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How to Conduct Effective Lease Due Diligence for M&A Transactions

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How to Conduct Effective Lease Due Diligence for M&A Transactions

In a vast majority of M&A transactions, the real estate component of the transaction may not sink a deal. However, it is an important component of the whole transaction. This course will focus on how to effectively review a lease in connection with a M&A transaction so that (i) the transaction is not held up or delayed by an aggressive landlord, and (ii) the acquiring company is not left with fewer rights and more obligations than what the acquiring company contemplated. The issues covered in this course apply to all types of leases – offices, retail and warehouse. This course will be beneficial to both new attorneys and the experienced practitioner.


Amol Pachnanda
Ross Katz & Pachnanda PLLC


Kara Wenzel - Hello, I'm Kara Wenzel. I'm a program attorney here at Quimbee. And today, I'm talking with Amol Pachnanda, hi, Amol.

Amol Pachnanda - Hi, Kara. How are you?

Kara Wenzel - Doing well, thank you. Today we are gonna talk about lease due diligence for M&A transactions. But before we get into the meat of the presentation, I'd just like to take a brief moment to thank you, Amol, for coming to talk to us about this and also give some background on your practice.

Amol Pachnanda - Oh, sure.

Kara Wenzel - If you don't mind.

Amol Pachnanda - It's my pleasure. I feel like leasing is the only thing that I can talk about intelligently, so I'll do my best to do that. I am a founder of the law firm of Ross Katz & Pachnanda. My practice is focused primarily on real estate. I would say majority of it is leasing, represent both landlords and tenants in office, retail and warehouse leasing. I try to approach leases from a business point of view, where we're really trying to achieve the tenants' business objectives in a cost efficient manner while still being friendly with the other side.

Kara Wenzel - Great, great, and I also heard that you have a leasing minute segment. Is that a podcast or a video that you produce?

Amol Pachnanda - So no, that's something I started doing on LinkedIn.

Kara Wenzel - Oh.

Amol Pachnanda - I would say maybe in the middle of the pandemic last year.

Kara Wenzel - Okay.

Amol Pachnanda - Just the kind of, as just another way to get the information and my knowledge out there. And I try to do it regularly and I try to keep it short. We try to keep it to like under a minute where we'll touch high-level leasing stuff that I think people may be curious about, or maybe just trigger something. And it leads to maybe more thought and more questions. But that's really kind of the gist of it. Try to hit high-level stuff quickly.

Kara Wenzel - Well, I'll definitely have to check you out on LinkedIn, yay.

Amol Pachnanda - I think we're gonna go longer than a minute though, right? I think.

Kara Wenzel - Yeah, this one, I think we will. I have full faith. Great, well, like I said, we are gonna be talking about conducting effective due diligence in connection with M&A transactions on leases. So just jumping in, I think most of us have seen some sort of real estate contract for a sale, either land or property, both. Why would you say though that contracts for purchase of sale are shorter in length or fewer pages when leases, which are not permanent, it's not an actual acquisition, can be 100 plus pages or more?

Amol Pachnanda - That's a very good question. I look at purchase and sale contracts as really capturing a moment in time. Because with very few exceptions, once the seller transfers the property to the buyer with the deed, that relationship is over, right? Now the new buyer has to deal with the tenants of that property, but that seller-buyer relationship is over. And if you contrast that with a lease, a lease is a longterm relationship. Many leases will run 10 to 15 years. If it's a warehouse lease, it may even be 25 years. And in that 10, 15, 25-year period, a number of things can happen. Of course you just have the normal day to day issues that may arise during a lease, but you also have change in the parties, right? The landlord could sell the building and now you have somebody else as the landlord. Or the tenant could be sold and acquired by another entity. And so now you have a different tenant. So I think one of the reasons leases are longer is because attorneys are trying to anticipate all the issues that may arise. Just one based on prior experience, and secondly, based on the tenant's specific requirements. Because the leverage that the tenant has is right before the lease is signed, and same for the landlord, right? Once the lease is signed, if you wanna change something that's not specifically provided in the lease, you gotta get back in the conference room and hash it out again. So I think that's one reason why leases tend to run longer. Not withstanding what you said, that you're not really getting anything. It's your renting space.

Amol Pachnanda - Well, you are for, for a time, right? Let's back up a second though. You mentioned also that the tenant could be acquired by another company. That sounds more like a corporate transaction, not real estate. So why would you need a real estate attorney in this sort of situation?

Kara Wenzel - A real estate attorney in a corporate transaction?

Amol Pachnanda - Mm-hmm. Yeah, so I think a corporate transaction is really guided by the acquiring company seeing something in the other company that they want, right? Either it's some technology they have or some other client contacts they have that the acquiring company wants. And you're right, real estate, excuse me, is not the driving force of that transaction. The transaction is not going to fail or succeed based on the real estate, but real estate plays an important role. If that company is, this is going back to law school, is producing widgets and they don't own the property where they're producing those widgets, they're leasing it. And in order for them to continue to produce widgets after the acquisition, they need that property. My wife likes to joke that the CLE is not gonna be relevant anymore when everybody's working from home because you don't need to deal with the landlord and consent anymore. I'm hoping she's wrong. In fact, I know she's wrong, 'cause I don't think we're ever gonna be 100% work from home, but that's a topic for another time.

