By Howard E. Schreiber, partner and co-head of
Global Real Estate Practice, and Trevor Ives, counsel
Hunton & Williams LLP
A sale leaseback transaction occurs when a company sells real estate that it currently owns to a third-party and simultaneously enters into a lease to continue to occupy the property.
This is a finance-driven transaction that can have many benefits for the seller, including improving the cash flow of the seller and allowing it to redeploy capital back into other areas of the seller’s business.
It may also allow the seller to improve its balance sheet by eliminating long term debt if the property was financed, providing certain tax benefits as well as transferring the risk of property ownership to a third party.
However, a sale-leaseback transaction does not come without its disadvantages for the seller (and eventual tenant).
The key component to the sale-leaseback transaction is the lease that will be negotiated between the seller and the third-party purchasing the property (the new owner).
These types of transactions can be structured in many different ways, but the leases in typical sale-leaseback transactions are customarily long-term (for a term of at least 15-20 years, plus renewal options), and are true triple-net leases in which the tenant is responsible for all aspects of the property (including maintenance, all payment obligations, insurance, etc.).
Therefore, one of the key issues that a seller must resolve during the lease negotiation process is the loss of the flexibility that it enjoyed as the owner (and occupant) of the property prior to the sale.
As the owner of the property, the seller previously enjoyed absolute control over all aspects of the use of the property without a third party limiting that use in any way (unless the property was financed, in which case a lender would have imposed certain limitations on flexibility typical in financing transactions).
Nevertheless, even if the property was previously financed, the addition of the New Owner into the picture presents an entirely different level of potential limitations on flexibility for the seller, which can make the lease negotiation process between the Seller and New Owner contentious.
This article will focus on a few of the key hot button issues for the Seller during the lease negotiation with New Owner.
The New Owner’s desire to limit or restrict the Seller’s use of the property during the term of the lease can be an important issue for the sller, particularly in the retail context. While the seller wants to maintain absolute flexibility on the future use of the property, if for some reason the Seller desires to change its use in the future (or as a result of an assignment of the lease, an assignee desires to use the property for something other than Seller’s original use), the New Owner will typically want to include a laundry list of prohibited uses and use restrictions in the lease in order to protect its investment in the property and to ensure that the property is being used in a manner that won’t diminish the value of the property. Accordingly, use restrictions are typically subject to extensive negotiation.
A Seller that has been occupying its property prior to a sale-leaseback transaction has been accustomed to maintaining insurance coverage that it felt was reasonable and necessary in connection with its business operations at the property. However, as is typical in a lease negotiation, the New Owner (and possibly its lender) will most likely attempt to impose more extensive insurance coverage requirements than what was previously being maintained, which can create an unexpected increase in premiums for the Seller going forward. This issue will ultimately need to be resolved by the risk management personnel for both parties, but it can definitely result in extensive negotiations, particularly for large properties.
The shifting of environmental risk can be a highly contested issue in sale-leaseback transactions. The New Owner is typically looking at this issue as a “lender” and will contend that the Seller should be responsible for and indemnify the New Owner for any environmental issues that arise at the property, regardless of the cause. However, the Seller will attempt to limit any environmental indemnity to only those issues caused by the Seller so that its liability will not extend to any issues caused by a third party, adjacent landowner, or the New Owner. This can result in extensive negotiation between the parties, with the result possibly being that each party indemnifies the other party for environmental issues caused by such party, with no express indemnification from either party for any environmental issues caused by parties other than the Seller and the New Owner.
The Seller in a sale-leaseback transaction will attempt to maintain as much flexibility as possible in connection with making future modifications to the building occupied by the Seller and any adjacent property covered by the lease without obtaining the approval of the New Owner. Depending on the type of property and the structure of the transaction, the New Owner will most likely attempt to maintain as much control as possible in connection with future modifications, with the result possibly being that the parties agree to certain thresholds of modifications that can be made without the New Owner’s consent. In the context of maintenance and repairs, the responsibility for the cost of such items (particularly if they are capital in nature) can also be an issue that is difficult to resolve.
The above items are just a sample of the key issues that will be the subject of negotiation during a sale-leaseback transaction that will not only present challenges to the Seller and the New Owner, but to the counsel representing these parties as well.
While these issues are obviously not unique to a sale-leaseback transaction (and can arise in “normal” lease situations), the context of a sale-leaseback can significantly impact the perspective of the Seller (as a future tenant) and heighten the sensitivity of such issues.