Cutting-Edge Corporate Property Disposition And Leasing Issues

As a result of the current economic climate, prudent corporate real estate owners and corporate tenants are employing nontraditional methods to increase cash flow and decrease leasing expenses, respectively.

By focusing on the negotiation of what were once considered "secondary" business points, corporate owners are maximizing their net profits on sales and sale-leasebacks of corporate real property and corporate tenants are reducing both their short- and long-term leasing expenses, both to dramatic effect.

Corporate Property Sales

Many corporate entities are now being forced to sell their surplus and non-surplus properties to create cash flow. The traditional approach to maximizing net profits on a sale of corporate property is to simply sell the
property to the highest bidder. While certainly price is still a major consideration when selling a property - as a result of the general decrease in property values - sellers are now focused on retaining as much of the lower selling price as possible.

Over the past few years, corporate sellers have tried to maximize the portion of the selling price that they ultimately retain by (1) limiting their recourse (i.e., limiting the buyer's ability to assert claims against the corporate seller after closing) under the purchase contract, and (2) structuring the purchase process to achieve surety of close.

Limiting Recourse

There are at least four material purchase contract provisions or concepts under which the buyer's recourse against the seller can be limited.

One such provision is the seller representations and warranties. More and more the buyer is forced to rely on their own due diligence when purchasing a property. Accordingly, representations by the seller relating to the property have become extremely limited. A corporate seller should only agree to provide so called "smoking gun" representations and warranties in the purchase contract, meaning that the representations should be limited to whether the seller has a writing in its file that materially impacts the value of the property.

As an example, rather than making the broad representation that "there are no existing violations of law with respect to the property," the seller should instead make the narrower representation that "to seller's actual knowledge, seller has not received written notice of any violation of law with respect to the property."

Not only will the buyer's ability to successfully sue the seller post-closing - and recover part of the selling price - after it discovers that the property is in violation of law decrease significantly in connection with the narrower representation, but the narrower representation is consistent with the buyer's duty to perform adequate due diligence prior to closing.

There are three additional purchase contract provisions which, when layered over narrow seller representations and warranties, further serve to protect the seller from post-closing liability costs.

First, the seller should include a provision in the purchase contract whereby the buyer releases the seller from all liability in connection with the sale or the property, except to the extent of a breach by seller of their representations and warranties. The maximum amount of seller's liability should then be subject to a deductible to avoid going to court over a relatively small amount of money and a ceiling, which is typically 3 percent of the selling price.

Finally, the purchase contract should provide that the buyer will indemnify the seller for any claims which arise after closing.

Surety of Close

In view of the difficulty of many buyer's obtaining financing to purchase a property and the seller's overriding goal to receive sale proceeds, sellers have understandably become particularly sensitive to a buyer's ability to close a sale. To increase the surety of close, sellers now typically require either that the buyer commit to a non-contingent deal, with a large, up-front, nonrefundable deposit, or comment to a significantly shortened due diligence period and a large deposit that becomes nonrefundable shortly after the purchase contract is signed.

Short closing periods have also become customary. Since most serious buyers currently in the acquisition market are all-cash buyers, they are willing and able to perform within the short-time frames described above. Interestingly, buyers understand that the ability to close is a major concern of any seller, and, particularly in competitive bidding situations for a desirable asset, buyers are actually proposing the above short-time frame structures to the seller in order to set themselves apart from other bidders and be awarded the bid.

Corporate Leases

In addition to the traditional approach to reducing leasing expenses (i.e., negotiating lower rent), there are at least three lease provisions which can have a tremendous impact on overall leasing expenses.

These provisions concern (1) property operating expenses that a landlord can pass through to a tenant, (2) the definition of fair market value (FMV) in connection with a renewal right, and (3) a tenant's ability to mitigate its occupancy cost downside by means of its assignment and subleasing rights.

Property Operating Expenses

One of the most important operating expense pass-throughs to negotiate is the pass-through of capital
expenditures.

A landlord's ability to pass-through capital expenditures should be limited to those capital improvements that are (1) operating expense reducing, (2) required by governmental laws enacted after the date of the lease, or (3) are required for safety or health reasons.

Another important nuance to consider regarding the capital improvement operating expense provision is the imposition of an industry standard, such as "sound real estate accounting and management principles, consistently applied," on a landlord's ability to classify operating expenses as expense items as opposed to a capital improvement. Such a standard will effectively prevent the landlord from passing through a cost as an expense when such cost should be classified as a capital improvement which cannot be passed through.

Fair Market Value

The FMV formula for rent during a renewal term and the accompanying arbitration process has become increasingly important due to the increasing tendency of tenants to stay in their existing space rather than
expending significant additional costs to negotiate a new lease and move to different space. Items to focus on in the FMV formula include the definition of comparable deals that should be reviewed (in terms of size and the date of consummation of the transaction) and the definition of the comparable buildings which should be looked at to find such deals (in terms of the age, size, and location of such buildings). These types of factors will have a dramatic impact on the determination of FMV.

Transfer Rights

The assignment and subleasing provisions in a lease provide a tenant with an opportunity to mitigate any downside - for example, the tenant downsizes its business operations and as a result, its space requirements decrease, which might occur during the lease term. Accordingly, a tenant should focus on limiting the transfers that require a landlord's consent and, when consent is required, focusing on the reasons under which such consent can be withheld. A tenant should also attempt to retain as much of any transfer premium or profit attributable to the transfer as possible, particularly in a market where rents tend to vary significantly over short periods of time and subleasing or assigning the lease for a larger rent number is a real possibility.

While corporate property owners and tenants remain focused on primary economic terms such as sales price and rent, the current economic climate dictates that prudent corporate property owners and tenants additionally direct their focus to the secondary business terms of sale and lease transactions.