Real Estate M&As and change of control clauses in lease contracts
Claudia S Mathiasen
Winsløw Law Firm, Copenhagen
In a transaction where the core asset is a company running its business from leased premises, it is relevant to do a due diligence that addresses the rights and obligations of the tenant in the commercial lease contract.
In a real estate M&A transaction where the underlying asset is a residential property in Denmark, the specific and mandatory limited change of control terms in the Danish Rent Act are also relevant to address in the due diligence on the landlord company and structuring of the transaction.
According to Danish law a change of creditor in a contract does not require the consent of the other contracting party. But change of debtor is only possible if accepted by the other party. Therefore, a tenant’s obligations in a lease contract cannot be transferred to a new tenant without the approval of the landlord.
If the transaction is structured as a share deal – and not an asset deal – no change of debtor/tenant in the lease contract takes place. As a consequence, consent from the landlord is not necessary in a share deal. In practice however, a change of control clause regarding the tenant is often agreed in commercial leases. In the clause the parties usually agree that certain changes in the control of the company/tenant trigger certain legal rights for the landlord. Such clauses are not common in commercial leases regarding change of control in the landlord company.
In share deals where the underlying asset is a property with more than six residential units or at least 13 residential units (if there are also commercial units in the property), section 102 of the Danish Rent Act gives the tenants the right of first refusal, ‘when the buyer obtains the majority of votes in the company’. In other words, the Danish Rent Act prevents a change of control in a landlord-company, if the residential tenants decide jointly to buy the underlying asset, such as the property. This change of control clause on the landlord side cannot be deviated from by agreement in a residential lease contract.
This article touches upon some of the relevant issues to address in real estate M&As and transactions with target companies that are commercial tenants, regarding change of control clauses in Danish lease contracts.
Change of control clauses in commercial lease contracts
The Danish Business Lease Act does not include terms about change of control in a tenant – or landlord company. The departing point is therefore that a change of control in a tenant company is possible without the approval of the landlord.
Section 55 of The Danish Business Lease Act gives the tenant an assignment right to a new tenant in the same industry. This can be deviated from by settling an anti-assignment clause in the lease contract.
If the landlord intends for a change of control of a tenant to violate an anti-assignment clause in its lease, it should be ensured that the lease expressly states that a change of control constitutes such an assignment. Typically, a change of control clause in a commercial lease states that a transfer of the majority of the votes in the tenant company is considered to be an assignment.
The agreed legal consequences of such an assignment are usually that the lease contract ceases, or that the landlord has the right to require renegotiation of the lease terms.
If the tenant/shareholder who owns the shares in the tenant company transfers the shares despite an agreed change of control clause, it is a violation of the lease contract. But if section 55 of the Danish Business Lease Act is not deviated from in the lease contract, the landlord must have substantial reasons to reject an assignment, such as the change of control in the tenant company.
A substantial reason can be the lack of financial ability. But a transaction of the majority of the shares in a company that a landlord has already accepted as a tenant does not change the ‘financial ability’ of the company – unless in rare cases where the new majority shareholder has a dubious past, for instance a number of bankruptcies. This would be the exception.
Another substantial reason can be the lack of industry knowledge. But like the above case of lack of financial ability, this does not change with the change of control in the tenant company.
Therefore, the landlord is not likely to have substantial reasons to reject the in-fact assignment that is the consequence of the change of control in the tenant company.
Does a landlord have other legal means if the change of control clause is violated?
It is a general principle that a landlord has the right to choose its tenant. As a tenant is usually accepted by the landlord after a due diligence and risk assessment including for instance the financial, commercial and environmental risks on that specific tenant, it is a fair principle that tenant cannot be replaced by another contracting party without prior approval from the landlord.
The same points are considered in a change of control clause, for example, the landlord has a justified interest in knowing the identity of the tenant/ultimate beneficial owner and keeping status quo on this throughout the full contract period. This is the interest that the change of control clause protects. Therefore, the possibility of deviating from the section 55 of Danish Business Lease Act in an agreed non-assignment clause supports indirectly that a change of control clause in a commercial lease can be agreed in a commercial lease.
The Danish Business Lease Act also states that it is void if the parties agree that the lease contract is violated and can be terminated without notice for other reasons than those specifically stated in section 69 of the Business Lease Act. The violation of a change of control clause is not mentioned in section 69. But section 69, subsection 1, number 6 states that the lease contract can be terminated without notice if the tenant partly or fully lets a third party use the leased premises. Even though a violation of a change of control clause is not mentioned specifically in section 69 it is fair to conclude that the landlord has the legal means to use section 69, subsection 1, number 6 to terminate without notice if a tenant violates a change of control clause, also if an anti-assignment clause is not agreed.
In short this means that a due diligence must address change of control clauses in commercial leases entered by a target company as a tenant, because the consequences of a violation of such a clause is that the landlord can terminate the lease contract without notice.
Change of control terms for landlord companies with residential properties
In due diligences where the target company is a landlord owning a Danish property with more than six residential units or at least 13 residential units (if there are also commercial units in the property), the residential leases have an in fact change of control clause because section 102 of the Danish Rent Act gives the tenants the right of first refusal, ‘when the buyer obtains the majority of votes in the company’.
The boundaries of the interpretation of ‘obtains the majority of votes in the company’ was tested by the Danish Supreme Court in a court ruling in May 2020 in the so-called ‘Six Pack Case’.
The case concerned the Carlsberg Trust which sold 100 per cent of the shares in five property companies to subsidiaries owned by three pension funds. After the transaction the shares in each company were owned respectively with 49 per cent, 35 per cent and 17 per cent by the three subsidiaries. The residential tenants claimed that they had the right of first refusal according to section 102 of the Danish Rent Act, because there was a change of control in the landlord company.
The Danish Supreme Court referred to a Supreme Court case from 1993 according to which the interpretation of section 102 of the Danish Rent Act cannot be extended to more than what the exact wording states. As a consequence, the relevant matter to consider is not that the current landlord company does not have the majority of the votes in the company(ies) after the transaction(s), but that none of the buyers ‘obtains the majority of votes in the company’.
In the due diligence process where the target company is a property company with Danish residential units, the focus in respect of change of control matters on the landlord side must be on stating whether the buyer ‘obtains the majority of the votes in the company’ through the transaction. If this is not the case, the transaction can take place without the landlord offering the property to the residential tenants.
In a due diligence process where the target company is a commercial tenant, the relevant matter to address is 1) if the lease contract has a change of control clause for the tenant; and 2) the interpretation of the wording of such a change of control clause. Usually, a change of control clause will be drafted on the perspective of change of control in the existing tenant – as opposed to the view in section 102 of the Danish Rent Act, where the existing landlord can transfer its control, as long as no new entity obtains the majority of the votes in the company. Therefore, a change of control clause in a commercial lease contract is worth paying attention to in the due diligence process.