Uhlig Transactional Blog

    Two basic deal types make up the bulk of my commercial real estate practice. We help clients transfer ownership of commercial real estate (purchase and sale agreements) and we help transfer possession of commercial real estate (commercial leases, easements, license agreements). While complexity of deal structure varies, I've basically spent the last 22 years negotiating hundreds of purchase and sale agreements and commercial lease agreements. In the beginning, I was trained on all manner of commercial leases: telecom tower leases, office leases, industrial storage leases, ground leases, restaurant leases and all manner of retail leases. Honestly, at first I viewed leasing work as pretty tedious; I was fresh out of law, school and very keen to work on purchase and sale deals. With purchase and sale  deals, the dollar amounts involved are larger (at least on their face), the property involved is often more complex, and the deal structures can be very complex, involving multiple parties, entities and numerous interweaving documents, not to mention numerous interweaving pre-closing and post-closing obligations.  contrast that to a commercial lease, which really involves only one document, at least, as far as attorneys are concerned, and after a commercial lease is signed the attorney may not hear about the property again until the term ends, unless something goes sideways or modifications to the deal are needed.  But even these days, and in these market conditions, negotiating a commercial lease with a top-tier landlord can take a month, and sometimes even two.

    Over the years, I've come to appreciate the commercial leasing practice much more. Purchase and sale agreement deals tend to be cyclical; that work is not as plentiful when the economy is trending downward.  There is, however, always commercial leasing work to be done. Businesses lease office, storage and operations space; they amend leases to shrink or expand the leased premises, increase or decrease the lease term, modify other terms, and sometimes, even terminate the lease agreement early. Restaurants and retailers often expand pursuant to quarterly or annual campaigns. When businesses (and commercial properties for that matter) are sold, leases are assigned to the new owner.   Landlords (and their lenders) frequently request subordination agreements as well as estoppel agreements from tenants in connection with financings and/or sales and these agreements warrant close scrutiny to save tenants from undesirable consequences.  

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   Earlier in my career I represented more landlords but these days I represent more tenants than landlords.  From large retailers and restaurant chains to franchisees and smaller mom-and-pop businesses, there is almost always leasing work in my queue. One thing that has been consistent, often, to my amusement, is the characterization of the work by the uninitiated as "simple" and something that should be "easy" to complete and quickly, of course! Over the years, I've come to see it as anything but. From my vantage point it's certainly arguable that even a relatively simple commercial lease document - let's say for 1500 ft.² of studio space – involves as much, if not more complexity than a simple commercial sales agreement for the same 1500 square-foot yoga studio. After all, the leasing document is intended to govern the relationship between the parties going forward in time often for a significant term of years. This is different than the sales agreement which typically (but not always) is limited to the relationship between the buyer and the seller from the date of the contract through a closing date.  It's difficult to accurately compare the two types of transactions because they differ in so many ways. But make no mistake, a commercial lease agreement can be every bit as complex as the PSA.

 Transferring small businesses – family businesses – to new owners, is often a private/close transfer of ownership to relatives and/or key employees which may be less complex than the arms' length sale of a business to a third party but such deals are anything but simple.  That said, on the client side there is often a sincere desire to avoid complexity, which is understandable;  complexity often brings with it increased expense and time pressures.  The new owners are often closely involved with the business being transferred to them. There is almost always a high trust level. The knee jerk, non-lawyer conclusion is that the deal should be simpler than an arms’ length transfer involving extensive due diligence by the buyers – of course, right? Actually, the conclusion is incorrect. And if your prospective legal professional is not at least a little hesitant to sign on, you might consider a slew of additional questions about that business arrangement! But, i digress.

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In many cases, the close relations of the parties actually lead to increased complexity. Here, my client wanted to “give” the business to his son who’d worked with dad for over a decade, and another employee, a manager who worked with dad for decades building their empire and who and had been closely involved with growing every aspect of this company since its inception.  As we began discussing the "simple" deal dad perceived, alarm bells were ringing in my head. I began asking questions aimed at sussing out what dad was looking to do; was he wanting me to structure the deal (which wasn't going to be as simple as he thought) and put it onto paper? It turns out, no such luck! His needs were much more complex.