And so getting back to what I was saying is because the acquiring company is going to wanna have the right to use the space to produce the widgets, they're gonna have to make sure that the lease kind of goes along with the transaction. Many leases will generally have a very strong anti-assignment provision. It may just say, landlord does not allow the tenant to do any assignment or transfer without the landlord's consent. Or it may say the landlord will give consent, but it has to be reasonable or it has to give sole and absolute discretion, or it has to give us consent, excuse me, in sole and absolute discretion. Or if a transaction is a stock transaction and the entity isn't really changing, the tenant entity meaning continues to be the same, but there is a change of control, well, does that require the landlord's consent? So in my experience, when a corporate lawyer is involved in an M&A transaction, they will say, hey, we're doing this deal. It's this type of deal. It's a asset sale, stock or change of control. Can you look at these leases, 3 leases, 10 leases, whatever it is, and see if we need the landlord's consent in order to consummate this transaction that we are intending on undertaking? So while I don't think the real estate part is the most important part, it is definitely part of the due diligence if you wanna continue to operate from the space.

Kara Wenzel - Yeah, that totally makes sense. Can we also back up a minute, remember, I am not a real estate attorney.

Amol Pachnanda - Lucky you.

Kara Wenzel - I just need a little extra time on some of these things. You talked earlier about assignment of the lease. My guess is that's a technical term. Please, can you explain?

Amol Pachnanda - So that's a good question. What is an assignment? And, I guess, what is not an assignment? So an assignment is a relationship that the tenant has with a landlord. And when the tenant decides to assign the lease to a third party or even a related party, what he's saying is, hey landlord, I wanna be out of this picture. I want you to have contract rights with the new assignee and the assignee also has a lease hold right now that I used to have. The important point is that the assignor is never released from liability, except if they specifically ask the landlord to be released and the landlord actually releases them.

So even though a tenant may have assigned the lease to company B, tenant A continues to be liable under the lease and the landlord, if there is a default, can go after both company B and company A, so that's the assignment. A sublease is where a tenant transfers less than all of its interest for less than the remaining term on the lease. So if you look at a 10-year lease, right? And if tenant A assigns all of that space under that 10-year lease to tenant B and has no right to go back into that space, that's an assignment. But if tenant A says, you know what? I have this 10-year lease, I have three floors. I only need one for the next five years, maybe the other two I can do something with. And in that case, they can sublease those two floors for five years because after those five years, they get the space back. So they've reserved an interest for themselves, and they're only allowing the subtenant to have less than the entire space. So that's a sublease and that's really the big distinction between the assignment and the subleases.

Kara Wenzel - Got it. Got it. So backing up again, you mentioned another type of transaction, the change in control. So tell us more about that. Is that happening at the parent level?

Amol Pachnanda - Yes, but I just wanna back up a little bit, 'cause we had kind of talked about, when the M&A lawyer comes to and says, this is this type of deal. I want you to tell me what I have to do under the lease.

Kara Wenzel - Yes.

Amol Pachnanda - So I wanna talk about maybe the easier part of this, which is kind of, ah, I see it, this is an assignment. If you look at like an asset sale and you think of like a medical office, for example, right? If Dr. X is selling the medical practice to Dr. Y at that location, well, the location of that lease has to go along with it. So the tenant on the lease is not the same entity anymore, right? The lease has been assigned to a new entity. There's a new name. Or if you think of it like in an office context, it's people with the same name tag going to the same floor, but the company that writes the checks on their paychecks is a different company. Right, I think everybody can agree, well, that's an assigned now, because the tenant has changed on its face. And everybody knows that. So I think that's the easier one. The change of control is a little bit different. And you had talked about, is it a change of control at the parent level? And I say yes, but it can mean a whole bunch of things. Change of control can also mean a change in the management of the company. It can also mean, in a closely held corporation, a change in the controlling interest by one of the individuals in that closely held company, that could also be a change in control. And so you really have to look at the lease language to determine what is a change of control.

And we have information in our materials and I'm gonna read from it, 'cause what I wanna stress the, obviously the point that the words are gonna matter, obviously. It's the law, so the words in the assignment and subletting and change of control section are going to matter. And I wanna show that one, without a doubt, the landlord's gonna have a broad prohibition against any kind of assignments. Despite the fact that courts generally will say any restraints on alienation must be construed very narrowly. But landlords want to one, they wanna see who is coming into their building. Is the party that I negotiated the lease with still the party on the lease? And they wanna make sure that the rent is gonna be paid. I think landlords and attorneys for landlords, and I do a lot of landlord work, we recognize that change is gonna happen in corporations, right? The identity of the entity may change. It may become, from a partnership, to a limited liability company. All those things may happen. And I think landlords are okay with it as long as there is protection.

But I wanna talk about how broadly some of the change of control language is, because the issue becomes like, as you had said, is it the parent or is it the parent's parent? Is it the parent's parent's parent? Like how far up the chain in the organizational chart do we go? And really what's we reasonable in terms of how far do we go? So this is an example in one of our materials which talks about what is an assignment? So obviously the first is, tenants shall not assign mortgage or encumber this agreement without the prior written consent of owner in each instance, right? So that's like the asset assignment that we spoke about, right? We can't do it. But it goes farther because it defines change of control as also an assignment that requires the landlord's consent. So it talks about the issuance of interests in tenant, whether stock, partnership interest, or otherwise, to any person, whether in a single transaction or series or related or unrelated transaction to the direct or indirect transfer of more than 50% beneficial interest of tenant.

