In transactions that proceed by way of a stock deal, Stikeman Elliott LLP partner Mario Paura says the buyer understandably focuses its attention on active leases and currently occupied premises. But that’s only part of the picture in a full assessment of the risks assumed by the purchaser in the deal, he says. “It’s easy to forget about the ones that have been disposed of by the target, whether by assignment or sublet,” Paura says. “But unless the landlord has released that entity of its obligations, it continues to be liable for the duration of the term, and depending on the lease language, it could potentially be liable beyond that to the extent that the lease gets renewed. You need to flush out as part of the due diligence process which stores used to be occupied whether the leases have been properly surrendered or terminated.”
Another potential stumbling block comes in the form of landlord consents. Very few leases allow changes of control to go through without landlord consent, and some could trigger extra responsibilities to the buyer or benefits to the landlord.
“The rent may increase as a result of the transaction, or landlords could have a right to terminate, or to demand the tenant fix up the place. Those are all things going into transactions you need to inform yourself of before you approach the landlord,” Paura says.
Often landlords will be constrained by a clause in the lease that prevents them from unreasonably withholding consent, but in the hot retail sector in particular, consent is not something you can take for granted, according to Paura.
“Retail has been a very hot market in the last couple of years. Rents have been rising very steadily over the last decade, and there are lots of foreign retailers looking to come to Canada. So landlords certainly have no problem, to the extent they have smaller independent chains, trying to find reasons to make room for these newcomers,” he says. “In an upswing market, if they’ve signed unfavourable leases, they may be willing to get their space back and re-let it out.”
Paura’s firm was at the heart of the deal that brought one of those foreign players into the Canadian market. Stikemans represented the Hudson’s Bay Co. in its sale of almost 200 Zellers leases to U.S. retail giant Target. “That has been a revolutionary transaction in terms of increasing the value of those shopping centres. With a significant attractive anchor tenant, it’s going to revitalize them, and there will certainly be opportunities in terms of redevelopment and rising rents,” Paura says.
Ironically, the $1.8-billion deal’s unusual structure meant many of the normal concerns in lease transactions were not in play. Landlord consents were not an issue because it was virtually inconceivable that landlords would object to Target as a tenant.
“Any shopping centre owner who was able to attract Target would win pretty much regardless of the rent that Target was paying them,” says Doug Klaassen, Stikeman’s real estate partner on the Zellers deal team. Instead, the deal was engineered to maximize Target’s leverage in negotiations with individual landlords.
Instead of purchasing Zellers’ entire portfolio of 275 leases, the deal closed in January 2011 with Target committed to buy up to 220 leases in the following eight months. That meant landlords could not be certain that their location would make the final cut, and Target was given some wiggle room to secure better terms during the selection process.
Representations and warranties from HBC were also at a bare minimum, while Target was prepared to swallow any ongoing liabilities owed by Zellers under the leases it selected.
“The bottom line was that Target’s covenant is good enough. In many cases we were released, but where it didn’t happen, Target is indemnifying us, and it wasn’t really a concern on that simply because they have an investment grade rating in the U.S.,” says Klaassen, who adds that the absence of a third-party lender allowed both parties to get more creative in the structuring of the deal.
Selected leases were immediately subleased back to Zellers by Target, with the U.S. retailer given an option to terminate with notice, allowing them to complete a staggered takeover of stores in the next couple of years.
This article is a sidebar to "Choosing arbitration to mend leasing woes," from the June 2012 issue of InHouse.