Mergers & Acquisitions 2009—Preparing for “Carve-Out” Transactions: Real Property

A common theme present in all successful carve-out transactions is advance planning. Understanding the fundamental issues that are unique to a carve-out transaction—from the perspective of both the seller and the buyer—can mitigate unnecessary deliberations, costs, and fees. This is particularly true with respect to real property, whether such real property is owned or leased. Obviously, one of the most fundamental considerations when operating a business is identifying, financing, equipping, and maintaining the physical space that the business will occupy, and relocating the business in connection with a transaction has the potential to result in significant disruption to business functions.

It is not uncommon for a company with multiple business lines to operate all of its business units out of a single facility—or, in the case of a large corporation, multiple shared facilities. Such an arrangement has obvious advantages in terms of cost savings and accessibility. For purposes of a carve-out transaction, however, that shared facility presents unique issues, regardless of whether the property in question is leased or owned by the seller. The following is a short summary of some of the important issues raised in a carve-out transaction with respect to leased or owned real property:

• Leased Real Property: Where the divested business unit operates out of a shared leased facility and the buyer desires to utilize such facility going forward, two principal options are available. First, assuming that the lease agreement allows for subleasing (and even in the event that it does, the landlord’s consent may still be required prior to formalizing the sublease arrangement), the seller would need to enter into a sublease agreement for such facility. Considerations for the sublease are numerous, including the risks assumed by the seller. Moreover, in order to preserve deal value, the seller must carefully examine shared costs that will be split with the new subleasee—including maintenance, shared space (e.g., conference facilities, reception), security, and other hard and soft costs (e.g., HVAC, electricity) that need to be built into the financial terms of the sublease.

  In addition, if the facility has an open floor plan, the seller will need to consider what space will be occupied by the buyer and whether modifications to the space are required to protect confidential information. From the seller’s perspective in particular, it is important to examine all of these costs in advance so that they can be appropriately allocated to the buyer. A good deal can be soured by the legacy of a poorly drafted sublease. To the extent that the seller’s lease agreement requires landlord consent for a sublease, obtaining such consent—and planning for the time involved in obtaining such consent—needs to be built into the deal process along with the negotiation of the sublease.

  The second option is the entry by the buyer into a direct contractual relationship with the landlord. As with a sublease, deal professionals need to be sensitive to the timing required for the buyer to negotiate such a lease, particularly because it may involve the negotiation of a broader set of terms than in the negotiation of a sublease. In general, each party is best served by working together in order to avoid a situation where the landlord holds the deal hostage in an effort to extract higher rents. Generally, the current economic climate is not favorable for such strong arm tactics by a landlord, but the deal team should monitor the landlord relationship carefully in order to avoid any timing delays.

  The seller may want to take advantage of the opportunity created by the new lease for the buyer to reopen discussions on its current lease. These discussions may in fact be necessary due to the reduction in space leased and allocation of certain costs to the carved-out entity. The timing of these discussions, however, needs to be considered carefully within the overall context of the deal, and should only be conducted after assessing the landlord’s receptiveness to them. The goal of such discussions would not be to damage a healthy landlord–tenant relationship but rather to secure a market-appropriate lease for the seller and provide the landlord with long-term stability.

• Owned Real Property: If an owned site is shared by a business unit that is to be divested and business units that are retained by the seller. The first option is a lease of a portion of the owned site from the seller to the buyer, which presents many of the same issues described above. The obvious difference is the greater level of control the seller will have with respect to timing (because no landlord consent will be required) and terms of any lease entered into by the buyer. In this instance, the lease agreement can become a more central component of the transaction and the value derived by each party from such transaction. As in the sublease scenario presented above, the seller needs to consider all costs that will be allocated to the buyer. This planning can be started even prior to identifying a buyer and can have the added advantage of reducing costs in future transactions if additional business units at such facility are also candidates for divestiture.

  The second option is for the seller to convey to the buyer fee title to the real property to be used by the carved-out business. In this instance, additional issues must be resolved. For example, does the conveyance of a portion of an owned real property trigger local zoning or subdivision issues? Does the transferred real property have access to roads, utilities, and facilities needed to operate? Environmental issues may also play a factor in the negotiation of the transaction documents. In the event that the entire property is sold with the business unit, there may be a need for seller to lease back space for retained businesses—either in the short term until a new facility can be identified, or in the long term if the parties desire to maintain a landlord–tenant relationship going forward.

As evidenced above, many of the issues that arise in a carve-out transaction can be addressed when identified early in the transaction process and incorporated into the terms of the deal. With real property, determining how that property or interest will be conveyed is fundamental to the deal structure and must be addressed early in the transaction process.

Additional LawFlashes relating to carve-out transactions can be found at http://www.morganlewis.com/carveouttransactions.

For further information on the topics discussed in this LawFlash, please contact any of the following Morgan Lewis attorneys:

New York
Robert W. Dickey

Los Angeles
Scott E. Adamson

Philadelphia
Richard B. Aldridge