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The ‘Sale And Leaseback’ – A Means To Liquidity In Choppy Times? – Landlord & Tenant – Leases

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In a turbulent market, a sale and leaseback may be a win-win for
both investor and tenant. The arrangement provides a liquidity
solution for businesses wishing to release locked-up capital and
gives investors access to assets that would not have otherwise been
on the market. But how does a sale and leaseback work and what are
the common issues to be aware of?

The what and the why?

A sale and leaseback involves the sale of a property (or
portfolio of properties) from party A (the seller) to party B (the
investor) in return for a lump sum. Party B then immediately leases
the property back to party A (now the tenant) for an agreed term
and rent structure (usually open market rack rent; index-linked; or
calculated by reference to the purchase price). Sale and leasebacks
have been popular with supermarket chains for a number of years and
use in other asset classes is increasing too, notably hotels,
logistics and life sciences – for example, Oxford Biomedica has recently agreed a strategic
£60 million sale and leaseback of its headquarters in
Oxford
.

On top of accessibility of assets, sale and leasebacks are also
popular with investors due to the stable nature and predictable
flow of returns – the properties are already operating, a
tenant is guaranteed and rental payments will likely be regular and
fixed, at least until the first rent review (which would usually be
upwards only or framed with a cap and collar). Since the investor
will own the property, it will also benefit from any increased
property value, sometimes without conducting any repair or capex
works itself. For the tenant, the arrangement releases locked-up
capital from its balance sheet which can be used to pay down debt,
to re-invest cash into the business or to pursue new opportunities.
The business’s operations, and importantly the location of
those operations, remain unaffected.

Common issues to consider

Should the deal be on or off the record? Both
parties should think carefully about the confidential nature of the
terms of the transaction and whether all terms should be set out in
the lease which, in most cases, will be publicly available at the
Land Registry (to the extent unredacted). Alternatively, a separate
framework agreement, which will remain private, could house the
commercial terms. An investor will not want to prejudice its future
negotiating position by revealing to the market the terms it has
agreed to previously. A tenant will not, for example, want its
competitors seeing the reporting requirements and other financial
or capex covenants.

Appropriate repair and capex provisions.
Landlords will favour a triple net/FRI lease whereby the tenant is
responsible for taxes, insurance and maintenance of the property
– this allows for maximum returns (in the form of rental
payments and rise in property value) with minimum input. The repair
clause should be carefully drafted to ensure the property is
maintained to an appropriate standard. In many cases, capex
provisions (which require the tenant to invest above and beyond the
repair provisions in a typical occupational lease) may also be
appropriate. Such provisions retain the tenant’s feeling of
owning the property and controlling the works. However, the tenant
should ensure that it can comply with the covenants included, not
only financially but also in terms of the frequency and standard of
the required maintenance and development works.

In uncertain times, find certainty in
reporting.
Landlords will want to ensure that the tenant
is operating profitably and able to comply with rent, repair and
capex covenants. Information is key. A landlord will include
stringent reporting requirements in the lease or framework
agreement for the provision of turnover related information,
evidence of covenant compliance etc. However, as the landlord will
want access to a wide range of supporting data, a well-advised
tenant will impose stringent confidentiality obligations. The
confidentiality clause should not be overlooked.

Catering for the next liquidity event. Although
long-term investors are often attracted to sale and leasebacks,
they will not want to be locked-in forever and may wish to sell the
investment, particularly if the lease has a long term. Leases
rarely prohibit a landlord from transferring its interest, but a
tenant in a strong negotiating position may limit the category of
persons to whom the landlord could sell to (e.g., not to the
tenant’s competitors).

The tenant may also want to exit before term expiry, be that due
to financial difficulties or otherwise. Since the landlord
transacted based upon the identity and covenant-strength of the
tenant, the landlord may restrict the tenant’s ability to
assign the lease. If the lease contains open-market rent reviews,
the landlord should ensure that any provisions restricting the
tenant’s right to assign the lease are disregarded on rent
review so that the tenant cannot rely upon the onerous nature of
the restrictions to secure a below market rent. More favourable
underletting provisions may be a suitable compromise.

Whilst change of control clauses are uncommon in English law
leases, depending on the identity of the tenant, adequate
flexibility may need to be built into any change of control clause
to permit an indirect owner of the tenant to exit its
investment.

Any renewal options should also be discussed at the outset. If
the landlord is opposed to granting a renewal option, it should
also contract out of the security of tenure provisions in the
Landlord and Tenant Act 1954 to ensure it is not obliged to grant a
further lease to the same tenant. Adequate forfeiture provisions
that cover the risk of tenant default are a must-have. Any break
rights (mutual or otherwise) will also need to be agreed.

What’s next?

The popularity of sale and leaseback transactions continues. It
is a trend that will likely develop further during the months ahead
as businesses seek to release locked-up capital in a time of
economic uncertainty and restricted debt markets. As the terms of
the arrangement extend beyond those of a typical occupational
lease, a balance will need to be struck between the need for
liquidity and future proofing lease terms.

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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