Record high numbers of people are quitting their jobs to start their own businesses. This rise in entrepreneurial pursuits is creating an opportunity for tenant-only commercial real estate leasing agents. In order to successfully fill this opportunity, however, agents must intimately understand how certain lease terms can cripple the startup from launching, let alone succeeding.
The nature of a startup is unlike an established business – the startup needs the flexibility to expand, contract, restructure and re-position itself. What the agent must understand is that this flexibility isn’t limited to just where the company is located or how many square feet its using. Rather, the need for flexibility extends to the company’s ability to reorganize its corporate structure, sell its assets or use its equipment as collateral for loans.
Read on to learn how to identify one of many clauses that can destroy a company and learn how to help your clients avoid expensive litigation…
Or don’t, at your own peril!
The Change in Control Clause: The Scenario
A few years ago you help negotiate a lease for your client, Environmental Check, a rapidly growing environmental research firm. During the negotiations you didn’t involve lawyers; the clients were in a rush as they were quickly growing and getting lawyers involved would only slow down the process. You also figured that a lawyer wasn’t necessary because you made sure that the most important clauses – rent, square footage, re-measurement and assignment and subletting rights – were all negotiated in favour of your client. The deal closed, you got paid and your client was happy at the location, until …
The CEO of Environmental Check calls you distressed. He’s in an intense legal battle with the landlord because you failed to properly advise him of the implications of the Assignment and Sublet Clause. He confides that the company lost the majority of its clientele due to the change in Alberta’s economic tide. In order to save the business, he restructured the company and assigned its shares to a parent company. During this process, Environmental Check continued to pay rent and the landlord was notified. A month later, however, he received a breach of lease notice along with the demand to pay $6 million - the full value of the lease.
How is this possible?
The landlord argued that the tenant breached the lease because the tenant was not allowed to transfer or assign its shares. Doing so was prohibited under the Assignment and Sublet clause and the landlord was enforcing its Accelerated Rent rights – a remedy for default. Your angry client is on the hook for $6 million and is being evicted. He blames you for not advising him to get legal advice and claims you failed to meet your professional duties.
What Happened?
You made a common mistake – assuming that the Assignment and Sublet clause deals only with the tenant’s ability to sign over its rights to occupy the premises. While the Assignment and Sublet clause does restrain a tenant’s right to allow someone else to occupy all or a portion of its premises, it doesn’t stop there. This clause goes further to restrict a company from “restructuring” its business.
What is this Clause and Why Does the Landlord Want it?
Landlords are concerned about tenants hiding their assets in order to prevent the landlord from fairly collecting what it’s owed should the tenant default. Anyone who’s ever been in lawsuit knows that you can successfully sue someone, but can’t always successfully collect!
Sophisticated landlords go through great pains to ensure that a prospective tenant has funds in the bank and that it’ll be able to meet its financial obligations. For example, landlords request prospective tenants to submit reference letters, bank statements and corporate status checks. Allowing a tenant to assign all of its assets or shares to another company would effectively undo this work because it could allow for an unscrupulous tenant to hide its assets. Given this legitimate concern, it only makes sense, then, to prevent a tenant from undergoing a “change of control” which can be worded as follows:
”3(b) […] The Tenant shall not Transfer the Lease […]
“Transfer” shall mean a transfer or issue by sale, assignment, bequest, inheritance, operation of law or other disposition, or by subscription of all or party of the corporate shares of the Tenant or an “affiliate” […] of the Tenant which results in a change in the effective voting control of the Tenant or a merger, amalgamation or other corporate reorganization of the Tenant […].*”
This clause says that the tenant can’t change its corporate structure even if the rent continues to get paid, the principals of the company stay the same, the corporation’s services stay the same and even if the tenant notifies the landlord of the assignment. What’s more - this clause does not require the landlord to even acknowledge, let alone consent to, a request for a transfer! The tenant is effectively barred from reorganizing its business, no matter how legitimate.
What Should You Do?
If you’re representing the tenant make sure that you strike out this clause completely. If the landlord has more bargaining power then you, insist that the landlord provide written consent, which cannot be unreasonably withheld.
Always put in a timeline when dealing with clauses requiring landlord consent. For example, insert wording such as:
”The Landlord must respond in writing to a Transfer request no later than 30 days after the request is delivered in writing to the Landlord personally or in accordance with any other provisions for the delivery of notice in this Lease agreement. If the Landlord does not respond within 30 days, it is deemed that the Landlord consents to the Transfer, no written approval is required and the conditions of section (3)(b) have been met.”
Adding a timeline to the clause ensures that your client doesn’t have to wait for an unreasonable amount of time before the landlord responds. After all, time is a luxury in our fast-paced economy.
Inserting a timeline can also prevent an unscrupulous landlord from taking advantage of a tenant’s potential misfortune. For example, a landlord could purposefully take its time to respond to a Transfer request in order to force the tenant into default and to trigger the Accelerated Rent provision. The landlord is then free to evict the tenant, collect the rent and then re-let the space to a new tenant.
An acceleration of rent provision gives the landlord the right, after a default by the tenant, to demand the entire balance of the unpaid rent owed under the lease for the entire remainder of the term to be paid in one lump sum.
Final Cautionary Thought
Understanding what your tenant is signing is the best defence to a potential negligence claim and prevents you from putting your client at risk. A better defence, however, is getting a lawyer involved, even if it’s for a quick review before you sign. After all, I’ve seen tenants sue their agents for not getting legal advice and for failing to detect lease terms that ended up materially affecting their business. Don’t be that agent.
Are you a Startup Company? Check out our commercial lease templates and samples of the clauses discussed here in the Clausehound Small Business Law Library!