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.