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Sale-And-Leaseback: The Importance Of Harmonizing The Lease With The Offer To Purchase – Landlord & Tenant – Leases



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In the real estate market, a sale-and-leaseback
transaction, or simply “leaseback,” is a method of
financing a business. In general, it consists in the sale of an
immovable property owned by the corporation operating its business
therein to a third-party buyer, carried out concurrently with the
leasing of the same property to the seller under the terms of a
commercial lease. In other words, through the leaseback of a
property, the buyer becomes the landlord and the seller (operating
corporation and original owner of the property) becomes the
tenant.

Sale-and-leaseback is particularly well suited to sales of
single-occupant retail or industrial properties where the occupant
is the owner.

In a real estate market where industrial properties are in high
demand and financing costs are rising, the popularity of
sale-and-leaseback transactions is likely to increase.

This type of transaction offers several benefits for both
parties. For the seller, the benefits include the opportunity to
take advantage of rising real estate values in the current market
and to use the profit from the sale to pay off debts or invest in
its business. In addition, the seller, as tenant under the
commercial lease entered into with the buyer, continues to operate
its business in the same building and retains some control over it.
This type of transaction can also have accounting and tax benefits
for the seller-tenant, such as the possibility to deduct the rent
paid from its income. For the buyer, the benefits include the
opportunity to acquire a real estate asset which is guaranteed to
generate a rental income for a medium or long term.

In these transactions, the lease becomes a key asset, protecting
the seller-tenant’s rights to remain in the building and to
continue operating its business therein and therefrom while
ensuring the buyer-landlord a certain return on investment through
rent. Consequently, the lease between the parties must be carefully
tailored to the transaction, and the terms and conditions of this
lease must be consistent with the provisions of the offer to
purchase notably those provisions of the offer relating to the
seller’s conventional representations and warranties and the
legal warranties of quality and ownership.

Conventional representations and warranties

According to the principle of freedom of contract, the parties
to an offer to purchase may add to, diminish or exclude entirely
the effects of the legal warranties, provided they comply with
certain guidelines. Moreover, an offer to purchase almost always
contains conventional representations and warranties, being
representations and warranties which are not provided for at law,
but rather negotiated between the parties.

While some of the standard conventional representations and
warranties do not require that any adaptation be made to the lease,
others deserve special attention, including those concerning the
state and condition of the property at the time of the sale. For
example, the seller may represent and warrant in the offer to
purchase that the property is, at the closing date, in compliance
with all applicable legislation, or that it is not and has never
been contaminated. The effects of such conventional representations
and warranties are to replace, at least in part, the legal warranty
of quality or to clarify its scope.

The legal warranty of quality

Even if an offer to purchase does not contain conventional
representations and warranties by the seller regarding the
property’s state and condition, a sale can be made with the
legal warranty of quality. Article 1726 of the Civil Code
of Québec
, which is the basis of said warranty,
expressly deals with latent defects in the following terms:

1726. The seller is bound to warrant
the buyer that the property and its accessories are, at the time of
the sale, free of latent defects which render it unfit for the use
for which it was intended or which so diminish its usefulness that
the buyer would not have bought it or paid so high a price if he
had been aware of them.

The seller is not bound, however, to warrant against any latent
defect known to the buyer or any apparent defect; an apparent
defect is a defect that can be perceived by a prudent and diligent
buyer without the need to resort to an expert.”

This Article sets out the four criteria which must be met to
conclude to the existence of a latent defect, namely that (1) the
defect is serious to the extent of rendering the property unfit for
its intended use; (2) the defect existed at the time of the sale;
(3) the defect was hidden; and (4) the buyer had no knowledge of
the defect.1

While the notion of latent defect applies to traditional cases
of damages or defects to the building, such as major yet
inconspicuous cracks in the foundation, it also covers cases of
contamination of the land on which the building is
built,2 provided that the four criteria mentioned
above are met.

The legal warranty of ownership

The sale of a property can also be made with the legal warranty
of ownership, which can be combined with the legal warranty of
quality. Under the legal warranty of ownership, a seller warrants
to the buyer that the property is free of any private or public
rights, except those declared to the buyer at the time of the sale.
While this warranty applies to cases where a property is sold
without a clear title, or where a hypothec that the buyer has not
assumed subsists on the property, it also applies to cases where a
property does not comply with the environmental legislation
applicable at the time of the sale.3   

Lease provisions to adapt

If a property is sold with the legal warranty of quality or the
legal warranty of ownership, or if the seller makes certain
conventional representations and warranties regarding the state and
condition of the property at the closing date, then certain
provisions of the lease must be adapted accordingly including,
without limitation, those listed below:

1. Condition of the property

Since, in a sale-and-leaseback, the tenant is a corporation
which has been operating its business in the property for several
months or years prior to the sale and is therefore familiar with
the state and condition thereof, the lease generally contains
provisions to the effect that the tenant accepts the property
“as is”. While these provisions are common in most
commercial leases, they often need to be adapted for a leaseback in
order to extend their scope.

