In the wake of a series of announcements regarding the closure of the operations of several Canadian retailers as well as the withdrawal of US retailers from the Canadian market, questions are being asked regarding the potential impact on the landlords of the numerous store locations affected. This is not surprising given that a retailer’s entry into or expansion strategy within Canada routinely involves the assumption of various existing leases. The consequences of the recent closure announcements will, no doubt, be felt across the Canadian commercial real estate market and retail scene for years to come, as landlords scramble to fill vacant sites, in some cases representing very large footprints. Further, in instances where a departing retailer was the anchor tenant, the closure of operations may also impact the traffic flow to other retailers in the same shopping centres. The negative financial impact on landlords, however, may not be the same across the board: some landlords may have obtained financial covenants to backstop the departing tenant’s lease obligations.
Assessing the lease implications of retail closures may be instructive in the M&A context, particularly insofar as they raise a number of other lease considerations that landlords and parties to asset purchase and sale transactions should be aware of in asset purchase and sale transactions where leases are being assigned and assumed. Specifically, most commercial leases will require landlords’ prior written consent to an assignment and provide that the original tenant/assignor will not be released from its covenant, notwithstanding any assignment.
From a landlord’s perspective, while the terms of a lease may require that such consent not be unreasonably withheld, delayed or conditioned (or some combination thereof) and otherwise provide criteria for approval, landlords will want to be satisfied with the financial strength and operating history of the proposed assignee and drill down on the corporate structure to ensure that the proposed assignee providing the covenant has the means to meet the lease obligations, or that a sufficient guarantee/indemnity is obtained, with the above scenario a prime example as to why. This becomes even more important to landlords if the existing tenant is requesting a release.
Often, while the parties in an asset purchase and sale transaction turn their minds to the requirement for landlords’ consent to the assignment of leases and include such as a closing condition, sometimes sellers fail to turn their mind to the fact that they (as well as any guarantor/indemnifier) may not be released from the leases by the landlord upon such assignment and the potential implications, namely continued liability after the assignee has taken over the premises, particularly if the tenant/assignor entity is an operating company with other assets not included in the transaction. While an indemnity from the assignee may be obtained to temper this risk, an indemnity too is only and strong as its covenanter. In such circumstances sellers may want to require releases and/or a replacement covenant from the purchaser/assignee satisfactory to the landlords as a condition precedent to closing.
From a purchaser/assignee perspective, in addition to wanting to include express provisions in an asset purchase agreement for landlords’ consent to lease assignments, other important closing deliverables/conditions include landlord estoppels, notices of key leases being registered on title to the subject properties and non disturbance agreements being obtained from landlords’ secured creditors. A discussion of the importance of the foregoing will be the subject of a subsequent post to this blog.