By Erin Tenner, Gray Duffy LLP
In the prior four articles on Buy/Sells we discussed the three different types of buy/sells: asset sale and purchase agreements, stock sale and purchase agreements and shareholder agreements. But what role does the real property play and how is it transferred in each of the different types of buy/sells?
In an asset purchase, the assets are purchased and the land can be leased or purchased or leased with an option to purchase. The lease term will typically be a minimum of 5-10 years with 2-3 options to renew the lease term for additional five year periods.
The lease should always be less than 35 years, including options to renew. A lease that is 35 years or more, even if part of that term is the options to renew, will result in a reassessment of the real property because it is treated like a transfer for tax purposes.
The lease will either be an assignment of an existing lease or negotiated as part of the transaction. If it is negotiated, ideally it will be done at the same time the asset purchase agreement is negotiated. If it is not completed and attached to the asset purchase agreement as an exhibit, the asset purchase agreement may not be enforceable. Negotiation of the lease will have to be a condition to closing. If terms are not agreed upon, the purchase agreement will not close.
If land is purchased, a separate purchase agreement is drafted for the purchase. The purchase agreement for the land will include a condition to closing that requires the asset purchase agreement to close at the same time. The asset purchase agreement will likewise include a condition for the closing of the real property purchase at the same time. Like a lease, if not drafted at the same time as the asset purchase agreement, it could render the agreement unenforceable.
The land is treated differently if it is leased and stock is purchased than it is in an asset purchase. The lease does not need to be assigned as part of a stock purchase because when the stock is sold everything that is owned by the corporation is transferred with the stock.
Since the tenant on a lease will be the corporation, its rights under the lease do not change and the new owner can enforce the corporation’s rights under the lease. The same is true for a limited liability company, since it is a separate legal entity, but not for a partnership or limited partnership, because they are not separate legal entities. If the business is owned by a partnership or by an individual, the lease would need to be assigned.
In a shareholders’ agreement stock is again being transferred, so the same logic applies to the purchase of a minority interest of an entity. The buyer who buys 25% of the shares of a corporation or limited liability company does not own 25% of all the assets of the business. The entity owns all the assets of the business and the new stockholder or member owns instead a 25% interest in the entity. The Directors and officers make decisions on behalf of the entity, not the shareholders. The shareholders elect Directors. The lease will have to be approved by the Directors.
If the entity is a limited liability company, the owners are members. The members appoint managing members. The managing member can have authority to make decisions about things like a lease, or that authority can be left to the members. The Operating Agreement will have to be reviewed to determine who has authority to sign an assignment of the lease.
If land is being purchased rather than leased, a new entity will typically be set up to buy the land. The new entity should never be a corporation because holding land in a corporation has adverse tax consequences. A limited liability company is typically used to hold land.
Whether land is purchased or leased, due diligence needs to be done in any buy/sell to make sure there are not liens or encumbrances that could adversely affect the rights of the tenant or new owner, environmental issues that could expose the tenant or new owner to liability, or building defects or legal compliance issues that could be costly after closing.
Whether a buyer is buying all of a business, or only a minority interest, the value of the interest purchased will depend in part on exposure to liability after purchase. This article only touches on the many issues that affect a lease or purchase. It is not intended to be legal advice on any particular issue.