By: S. Timothy Buynak, Partner

May 2014

Your company’s lease may determine the marketability and value of your company.  Is the lease transferable; if it is, who gains the “value” of the lease — the company owner or your landlord?  If there is a lease recapture by your landlord, or excess rent or transfer premium clauses in the lease, the value of the lease (and a good portion of your company) belongs to your landlord.

 Initial Lease Negotiation – Time for Consideration of an Appropriate Approach for Sale of Your Business/Company.  At the time of establishing your company at a location, it is important to ensure that the lease for the company’s premises is best for your current operation — and for your and your company’s future.  All too many times, the future saleability and value of the company/business is overlooked.  In the end, the value of your company/business, along with the lease’s value, should be that of the owner(s) who has toiled many years to establish it’s viability, reputation and good will.  That valuation should not be split with the landlord unknowingly.

Assignment of Leases.  Recognizing these principles, the California Supreme Court in Kendall v. Ernest Prestana, Inc. determined that commercial leases are freely assignable by the tenant, unless there are clearly identified standards and restrictions governing lease transfers.  California law (i) requires contractual good faith and fair dealing in every contract, including leases and (ii) restrict unreasonable restraints in alienation. Applying these principles in Kendall, the California Supreme Court held that a landlord may refuse consent to an assignment only if there is a “commercially reasonable objection,” agreed upon in advance.

Landlord Clauses.  Since rent under commercial leases is many times not consistent with market rent for the same premises upon transfer of the lease/business, landlords have generally incorporated clauses into the commercial lease to redeem the value of their lease, all consistent with the Kendall case.  Such clauses usually take the following approaches and are in the AIR lease forms that are used by commercial realtors along our coast:

• Transfer Premiums. These are clauses that require some or all of excess rent to be paid to the landlord upon lease transfer.  When the rent charged to a transferee by a tenant exceeds the rent paid by the tenant to the landlord, such a clause takes the excess rent and transfers it to the landlord.  It is normal that such excess rent be split in some manner between the landlord and tenant.

• Right to Recapture. These are clauses that give the landlord a right to terminate the lease upon the tenant’s request to transfer the lease.  Such clauses are valid, Carma Developers v. Marathon, placing the landlord in a control position on whether the company/business may continue in its location.

Besides the transfer premium excess rent and recapture clauses, it is suggested that companies pay attention to at least two other clauses in standard commercial leases:

• NNN Taxes. Tenants typically pay all real property taxes for their premises under triple net commercial leases.  Because of Proposition 13 and its reappraisal/reassessment of property taxes only upon a “change of ownership,” real property taxes may increase significantly due to changes of the landlord during the term of a commercial lease.  Particularly, the landlord may sell the premises, may die, or transfer control of the landlord entity, all of which trigger the reappraisal of the property and increase property taxes.  Since landlords gain the value of these transfers, it is appropriate for tenants to negotiate for relief in this area — that the tenant, and its requirement to pay taxes under triple net clauses, is not required to pay increased taxes due to voluntary activities by their landlord in making transfers.

• Compliance with Laws. This clause in a commercial lease always sounds so simple, as everyone will obviously comply with the law.  However, such provisions are used to determine whether the landlord or tenant is liable for major, statutorily required upgrades to the leased premises (e.g. seismic or asbestos removal).  Such a clause should be negotiated for equitable treatment, so that if there is a change of use by the tenant, the tenant is liable for legal compliance caused by the change of use; but straight statutory upgrades that will remain with the building forever, are typically at the cost of the landlord.

Bottom Line- Negotiate Well with Your Landlord Initially; Know the Consequences of Each Clause; Contact an Attorney to Assist. The future value of your Company is highly dependent on your obligations and your advantages under your Company’s lease. You’ll enjoy finding the “perfect spot” for your Company even more if you have preserved its value in the future when you are transferring some ownership interests to others (like investors or employees) or are selling your business.

 S. Timothy Buynak, Partner

TBuynak@BFASLaw.com

(Direct) 805.966.7575

This Advisor is one of many business, real estate, employment and tax advisories provided by the attorneys at Buynak, Fauver, Archbald & Spray, LLP. You may review them at our website under Resources at www.BFASLaw.com.  This Advisory is not exhaustive, nor is it legal advice. You should discuss your particular situation with us or with your own attorney. Our legal representation is only undertaken through a written engagement letter and not by the distribution of this Advisor.