Again, it's saying direct or indirect. And again, whether in a single transaction or series of related or unrelated transaction. Now I would think when we're talking about change of control that you're talking about one level up, because if you continue to go up the chain of the organizational chart and it gets very complicated, it it's almost like, are we now concerned about the change of control in the parent's parent, as opposed to the change of control of the tenant entity? And those are two different things. And I think courts obviously will look to the lease language, but as I mentioned, courts construe these anti-assignment clauses very, very narrowly and the language in the lease is going to govern. And so if the language in the lease and the landlord feels so strongly about it that they put language in the lease, it's kind of saying essentially, any upper tier transactions where there's a change in ownership, and it's a controlling change in ownership, I deem that to be an assignment. It's a very strong possibility that the court will say, okay, this is what the landlord wanted. That we're very clear about it. And they put it in the lease.

If the landlord isn't so careful, I would think a tenant would argue that it should only matter what my immediate parents change happens, not the parent's parent. And the interesting thing is also that the case law in this stuff is not wide, right? Because assignments are kind of dictated by timing. When you wanna do a corporate transaction, yes, you wanna do the transaction correctly. So you don't wanna go into litigation with a landlord on whether or not something requires consent, 'cause we all know litigation would take years and then what happens with that corporate transaction? So I think the litigation on this is sparse for a reason, but the language is important. So if you are the landlord and you're concerned about those upper tiers, you should put that in. And if you are the tenant and you wanna be 100% sure that the landlord doesn't get a right to look so far up the organizational chart, you should put that in just so that there's no chance for a judge to interpret it differently.

Kara Wenzel - Okay, so I'm assuming that you have seen a wide variety of leases in your practice time.

Amol Pachnanda - Yeah, sure.

Kara Wenzel - Can you tell us a little bit about if a tenant has some of these clauses that you just mentioned about transfer, about ownership, and how that works? What are some of the issues that sometimes arise most often?

Amol Pachnanda - So if you do have to go, I think this is what you're asking me, if you do have to go to the landlord for consent, as it turns out, what can happen?

Kara Wenzel - Yeah.

- Essentially, right? What issues are you dealing with now?

Kara Wenzel - Yeah.

Amol Pachnanda - So ideally it's, yes, you can do it. And everybody goes their own way. Sometime it could be no, and everybody goes their own way. But it can also be a lot more complicated. Many leases will say that if you have to go to the landlord for consent, the landlord has a number of options. Obviously the landlord can say yes or no, but the landlord can also say no, but I wanna take the space back, which is known as a recapture option, right? Which is the landlord saying, you wanna assign this lease or you've had a change of control that I deem an assignment. I wanna take that space back from you. And if you're the tenant and you're part of this M&A transaction, there may be some redundancy if you have couple of office spaces in the same market where you may say, you know what? That's actually great. I don't want the space. So take it. But generally that takes time to figure out that, which space do we wanna be in? Where do our employees wanna be? Which has the more favorable lease terms?

So if the landlord says, I'll take the space back. Well, that may be a surprise that you're not ready for. Though I think on a practical level, if the market is cold, the landlord has no reason to take the space back, because he's just adding to his vacancy. But even in a market that's booming, the numbers really would have to make sense for the landlord, right? 'Cause it's not easy to take back space. You can't just put it in the market the next day. You're gonna have improvement allowances, brokerage commissions, it's gonna sit empty for a while. But that's one option where the landlord can kind of just take the space back from you and you're not ready for it. And it would be a terrible option if you were actually excited about being in this new space, because it's in a great building, great location, there's signage rights as you enter in the elevator lobby, they're everywhere, and now that's gone. But that's an option that the landlord has.

Essentially in 99% of the leases that I've done, The landlord may also say, this acquisition that's happening is for a huge sum of money. And the lease allows me to get a share of the profit of that consideration. The lease language generally will say that whatever rent or other consideration you are receiving in connection with an assignment, the landlord gets to split that with you after your expenses, whatever is profit. And so that may involve talking with tax council to figure out, well, how do we get around this provision, because we really got ourselves in a bind. Some leases, if they're negotiated poorly, may also give the landlord the opportunity to say, you know what? Now I can increase the security deposit, because now an assignment has happened. So the landlord can really take this down a number of avenues that you may not think about when you're just looking at, well, do I need the consent or not?

Kara Wenzel - It definitely sounds like if you're trying to complete a serious transaction, you would want to avoid having to go to the landlord for consent to proceed, right? So.

Amol Pachnanda - Yes.

Kara Wenzel - Yeah, that's the basic takeaway that I just got from what you said.

Amol Pachnanda - Yeah.

Kara Wenzel - How can a practitioner approach the sale of business in the assignment and subletting clause that you were talking about?

Amol Pachnanda - And this goes back to why the leases are so long. I've seen assignments in subletting clauses and leases that are like 10, 15 pages long. And like by the time you get to the end, you're like, what was I reading? But there's a reason, you're trying to anticipate all these different issues that may arise and the assignment and subletting clause, I really look at it as part of a tenant's exit strategy. So it has probably, undo, so, let me rephrase that. So it's got immense importance in a lease negotiation when you're trying to figure out, hey, what might happen in the next three, four, five years? And so there's a couple of things you can do. And we spoke about some of what the landlord's concerns are, right? And landlord's attorney and landlords know that transfers are gonna happen. And very few landlords are interested in kinda getting into the shorts of the tenant and the nitty gritty on this individual selling his share, or this partner selling his. They don't care. They wanna make sure that the entity that's on the lease can pay the rent. They wanna make sure that the entity isn't doing anything to the space to make it dangerous, to make it something that's not appealing to other tenants. That's the biggest concern.

