You’ve sold your business, so why are you still responsible for the rent?
Selling your business should mean a fresh start. But handing over the keys does not necessarily mean walking away from the lease or the financial obligations that come with it.
For many business owners, a sale represents the payoff for years of hard work. The sale agreement is signed, the purchase price is paid, and the new owner takes over.
But what happens if, six months later, the new owner stops paying the rent?
The answer may come as a surprise: the landlord could still look to you for payment.
The hidden risk in commercial leases
Most businesses operate through limited liability companies. When entering into a commercial lease, however, landlords commonly require directors or shareholders to provide personal guarantees.
If the company fails to meet its obligations under the lease, the landlord may be able to pursue those guarantors personally.
When a business is sold, the lease is often assigned to the purchaser. Although the purchaser takes over responsibility for paying the rent and complying with the lease, that does not necessarily release the outgoing tenant or its guarantors.
Under New Zealand law, the original tenant will generally remain liable after an assignment unless the landlord agrees to release it. Whether the original guarantors also remain liable, and for how long, will depend on the wording of the lease, guarantee and assignment documents.
Under commonly used The Law Association (formerly ADLS) leases, liability will generally continue until the end of the current lease term in which the assignment occurs. It will not necessarily continue into a renewed term.
Every lease is different. Some provide for guarantors to be released on assignment, although this is uncommon. Others limit the period for which a guarantor remains liable.
For example, a long-term motel lease may limit a guarantor’s continuing liability to a set period, such as three years after an assignment.
Whether liability extends to subsequent renewals or variations will depend on the particular documents and circumstances.
Importantly, signing a deed of assignment will not usually release the outgoing tenant or its guarantors. An express release from the landlord is generally required.
A costly surprise
Imagine selling your café with three years left on the current lease term. The purchaser takes over, the landlord consents to the assignment, and you move on.
A year later, the purchaser’s business struggles and the rent stops being paid.
Although you no longer own the café, the landlord may still have a claim against your former company and potentially against you personally if you guaranteed the lease.
The purchaser may have indemnified you against those liabilities, but an indemnity provides limited protection if the purchaser has no money to meet the claim.
How can you protect yourself?
If you are planning to sell your business, consider these practical steps:
1. Review the lease early. Check the remaining term, renewal rights, personal guarantees and any provisions dealing with liability after an assignment.
2. Consider the timing of the sale. If you have given a personal guarantee, assigning the lease towards the end of the then current term may reduce the period for which you remain exposed.
3. Consider surrendering the lease. Explore whether the existing lease can be surrendered and replaced with a new lease directly between the landlord and purchaser.
4. Negotiate a release. Where possible, seek the landlord’s written agreement releasing the outgoing tenant and guarantors from future obligations.
5. Limit your exposure. If the landlord will not agree to a full release, consider whether your liability can be capped by time or amount. Ideally, this should be negotiated when entering the lease or, if you are buying the business, as a condition of taking over the lease.
6. Protect yourself in the sale agreement. Ensure the purchaser indemnifies you against future lease liabilities and consider whether additional security is appropriate. Remember that an indemnity does not prevent the landlord from pursuing you directly.
7. Get the documentation right. Make sure any agreed release or limitation is clearly recorded in the assignment documents and takes effect on settlement.
The bottom line
Selling your business should allow you to move on. But unless the lease and any associated guarantees are properly dealt with, you could remain responsible for the purchaser’s business difficulties long after settlement.
A little planning before settlement can help avoid an expensive surprise down the track.
If you’re considering selling your business, the commercial property team at Duncan Cotterill can help you understand your lease obligations and negotiate an appropriate exit.
Special thanks to Partner Andrew Oh and Solicitor Annalise Cook for preparing this article.
Disclaimer: The content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.
