Target falters after closing and stops paying rent to its landlord. The seller sues the target and the buyers to manage his exposure because of a personal guaranty he gave to landlord.
April 14, 2021
It is very common for the owner of a company to guaranty the company’s office or facility lease. This personal guaranty is a source of risk for the owner when selling the company. The deal below illustrates the problem
The seller in this deal previously founded the target which executed a commercial office lease with the landlord. As a condition of the lease agreement, the seller also executed a guaranty, under which he personally promised to pay rent due under the lease agreement in the event the target failed to perform its obligations under the lease. Two years later, the seller sold a majority interest in the target to the buyers pursuant to the terms and conditions of a stock purchase company.
The target began experiencing financial difficulty and its last rent payment under the lease agreement was about a year after the closing. Five months later the landlord commenced an action against target and the seller alleging breach of contract against the target for breach of the lease agreement and against the seller for breach of the guaranty agreement.
The seller sued the target and the buyers in a New York state court. Notably there was no claim that the buyer or target breached any promise in the stock purchase agreement to indemnify the seller for a target breach of the lease. .
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 seller does not appear to be in a strong legal position from what we know of the facts.
So, how can a seller deal with a personal guaranty of his company’s lease when selling his company?
The best M&A legal risk management tool would be for the seller to get the landlord to release the seller from his or her personal guaranty before the closing. Failing that, the seller could require the target and buyer to indemnify the seller for any loss the seller suffers under the guaranty. This risk management tool would be significantly enhanced by some sort of meaningful security for the indemnification, such as a letter of credit or an adequately funded escrow arrangement.
By John McCauley: I help people manage M&A legal risks.
Telephone: 714 273-6291
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