What is a Leaseback Agreement?
A leaseback agreement is a legally binding alternative financing structure whereby the seller of a property simultaneously sells the property to the buyer and then leases back the property from the buyer as a tenant. While a sale is a transfer of ownership, in a leaseback agreement there is only a transfer of possession. The seller conveys both title and possession of the property to the buyer through the sale and then the buyer conveys possession and use of the property back to the seller through the lease. Of course, the buyer wants to ensure that the owner/vendor/tenant is obligated to meet its conditions in the purchase agreement and the lease agreement even after the closing has occurred so the buyer should carefully draft the terms of the lease including the time period for the lease, what payments are required, what happens if the owner/vendor/tenant fails to make the payments, how late the payments can be or how long the tenant can remain in possession of the property without paying rent, etc .
It is important to note that a leaseback agreement should be carefully drafted to comply with any applicable landlord-tenant statutes. Most states require specific actions to have taken place prior to the conclusion of a termination of the lease. For example, in Florida, a lease terminated on the last day or upon the expiration date stated in the lease unless a 15-day notice of termination was given. Depending on the state, a notice of non-renewal may also have to be provided. If there are any issues related to the leaseback provisions contained in the purchase agreement or the termination of the leaseback provisions, it is important to consult an attorney so that the issue can be resolved.
Benefits of Leaseback Agreements
There are many advantages to entering into a leaseback agreement. It serves as a bridge for both the seller and buyer who may find themselves in a tight situation that could prevent a smooth and effective transition. Sellers may need to lease the property from the buyers beyond the normal real estate contract contingency timeframes should their new home not be ready, renovations take longer than expected, etc. Practically speaking, this avoids the seller from having to pay rent while paying a mortgage on their current property, which can burden the seller financially.
Leaseback agreements also afford the seller some time for sale-related inconveniences that may not have been anticipated.
For the buyer, the benefits can be equally as great. The buyer gets to enjoy moving into their new home without any stress in having to sell a home before buying, or being left homeless should the closing date not line up. Additionally, it provides more time to renovate, decorate, and move into their new home, while ridding themselves of the burden of paying mortgages on both houses.
How Leaseback Agreements Function After Closing
Some sellers enter into lease back agreements to address what will be a time gap between closing on the sale of their home and moving into their next home. The need for the lease back agreement may be as short as a few days or as long as a few months.
While these arrangements may be great for some sellers, there are important considerations to keep in mind:
A lease back agreement is an agreement between the current owner of the property and the buyer, leasing the property back to the seller for a specified period of time. This process happens after the real estate transaction closes. A lease back agreement specifically creates a lessor/lessee relationship (or landlord/tenant relationship) between the parties, and not a grant of title.
Typically, the Buyer wants the closing to occur as quickly as possible, compensating the Seller for the additional costs of temporary housing during the time period between closing and the move-in date. This compensation can take many forms, but it generally can be housed within the following framework:
Factors affecting the cost of Leasebacks:
Sellers should be careful in ensuring that they are compensated for all expenses related to the leaseback. These costs fluctuate to reflect the cost of living/demand and availability between locations. Let’s say you are moving from Palm Beach to New England in January/February. You may have higher costs for a rental property with a shorter leaseback term if you request that the buyer pay for your rental at the new location.
Lease back agreements are also negotiated to cover damages, security deposits, pets, etc.
Common Terms in Leaseback Agreements
A leaseback agreement must have certain terms to be enforceable and practical. What are the most important terms to include?
Rent Payment
The leaseback agreement must specify the rent to be paid. Government regulations may also impose certain controls on this.
Term
The duration of the leaseback agreement must be specified. Consideration should be given to extension at expiration of the term, as well as termination rights before the end of the term.
Financial Accountability
How will the buyer finance the leaseback? How will bills be paid? Consider the implications if the buyer cannot afford to pay the bills. Will creditors seek payment from the seller?
What happens if the seller is required to pay ongoing expenses for the business during the term of the leasehold?
