When the time comes to buy or sell a business, attention goes to the price, the equipment and the customer base. Yet the document that often determines the real value of the business sits in a filing cabinet: the commercial lease.
Here is why this contract deserves to be read, and sometimes renegotiated, before you sign anything.
The lease, backbone of the business
For a restaurant, a shop or a clinic, the location is an integral part of the value of the business. The neighbourhood clientele, the foot traffic, the visibility: all of it rests on the right to occupy the premises.
That right does not belong to the buyer. It flows from a contract entered into with the landlord, on specific terms and for a limited time. If the lease cannot be transferred, or if it expires shortly after the transaction, a significant part of what you are buying evaporates.
In many transactions, the lease is thus the single most important contract of the entire deal.
Broad contractual freedom, little safety net
In Québec, the commercial lease is governed largely by freedom of contract. Unlike a residential lease, the Civil Code of Québec offers commercial tenants only limited protections.
The concrete consequence: there is no automatic right of renewal. At the end of the term, the landlord can refuse to renew, demand a higher rent or impose new conditions, unless the lease provides otherwise.
In other words, almost everything comes down to the text of the lease. What is not written there generally does not exist.
The clauses that can derail a transaction
Certain clauses come up constantly in business purchase and sale files. Before committing, pay particular attention to the following:
- the assignment and subletting clause, which almost always requires the landlord’s consent before the lease can be transferred;
- the change of control clause, which can treat a sale of shares as an assignment of the lease;
- the remaining term of the lease and the renewal options, along with the conditions for exercising them;
- additional rent: taxes, insurance, maintenance and operating costs added on top of the base rent;
- exclusive use and non-compete clauses, common in shopping centres;
- the personal guarantees given by the tenant or its shareholders.
Each of these clauses can change the price of the transaction, its structure, or even its feasibility.
Three clauses to examine closely
Assignment vs change of control
An asset sale usually requires an assignment of the lease, with the landlord’s consent.
A share sale seems to avoid that step, but many leases provide that a change of control amounts to an assignment. The landlord’s consent then becomes necessary again.
Renewal options
A renewal option must generally be exercised within a specific deadline, in writing, and sometimes at a rent yet to be determined.
You need to confirm whether the options follow the lease upon a transfer and whether they are enough for the buyer to earn back the investment.
Personal guarantees
Many leases require the shareholders to personally guarantee the tenant’s obligations.
In a sale, the seller will want to be released from their guarantee, and the buyer needs to know what they will be asked to sign in return.
Due diligence on the lease: a step in its own right
Before buying, the lease must be reviewed in full: the original document, but also its schedules, amendments and successive renewals.
Among other things, this review makes it possible to:
- confirm that the tenant is not in default and that the rent is up to date;
- measure the true occupancy costs, additional rent included;
- identify the landlord consents to obtain before closing;
- spot the clauses to renegotiate while you still have leverage.
This last point is essential: a lease is renegotiated before signing the purchase offer, not after. Once the transaction has closed, the landlord no longer has any reason to make concessions.
Why consult a lawyer before signing the purchase offer?
A commercial lease is a technical contract, often drafted by the landlord and in the landlord’s favour. Its effects play out over years and, for an established business, can add up to more than a million dollars in commitments.
Having the lease reviewed early in the process makes it possible to adjust the price, build the right conditions into the purchase offer and avoid unpleasant surprises at closing.
At Meka Avocat, we assist business buyers and sellers with the review and negotiation of their commercial leases. We identify the sensitive clauses, prepare the consent requests and integrate the lease into the overall strategy of the transaction.
Frequently asked questions
Does a commercial lease transfer automatically when a business is sold?
No. In an asset purchase, assigning the lease almost always requires the landlord's written consent. In a share purchase the lease stays in the company's name, but a change of control clause can give the landlord an equivalent say.
Which lease clauses should be examined before a transaction?
Three above all: the assignment and change of control clause, the renewal options and the conditions for exercising them, and the personal guarantees given by the owner. A personal guarantee that survives the sale is a classic trap.
Can the landlord refuse to consent to the assignment?
The commercial lease is governed by broad freedom of contract: the landlord may reserve a discretionary refusal, or a refusal on reasonable grounds only. Everything depends on the text that was signed, which is why it should be read before the price is set.
What happens if a renewal option is exercised incorrectly?
It is lost. Renewal options are subject to strict deadlines and formalities. A notice sent late or to the wrong address is enough to leave the tenant without a lease at expiry, which radically changes the value of the business.
A transaction on the horizon where the lease plays a key role?
A consultation is the opportunity to assess the lease in question, pinpoint the risks specific to your project and build a tailored negotiation plan. Book an appointment with our team before you commit.
The lease is only one of the assets to examine before a transaction. Due diligence surfaces the others, and the structure chosen, shares or assets, decides whether the lease follows the business automatically or has to be assigned, and our commercial real estate practice.
Book a consultation
Lawyer, member of the Barreau du Québec since 2014, founder of MEKA AVOCAT. This text sets out general legal information: it describes rules that apply broadly, not the answer to one particular case, and does not replace advice on your situation.
