The tenant’s right to assign its lease in connection with the sale of its business

There is, of course, no single most important “legal” point to raise in a lease negotiation, but in many cases, if I had to pick one, it would be to make sure that the tenant has the right to assign its lease to a purchaser of its business, without the landlord’s consent and without the landlord having any recapture or profit-sharing rights.

Selling a business is difficult enough. You certainly don’t want to give the landlord the ability to stop or upset the process by withholding a required consent, recapturing the premises or using a profit sharing right to demand a portion of the purchase price of the business.

Even a right of consent not to be unreasonably withheld can give the landlord the ability to extract an unfair advantage. Neither the seller nor the purchaser will want to delay the closing while consent is obtained, and the purchaser won’t be eager to accept the risk that consent will be denied (even if not justified) or responsibility for the potential cost of resolving a dispute with the landlord. Finally, in some cases (especially in retail) the lease and the business are nearly inseparable.

Assuming the tenant is a corporation or a limited liability company, the sale of its business can be structured as (i) a sale or all or substantially all of its assets, (ii) a merger in which it is or is not the surviving entity, or (iii) a sale of stock or membership interests.

To properly address the issue discussed in this post from the tenant’s perspective, the lease should:

include a provision such as “Tenant shall have the right, without Landlord’s consent, to assign this Lease to any person or entity which purchases or otherwise acquires (including by merger or consolidation) all or substantially all of Tenant’s business and assets as a going concern; no such assignment shall be subject to Section [the recpature provision] or Section [the profit-sharing provision].”
not provide that a “change in control” of tenant is deemed to constitute an assignment of the lease.

Listed below are various conditions which landlords often seek to impose on the foregoing and my suggestions for how the tenant should deal with each one.

Requirement that the transaction have a bona-fide purpose other than the mere transfer of the lease.// OK
Requirement that the tenant give the landlord prior notice and evidence of compliance with the applicable requirements of the lease.// Tenant should only be required to provide this notice and evidence after the execution and delivery of the assignment. Sale of business transactions are usually negotiated in secret and need to be kept secret until very close to the closing date.
Requirement that the assignee execute and deliver to the landlord an assumption agreement acceptable or reasonably acceptable to the landlord.// OK, but only in the case of an actual assignment, not in the case of a merger or consolidation and certainly not in the case of a change in control. In the first of these cases, it serves no purpose since corporate law includes the necessary assumption and in the second, it makes no sense since there has been no actual change in who the tenant is.
Requirement regarding the character of the purchaser.// No. Any subjective test puts the tenant in essentially the same uncertain position as it would have been in under the general reasonableness standard.
Requirement that immediately after the closing of the transaction the tenant satisfy a specified financial test.// This can be very troublesome and can effectively destroy the right to assign if not handled properly.
- Here are some examples.
  - A condition that the net worth of the tenant immediately after the sale of business transaction must be not being less than the net worth of the tenant immediately before the transaction can be troublesome because very often debt is taken on or cash is distributed in connection with the sale of a business and thus the tenant’s net worth is in fact reduced as a result of the sale.
  - A condition that the net worth of the tenant immediately after the transaction must not be less than the net worth of the tenant as of the date of the lease can be troublesome because the net worth of the tenant may fail this test even before the sale of business transaction.
- The landlord’s imposition of a financial test as a condition to the tenant’s right to assign the lease to a purchaser of the tenant’s business is hard to justify because, with the rarest of exceptions, leases do not impose financial tests on tenants during the lease term. For example, a reduction during the lease term in the tenant’s net worth never, by itself, constitutes a lease default, so why, one must ask, should it be a condition to assigning the lease in connection with the sale of the tenant’s business? Leases don’t contain dividend stoppers or restrictions on the tenant’s debt to equity ratio.
- If, as a matter of negotiating leverage, the tenant simply must accept a financial test as a condition to its right to assign to a business purchaser then
  - the financial test to be included in the lease ought to be thoughtfully designed, based on the actual characteristices of the tenant’s business, and ought to be easily calculable in connection with a sale of the business. For this purpose, balance sheet tests (e.g. net worth or tangible net worth) will be easier to apply than income statement tests (e.g. operating income or the ratio of earnings to fixed charges) which may require projections of future (i.e. post-transaction) revenue and expense.
  - the lease should also provide that if the financial test is not met, the tenant (either the assignor or the assignee) has the right to post with the landlord a specific amount of security or additional security (cash or a letter of credit) in lieu of meeting the test. This is very important because it gives the parties to the sale of business transaction an alternative means — within their own conteol — to effect the assignment.
- In all cases, even if the financial test is not met, if the assignee meets the other requirements of a business purchaser (i.e., it is acquiring all or substantially all of the business and assets of the tenant for a bona-fide purpose other than the mere assignment of the lease), the lease should (a) require the landlord not to unreasonably withhold consent, and (b) provide that no recapture or profit-sharing will apply.