The purchase and sale of real
property that is leased by one or more tenants presents a number of issues
worth thinking about and planning for, before you “sign on the dotted line”.
Usually, rental property is worth a premium because the owner receives…rents.
Often, however, rental property can be a trap for the unwary who focus on the
benefits, but not the burdens of income producing property.
Of course, when buying rental
property, the best time to focus on these issues is…before you buy. Some
sellers will allow potential buyers to review their leases before signing the
purchase agreement. From the buyer’s perspective, this is preferable. Why spend
the time and money on a contract, if, for example, your lease review uncovers
that there is only one year left in the lease term of the anchor tenant, it is
a down market, and the tenant has not renewed. Whether before the contract is
signed, or during due diligence, the lease should be examined carefully for
such items as: early tenant termination rights; inability to pass on to the
tenant, real estate tax increases due to the sale of the property; landlord
obligations to make tenant improvements upon renewal (or landlord obligations
to make initial improvements for a recently signed-up tenant); rents that
decrease after amortized improvements have burned off; caps on CAM increases;
and poorly draft assignment/sublease provisions allowing the tenant, without
landlord’s consent to assign the lease to an un-credit worthy assignee.
Assuming analysis of the lease
demonstrates its benefits outweigh its burdens (and assuming the lease does not
provide for its termination upon a sale), does anything further need to occur
for the buyer to become the new landlord after the sale? Is a formal assignment
of the lease from seller to buyer legally required?
As a general rule, the answer is
no, and no.
In almost all cases, when the landlord sells his interest in
real property, the purchaser takes subject to such lease, by operation of law.
The lease is an encumbrance against the title that existed prior to the
transfer, and consequently, it exists after the transfer.
So, if the lease
automatically transfers with the property, by operation of law, and assignments
are not required, why do lawyers prepare them? Is it just a ploy for attorneys
to charge higher fees and complicate seemingly simple transactions? The answer,
of course, is not at all. It is usually
when we try to simply, what is by nature complex, that unfortunate results
ensue.
So why do we prepare assignment/assumption of
lease agreements? First reason, as my Jewish grandmother used to say, is “it
couldn’t hoit”. While typically, a landlord’s lease rights and obligations
transfer to a buyer, without need for an assignment/assumption agreement, such
an agreement provides certainty to the process. In limited circumstances, the
buyer who wanted a “free and clear” property without leases might be able to
argue the leases are not binding against the buyer (and prevail in a court of
law) if he/she had no notice of the leases, same were not recorded, and that there
were no visible signs of occupancy at the property. On the other hand, the buyer
will have zero success trying to prove there was no notice of a lease if he/she
signed an agreement assigning the lease to him/her.
Equally,
if not more important, the assignment/assumption agreement presents a good
vehicle to finalize issues such as indemnifications (e.g., buyer indemnifies
seller for post-closing landlord obligations; seller indemnifies buyer for
pre-closing landlord obligations), responsibility for outstanding leasehold
improvements and obligations re: past due rents owed by tenants. The buyer can
ensure that it is not “buying” any extraordinary landlord’s obligations such as
the build out of a tenant’s space, by simply exempting same from the otherwise
catch all language making buyer responsible to assume all landlord obligations
under the lease.
The issue of security deposits can also be dealt
with in the assignment/assumption agreement. Without an agreement as between
buyer and seller, pursuant to Ohio law, the tenant may look to the original
owner (seller) for return of its security deposit. The case of Tuteur v. P. & F. Enterprises (21 Ohio
App 2nd 122 established this tenet of Ohio law in 1970. The
result in Tuteur would be problematic
for a seller (faced with having to return security deposits it no longer had)
because security deposits are typically credited to the new buyer by the escrow
agent at closing.
Many real estate investor/managers make a fine
living off the benefits of rental real estate. However, many others (usually
those who do not seek legal representation, or wait to consult an attorney
until after everything is signed) unfortunately, find that the burdens can far
outweigh the benefits. The assignment/assumption agreement is the perfect
equalizer.
Sellers wanting
to further insulate themselves from lease liability after a sale should be
proactive when drafting/negotiating their leases and provide
that the seller is automatically released from all liability under any leases,
arising after the sale. When faced with this proposed language, tenants should
negotiate for a qualification to the effect that such a release is effective,
only on an express assumption by the new owner of the landlord's obligations
under the lease, which brings us right back to the moral of this story:
When selling or buying rental real estate,
insist upon an assignment/assumption agreement to ensure the benefits and
burdens of rental real estate are fairly apportioned to buyer and seller, after
the sale.
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