere to the necessary notification and approval processes can result in serious legal consequences, including lease termination and/or financial penalties.
To avoid this pitfall:
(a) Review Lease Transfer Provisions in a Commercial Lease
Carefully review the lease agreement for specific provisions regarding lease transfers, assignment, or change of ownership. Comply with any notice periods, documentation requirements, or consent provisions outlined in the lease; and
(b) Establish Open Communication
Initiate early communication with the landlord or property management company to discuss the proposed business acquisition and seek their guidance on the necessary steps to transfer the lease. Maintaining open lines of communication can foster a positive relationship and facilitate a smooth lease transfer process. After all, since you will be engaging with the landlord or the property management company for the remainder of the lease, it is important to start off on the right foot.
4. Unresolved Lease Negotiations
When purchasing a business with an existing lease, unresolved lease negotiations can pose significant challenges for the buyer. Buyers must ensure that any necessary lease modifications or amendments are addressed before the purchase is finalized.
Consider the following:
(a) Request Lease Amendments
Identify any unfavorable lease provisions that may impede the business’s success or profitability. Work with the landlord and their representatives to negotiate lease amendments that better align with the buyer’s objectives and protect their interests. Remember that commercial leases are typically drafted in favour of the landlord. It is likely that not all of your amendments will be attended to, particularly ones which may increase risk for the landlord.
(b) Seek Legal Advice
Engage the services of a skilled business lawyer who can assist in negotiating and drafting lease amendments that address your concerns. Their expertise can help navigate complex legal issues and secure favorable lease terms for the buyer. A skilled business lawyer has likely reviewed plenty of commercials leases, but since there is no standard form commercial lease that is universally used by all landlords, it imperative that you equip your business lawyer with the time and resources to facilitate a thorough review.
Conclusion
Purchasing a business with an existing lease requires meticulous attention to detail and a thorough understanding of the potential pitfalls that may arise. By conducting a comprehensive lease assessment, notifying the landlord, and resolving any lease negotiations before the purchase is finalized, you can mitigate some risk to protect your interests. While I have outlined numerous considerations in this article, this article provides only a small overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Remember, seeking professional legal advice from an excellent business lawyer throughout the process is essential to ensuring a smooth and successful business acquisition.
Meet Sankar Nair, a skilled corporate lawyer and successful e-commerce entrepreneur. With over 14 years of experience in international business, Sankar has a proven track record of providing expert legal counsel to businesses of all sizes. From contract review to intellectual property protection, Sankar has the knowledge and experience to effectively navigate the legal landscape for his clients.