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As we talked, I realized one problem was the parties had already signed a contract. Dad quickly muttered something sounding like drafted by another attorney. Aside from the legally binding and closed sales contract, the slightly less obvious problem? Well, to state it simply, nothing was  “given”. The son had agreed to pay for the company over time.  Twenty Million dollars was the discounted valuation of the business so, while "small" in relative terms, the amount at stake, in the context of the prospective client's personal bank account and retirement plans, was no small issue, especially considering the note was intended to fund Dad's retirement and Dad still looked to be in pretty good shape to me for 65... Dad was in my office (on the screen actually) and as I continued asking questions about his son and the structure of the company he’d sold  in return for a promise, I observed tightening around his eyes and mouth as his annoyance grew.  He and I have worked together on several deals and he knows me well enough to predict where my questions were leading.  The thing is, he was clearly embarrassed to answer the questions because they revealed, in addition to his lack of professional planning for his retirement and sale of the company he'd spent nearly 30 years building, information about his family that probably cut far deeper. Eventually, he stopped me and implored me to see the simple nature of the deal. So I just asked the obvious question… Why was he in my office? How could I help? He explained that his son was not doing well at the company due to a falling out with his sixty something co-owner. It turns out, in his former partner's opinion, Dad did him a disservice by putting him into business with his baby boy! The answer to my question was that dad wanted to take his son out; to keep his ownership (as if it were never transferred) and to forget about the plan to fund his retirement through payments on the note.  Simple, right?

Another complicating factor is that trusted son does not prefer to return his membership interest in the company. It did surprise me the promissory note was unsecured.  Given that, it was less surprising to read that the purchase contract lacked any claw-back provisions, allowing Dad to reclaim his equity upon occurrence of certain events or failures to meet benchmarks, make payments, etc... Really? I hear you wondering! How was something so obvious not addressed in a document drafted by a lawyer at some point, and purchased for use by multitudes of others holding a 3 year graduate degree? With no hesitation I answer you - yes, really. And no they really don't teach you the necessary contractual language during contracts class in law school. Traditionally, that level of experiential training was saved for law firms. Frankly, this fact pattern is actually very tame and also very common. I've personally dealt with some variation of this generational ownership structure fact pattern many times over the course of 23 years in active deal practice.

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Whether or not those documents were prepared by some cheaper attorney (they're out there!) or by the pretty nice guy on the other side of the Zoom call himself, the drafter apparently lacked the information reasonably necessary to identify and raise the issue. I explained to Dad, that he in fact has no inherent legal right to a return of his equity in the company, since neither the contract or promissory note included mechanisms to accomplish that. What will happen here? I am confident, in the end, that we could have a good chance of convincing the son to return his equity to Dad. But it would require a substantial amount of discussion and negotiation and with substantial lawyer time comes substantial fees.  Unfortunately, Dad would spend substantially more in attorney fees for me to participate in “negotiations” having very little leverage. I'd only consider that if I had a 100% evergreen retainer in place and even then the whole thing still felt like UGH. So, I let him know I'd not be the right attorney for him this time. He won't be back but life is just too damn short.

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The proverbial lessons above are multitudinous so, i'll limit my further comments to this most obvious one (also my #1 Top Personal favorite Proverb of all time (please feel free to recite in your favorite movie star impression - I only see Bill Murray or ): Thou Shalt NEVER: #1. bargain hunt when choosing the author of documents affecting your financial future to any degree, regardless of apparent simplicity.

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Also, not proverbial but at least a Pro Tip for those vetting legal counsel, the words "Promissory Note" should immediately trigger one word in a trained attorney's mind. Hint(s): It's the same single word flashing in bold red letters through the cerebral cortex of any banker or lender of funds upon hearing "Promissory Note." Also, it's a polysyllable word beginning with "C". No, not "ChaChing!"

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Hasta la vista baby!

In the wake of the holidays, it’s the time of year many of us are trying to hold to our resolutions and are thinking about taxes. One resolution of mine was to write more often about interesting legal issues that come up in my practice and since I worked on several deals involving 1031 exchanges last year this quick article seems an appropriate way to kick off a year of active blogging.

Deferring capital gains by proper application of IRC section 1031 is nothing new to real estate investors or real estate attorneys. A twist arises when exchanging sales proceeds into property owned by multiple persons as a tenancy in common (TIC), an ownership structure where multiple owners each acquire an undivided fractional interest in property. In Colorado, TIC is the default ownership when multiple parties own real estate unless the conveyance deed states otherwise (Joint Tenancy is usually preferable for married couples). Arms-length TIC owners should execute a Tenancy In Common Agreement specifying rights and duties of the owners, governing management of the commonly owned property, financial obligations of the owners, establishing transfer restrictions and other rules the owners are bound by. Such an arrangement sounds similar to a limited liability company – so, why not execute an LLC Operating Agreement and invest sales proceeds in an LLC?

