Canada: Leases For Sale-Leaseback Deals – How Do They Differ From Traditional Lease Transactions?

Copyright 2009, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Real Estate, November 2009

The topic of sale-leaseback transactions is always timely. In a hot real estate market, sale-leaseback transactions are popular as businesses seek to monetize the high values which they can obtain for their real estate holdings. In a cold real estate market, the overall economy is also often weak. As such, sale-leasebacks tend to remain popular as they offer companies a means by which to raise much-needed cash for their operations.

Unfortunately, all too often the form of lease utilized in a sale-leaseback transaction does not take into account the peculiarities of a sale-leaseback deal. The parties simply use the same precedent which they would use for a traditional lease transaction. This results in a lease document that does not reflect, and sometimes conflicts with, the overall intent of the parties. This article describes some of the issues that are often overlooked in drafting and negotiating sale-leaseback leases.

Management/Control/Insurance Issues

In all lease transactions, the parties need to turn their minds to the allocation of responsibility for the ongoing maintenance and management of the property. However, this is particularly important in saleleaseback deals as the "off-the-shelf" apportionment of responsibility, as contained in counsels' precedent form of lease, usually does not work for the parties. The vendor/tenant may wish to retain maintenance and management duties as it already has the personnel and facilities in place to carry out these duties or because it feels uncomfortable relinquishing control of the property. On the other hand, in order to better protect its investment, the purchaser/landlord may wish to assume control over maintenance and charge the costs back to the tenant. The purchaser/landlord may also wish to assume control so that it may charge the tenant a management fee (thereby increasing its return on investment). Of course, the opposite may be true for both parties: the purchaser/landlord may simply want to collect rent and transfer all maintenance responsibilities onto the tenant, or the vendor/tenant may want to sit back and have the landlord take care of the maintenance and real estate management issues. There is no "right" or "wrong" way in which to allocate responsibility – it all depends on what the parties intend – but the parties must be careful to ensure that the lease properly reflects this allocation.

The same holds true for insuring the physical structure of the building which houses the premises. In most commercial leases, this is the landlord's responsibility. However, in a sale-leaseback transaction, the vendor/ tenant may wish to obtain such insurance as it is a matter of simply continuing on with the policy which it already has in place.

Operating Costs Exclusions

In any real estate transaction, it is not uncommon for the purchaser to seek a price reduction if, during its due diligence period, it has uncovered items in need of repair or replacement. Typical examples include price reductions for roof, HVAC and parking lot repairs and replacements. Where the vendor has agreed to a price reduction, it should ensure that the lease does not permit the purchaser/landlord from later recovering the cost of the repair or replacement as an operating cost under the lease. In other words, the lease should prohibit the purchaser/landlord from later performing the work and recovering the cost of any repair or replacement for which it has received a price reduction. This will prevent a double recovery on the part of the purchaser/landlord.

If the purchaser/landlord has sought a price reduction but the vendor has refused, then the parties still need to consider whether the cost to rectify the deficiency should be recoverable as an operating cost under the lease or whether it should be an express exclusion.

Pre-Existing Environmental Conditions

In most real estate transactions involving the sale of commercial property, the parties expressly turn their minds to, and allocate risk for, pre-existing environmental conditions. This allocation of risk is normally addressed in the agreement of purchase and sale or closing documents, or both. It is imperative that any such risk allocation scheme be carried through and be reflected in the lease agreement. By way of example, where the purchaser has had an opportunity to conduct its own environmental investigations and is purchasing the property "as-is" (thereby agreeing to assume the risk for pre-existing contamination), the lease should reflect that the vendor/tenant is not to be responsible for any contamination which was present as at the commencement date of the lease. All too often, the parties leave the boilerplate environmental clauses in a lease unchanged with the result that they contradict what was agreed to elsewhere.

"As-Is, Where-Is" Issues

This is an extension of the pre-existing environmental contamination and operating cost exclusion issues described above. Where a purchaser/landlord has agreed to acquire a property on an "as-is, where-is" basis, it may be appropriate for the lease to release the vendor/ tenant from all responsibility and liability associated with other pre-existing conditions such as a failure of the property to comply with laws if such contravention was in existence as of the commencement date of the lease. Similarly, it may be appropriate to delete from the lease any obligation on the part of the vendor/tenant to remove leasehold improvements or other fixtures present in the premises as of the commencement date. As most leases also require the landlord's consent for the installation of signage, satellite dishes and generators, the vendor/tenant should consider including an express acknowledgement from the purchaser/landlord of its approval of these and other pre-existing items.

Registration/Lender Subordination

Most leases permit the tenant to register a notice or other instrument evidencing the existence of its lease. However, the timing of the registration is not normally addressed in a lease. In a sale-leaseback transaction, the tenant should seek the right to register notice of the lease immediately following the registration of the property transfer/deed and prior to the registration of any financing which the purchaser/landlord may be securing for closing. This will provide the tenant with security of tenure should there be a default under the financing and the lender assumes the landlord's position. The purchaser/landlord's lender may also require the lease to be registered in priority so as to ensure that the tenant remains bound to the lender should the lender assume the landlord's position. If this is the case, then the purchaser/landlord should ensure that the lease contemplates the required priority.

Of course, where the tenant is not permitted or unable to register its lease prior to the purchaser/landlord's financing, then the tenant should insist on obtaining non-disturbance protection from the lender.

Future Re-Sale of Property

Admittedly, issues associated to the future re-sale of the property are not limited to sale-leaseback deals. However, in a sale-leaseback transaction, the vendor/ tenant often has more leverage to negotiate a right of first offer or refusal, option to purchase, or restriction on the sale of the property to a competitor of the vendor/ tenant. Where appropriate, the vendor/tenant should seek to secure these rights.

Area Determination/Rent

Most leases contain provisions requiring the landlord to certify the area of the premises and to adjust rent accordingly. However, in a sale-leaseback transaction, the purchase price for the real estate is often calculated based on the rent payable under the lease. Accordingly, in order to avoid a situation where there is an unexpected rent increase or decrease after closing due to a measurement of the premises, but no corresponding right to adjust the purchase price, the parties should proceed on the basis of a deemed rentable area of the premises (thereby doing away with the need for measurement). Alternatively, rent should be expressed as a total annual sum and not as a per square foot amount.

Entire Agreement Clause

Most leases contain "entire agreement" or "four corners" clauses. These provisions stipulate that the written lease agreement constitutes the entire agreement between the parties and that any other terms, covenants or conditions not contained in the lease have no force or effect. Of course, in every sale-leaseback transaction, there is an agreement of purchase and sale and a myriad of closing documents that usually have a bearing on the relationship of the parties and the premises. These other documents should be considered and, if necessary, the entire agreement clause should be amended to reflect the existence of these documents and their applicability to the lease transaction.

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.