Landlords have been known to demand a portion of the sale price from business sellers before granting a lease assignment, and that demand is hard to ignore when a lease assignment is an essential component of the sale. The landlord's usual justifications for this demand are twofold: (1) the seller would not have been as successful, and would not have obtained that sale price, had the business not been located at the landlord's property, and (2) the landlord claims to be allowed otherwise to raise the rent to "fair market value" upon assignment of the lease. What can a seller do in this situation?
Answer Part 1: Landlord May Include in Lease a Demand for Portion of Sale Price
California statutory law addresses this situation. Civil Code section 1995.210(b) states: "Unless a lease includes a restriction on transfer, a tenant's rights under the lease include unrestricted transfer of the tenant's interest in the lease." Civil Code section 1995.240 states thereafter: "A restriction on transfer of a tenant's interest in a lease may provide that the transfer is subject to any express standard or condition, including, but not limited to, a provision that the landlord is entitled to some or all of any consideration the tenant receives from a transferee in excess of the rent under the lease." Therefore, a landlord IS entitled to receive a portion of the sales price on assignment of the lease if (1) the right to receive a portion of the sales price is in the lease itself, and (2) the amount demanded is the amount "in excess of the rent under the lease."
Answer Part 2: Landlord Demand Limited to Appreciated Rental Value
Some landlords try to use Civil Code section 1995.240 to justify taking various amounts from the seller, including up to the entire goodwill value of the business! I am aware of at least one case where a dentist selling his dental practice paid a $50,000 "ransom" to the landlord for the lease assignment! However, this sort of abuse was declared illegal quite some time ago, in Ilkhchoovy vs. Best (1995) 37 Cal.App.4th 395. The court stated: "... the Legislature intended the term 'consideration' in section 1995.240 to be limited by its connection to the value of the lease." The court ultimately held that the landlord could only demand the "appreciated rental value" of the property in exchange for granting the assignment. In lay terms, "appreciated rental value" means the dollar amount the lease is below market rate until the earlier of (1) expiration the remaining term of the lease, or (2) adjustment of the rent to fair market value, whichever comes first.
Answer Part 3: Limits Apply Only to "No Change" Lease Assignments
IMPORTANT: The limits placed on landlords, to demand only the "below market value" of the remaining lease term, only applies if the lease is to be assigned with NO changes whatsoever. If the buyer wants to extend the lease term, change the rent or make ANY other change to the existing lease, what is being requested is not a "no change" assignment, but a new lease - and (subject to the lease terms and other California law) the landlord can demand whatever he chooses to demand in order to enter that new lease with the new tenant.
Before signing a new lease or receiving a lease assignment in a business purchase, confirm that the lease (1) does not address the landlord's right to receive anything from what you receive from the sale of the business or assignment of the lease, or (2) limits the consideration payable to the landlord on assignment to the amount "in excess of the rent under the lease."If you already have a lease that contains this language and the landlord demands a portion of the sale price on a "no change" lease assignment, point the landlord to this Legal Guide - the Ilkhchoovy case protects you from paying more than the appreciated rental value. If your business is not yet for sale, you might consider revising the language at your next negotiation opportunity to either eliminate that language completely, or pare it down to the current legal requirements.
Disclaimer (Legal Stuff)
IMPORTANT: This Legal Guide is made available for educational purposes only. There is no attorney client privilege between you and the attorney author. This Legal Guide is not a substitute for competent legal advice from a licensed attorney that specializes in this area in your home state and with whom you have an attorney client relationship. Also, law changes frequently and varies from jurisdiction to jurisdiction. The information and materials provided are general in nature, and may not apply to a specific factual or legal circumstance described in the question. Copyright 2009 by Robert W. Olson, Jr. - all rights reserved.