To qualify for exchange treatment under section 1031 the property sold and the replacement property must be “like kind” and according to the IRS, membership interests in an LLC (or shares in a corporation) aren’t similar similar enough to real property held for investment. So, rolling proceeds into TIC owned property allows one to invest in a property with multiple co-owners outside of an LLC and qualify for exchange treatment under section 1031.  This enables a seller to invest their proceeds into larger and more sophisticated properties with greater potential ROI.  Since TIC structures can be similar to partnerships and LLCs, the IRS issued Revenue Procedure 2-2022 outlining requirements TIC structures must satisfy to qualify for 1031 treatment.  The revenue procedure establishes 15 conditions and standards for investments in TIC structures to qualify for exchange treatment.  One simple condition is that there may not be more than 35 TIC owners. Another condition is that property management agreements must renew at least annually and while the manager may be a co-owner of the TIC property, they may not be a tenant.  Additionally, TIC agreements should require unanimous consent for decisions that will impact the property economically or which result in any other material impacts on the property.

When sellers want to roll proceeds into a TIC interest in a property, the TIC Agreement, Property Management Agreement, LLC Operating Agreement (where the TIC interest is to be owned by an LLC) and all other material agreements among TIC owners related to the property bear close scrutiny to confirm the exchange qualifies for section 1031 treatment.  

Thanks for reading & happy new year!  Good luck with those resolutions…

     Through the years, it's been my experience that many business owners, while extremely cautious with their commercial real estate purchase agreements, operating agreements and core commercial contracts, give surprisingly little thought to their lease agreements.  This holds true for even the savviest of operators - until they get bitten.  Unfortunately, when clients come in with an executed lease agreement it is usually to late to assist.

     Most businesses that rent space understand the distinction between base rent and CAM (i.e., additional rent comprised of operating expenses, insurance and real estate taxes), however, fewer understand the ins and outs of percentage rent clauses.  In Denver, percentage rent clauses were mostly exclusive to volume restaurant leases once, and even then not all.  In recent years however, they've become something I see in many retail oriented leases, especially for locations in highly desirable locations - which describes most of Denver these days!

     A percentage rent clause entitles the landlord to a cut of a tenant's gross sales revenue in addition to monthly base rent and CAM pass throughs.  While there are several methods of calculating the ratio, the most common ratio is a percentage of gross sales above a natural breakpoint.  For example, "5% of Gross Sales over a Natural Breakpoint."  To the uninitiated this terminology may sound a bit esoteric but in reality it's quite simple: the natural breakpoint is the annual base rent divided by the percentage.  So, if annual base rent is $50,000.00,  and the percentage is 5%, the natural breakpoint is $1,000,000.00.  In addition to base rent and CAM, the tenant must pay 5% of it's annual gross revenues over $1,000,000.00.  So if a site generates $1,750,000.00 of gross revenue, $37,500.00 of percentage rent is due to the landlord.  Simple?

    One clause warranting close attention is the definition of "Gross Sales."  Like the definition of "operating expenses" with respect to CAM provisions, the initiated tenant should negotiate for both customary and fair carve outs from gross sales.  One obvious example is revenue derived from vending machines used by employees only.  A less obvious but important example is credit charges due by the tenant to third parties attributable to credit sales; this can add up to a substantial amount for most businesses in today's economy where point hoarders (I know I am one!) use credit cards for a large portion of their monthly consumer spending.  Discount sales to employees is another example. In a recent negotiation for a restauranteur I received pushback from the landlord on this request - in the end the landlord agreed to the exclusion so long as that amount was capped at "3% of total gross sales to employees in a Lease Year."  The list of gross revenue exclusions that are warranted in lease negotiations are informed by the specific business a tenant is engaged in, what is common in a given center's lease negotiations, industry custom and of course, a given landlord's willingness to negotiate. 

    Summit 6 Legal represents a wide range of local and national retailers and restauranteurs and is adept at helping our clients negotiate fair terms in their LOIs and Lease Agreements.

    Contract Wisely!

    David C. Uhlig