Property due diligence when buying a business: three lease checks before you complete

Can the business you are about to buy actually stay in its premises after the sale goes through? Not always. On a share sale, even when you assume the lease comes with the company, a change of control clause can put you in breach on the day you complete. Here are the three things I would check on the lease before committing to any purchase: the change of control clause, whether the lease is contracted out of the Landlord and Tenant Act 1954, and who the landlord actually is.

Corporate solicitor vs property specialist

A quick disclaimer first. I am not a specialist property solicitor. I am a corporate solicitor who helps people buy businesses. Where a target company has a property element, and especially where that element is important to the deal, I would typically work alongside a specialist property solicitor who deals with those aspects. What follows is the brief property due diligence I would expect any buyer to understand before they commit. It is not a substitute for specialist advice, and if the premises are central to the business you are buying, you should get that advice.

Change of control clause in a commercial lease

This is the one that catches buyers out the most. A well-drafted commercial lease usually includes a change of control clause. It means that if there is a change of control of the limited company that is the tenant under the lease, that change of control is treated as an assignment, or an attempted assignment, of the lease. An assignment without the landlord's agreement is a breach, and that in turn gives the landlord the right to terminate.

Here is the trap. On a share purchase, the tenant company does not change. The same company is still named on the lease, and nothing has been signed over to anyone. So buyers assume the lease simply comes with the company. But you buy 100% of the shares in the target company, complete the deal, and find out that you are technically in breach of the lease the moment you complete. The landlord's remedies typically include the right to end the lease, which means the company now needs to vacate the premises. The business you have just paid for has nowhere to trade from, and the goodwill attached to that location goes with it.

How to avoid it:

• Read the lease in full at the start of due diligence. Not at the end, when the timetable is fixed and everyone is focused on completion.
• If there is a change of control clause, get the seller to seek the landlord's consent. The seller has the relationship with the landlord, and it is the seller who is asking for the deal to be allowed to go ahead.
• Make landlord consent a condition precedent to completion. That means completion does not happen until the consent has actually been received. Do not complete on a promise that the consent is on its way. If the landlord refuses, you want to find that out while you can still walk away or renegotiate, not after you have paid.

Landlord and Tenant Act 1954: contracted-out leases

Second, the Landlord and Tenant Act 1954 gives most business tenants a legal right to renew their lease at the end of the term, even if the landlord does not really want to grant one. If the parties cannot agree the terms of the new lease, the court can effectively order one.

But landlords routinely insist on contracting out of those rights. A contracted-out lease ends on its expiry date. It does not automatically renew, and the tenant has no right to force a renewal. Whether the business stays in the premises after that date is then up to the landlord.

Why does this matter to you as a buyer? If you are buying a business with two years left on a contracted-out lease, you are not buying ten years of trading at that address. You are buying two. If the location is part of what makes the business valuable, because customers know it, because the fit-out is expensive to replicate, or because there is nowhere else suitable nearby, that is a very different purchase from the one you thought you were making.

So the question to ask is simple: is the lease contracted out of the 1954 Act? And if it is, how long is actually left on the term, and is the price you are paying consistent with that? If the answer is that you are buying a short period of security at a location the business depends on, that is something to raise with the seller before you agree the price, not after.

When the seller is also the landlord

This is where I see most buyers of small businesses get caught out. In owner-managed businesses, the seller often owns both the trading company and the property it trades from. The property might be held through a property holding company, in the seller's personal name, or through a self-administered pension. They sell the business, keep the property, and the lease becomes part of their retirement income. There is nothing wrong with that as a plan. The problem is how the lease was written.

Typically the problem is that the lease was put in place by the same person on both sides. They were the owner of the property and the owner of the business, so they could decide what terms went into the lease without anyone pushing back. If they were planning to sell the business one day and keep the property, which is often the case, they may have included provisions that benefit them as a landlord rather than as a business owner. That might include:

• a very long term for the lease, running for many years, which locks the company into the premises and the rent
• a higher rent
• more onerous obligations on the tenant

None of that was negotiated, because there was nobody on the tenant's side to negotiate it. So when the landlord is the same person as the seller, the lease should be seen as another document to be negotiated as part of the deal, in the same way you would negotiate the share purchase agreement. The fact that the lease is already in place and already signed does not mean you cannot ask the seller to take the steps needed to bring that lease to an end and replace it with a new one that you have negotiated with them. The seller wants the sale to go through, and the lease is part of the price of getting it there.

Next steps

Read the lease in full before you commit, ask whether it is contracted out of the 1954 Act, and check who the landlord actually is. If the premises matter to the business, speak to a corporate solicitor early so that landlord consent and any renegotiated lease can be built into the deal timetable and the SPA, and so that a specialist property solicitor can be brought in where needed. In my opinion the most important area of due diligence on a share purchase is corporate records, which you can read about in corporate records due diligence.