When a commercial property is sold, there often will be tenants already in place. If those tenants continue to pay rent and fulfill the lease, the buyer will be able to take over without a problem. If, however, the tenant fails, then the buyer may be unprotected if it hasn’t officially taken an assignment of the lease from its seller. A recent case from Washington illustrates the problem.
A corporation rented a restaurant space in the Spokane area, and the main shareholders signed a personal guarantee that they would stand behind the corporation in case it was unable to pay. The landlord then sold the building, but the buyer did not get the lease assigned. Unfortunately, the restaurant failed and closed, paying at most hald a month’s rent for the last two months of operations. (The landlord and tenant disagreed whether the half month was paid.) The buyer was able to find a replacement tenant about eight months later and sued both for not paying rent for the period from the first missed payment to the date it re-rented the space and for violating a clause in the lease that the restaurant would remain in operation.
The most significant point to be decided, when the case reached the Washington Court of Appeals, was whether the buyer had the right to enforce the lease, and against whom. Because the lease was not assigned to the buyer, it didn’t have rights in the lease as a contract. Because, however, it owned the building, it did have rights based on the occupancy of the space by the restaurant. Any part of the lease that gave a benefit based on ownership of the building could be enforced by the buyer.
Nobody seriously disputed that the corporation’s obligations to pay rent and to keep the restaurant running gave benefits that the buyer could enforce. With the exception of that part of the restaurant equipment and inventory that wasn’t taken by other creditors, however, the corporation was almost certainly insolvent. The court ruled that the guarantee was not connected with the ownership of the building, but was only an agreement with the seller. As a result, the buyer could not enforce the guarantee against the shareholders. As a result, when the case is reheard by the trial court, the buyer will probably be out of luck.
Anyone who wants to buy commercial property may want to negotiate for an assignment of any existing leases as part of the deal. That way, if a tenant is unable to pay, any guarantees would be enforceable by the buyer. If the seller doesn’t want to assign, then that should be taken into account when negotiating the purchase price.