Copyright 2009, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Commercial Real Estate, September 2009
In preparing the property for sale, it will be important for the vendor to undertake a thorough review of all of the property leases and service contracts. On a purely administrative level, the vendor will wish to ensure that it has copies of all of the relevant lease and service contract documentation on file, to obtain copies or originals of any incomplete documentation and signatures on any unsigned documents. It may also be desirable to convert any existing offers to lease into formal lease agreements and any lease renewal discussions into formal renewal agreements.
The leases should be reviewed by the vendor to ascertain whether any of them contain any unusual or onerous provisions, such as rights of set-off, rights of early termination and – particularly in a retail context – exclusivity clauses or restrictive covenants. Any exclusivity clauses or restrictive covenants should be carefully considered to ensure that there are no existing conflicts or overlaps between the rights of different tenants.
Rights Of First Offer Or Refusal
The leases should also be reviewed by the vendor to determine whether they contain any rights of first offer or rights of first refusal. If a lease contains a right of first offer, the vendor may wish to consider triggering the right of first offer before going to market. The specific provisions of the right of first offer, including applicable time periods and any requirement to go back to the tenant once offers are received from third parties, will have to be reviewed carefully to avoid any unexpected surprises. If a lease contains a right of first refusal (i.e., where a tenant has the right to match any third-party offer that the vendor obtains), it will be important for the vendor to identify any such rights and to disclose them as part of the marketing of the property so that any agreement with a purchaser is made subject to, and conditional upon, such rights. An effort should also be made to have the tenant waive any right of first refusal in advance.
The vendor should also identify any security deposits or letters of credit held from tenants under the leases. The purchaser will be interested to ensure that these are in place and both parties will wish to ensure that appropriate credit is given for them on the statement of adjustments delivered at closing. In the case of letters of credit, these will have to be re-issued to the purchaser or substitute security provided by the tenant. Advance planning will be required to ensure that the appropriate arrangements are in place for closing.
If the property includes vacant space, the vendor may be compelled to consider the grant of a head lease in favour of the purchaser. Pursuant to a head lease, the vendor agrees to lease all or some of the vacant space at the property on closing from the purchaser for a certain period of time at a minimum base or gross rent, thus guaranteeing the purchaser part of its return. Head lease arrangements typically allow for the vendor-tenant to find suitable subtenants for the space, with the purchaser-landlord's consent, with the vendor-tenant being responsible for any tenant inducements and leasing commissions. Where the sublease is for rent that is at or above the rent paid by the vendor-tenant for the same term under the head lease, the sublease space is removed from the head lease and the sublease is assigned to the purchaser-landlord or a new lease is entered into directly by the subtenant with the purchaser-landlord. An estoppel certificate is usually requested to evidence that the permitted sublease is in place and to allow for the vendor-tenant's release. Where the sublease is for rent and duration that is lower and shorter than provided for under the head lease, the space is typically not released from the head lease and the sublease arrangement is maintained.
Rental Indemnity Or Guarantee
As an alternative to a head lease, the vendor may wish to offer instead an indemnity or guarantee for any rental revenue shortfall and vacant space existing at closing for the agreed-upon period. The advantage of offering an indemnity or guarantee is that the vendor-tenant is only responsible for payment of the rental shortfall and is not responsible for any other financial or non-financial obligations under the head lease, such as maintenance and repair, nor for any tenant inducements or commissions (although they may be factored into the indemnity). The vendor would also want to have the ability to have its indemnity or guarantee reduced for any vacant space that is leased from time to time.
With respect to the service contracts, the vendor will want to focus on the termination provisions and any penalties associated with termination. In today's marketplace, the purchaser may not wish to assume any of the service contracts, but would prefer to negotiate better rates with its own or the same suppliers. Contracts which are not terminable should also be identified by the vendor, as the vendor will try to have the purchaser assume such contracts or will need to negotiate their termination with the service provider.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.