And so what is transpired over time is an agreement just based on what the market and what landlords and tenants' attorneys that have been practicing for a while kind of know what to ask for recognizing that tenant wants the ability to do some type of corporate transactions and the landlord wants some knowledge of what's happening. And we have this in our materials, which is this concept of like permitted transfers, right? I wanna be able to sell my business to a third party without the landlord interfering in it. And that's like the asset sale, right? So in that case, you can say, I wanna be able to sell to a successor, but landlord, I get you, you wanna be made comfortable that the surviving entity or the new entity is gonna have the financial capability, which I can provide to you by showing you financials. I can give you prior notice that I'm doing something. And then in the change of control, it's the same thing that I don't want. And we could talk about a closely held corporation.

So just think of a company owned by four guys that each own it individually. I have done leases where I will say if those guys decide to sell their interest, just that 25%, well, that's not a assignment. If the two of them do it and that's 50, well, that's not an assignment either. If it's 75, now I get it, landlord. You're concerned because if those three guys were really involved in making this company profitable and now they're leaving, well, I don't wanna be left holding the bag, right? I wanna know what's happening.

So maybe I want more information before you do those things. And so that's really where the fight is in terms of, well, what kind of financial test must this successor meet? What do I have to show you? How much prior notice do you want, landlord? What is a form of assignment that you wanna see to show that the new entity is really gonna be obligated under the lease? And our materials kind of give really good examples of clauses that you'll see, like in a permitted transfer clause. But you have to negotiate that beforehand obviously. Not when you're trying to do the transaction. You can't go back at that point and say, well, I wanna change this. And you also wanna negotiate flexibility, not just third parties, but also intraparty. So if you have an affiliate, you wanna be able to assign the lease to the affiliate. You wanna be able to sublease to an affiliate or the parent or another subsidiary. So those kinds of protections, it's always like the conversation I have with a client that, give me a sense of who owns this, and what do you think is gonna happen in the next five years during the term of this lease, that's important to you, and you don't want anybody to say, hey, wait a minute. You can't do that without my consent.

Kara Wenzel - That makes sense. Yeah. So just taking a break from consent for a moment. We can come back. But once you've determined that consent is required or not, what are some other provisions that are really important to pay attention to when you're doing lease due diligence?

Amol Pachnanda - Right, so, obviously the financial stuff is important, but, I mean, and I don't wanna focus on that, because I think anybody doing a lease abstract will be able to figure out what the financial stuff is, right? You see the rent chart. You see the operating expenses, taxes. I really like to focus on, like the non-monetary, the day to day stuff that may impact the operations of the company. And, I guess, maybe the most important thing is you wanna make sure you got the entire lease file. You wanna make sure you have all the amendments. You wanna make sure you got the commencement letters, any correspondence, any estoppels, any SNDAs, so first off you wanna make sure you got everything with you, and then then your job is, all right, now I gotta read this 100-page lease and really figure out, if I'm doing like a lease abstract for the M&A attorney, I don't wanna give them eight pages. I wanna give 'em something that they can kinda share with the client. And the client can kinda do like a checklist, okay. I see this, see this. I don't care, I don't care, that kind of stuff. So you really wanna figure out what are the important issues, right? What kind of stuff can impact the day to day operation of this tenant once they're in the space? And so I think those are like the non-monetary things that you should be reviewing when you're doing this for 50 leases, for example.

Kara Wenzel - So focusing on day to day operations, potential disruptions to the business, or something that might affect the overall rights. Will these additional provisions depend on or change depending on the type of lease or the size, what other factors?

Amol Pachnanda - Yeah, size is obviously important, right? The bigger you are as a tenant, the more rights you have. And the opportunity for more rights to go away if you do an assignment that's not permitted by the lease document. And we'll talk about this later about like personal rights that the landlord will say, yes. I signed lease with A, B, C, but if A, B, C is not gonna be the tenant anymore, it's gonna be X, Y, Z. Well, I don't want these certain rights to go to X, Y, and Z.

So, yes, so size is important. Office and retail, there's probably a few differences in those as well. I look at the permitted use clause, I think, in an office lease is always gonna be general and administrative offices. Whether it's accounting or management, it doesn't really matter. Retail may matter more, right? If you're selling Turkish food and the entity that you're selling to now wants to sell something else, but the lease only allows you to sell Turkish food, well, you may have a problem. Though I think there is case law in New York that says, just because it's the permitted use you don't like, landlord, or it's not permitted by the lease, that in itself is not enough to say no to a transaction, right? You need other stuff. And that's what we talked about, like the financial conditions.

You also think about the pandemic, right? And retail leases will generally have a continuous operations clause saying the tenant must continually and uninterruptedly operate in the premises for these hours and maybe with an M&A transaction, and the company's not sure whether it wants to keep this location. It would behoove a practitioner to say, you know what? I wanna carve out a certain time period after a corporate transaction that this continuous operations clause does not apply. So it's something that you're gonna have to think about in advance, because if the corporate transaction happens and that store shuts down, but the lease has a continuous operations clause, well, now you're in breach of the lease.

Kara Wenzel - Definitely don't want that. So now can you list for us some of these more important lease provisions to be aware of during due diligence, and then I'm probably gonna prompt you to explain somewhere in detail.

Amol Pachnanda - Oh yeah, sure. So I think I have like about seven or eight that I think are important, but I always preface it by saying, it's obviously not a complete list. Leasing is an art. It's not a science. So the way you do it may be different than the way I do it. Mine is right. Yours is wrong. No, I'm just kidding. So they all may change. And obviously a lot of it just depends on the particular lease. And some of these things may be important in the lease. And there may be other things that up that are not in one particular lease. But I think of it as like seven things, right? It's like the end of term removal obligations, rights that are personal to the tenant. If there's any type of guarantee. If there's any outstanding landlord obligations, that the landlord not done something that it was supposed to do. The relocation of the premises, can the landlord move me from the fifth floor to the sixth floor? Is there a requirement that the landlord has to provide me a subordination, non-disturbance and a torment agreement. If I want to get a loan and my lender wants to take the property in my space as collateral, well, do I have that right? Or is the landlord gonna say, no. You can't put a lien on anything that's in your space.

I represent a landlord who has like a clothing retailer in its office space, right? So they have like their dresses on the office floor. I think, 'cause people come out to look at 'em. And they want the right to lien those, because that's what their lender wants. But the lease doesn't allow them to do that. So now we're kind of negotiating outside of the lease document saying, okay, if you wanna do those things, you have to give me comfort that one, you can perform under this lease and two, if something happens, like what's gonna be my recourse, what else can I get? Because I can't get the wrench from you now if you've defaulted, but maybe there's some collateral and maybe the dresses are something that I should have a right to. So it's those things that you kind of have to think about when you're negotiating the lease, obviously. And I keep coming back to that, right? It's just like that's where the leverage is for both parties to kind of think of these issues that may arise while you're negotiating the lease.

Kara Wenzel - Yeah, well, dresses are important. Definitely.

Amol Pachnanda - Yeah.

Kara Wenzel - Let's back up a second. You mentioned bucket of personal rights. Can you explain that a little bit more?

Amol Pachnanda - Yes, so bucket of personal rights really refers to language in the lease where the lease may say, and I'll use a renewal option as an example, for example that this renewal option is only exercisable by the tenant named in the lease. Now when we talked about an asset sale and the tenant is changing the lease doesn't allow the new tenant to be able to exercise the renewal. If there's other rights where the lease says this termination right is specific to the named tenant, and the named tenant has changed, right? So that right no longer applies.

So what you wanna do when you're negotiating these, and we can give more examples, is you wanna be able to say in the lease, hey, landlord, I want these rights to be transferred to anybody that's my successor. If I've sold my business or there is some change of control that you're deeming an assignment. Well, I want all of that to not interfere with these rights that I've negotiated, because this is a corporate transaction. This is not real estate. This is corporate, and I want those rights to flow with it. And a couple of other examples could be, expansion rights, right? If there's a first offer, if there's a hard expansion option, if there's a contraction option. So not that you get to terminate the whole lease, but you get to terminate one floor, which again, we're talking about an M&A, and there's redundancy, well, that may be a great option to have if you think, you know what? I don't need three floors here. I only need two to be able to give back a floor, if that option exists.

Other thing I think is very important are signage rights. Everybody loves the branding to be able to walk into the building, see your name on the plaque, go into the lobby, see the name by the security desk, go to the elevator, see the name. And you don't want that stuff to go away just because you undertook a corporate transaction. Competitor restrictions, a lot of companies don't wanna be in buildings with their competitors, right? And I think the concern is that they might try to poach their employees if they see them around the building or in the cafeteria or in the gym. But if those competitors are also important to the entity that's acquired you, you wanna make sure that the competitors are kept out. Amenities, sometimes landlords will agree with a particular tenant that, yes, I can provide this amenity to you. But if you're not the tenant, I don't have to provide this amenity to you.

And I had done a lease probably 10, 15 years ago. We were, it was Atlanta. And this office building had this great white tablecloth restaurant. And it was a very big deal to this client that this white tablecloth restaurant always be there. And so when the landlord said, well, no, if you do an assignment, I don't wanna have the obligation to continue to operate this white table coth restaurant. Our client were ready to walk away from the deal because of that, because that right was so important to them to be able to have it. And I will say though, I feel like the personal rights probably are saved, in a sense, by some of the M&A lawyers kind of use of setting up corporate transactions.

So what you'll see happen more commonly, instead of an actual assignment where there's a change in the name of the entity, you'll have like a reverse triangular merger. And so, I'm not an M&A lawyer, but my basic understanding is that in a reverse triangular merger, if company A is the acquiring company that wants to take over company B, company A sets up a subsidiary, let's call it company C. And company C merges with B. So there has been a transfer, there's been a change of control, because now B is owned by the subsidiary of A, but the tenent on the lease is still B. So the rights that may be personal to B are still in place because B hasn't changed. Right, and so that is a great trick. And obviously I doubt the reason it was, the reverse triangular merger arose is because to get away from this restriction on taking away of personal rights. I'm sure it's probably tax reasons and kind of separating liabilities. But it's an interesting result in the real estate leases of that transaction. Because for all intents and purposes, the tenant entity hasn't changed, but a transfer, a change of control has happened. So these personal rights will continue.

Kara Wenzel - Well, if they were smart enough to choose really good ones, then that's a good thing.

Amol Pachnanda - Yeah.

Kara Wenzel - It reminds me of, there was no happier day in one of my former offices than when a doctor's office was replaced with a Starbucks on the ground floor of our building. And for an office of lawyers, that is like Mecca.

Amol Pachnanda - That's it, you know. Get the app open and I'm down there in three minutes.

Kara Wenzel - Exactly. Exactly. Okay, so it seems like personal rights would be a great marketing tool or increase the marketability of a lease if a tenant would want to assign their lease someday to a third party. So why shouldn't personal rights follow in the situation of assignment?

Amol Pachnanda - Yeah. that's a good point, right? Obviously the more rights a tenant's lease has, the more marketable that lease is, right? Meaning that it can potentially get higher rent. And for a tenant that doesn't need the space, it's able to assign it to somebody that'll pay 'em more, it doesn't get any better, right? But the way I look at third party assignments is that you're naturally gonna have to go to the landlord for third party consents. In your example, if the medical office wanted to assign to Starbucks, well, the Starbucks isn't taking over the medical office, so it's not a successor. It's just the doctor's office is saying, Starbucks is gonna pay me a boatload of money. I want them to come in here. And if I was negotiating that lease for the doctor, I would say, you know what? Let's not worry about that. Because if that happens, we're gonna have to go to the landlord for consent anyway. And at that point, us and Starbucks can ask for whatever we want, because we're gonna need the landlord's consent to do those things.

So if the doctor had a great, huge awning, and the lease says, well, this is only for the doc. And now the Starbucks is coming in. And the landlord said, well, Starbucks, you can't have it, I'm pretty sure that Starbucks and the landlord will be able to negotiate something on that, right? 'Cause the landlord's gotta approve Starbucks anyway. So if the landlord's approving Starbucks, there's no reason why it wouldn't approve certain other changes in the lease. The other reason where I'm less kinda, where I'm less concerned about is one, lease assignments happen very rarely. You see more subleases. And if you see an assignment, and we kinda talked about this earlier, right? That you're the entity that's assigning the assignor, it's always on the hook. So if I have an expansion option, I have a ROFO option, I have a renewal option, I am not so keen on an unrelated third party exercising those options because all that means is now I am on the hook. These would be the landlord for expansion, for ROFO, and for renewal, when all I want is to be out of this space.

So for that reason, while I agree with you, I think they obviously increase the marketability of the space, it just registers really low for me in terms of what I think is important when you're negotiating the lease. I wanna make sure that I can sell the business to whoever is gonna succeed me and take it over. But third party, then we'll just deal with it when it happens or if it happens.

Kara Wenzel - Okay. I like your style.

Amol Pachnanda - Yeah.

Kara Wenzel - Going back-

Amol Pachnanda - There's enough things to fight about in the hundred page at lease.

Kara Wenzel - Pick your battle.

Amol Pachnanda - Yeah. Pick your battles, exactly.

Kara Wenzel - Okay, so earlier in your list of important provisions, you mentioned guarantee. Can we go back to what that means when you're talking about corporate or personal guarantee?

Amol Pachnanda - Sure, so many leases will be signed by a single-purpose entity, but many times the landlords will say, that's fine, to have this single purpose entity, but I really need a more credit-worthy entity on the lease. And many times that will be in the form of a guarantee from a parent or some other related entity which has some skin in the game and really can support the lease obligations in case something happens to the single purpose entity, right? 'Cause it's very easy, if you're struggling, to say, you know what? I'm just gonna get rid of this single-purpose entity, put it into the bankruptcy, whatever. I don't have to deal with the lease obligations anymore. But you can't have that if you have a parent as a corporate guarantor.

So you look for a corporate, and sometimes the corporate guarantee will be for the entire term of the lease. Sometimes it's really for, hey, landlord. I know I don't have great credit now. I'll give you a corporate guarantor for the next three years. But if I don't default in those next three years, I'm paying you rent on time. Let that guarantor off the hook. So there's different variations of the corporate guarantee, right? In New York, we have a good guy guarantee. And I think New York and few other states have it. And it's a whole different animal. So with a good guy guarantee is the guarantor, I always say the guarantor is somebody that can say to the people, hey, get up. We're getting outta here, right? He's gotta be somebody who's an owner. It can't be Joe in accounting that people are like, oh, be quiet, right? He can't be the guarantor.

But the guarantor is an owner. And the relationship of the guarantor and the tenant, vis-a-vis the landlord is that the guarantor says to the landlord, hey, if the tenant can't pay the rent in under the lease, I am gonna be a good guy guarantor. And what that means is I'm gonna vacate this space, because once I vacate the space, I do what I'm supposed to do to return the space to you in the condition required under the lease, I pay the rent that's required under the lease up to the date that I leave, because that allows a landlord to go lease the space. But it doesn't cut off, obviously, the tenant's liability, right? So in a 10-year lease, if after year four, we send that notice, well, the guarantor is now off the hook personally, but the tenant obviously continues to be liable under the lease. And kinda the purpose of the good guy guarantor makes sense, right? If you're a landlord, you say to a tenant, hey, if you can't pay me the rent under the lease, at least get out of my space, so I can lease it to somebody else, since you'd be a good guy.

Kara Wenzel - Yeah.

Amol Pachnanda - Right? And I think arrive, I'm sorry, not arrive. I think it's prevalent in New York because in New York it can take a long time to evict a tenant. And tenants' lawyers can make it really a burdensome and lengthy process. But if the tenant is gonna do that, well, the good guy guarantee just continues. And the guarantor obviously has no incentive to be personally liable for a long period of time.

Kara Wenzel - Yeah, you would think if a tenant knows they can't afford it anymore, for whatever reason, they're just digging themselves a bigger hole by staying anyway.

Amol Pachnanda - Right, and the tenant may not care, right? Because if they're a single purpose entity, they may have no money. But the guarantor who's personally liable, well, he's gonna care a lot.

Kara Wenzel - Yeah.

Amol Pachnanda - 'Cause he wants to end his personal liability as soon as possible.

Kara Wenzel - Mm-hmm.

Amol Pachnanda - But I feel like it's like in New York and some other states, really used the good guy guarantee.

Kara Wenzel - You wouldn't think of New York as a place that would advocate for good guys but.

Amol Pachnanda - Right. Right, but if you could see how long it takes to evict the tenant here, like, come on. Be a good guy, get out.

Kara Wenzel - Well, I like the term.

Amol Pachnanda - Yeah.

Kara Wenzel - So can we turn our attention back to landlords now. What types of obligations of a landlord can be outstanding that an acquiring entity should be aware of?

Amol Pachnanda - Right, so once the space is delivered to the landlord, sorry, to the tenant by the landlord, in many cases that just doesn't end the landlord's obligation, right? If the tenant is gonna build a space out, the landlord made an obligation to pay an improvement allowance to the tenant. A lot of times tenant may forget to ask for it timely. A lot of times the tenant may ask and landlords may forget to pay it but if you're acquiring the company, you need to know that, okay, this tenant was supposed to get $5 million. They've only gotten 3 million. So that's $2 million that I'm owed by the landlord. And I gotta make sure that I get it.

The landlord may have other delivery obligations in terms of doing some additional work or making sure that we talked about like the white table cloth restaurant, that may be an obligation of the landlord to make sure that I get certain amenities in the space. We've had, when I represented a landlord, tends sometimes to impose obligations on us that saying, okay, in six months you gotta have the gym up, because you're telling me you're gonna do the gym and I want you to do the gym. And if you, landlord, don't do it, there's gotta be consequences, right? And so if you're acquiring a company that had that right in its lease, well, what happens if the gym wasn't delivered? Are we entitled to additional free rent? So those are obligations that a landlord may have to perform to the tenant. And one way that the acquiring company can find out is really ask the landlord for an estoppel, which is, tell me that you've done X, Y, and Z, or you haven't. Or if you think that the tenant is in default. It's another way to find out if the tenant that you're acquiring is actually in good standing with the landlord, right? And has paid the rent for example, and is not fighting with the landlord on something else. So that that's a landlord estoppel that'll let you know if the landlord has any obligations that are outstanding.

Kara Wenzel - That makes sense. Yeah. Going back though, again, to your important provisions list, you mentioned the SNDA. Can you tell us a little bit more, tell us a little bit more about that, and why is it so important?

Amol Pachnanda - Sure, so I'll take a step back, right? So the SNDA is a subordination, non-disturbance, and attornment agreement. It's really an agreement between the tenant and the landlord's lender. And it provides that in the event the landlord defaults on its loan to the lender and the lender forecloses on the loan, and becomes the landlord now under the lease, the landlord is going to recognize the tenant as the tenant under the lease on the same terms and conditions as the lease, right? And again, it becomes important if you think of the example that this lease was signed 15 years ago its below market, and now the rents are through the roof. Well, in that case, if you don't have that SNDA protection, the lender may say, excuse me, the lender may say, you know what? I'm gonna kick you out, because now I can get $20 more per square foot for the same space. So while I think that that's something that the lender may do, on a practical level, I feel like lenders don't really wanna be operating in real estate game. They want the money. And their interest really is in collecting the rent rather than trying to fill up office space.

And as we talked about before, right, it's just not easy to fill up office space. You gotta get it in condition ready to be occupied. You gotta spend money on tenant improvement allowance. You gotta deal with vacancy before the space can be filled. You gotta deal with brokerage commissions. So when I'm representing small tenants, I generally don't even ask for an SNDA. When I'm representing bigger tenants, you'll ask for it, but sometimes the lender's SNDA can be so burdensome that you almost have to make the decision, well, do I even want it? Like let me just take my chances and see what happens. I've negotiated SNDAs where the lender will say, I know you're entitled to a $5 million tenant improvement allowance, but I'm only gonna give you half of it if the landlord defaults before he's given you the full amount. And then you're like, yeah, well, that doesn't sound that great. Like I want the whole things. And so maybe, you know what? Forget it. I'll just take my chances. That if something happens, we'll negotiate it. But if you are taking a lot of space and it's your headquarters, I think you're gonna want an SNDA for the protection that I'm not gonna be out on the street.

However remote that possibility, right? Just that result would be terrible, so you won't obviously minimize it, but I think when you're taking large chunk of space and it's your headquarters, you have more leverage. And even if the lender at that point says, you know what? I'm only gonna give you half of the allowance, then okay, you know what? Then I want the right to offset it against rent or reduce my rent, because the rent that I'm paying you is based on a $5 million allowance. And if I'm not getting the five million, well, now my rent should be lower. Or you can say to the landlord, you know what? Don't give me an allowance, because if the lender isn't going, if the lender, if he becomes my landlord, is not gonna give me that 100% of that allowance, I don't want it. Just reduce my rent. It's gonna cost obviously the tenant money, 'cause they have to come out of pocket to build the space and don't have an allowance, but their rent is lower. And now they've minimized the risk of the landlord going under and the lender not giving them 100% of the allowance.

Kara Wenzel - So your official answer is an important, it depends.

