Legal & Tax Tips

The Sale Of A Business Or Professional Practice And Related Lease Of Real Estate

I. Client Broker Attorney Relationship

A. Determination of What Needs to Be Done and Allocation of Duties (e.g., identify what each is to do)

B. Attorneys Have Different Techniques

C. Obtain an Estimate of Legal Cost and Who Prepares the Documents. Determine the Normal Scope of Attorney Review.

D. Benefits of Good Brokers

II. Key Areas In Purchase Agreement

A. Contingencies

  1. Active versus passive satisfaction of contingencies.
  2. Time periods to perform due diligence and other tasks.
  3. Written objection before due diligence time period expires.

B. Disclosure of Contracts, Leases and Debts. All Contracts, Leases and Debts Should Be Disclosed by the Seller, Even Those Not Assumed by Buyer.

C. Indemnification

  1. Should include scope, breaches of purchase agreement, claims filed by third parties, attorney fees, etc.
  2. Careful drafting.

D. Allocation of Purchase Price

  1. Get good tax help.
  2. Careful of special rules such as acceleration of income tax on recapture of depreciation on personal property (e.g., equipment) even if installment method is used.
  3. Compare benefit of increasing depreciation for buyer versus paying more sales tax.
  4. Allocation of the purchase price to the covenant non-compete will probably be small, since it has lower tax benefits than other allocations.

E. Escrow Company

  1. Pick one with experience.
  2. Pick one who your broker or attorney uses.

F. Survival of Representations and Warranties

  1. The parties often argue over how long representations and warranties of seller will last.
  2. Purpose.
  • Forces seller to think about what they didn't disclose
  • Allows exceptions to be listed
  • Part of buyer's due diligence
  • Avoids problems later

G. Inspections and Disclosures

  1. Pick an inspector who can provide cost estimates and is licensed to do the repair work, which saves from having to hire both an inspector and repair person (or contractor).
  2. Pick an inspector who is available and will work to resolve problems with the seller's representative.
  3. Start process early.

H. Non-competition Provisions

  1. This is a very important provision to protect the buyer's goodwill. It is enforceable unless the time period or area of restriction is overbroad (e.g., where it does not correlate to the protection needed by the buyer).
  2. Carefully define any exclusion from the restricted area.
  3. Make sure the covenant can be transferred to the next buyer.

I. Liquidated Damages

  1. It allows the parties to fix the amount (or maximum amount) of damage if there is a breach.
  2. Should you agree to this type of provision? (It depends.)

J. Mediation/Arbitration

  1. Pros and cons. Many different types of provisions.
  2. Should you agree? (It depends.)

K. Employees

  1. Issues at closing. If possible, have each employee sign a statement that they are not owed anything and are terminated by seller with buyer's option to hire.

L. Attorney Fee Clauses

  1. If this type of provision is not included in the purchase agreement, you cannot recover your attorney fees and costs if you win the lawsuit.
  2. This provision may or may not be in arbitration provision, but certainly won't be one in mediation provision.
  3. The pros and cons of having one.
  4. Check all contracts for one.

III. Key Issues Regarding Leases

A. Assignment of Existing Lease Versus New Lease

  1. Normally there is no release of liability of seller on assignment of the lease to buyer.
  2. Fewer costs on assignment because lease is existing.

  3. Buyer should try to negotiate with landlord new tenant improvements.
  4. Deciding to keep the existing lease depends on its provisions versus what might be negotiated for a new lease.
  5. Even if there is an assignment, the buyer may still be able to add new terms, such as an option to extend the term.
  6. A bad assignment clause can prevent a sale of the business.

B. Maintenance and Repairs

  1. Carefully review provisions to determine who has the obligation to repair and maintain the different parts of the premises (exterior, roof, plumbing, etc.).
  2. Inspect equipment (e.g., heating, ventilation and A/C) and make sure it is in good order at closing.

C. Improvements and Signs

  1. Buyer should obtain approval for signs at time of signing the lease.
  2. Detail all terms of improvements to be made by landlord's contractors and tenant's contractors including who performs them, timeline, total costs, and who keeps the improvements at end of the lease.

D. Limitations of Landlord Liability

  1. Limitations regarding landlord's negligent and related activity. Try to delete.
  2. Landlord usually wants to limit claims against it to the subject property and not other assets of landlord. Less likely to get deleted.
  3. Release of landlord's liability upon transfer of landlord's interest to a buyer of the property. Not likely to delete.

E. Indemnification

  1. Similar as earlier discussion in Section II C.

F. Guarantees

  1. Avoid if possible, otherwise try to limit them in terms of length of time or dollar amount.
  2. Remember a lot of money is at stake.

G. Options to Extend

  1. Buyers should always try to get as many options to extend the term of the lease as possible.
  2. Determine whether the options are personal or carry over to new buyer on an assignment.
  3. Read carefully how the new rent is calculated when an option is exercised.

H. Inspection

  1. Similar discussion as in Section II G above.
  2. Get disclosures regarding real property. Consider similar disclosure format as residential sales agreements, unless it is a large property.
  3. Accompany inspector or do separate one yourself. Pay specific attention to things not likely to be discovered on a walk through, like a noisy neighboring tenant.

I. Hazardous Materials

  1. Carefully review provisions regarding liability for hazardous materials.
  2. Need legal help to address existence of waste problems, liability allocation and indemnification provisions.

J. Cost of Living Increases (COLA)

  1. Pick a favorable cost of living index (CPI).
  2. Determine if the provision is compounding or noncompounding.
  3. Watch the wording.
  4. Consider a ceiling on the cost of living increase, although landlord may then want a floor (minimum).

K. Common Area Maintenance Costs (CAMS)

  1. Consider negotiating limits on the CAMS.
  2. Consider an initial period of relief or limit on the CAMS to an amount in excess of existing expenses.
  3. Review the CAMS to see if landlord has loaded up expenses.
  4. Don't count on landlord's large tenants to negotiate for you — they may have a special deal.
  5. Determine if landlord will limit your property tax expense due to a future sale of the property and resulting tax increase due to California Proposition 13.

L. Assignments

  1. Very important to preserve your right to assign a business. Landlord's obligation to not unreasonably withhold consent is OK if criteria for rejection are reasonable.
  2. Careful of shopping mall leases where you give up payment for your goodwill to landlord if he/she exercises his/her rights to purchase on certain events.

M. Relocation of Tenant

  1. Try to avoid these provisions.
  2. If necessary, make sure all costs are covered and a similar location is a requirement.

STEPHEN A. COLLEY, APC

San Diego, CA 92130

colley@colleylaw.com

858.259.0888