Scope of Use
Define the scope of use to which the property is to be put after close of the acquisition transaction.
Condition of Assets
A seller may want to ensure that it retains control over how its remaining business assets are used and maintained. It would not want those assets to be damaged or neglected, but at the same time, the buyer will not want be restricted in how it uses those assets.
Insurance
Will the seller be liable for loss or damage to the asset? Will insurance be put in place? Who pays the premiums?
Legal Framework and Requirements
It is critically important that the terms of the leaseback be clearly defined and separately represented from the purchase price. Leaseback agreements should be carefully drafted, even if they are not required by state or local law. Such leaseback agreements can be problematic if they are unclear, overly broad or poorly drafted. From an enforcement perspective, such agreements could be considered as a "backdoor" mechanism for attempting to coerce a seller to retain an asset without a fair price. Clarity and accuracy are vital, and in the event that any elements or features of the leaseback are vague or point to any later undefined terms, a careful and thorough review of the entire purchase and sale agreement involving the real property or business needs to be taken into consideration when drafting and reviewing the leaseback.
Parties seeking to enter into a leaseback should consider several important areas of the law and legal requirements before executing a leaseback agreement, including:
Whether the new owner has standing under state law (such as successor liability theory, joint employer standard, or other similar doctrines) to bring a lawsuit against the seller based on conduct that occurred prior to the seller’s relinquishment of interest in the business or real property. For instance, if a party is concerned about assuming the liabilities of the seller that conducted the business or owned the real property, it should be confirmed whether a successor may be liable for pre-transfer business torts, wrongful terminations, safety violations, agency violations , discrimination, workplace injury claims, environmental contamination, debts to creditors, tax liability, and/or wage claims.
Whether the new owner (as a purchaser of a business or real property) can enforce against the seller (as the lessee) any obligations or agreements purportedly undertaken in the leaseback, including but not limited to a good faith negotiation of a lease and/or forbearance of evictions, commercial rent control, condemning or demolishing all or part of the property, failing to preserve the condition of all remaining improvements, requiring the lessee to enter into a sublease and enforce the same, and enforcing compliance with applicable federal, state, and/or local law.
Whether the seller as the lessee has the legal right to transfer, sublet, or assign the leaseback.
Whether the leasing process is legally sufficient, such as whether the leaseback meets the requirements of form and execution, and conformance with the Statute of Frauds.
Whether it is a legal imperative that the leaseback be approved by a court or governmental authority, and if not, the preference that the leaseback be approved nonetheless.
Whether recordation of the leaseback is necessary or should be required, and if not, whether an option to record the leaseback should be included to avoid problems if the leaseback is mislaid or destroyed.
If the leaseback provides for occupancy or possession for a period of time that is longer than the statute of frauds governing the statutory period of limitations applicable to unlawful detainer actions, the leaseback may need to be amended.
Possible Risks and Issues
It is not uncommon for sellers to enter into leaseback agreements with the buyers of their property. However, such arrangements are not without their risks and potential pitfalls. A seller may not be able to secure what they believed was a secure exit and seller financing in order to close the sale. While a purchase agreement may obligate the buyer to refinance an installment note, obtaining refinancing is not always so simple. Delays or denials or recourse by the borrower/guarantor can create havoc for the seller, who expects to get out of the transaction and be free of further financial obligations. Issues such as these can result in litigation.
