Buying a business: short term lease

Buying a business: “It’s only a short term lease so nothing to worry about”

It is easy when buying a business to focus on the exciting bit, the business itself, and not give any real thought to the property the business may occupy.

Where property is seen as peripheral to the business, it is natural to pay less attention to it and to the due diligence of the property aspects. However, leases, even short ones, can come with some serious unwanted liabilities. Early consideration to the property matters can pay dividends in ensuring there is no delay to the sale process by addressing property matters in good time, negotiating any leasehold matters without tight time constraints, and setting the business property in the context of the new owners business plans (be it expansion, relocating, or future sale).

Early exit

If the property will not form part of the business plan moving forward you will need to identify the swiftest cost effective exit. A tenant break clause in the lease is the best method (a clause allowing the tenant to serve notice on the landlord terminating the lease) but you will need to identify whether it is a rolling break, when the tenant can serve a notice at any time, or a fixed date break clause. It is not just the date however that is important; you should understand the conditions around the break date, which could mean it does not apply. How much notice is required? Are there any express financial penalty payments? Are there any rent arrears or other breaches of the lease, which would prevent exercise of the break clause? Break clauses can easily be invalidated on legal technicalities therefore it is always advisable to understand the break date conditions and instruct a solicitor to deal with this aspect.

If there are no break clauses when does the term expire? If the contractual term has expired and the tenant is ‘holding over’ you may need to take account of the time scales required by statutory notices to end the lease and a solicitor should be instructed to serve these.

If there is no break clause then you may need to look at assigning the lease or underletting. An assignment is finding a new tenant to take on the lease, and an underlease is the tenant itself granting an underlease to a sub tenant. You need to check whether assignment and or underletting is permitted in your lease and consider the terms. You may need to budget for marketing the property if you want to assign or grant an underlease. If the market for this type of property is poor, you may consider negotiating a surrender directly with the landlord although a premium is likely to be due.

However a lease ends, the ‘yielding up’ clause often requires you to redecorate and to reinstate previous alterations making good any damage. This can be a significant cost with no benefit to you but it may be possible to renegotiate with the landlord particularly if reinstatement is not required by a future tenant or the property will be redeveloped. Any new agreement should be documented by a formal variation of the lease to avoid invalidating a break clause. Even if the landlord has exercised a landlord break clause the yielding up covenants may apply.

Upon termination of the lease, the landlord may have additional rights to recover monies resulting from a breach of the lease. This will include readily quantifiable claims such as rent arrears, and dilapidations claims but future contingent liability should also be identified.

Continued use of property

If you intend to continue to use property, you will need to consider whether the lease terms are suitable or whether you wish to approach the landlord to negotiate. Does the lease plan accord with your understanding of the area actually used by the business in practice? What is the remainder of the term? Does the business have a statutory right to a renewal? Does the landlord have a break right and what period of notice will be provided? Do you have a relocation plan if the landlord exercises a break right? You may also need to give some thought to who is occupying the property. Many companies are part of group structures and there are often different legal entities within the group occupying the space. Sharing occupation is often expressly prohibited in leases. You also need to consider the permitted use in the lease and planning status, are they compatible with what you want to use the property for?

Care should also be taken to ensure that any future liabilities due to a past breach by the business are identified and accounted for before completion.

Conclusion

In an ideal scenario early negotiation will lead to the completion of variations, surrender, or new leases simultaneous with completion of the purchase of the business. If this is not possible and the risk is acceptable, an informal agreement in principle will add comfort. Quantifiable liabilities, such as repairing liabilities, should be determined and accepted by the seller and taken into account upon payment at the completion of the purchase of the business. Contingent future liabilities such as environmental or planning issues or those which cannot be quantified at present can be dealt with by warranties and indemnities in the contractual documentation. Where the liability is significant, a retention can be made from the purchase monies. It may only be a short-term lease however they can trip up the unadvised tenant. Tread carefully.