Amol Pachnanda - Right. I think it's like with anything, right? Anything with life in general, it just depends. I don't know.

Kara Wenzel - That's helpful though. You gave some examples of what to consider so.

Amol Pachnanda - Yeah.

Kara Wenzel - Good. Good.

Amol Pachnanda - And some tenants feel really strongly about it and some don't. It just depends on, and also depends on the document, right? If the document looks bad, is there any reason for me to sign a bad document or let's take my chances and see what happens. Because again, the lender doesn't wanna operate till we're more likely to negotiate with you at the point that they become the landlord.

Kara Wenzel - Right.

Amol Pachnanda - I said that in a very roundabout way, but I guess essentially all right, it depends.

Kara Wenzel - Well, thinking about this all a little more holistically, all of these lease provisions have some importance. But if you're thinking about, in the whole scheme of a corporate transaction, is this really kind of more like a tail wagging the dog? What should come, what should lead?

Amol Pachnanda - Yeah, you know what? And we kind of said it at the outset, right? I mean, this is not the major part of the M&A transaction, but unless everybody's working from home, the employees, the widgets need to be someplace, they need to be produced someplace. Somebody needs to sit at some desk someplace. And you need to know, okay, one, I have this lease. Forget the landlord consent part. Like what's gonna happen when I get into this space? What is my day to day obligations? What are my day to day rights? But it requires the due diligence that you really have to spend the time to figure out that maybe the repair and maintenance section isn't the most important section in the lease. Because if something happens, you're gonna look through that provision and kind of figure out who's responsible.

But if there's a contraction option, I think that's kind of important in an M&A transaction. Or if there's a renewal option, right? You wanna know if this lease is expiring in six months, should we already be looking for more space? What you don't don't want are surprises, right? And that's, I mean, it's the purpose of any type of due diligence. We're talking about lease due diligence in an M&A transaction, but of course, there's environmental due diligence, there's tax due diligence. If you own the property, then there's title due diligence, there's survey due diligence. So the purpose of the due diligence is to make sure that there's no surprises. And so my goal here really was that I trust everybody to figure out the monetary provisions, but sometimes the non-monetary stuff can have an outsized impact. And some of those provisions may not be as obvious, that you may not think about, or it may not be obvious in the lease document that this right exists or this right is personal.

So it's really like if you have, in the back of your mind, that yes, I wanna figure out what is the stuff that can impact the day-to-day operation of my space, the conduct of my business, and my future rights. One of the things we didn't talk about was like substitution of premises, right? If I'm on the fifth floor, can the landlord move me to the 15th floor or can the landlord move me to another space in the back part of the building, right? So now I don't have this great view that I used to have. Again, nobody's gonna blow up an M&A transaction on it, but you wanna know, okay, well, this is where we think our CEO's gonna sit and is he gonna be happy that he's moving up now, he's moving up a floor, but he's at the back of the building? If you can kind of anticipate those issues, you do 'em at the point that you're being asked to do a lease abstract in connection with the M&A transaction.

Kara Wenzel - So if you had to give one piece of advice to someone tasked with reviewing a lease for due diligence for the first time, what would it be, top tip?

Amol Pachnanda - I would say take your time and be thorough. And if you think something may or may not be important, I always err on the side of more. When I was a young associate, I always kind of looked at my job is to put all the comments in and all the things that I think are important, but really allow somebody with more experience, with the client and in the field to kind of figure out, you know what? It's a great point, but it's not important here. Because I always look at it as like, I wanna reduce, it's much easier, I always feel like, to correct a document rather than to think of theories, right? If I have to start thinking about, well, should this be here or that be here, that requires a lot of work. But if I can have somebody list out the five different options here and now I can pick, well, now it's totally different.

 So if somebody thinks the maintenance and repair section has something that's important, put it in, and let the partner or senior associate make the decision on what's important and what's not important. And that's how you learn, right? A lot of it is just, you just have to be in the battlefield. You just have to kind of get knocked down, learn the things that are important and figure out what is important. What's not important, what you can trade, 'cause ultimately, it's negotiations. Nobody expects to get 100%, but I think an attorney that knows the client and knows what's important can at least get you a document where you're like, you know what? I identified the issue and I think I'm adequately protected. So that's the way, if I was a young person in it for the first time is, err on the side of being more thorough and spending more hours than you think are necessary, because the next time, I guarantee you, it won't take you as long. 'Cause you'll figure it out that, okay. You know what? This isn't that important. This is very important. Let me put this in.

Kara Wenzel - Yeah. So use your track changes.

Amol Pachnanda - Exactly.

Kara Wenzel - All right. Always good advice. Well, thank you so much, Amol. We are just about out of time, but I wanna give you a chance to tell people how to contact you, how to find you?

Amol Pachnanda - Oh, well, first, thanks so much. I really enjoyed doing this. It was a lot of fun. And I can't believe the hour went by so quickly. So we have our website rkplawgroup.com. You can find me there. I'm also on LinkedIn, check out my leasing minute. And if you have stuff that you're curious about, I'll be happy to cover it in under a minute. But, yeah, so those are the best ways to reach me.

Kara Wenzel - Wonderful, and we'll have a link to your bio on our contact page for this course as well. Thank you so much for all of your insight. I loved hearing your war stories and-

Amol Pachnanda - Yeah.

Kara Wenzel - Yeah, we had a great time. Thank you again, Amol.

Amol Pachnanda - Oh, it was my pleasure. Thank you so much.

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