For example a seller sells property for $1 million and receives a $900,000 note from the buyer, which provides for a balloon payment after five years. The seller requires $100,000 back through a leaseback of the property for five years at $2,000 per month so that it may pay down debt. The seller maintains an unsecured installment note with the buyer and wants "cheap, dirty and quick" so that the sale may close. The issue is that the buyer and its lender want a recorded (as opposed to unrecorded) lease in order to add assurance in the event a lawsuit is necessary down the line. The lender using a form of lease that makes the tenant responsible for maintenance, repairs, utilities, taxes and insurance (TCB, Inc. v. Kaiser Aetna, 156 Ariz. 574, 754 P. 2d 345 (1988)). The seller counters with a provision to maintain property insurance and utilities (Thompson v. Balsam, (1977) 76 Wn. 2d 502, 458 P. 2d 187). The buyer insists on an indemnification clause, which the seller refuses to accept on the premise that potential future claims are too indefinite until such claims may actually arise. The closing proceeds with the buyer securing financing and recording the lease, but the seller’s unsecured installment note creates an additional risk. If the leaseback is not a financing transaction (where the seller holds a direct interest in the property), the lender does not have a direct security interest in the leaseback property. Karoutas v. UCAR Financial Services (2003) 115 Cal.App.4th 141, 8 Cal.Rptr.3d 257, 2003 Cal. App. LEXIS 930; and see S.e.i. Investments, C.V. v. Superkicks Chauffeured Limousines, Inc. (2004) 116 Cal.App.4th 209, 210-11, 11 Cal.Rptr.3d 826, 2004 Cal. App. LEXIS 795. When the seller defaults, it places additional demands on the lender, while the seller is unable to meet its loan obligation normally satisfied by rent receipts from the terminated lease. For all of these reasons, both the buyer and seller of property should make certain that the terms and conditions of a leaseback arrangement are appropriate and agreed upon before opening a bottle of champagne.
Examples of Leaseback Agreements
Examples of the use leaseback agreements are frequently utilized in commercial real estate transactions in order to make the best use of the parties’ cash flow. The tenants can deliver a substantial upfront deposit as security for a lease and still have cash to invest elsewhere. The landlord can finance the real estate with the lease payments by the tenants, significantly reducing its investment in connection with the acquisition of the property. The leaseback agreements also create the right to apply the rents from the tenants to the debt service while the tenants occupy the property and allow such tenants to amortize their investment in the property over the term of the lease agreements while retaining significant reserves to invest elsewhere.
Tenants who use leaseback agreements typically have an existing institutional character with substantially high credit. For example, a state chartered bank who occupies several sites in and about the city of Memphis, Tennessee approached the investor in order to renegotiate its existing leases, which were primarily leases with renewal options and long terms. The investor agreed to allow the state chartered bank to close on the property subject to the terms of the leaseback agreements and use the capital on new office space for its corporate headquarters in a new emerging area of downtown Memphis.
The leaseback agreement negotiated by the parties was advantageous to both parties because it allowed the bank to retain existing real estate while still accruing the benefits of having a presence in the downtown area. Due to the state chartered bank’s financial position, the investors requirement for lease payments was low due to the low level of risk associated with such a loan. The investor acquired multiple functioning properties at a time when vacancy rates in Memphis increased, thus benefiting from a stabilized rental income without the capital needed to place tenants in the properties.
Strategies for Negotiating a Leaseback Agreement
Engage in Open Dialogue
As with all aspects of a real estate transaction, clear communication with all parties is the key to successfully completing a sale and post-closing leaseback agreement. If you have questions regarding the type of leaseback best suited for your needs – or the purchase price of the asset – be sure to ask before any legal documents are drafted and submitted for review. Otherwise, negotiation may become more complicated than necessary.
Understand the Value of the Asset
Asset valuations can be extremely subjective. It is possible for two parties to see the same property and arrive at different values depending on their goals and needs. Securing an accurate property valuation is vital to negotiating a fair and reasonable leaseback agreement.
Define Key Terminology
A good deal for your company is not necessarily a good deal for the other party in the transaction – and vice versa. Therefore , it is important to define the terms in the leaseback proposal to ensure everyone agrees with the meanings and descriptions.
Engage Experienced Counsel
The value of taking the time to retain the services of an attorney with experience in leaseback agreements cannot be understated. An attorney can ensure your legal documents are in accordance with all federal, state and local laws while protecting your interests, from deal-proposing to signing on the dotted line.