Addressing Real Estate Issues in an M&A Transaction

By Keith E. Marlowe, Partner

A Company’s real property assets and leases are an inherent and financially critical factor in nearly all transactions involving the sale of the company (the “Target”); whether in the form of a sale of substantially all of the Target’s assets or a sale of the equity interests in the Target. Often overlooked in the initial stages of a Target’s preparation for a transaction, it is important for the Target’s owners to focus on the following four issues:

Will the business continue to be operated from the building(s) and real estate (the “Real Estate Assets”);
Who owns the Real Estate Assets where the business is located (i.e., the Target, a party related to the Target or an independent third party):
What, if any, environmental issues need to be addressed as federal and/or state law requirements may be applicable; and
What are the tax consequences of the disposition of the Real Estate Assets and what, if any, planning opportunities may be available to defer the taxable gain, i.e. 1031 transactions.

The determination of whether the post-transaction operations of the Target will continue in the Real Estate Assets may impact whether or not the transaction is practical for the Target. If the operations are not to be continued post-transaction in the Real Estate Assets, what is to be done with the Real Estate Assets? Worse case scenarios if the operations are to be moved post-transaction, are that the owners of the Target end up owning vacant real estate or the owners end up having to remain obligated to third party landlords for rent that otherwise would have otherwise been funded by the Target. If the operations are to be continued at the Real Estate Assets, it must be determined (i) what if any approvals and/or consents are required if the property is owned by a third-party landlord and (ii) if the Real Estate Assets are owned by the Target, will the assets be part of the transaction or leased to the acquiror. The terms of the on-going relationship needs to be addressed as part of the initial negotiation of the transaction’s terms. If the assets are not part of the transaction and instead leased to the acquiror, will there be a fair market arms-length lease or a related-party arrangement. One additional item to address is whether there will be a “commission/fee” paid on the portion of the consideration, if any, attributable to the real estate.

Regarding the issue of the ownership of the Real Estate Assets, the first item to address is who actually owns the Real Estate Assets. Generally, there are three alternatives: (i) the Real Estate Assets are owned by the Target; (ii) the Real Estate Assets are owned by a related party or (iii) the Real Estate Assets are owned by an independent third party. In the case of item (ii), it must be determined if the ownership of the ownership of the Real Estate Assets is consistent with the ownership of the Target both as to the individual owners of the Real Estate Assets and the respective percentage interests; i.e., does owner A own 20% of the equity in the Target and either 15% or 25% in the owner of the Real Estate Assets. If the latter scenario is the case, it needs to be determined whether all of the owners’ interests are aligned and if not, how are such non-alignments addressed in the entities’ respective organic documents. In the case of item (iii), what if any approvals and/or consents need to be received from the third-party landlord.

Environmental issues need to be addressed as federal and state law requirements may be applicable. First, is the transaction subject to any reporting requirements (federal or state); i.e. (as an example NJ has the “New Jersey Industrial Site Recovery Act (“ISRA”), which requires owners and/or operators of “industrial establishments” in New Jersey that cease operations or undergo a transfer of ownership or operational control to conduct an environmental review of and, if necessary, remediation of the industrial establishment prior to closing the transaction. Second, is the Target subject to any on-going reporting requirements or does the Target have any permits that are necessary for the business and are the permits transferable/assignable. Third, has the property previously been subject to a remediation or is it currently subject to on-going monitoring or reporting obligation(s). If there are on-going monitoring or reporting obligations, it must be determined who will be responsible to meet such obligations post-closing. Finally, the owners need to gather all prior environmental due diligence, reports, correspondences, etc. as part of the general due diligence process.

The tax consequences of the sale or disposition of the Real Estate Assets needs to be addressed as part of the overall tax analysis of the Transaction as planning opportunities may be available, i.e. 1031 transactions. If a 1031 like kind transaction is considered, the parties need to reach out to their advisors immediately as the Internal Revenue Service rules are very specific and “unforgiving.” Although beyond the scope of this article, the issues to be addressed would include:

are the parties willing to part with the receipt of cash from the transaction in return for the current tax savings and having to reinvest the proceeds in other real property for a period of time;
does the structure of the current ownership of the Real Estate Assets need to be adjusted and will there be tax consequences to such restructuring;
the owner of the Real Property Assets needs to engage a “qualified intermediary” to take hold all of the consideration attributable to the real estate;
potential replacement property or properties need to be identified
individually addressing items on the settlement statement to minimize the amount of the consideration that may be subject to tax; and

the timing to identify any potential replacement property and the actual closing of the acquisition of the replacement property.