Does a Buyer Inherit All of a Seller's Liabilities?

One important part of any business transaction is negotiating the rights being acquired, and the liabilities being assumed, by the purchaser.  Naturally, a buyer wants to broaden the rights while narrowing liabilities.  Although this may be possible in a corporate asset purchase, it may be difficult to do in other deals, such as a real estate deal with lease and tenant obligations, as the Appeals Court ruled in September 2012.

The Appeals Court held that the buyer of a commercial building that was subject to an existing lease and tenant could not cherry-pick the obligations of the lease that it agreed to assume, particularly where the tenant had not consented to the arrangement.  Thus, even though the buyer had executed an "assignment and assumption agreement" with the seller/landlord that purported to limit the buyer's future obligations, the Court rejected that agreement as an improper, unilateral alteration of the lease.  The Court imposed all of the underlying lease obligations on the buyer as the new landlord.

The case was titled, Bright Horizons Children's Centers, Inc. v. Sturtevant, Inc.  Sturtevant had purchased a building that was subject to an existing lease with the Bright Horizons tenant.  The lease obligated Sturtevant' seller, as landlord, to construct a building for Bright Horizons by a certain date or pay a rental credit for late delivery. 

 

At the time Sturtevant purchased the property, the building was already far behind schedule.  After further delays, Bright Horizons finished the building and then sought its costs and the rental credit from Sturtevant.  Sturtevant claimed that it had signed an assignment and assumption agreement with the seller which absolved Sturtevant of any construction-related lease obligations owed to Bright Horizons. 

At trial, the judge agreed with Sturtevant's argument.  However, on appeal, the Appeals Court rejected it, holding that Sturtevant and the seller were not allowed to alter Bright Horizon's rights under the lease simply by conveying the property and entering into an assignment and assumption agreement. 

The Court cited "black-letter law" on these issues:  "A deed transfer of real property, subject to a leasehold estate, operates as a matter of law as an assignment of the lease", so that "a successor lessor, who takes by deed real property subject to a pre-existing valid lease, stands in the shoes of and has the same rights and duties under the lease as had been held by its predecessor." 

 

Also, "one party to a contract cannot alter or modify the rights or duties of a counterparty by unilateral action." 

Sturtevant was not able to use its assignment and assumption agreement to carve out obligations that were otherwise contained in the lease (e.g., construction and rental credit responsibilities), which obligations transferred to Sturtevant when it acquired the property.  One important lesson from this case is the value of thorough factual and legal due diligence for a buyer before closing on a transaction, to make sure the full scope of liabilities is known and addressed.

Although the Court rejected the assignment and assumption agreement in this context, it noted that a buyer could lawfully cherry-pick obligations and liabilities that it would agree to assume in a corporate asset purchase.  In an asset purchase, the buyer and seller can negotiate which assets and liabilities will be transferred to the buyer, and which ones will remain with the seller. 

 

In July 2012, I circulated a memo concerning asset and stock purchase deals and "10 Terms for Your Term Sheet".  Please contact me if you would like to obtain a copy of that memo.

Please contact me if you or a colleague have any questions regarding assignment and assumption agreements, asset or stock purchase agreements, or the purchase or sale of a business or real estate.

Five Tips for Real Estate Development

According to a November 2012 editorial in Banker + Tradesman on housing development, "Now is the time for the private development community to step up and start building."

The Boston Foundation's 2012 Housing Report Card for the Greater Boston area documents the need to double or triple yearly housing production through 2020 (to 12,000 - 19,000 new units per year), with a likely shift in demand toward multi-unit condominiums and rental housing but with a significant number of single-family homes, too.  The Foundation predicts that the market will be shaped by young households "increasingly saddled with student debt" as well as the aging of the baby boom generation looking to downsize.  Both factors point to smaller housing units.

Governor Patrick's housing plan calls for 10,000 new units per year through 2020 with an emphasis on "transit-oriented development" (higher-density housing near village and urban centers or near trains, subways, or other public transportation).

The Boston Foundation concludes that, "More than ever, the Commonwealth should see housing development and housing affordability as both a moral obligation to its residents and an economic necessity for a prosperous future."  (my emphasis)

 

Now for some practical information:  Many real estate development projects were permitted but not built due to the economic recession.  For owners, engineers and consultants looking to start construction under those permits, or for buyers purchasing those projects or lenders advancing funds to develop them, it is important to confirm that construction is truly ready to begin.  Here are some considerations:

1.         The existing approvals need to be reviewed carefully to ensure that they have not expired and do not include pre-conditions that could delay the work.  Bear in mind that the 2012 Permit Extension Act provided an extension for many local and state permits that were in existence between August 15, 2008, and August 15, 2012.  (I circulated a memo regarding the Permit Extension Act in August 2012.  Please contact me if you would like a copy of it.)

2.         A strategy should be developed to address permits that may have expired or are close to expiring.  Note that the expiration date in some permits refers to completing work whereas in others it refers to starting work, which can be a big difference.  A strategy to deal with possible permit expiration could involve filing a request for an extension or renewal (with adequate documented reasons), appearing before the permit granting board, commencing some aspects of the work or otherwise exercising rights under the permit, or taking some other measures.

3.         Many permits contain requirements that must be met before work can begin.  Although some requirements may be inexpensive and easy to satisfy, some pre-construction conditions may be time consuming or costly.  For instance, if an additional study or plan was required, that could take significant time or money.  Similarly, time and money would be involved if a condition required the creation of an entity to perform future operation and maintenance (O+M) activities or required the grant of a conservation restriction or some other real estate conveyance.  Thus, the pre-conditions need to be evaluated carefully.

4.         The bylaws, ordinances and regulations should be reviewed to determine if there have been new amendments since the project was approved.  Although "grandfather" protection may exist under certain land use laws, that protection may not be absolute and may not extend to all laws and regulations.

5.         If the land or building is controlled through an option agreement or purchase and sale agreement with provisions for permitting or other due diligence, the agreement should be examined to ensure that all conditions to complete the transaction have been or will be satisfied.  For instance, if the agreement contains provisions for notice, extension, or achievement of certain milestones, it is important to confirm that those steps are taken.

 

After the tough real estate conditions over the past several years, it will be interesting to see if we meet the annual housing goals leading up to 2020.  With our "moral obligations" and "economic prosperity" on the line, let's hope that the market rate and affordable housing that our area needs is actually constructed.

Please contact me if you or a colleague has any questions regarding real estate development or construction issues. 

Are You Ready for Your Business Succession and Exit?

We are often asked to help a business through a transition involving a sale, acquisition or a succession within a family, with co-owners or with key employees. Given that these transitions may evolve over a long period of time, it is important for owners to plan “exit strategies” to maximize their business value and achieve their exit goals. Although the terms of each deal are unique, the following issues often come up and require negotiation among the parties:

1. Buy/Sell Agreement (aka Business Continuity Agreement): These provisions are important for business continuation because they specify the conditions for transferring the partners’ interests in a business, with the goal of identifying who can (and who can not) acquire the interests; the triggering events for the transfer (e.g., resignation, death, disability, bankruptcy, divorce, business disputes, etc.); and, the method to value the interests at the time of transfer.

In essence, the remaining owner(s) agree to purchase the interest of the departing owner pursuant to the terms of the agreement. Without such an agreement, a business could falter if there were problems with the withdrawing owner, an ex-spouse or heirs. An important component of a buy/sell agreement is the funding mechanism to buy out the interest and pay any estate taxes, to accomplish the transfer, such as “key person” life and disability insurance.

2. Earn Out Provision: The acquirer may want to pay part of the acquisition price over time, through an earn-out provision. Thus, some amount is paid when the deal closes and the balance is contingent on the company’s future performance. Certain target goals are set for several years in the future for such metrics as gross revenue, earnings, net income, new customers, etc. Of course, care must be taken to ensure that the targets are not made difficult to achieve or manipulated (e.g., reducing the marketing budget, increasing or inflating overhead expenses, making unexpected capital expenditures, poorly operating the business, customers preferring to deal with the prior owner, change to the company’s operations, etc.)

The seller can monitor the company’s future business if it negotiates a new role as an employee or consultant, with limitations on the buyer’s ability to replace the seller. Monitoring may also be achieved by retaining rights to audit the company’s books. A dispute resolution provision can be helpful so the parties know in advance how disputes will be settled.

3. Non-compete provision: A covenant not to compete may prevent the seller from competing with or diverting business away from the company. A non-compete provision may not trouble a retiring owner but it may concern a younger seller who is prepared for the next business venture. Non-compete agreements are enforceable in Massachusetts, especially those contained in an agreement to purchase a business. (However, new legislation has been discussed in Massachusetts in recent years to regulate non-compete agreements in the employment context.)

Although non-compete agreements are judged on a case-by-case basis, enforceability often turns on whether the agreement is supported by “consideration” at the time it was signed (such consideration is typically found in the purchase of a business); is tailored to protect a legitimate business interest, such as prohibiting the individual from soliciting the company’s customers, protecting trade secrets, and protecting good will; and, is reasonably limited in terms of its duration, geography, and scope.

Business succession raises additional issues concerning future management, business valuation, tax liabilities, legal structures, and the like. A proactive owner should consider these issues with trusted advisors (e.g., accountant, financial planner, insurance agent, attorney, etc.) in order to plan a rewarding exit.

Please contact me if you or a colleague has a question on business succession issues or this post..