Why Sale-Leasebacks Fall Apart Before Closing

The phrase has two meanings, and they are easy to confuse. This guide is about deals that collapse before closing. The other is an accounting term: a failed sale is a completed transaction that does not qualify as a sale under ASC 842, typically because the buyer does not obtain control under the revenue standard, because of a repurchase option, or because the leaseback is a finance lease. In that case, the seller keeps the asset on its books, records the proceeds as a liability, and treats the payments as principal and interest.

That outcome is covered in our guide on when a sale-leaseback is treated as a financing. It is worth knowing about here because a surprise on that front, discovered late, can also stall a deal, so bring your CPA in while terms are still open.

After the letter of intent, the buyer investigates. A title company writing about commercial deals generally points to environmental or zoning problems and title defects as common reasons for failure before closing. In a sale-leaseback, the buyer checks both the property and the company that will pay the rent.

• Environmental. Contamination, including from a prior occupant, can stop a deal or change it. Environmental liability is often strict on owners, so buyers take this seriously, and these issues are often negotiated between buyer and seller-tenant.
• Title and survey. Unpaid taxes, liens, easements the parties did not know about, encroachments and boundary disputes can all surface. Any existing financing or liens need to be resolved by or at closing.
• Recorded restrictions. Agreements affecting the land may limit future use, which matters to a buyer that needs other possible uses after your lease.
• Zoning. A buyer will want to know whether structures are legally conforming and could be rebuilt after a casualty, and whether certificates of occupancy and parking comply.
• Condition. A property condition assessment can reveal costly or urgent items, and the investor may push those back to you.
• Your company. Financial results, liquidity, litigation, judgments or liens that do not match what the buyer was told can undercut the rent the price depended on.
• Authority. The entity selling needs to be properly formed and in good standing, with proper approvals for the sale. Family or partner-owned buildings can run into trouble here.

Many deals do not die on the first bad finding. They get retraded, meaning the buyer comes back and asks for a lower price or better terms. A retrade can be legitimate when diligence reveals a real problem, and it can also be a tactic, with a buyer counting on the fact that you have stopped talking to anyone else and committed time and money. The risk grows once exclusivity is in place and your alternatives have gone cold.

Whether the deal survives depends on how large the request is and what your options are. Your main protection comes before signing: knowing your own building, having a credible second bidder in mind, and tying up the buyer's rights so that any change has to be supported by a specific finding.

Some buyers have the money. Others have to find it. Common problems include a gap between the purchase price and the loan amount, a lender who does not approve, or investors who pull out. A financing contingency gives a buyer a way to leave if that happens. Buyers also commonly ask for inspection and appraisal contingencies, and a low appraisal can bring the price back into question.

An investor's own process can create delays too. Some buyers complete underwriting and take the deal to an investment committee only after the letter of intent is signed. A buyer that pays with its own equity, without a mortgage or a lender's approval, removes one layer of this risk, which is why certainty of funds deserves as much attention as price.

This cause is specific to sale-leasebacks. In an ordinary sale, seller and buyer part ways at closing. Here they are about to spend years together, and they have to agree on a long lease while also agreeing on a sale. Disagreement over any of these can stop the deal:

• Responsibility for roof, structure and major capital replacements.
• Assignment and change of control, especially if a future sale of your company is possible.
• Credit support, such as a parent or personal guaranty.
• Renewal options and how renewal rent is set.
• Rights to alter or expand the building, and the condition required at surrender.
• A repurchase right that the seller wants and the buyer or the CPA cannot accept.

A lease impasse tends to appear late when the letter of intent says little about the lease. Price and rent were agreed in a week, and then the first draft of the lease arrives with terms that the seller did not expect. The remedy is to put your key lease terms in the letter of intent. At TAG, we negotiate the price and the lease together on the seller's behalf for this reason, since a good price on a lease the business cannot live with is not a good outcome.

Not every failure comes from the buyer. Your loan documents may restrict the sale. Law firm Cleary Gottlieb advises checking whether debt agreements specifically restrict sale-leasebacks, limit them through an asset-sale covenant, or require mandatory prepayment or reinvestment of the proceeds. If proceeds are swept to repay a lender, you may not have the cash the plan assumed.

Partners and family members may also disagree about the price, or about how the proceeds will be divided, once the deal is real. Changes in the business during the deal can matter too, because a bad quarter changes how the rent looks to the buyer.

1. Before going to market, pull your title and survey, environmental reports and property records, and fix what you can.
2. Read your loan documents and speak with your lender about payoff, prepayment and consent.
3. Have your CPA review the structure, including any repurchase right, before terms are set.
4. Make sure all owners and decision-makers agree on the goals and the division of proceeds.
5. Test buyers for certainty of funds and approval process before granting exclusivity.
6. Put the important lease terms into the letter of intent.
7. Limit diligence and exclusivity periods, with clear start and end dates.
8. Keep a second bidder informed for as long as your agreements allow.