Learn about the risks and solutions associated with personal guaranties for office or facility leases during M&A transactions. Find out how sellers can protect themselves from post-closing problems.
M&A Stories
April 14, 2021
Introduction:
When selling a company, it is common for the owner to provide a personal guaranty for the company’s office or facility lease. However, this guaranty can expose the seller to risks if the company falters after the sale. This blog discusses a real-life case where a seller faced post-closing problems due to his pre-closing guaranty of the target’s lease.
The Deal:
In this case, the seller founded a company (the target) that entered into a commercial office lease with a landlord. As a condition of the lease, the seller personally guaranteed the payment of rent in case the target failed to fulfill its lease obligations. Later, the seller sold a majority interest in the target to the buyers through a stock purchase agreement.
The Problem:
After the sale, the target encountered financial difficulties and stopped paying rent to the landlord. Subsequently, the landlord sued both the target and the seller for breach of contract, citing the lease agreement and the seller’s personal guaranty.
The Lawsuit:
The seller responded by suing the target and the buyers in a New York state court. However, there was no claim that the buyer or target breached any promise in the stock purchase agreement to indemnify the seller for the target’s lease breach.
This case is referred to as 950 Third Ave. LLC v. Theirapp, Inc., Docket No. 653316/2020, Third-Party Index No. 595747/2020, Motion Seq. No. 001., Supreme Court, New York County, (April 1, 2021). https://scholar.google.com/scholar_case?case=9776270755032175666&q=%22stock+purchase+agreement%22&hl=en&scisbd=2&as_sdt=2006&as_ylo=2020
The Solution:
Given the potential risks, sellers should take precautionary measures to manage personal guaranties during the sale of their companies. The best approach would be to negotiate with the landlord to release the seller from the personal guaranty before the closing. If that’s not possible, the seller can demand that the target and buyer indemnify them for any losses incurred due to the guaranty. To enhance the effectiveness of this risk management tool, the seller should seek meaningful security for the indemnification, such as a letter of credit or a well-funded escrow arrangement.
In conclusion, sellers should be aware of the risks associated with personal guaranties in lease agreements when selling their companies and take necessary steps to protect themselves during M&A transactions.
By John McCauley: I help people manage M&A legal risks.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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