California cannabis leases: transfer headaches
Last month, I wrote an article postal Explain some of the problems that buyers of cannabis companies face when dealing with the landlord of the company they are buying. In short, leases almost always contain clauses restricting transfers and subletting. These clauses usually state that certain changes in control of cannabis tenants are considered transfers that require pre-approval from the landlord.
I discussed this concept at a high level in the context of M&A transactions in my previous blog post, but today I want to understand more about the meaning and appearance of these terms.
First, let us look at the difference between the assignment of a lease and the subletting under a lease. Generally speaking, in the case of subletting, the original tenant lets the new subleter rent part of the leased house. The original tenant is still a tenant, and now there are two agreements-master lease and sublet. In the transfer, the original tenant transfers all its rights and interests in the lease to a third party who becomes the new tenant-only one lease remains. It is worth noting that the transfer does not necessarily exempt the transferor from responsibility, so the transferor will want to use this specific language in the transfer agreement.
I should also point out that, at least in California, under the cannabis regulations for licensed companies, any of the above is not allowed. Once an enterprise has obtained a permit, it cannot sublet the licensed premises. Nor can it simply allow a new entity to enter and take over under its permission.
Instead, the only feasible way is if the new business enters the ranks of any purchasing license holding entity. In other words, if ABC Co. holds a license at 123 Main Street, it cannot sublet the property to XYZ Co. It also cannot transfer its lease to XYZ Co., because then ABC will not have the right to use the property, which is a requirement to maintain the license. But if XYZ purchased ABC, then ABC will still have licenses and leased premises. Literally, the concepts of assignment and subletting do not apply.
This is where the landlord can be creative. All the good leases I have seen will define assignment to include a change in control of the licensee. This also happens outside the cannabis industry, and even the popular commercial form of lease used in the state includes them. The purpose of changing control/transfer/subletting restrictions is to let the landlord know to whom the property is rented out. In the example above, the landlord will review the property before renting it out to ABC to make sure it can pay bills, etc. From the POV perspective, it wants to ensure that any assignee, sub-tenant or new owner of ABC can also manage the business and pay rent on time.
Changes in control terms are difficult to determine because it is not always clear what meets the threshold. When we talk about changes in control, we usually set a threshold (for example, the sale of 50% of a company’s stock), but even then it becomes ambiguous. Do we only want percentages to affect certain classes of stocks? When the list of directors or senior staff changes, do we also need to approve it? Are we talking about cumulative changes in control over a certain percentage, in which a series of small sales may reach the target, or is it just a single change in control over that percentage (the latter case is easy to bypass)? These are just some of the issues we see when tenants negotiate control changes, which can be very dynamic.
I should also point out that in many leases, the landlord will be able to charge the tenant a fee to consider whether to agree to transfer, sublet, or change control. Why? Well, landlords usually want to conduct due diligence on potential tenants, which may involve a costly lawyer or accountant review. I have seen some leases charge thousands of dollars to consider any distribution. If the tenant anticipates future transfers (usually in cannabis, the company will lease the property and then sublet or transfer the lease to a special purpose entity just to hold a specific license before applying), it may be good to consider obtaining A clause in the proposed lease that allows transfer without further approval from the landlord.
Now what happens when the lease has clauses restricting transfer and subletting, but there is no mention of change of control? Well, this question is not clear, which is never a good thing for the contract. Tenants never want to be in a situation where the landlord says “you have violated the lease and did not seek consent for the change of control”, while the tenant says “the lease remains silent about this.” Even though tenants may pass certain rights to the landlord by requiring the entry of the change of control clause in the lease agreement, they will at least clarify the process.
I want to solve two final problems here:
- What happens if a tenant transfers, subletes, or changes control without the landlord’s consent? Usually, this is an automatic default (default) of the lease. Some leases say that this is not even a curable breach and the landlord has the right to terminate the lease. It is obviously a good thing to understand these regulations.
- In the case of assignment, what will happen to the original lease guarantor?In my experience, many (if not most) commercial landlords in this industry require tenants to find a person or company they want ensure The lessee’s obligations under the lease. If the tenant changes (again, licensed cannabis businesses are not allowed) or is sold, the guarantor may want to withdraw, but it is wrong to assume that they automatically withdraw. Finding a new guarantor and/or negotiating about it is often a headache.
In short, the change of ownership under lease can be a real challenge. Stay tuned to the Canna Legal Blog to learn more about cannabis leasing.
You can read more about them in some of our previous posts: