The Sale-Leaseback Agreement Explained

If you search for a sale leaseback agreement, you might expect one contract. Some deals do use one title for the sale document, but the substance is almost always divided into two parts.

• The purchase and sale agreement, often called the PSA. You are the seller and the investor is the buyer. It covers what is being sold, for how much, what you promise about the property, what can end the deal, and how closing works. Most of its work is done on closing day.
• The lease. You become the tenant and the investor becomes your landlord. It covers rent, increases, who pays for what, what you can do with the building, and what happens at the end. Its work begins on closing day and may continue for decades.

FBT Gibbons, a law firm that has written a series on these deals, notes that the two are usually drafted together, and that the lease governs long-term payment obligations and the ongoing control and use of the property. Other papers come with them, such as a deed, title documents and closing statements, and possibly a guaranty if someone other than the tenant stands behind the rent.

Think of the PSA as the document that gets you to closing safely. The sections that are most commonly negotiated are these.

• Price and financial terms. Price is tied to the rent you will pay, so the PSA is never really separate from the lease.
• Representations and warranties. These are statements of fact you promise are true. Because you have owned and operated the building, buyers usually ask for more detail than in an ordinary commercial sale, covering environmental matters, physical condition, title and occupancy.
• Contingencies. These are conditions that let a party walk away. Buyers typically ask for financing, inspection and appraisal contingencies. A common seller contingency is securing a lease on favorable terms.
• Diligence and closing mechanics. How long the buyer has to investigate, what deposit it posts, and when and how the deal closes.

Read the representations carefully. A buyer may want a flat statement that no violation of environmental law exists, instead of a narrower statement that you have received no written notice of one. The first is a much bigger promise, and it is the kind of language a seller should review with its attorney before signing.

The lease is where risk tends to concentrate, because it outlasts everything else. In its review of commonly negotiated lease provisions, FBT Gibbons lists these areas:

• Base rent and increases over time.
• Term and renewal options.
• Assignment, subletting and change of control, which matter if you later sell the company.
• Permitted use of the building.
• Maintenance and alterations.
• Financial reporting to the landlord.
• Insurance requirements.
• Casualty and condemnation, including what happens to insurance proceeds if the building is damaged.
• Repairs and other items that the parties agree to finish after closing.

Our other guides go through these clauses one at a time. The point here is that you are signing a long operating agreement with a landlord, not just collecting a check. At TAG, we negotiate the price and the lease together on behalf of the seller who becomes the tenant, because the two are the same economic decision.

The contracts connect in three ways that a first-time seller may not expect.

They connect on economics. Rent and price move together. A buyer works from the rent to the price it can pay, so asking for a lower rent generally lowers the offer, and asking for a higher price generally raises the rent. Terms that look purely legal, such as who pays for a new roof, also feed into what the buyer will pay.

They connect on timing. The lease is commonly attached to the PSA or finalized before closing, and it is signed as part of the closing. If you sign the PSA with the lease still loosely described, you may have given up your leverage on it while the buyer's diligence clock is running. That is why a seller might ask for a contingency tied to reaching agreement on the lease.

They connect on promises. Something you represent in the PSA, such as the condition of the building, may also appear as an obligation in the lease. Any repair items or minor title matters left open at closing may be carried in a separate post-closing agreement. Check that the documents say the same thing, and that it is clear which one controls.

A cross-default clause says that a default under one agreement also counts as a default under another. It is one of the more important terms for a first-time seller to understand, because it can make a small problem much bigger.

It can appear in a few places. If you sell several properties, a default at one site may be treated as a default across a master lease covering all of them. One public company described that risk in a securities filing, warning that a breach at a single facility could subject multiple facilities under the same master lease to the same default risk, and that a portfolio default could activate cross-default provisions in its debt and other leases. A landlord may also ask to tie the lease to a guaranty, to other leases with the same landlord, or to your loan agreements.

• ✓Which other agreements does the lease cross-default with, if any?
• ✓Do any of our loan agreements treat a lease default as a loan default?
• ✓Can a small or technical default trigger it, or only a serious one?
• ✓Do we get written notice and a chance to fix the problem first?
• ✓If we have several sites, can a default be limited to the site where it happened?
• ✓Do the PSA, lease and guaranty describe default the same way?

Whether and how a court would enforce a particular clause depends on the wording and the state, so have your attorney review it.

1. A letter of intent sets out the main business terms for both the sale and the lease.
2. Your attorney and the buyer's attorney draft the PSA and lease, usually in parallel.
3. The PSA is signed, and the buyer's diligence period runs under its terms.
4. The lease is finalized, if it was not already attached in final form.
5. At closing, the deed transfers, the lease is signed, you receive the proceeds and any existing mortgage is paid off, and you begin paying rent as the terms provide.

One accounting point can influence how these contracts are written. Some provisions, especially a right to buy the building back, can keep the transaction from being treated as a sale for accounting purposes. Show your CPA the drafts before the terms are fixed, not after.