Furthermore, if the sale is made with legal warranties or if the
offer to purchase contains seller’s representations and
warranties regarding the state and condition of the property or of
its equipment, then the acceptance by the tenant of the property in
its “as is” state and condition should not be subject to
latent defects, construction defects or non-compliance of the
property with applicable legislation. Depending on the nature and
extent of the warranties provided for under the offer to purchase,
a seller-tenant could accept the property “as is”, but
subject to apparent defects and all latent defects the
buyer-landlord was made aware of prior to the sale.

2. Environmental obligations

Each party’s environmental obligations depend on the legal
warranties and the seller’s conventional representations and
warranties provided for under the offer to purchase. Generally,
tenants are responsible for any contamination they cause to the
property or which is caused by their representatives, employees and
other persons for whom they are responsible at law or to whom they
allow access to the property during the term of the lease. However,
if the seller represents and warrants to the buyer that, at the
closing date, the property is not contaminated and complies with
all applicable environmental legislation, then the lease should
provide that the tenant is also responsible for any contamination
of the property existing even prior to the commencement date of the
lease, regardless of the cause of the contamination. The same
applies if the parties have not excluded the application of the
legal warranties.

3. Maintenance, repair and replacement
obligations

Maintenance, repair and replacement obligations are often
overlooked during the negotiation process of a commercial lease.
However, these often costly obligations can impact the value of the
building. In a “net,” “double net,”
“triple net” or “entirely net” commercial
lease, it is important to adapt the definition of the operating
costs charged to the tenant based on each party’s maintenance,
repair and replacement obligations. It is also essential to specify
which party is responsible for doing the maintenance, repair and
replacement work and which party is responsible for paying the
costs thereof; the party doing the work is not necessarily the one
paying the bill.

In a sale-and-leaseback transaction, assigning responsibility
for the work can be all the more important to each party. The
tenant, on the one hand, may want the landlord to be responsible
for doing most of the maintenance, repair and replacement work in
the building, and therefore have the costs of such work included in
the operating costs (and amortized if they are characterized as
costs of a capital nature). Indeed, one of the reasons some
corporations sell their property is that they no longer wish to
take care of it, preferring to invest their time and money into
their business. A landlord, on the other hand, may want the tenant
to handle most of this work, at the tenant’s costs, as is often
the case under industrial leases.

In addition, the parties should ensure that their respective
maintenance, repair and replacement obligations reflect the legal
warranties or the seller’s conventional representations and
warranties provided for under the offer to purchase. For example,
if the seller represents and warrants to the buyer that the
building is, at the closing date, free of latent defects, the lease
should provide that the tenant is responsible, at its cost, for
carrying out the work necessary to correct any latent defect
existing at the closing date. The landlord may also want to provide
for an option to perform this work at the tenant’s cost, plus
an administration fee. If a latent defect affects a part of the
building for which the landlord is responsible under the lease,
such as the structure of the building for example, the lease must
be clear with respect to the tenant’s obligation to reimburse
the costs incurred by the landlord to correct the defect; also,
such costs should not be part of the operating costs. Indeed, the
operating costs usually include only the amortized portion of such
costs over the lease term, with the landlord not necessarily
recovering the full amount of its expenses. This is because this
amount is payable only in installments, with the risks that this
entails. To amortize the costs of the repairs of a latent defect in
a situation where the seller represented and warranted to the buyer
that no such latent defect exists would go against the parties’
intention in the offer to purchase.

4. Tenant insurance

The tenant insurance clause in the lease should be tailored to
the tenant’s obligations thereunder. For example, if the tenant
is responsible for any contamination on, in or under the property,
including the contamination existing before the commencement date
of the lease, the landlord could require an environmental liability
insurance from its tenant.

5. Other equipment

If the building is sold with specialized equipment used by the
seller-tenant in the course of its business, then the lease must
also provide that said equipment is leased to the tenant and
specify which party is responsible for its maintenance, repair and
replacement. If the offer to purchase contains legal warranties or
seller conventional representations and warranties regarding the
state and condition of said equipment, such warranties will have an
impact on these obligations. On the contrary, if this equipment
remains the property of the seller-tenant and some of this
equipment is permanently attached to the building, it would be
prudent to include in the lease a list of the equipment belonging
to the tenant, and to specify if such equipment needs to be removed
by the tenant at the end of the lease.

Conclusion

Considering the complexity of sale-and-leaseback transactions,
the impact of the warranties provided for under the offer to
purchase on the parties’ relationship in the long term, and the
importance of the lease for each party, it is highly recommended
that the parties seek professional guidance from experts in the
field, who will be able to advise them and ensure that the lease is
in synch with the offer to purchase.  

Footnotes

1 These four criteria are sometimes combined into
three criteria and vary slightly among academic writers and
judges.

2 See, for example, Faucher v.
Développements Lemarco Inc., 
2010 QCCA 1807
and Pothier v. Viard, 2022 QCCS 354.

3 Coche, A. and Duchaine, C., La notion de
vices cachés et les garanties du Code civil lors de la vente
de terrains contaminés : modalités d’exercice et
principaux écueils
, Barreau du Québec – Service
de la formation continue (Développements récents en
droit de l’environnement (2012)), vol. 352, Éditions
Yvon Blais, Cowansville, p. 397; see, for example, Labelle
v. Bouchard
, 2021 QCCS 5089.


Read the original article on GowlingWLG.com

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.



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