Understanding Lease Provisions and Available Options

In most if not all dental practices we transition, whether representing a seller or a buyer, the space in which the practice is currently located must be either sold/purchased, leased, or a combination of both.  An outright sale/purchase of the real estate is fairly self-explanatory.  However, when a lease is provided with future potential ownership, or an existing lease is being assumed or sublet, we often witness confusion or misunderstanding as to terminology and the meaning of such as to the many options that arise.

To provide you with a better understanding, we will briefly explain some of the more common terminology you may come across while in the process of transitioning a practice such as: a Right of First Refusal vs. a Right of First Offer vs. an Option to Purchase; and an Assignment vs. Sublet of Lease.

The following three lease provisions involve situations where a change in the ownership of the real estate may occur:

Right of First Refusal (ROFR) is a contractual right within a lease granted by the owner of the real estate (Lessor) that provides the holder of the right (Lessee) an opportunity to enter into a transaction with the owner of the real estate according to specified agreed upon terms before the owner is entitled to enter that exact same transaction with a third party.  The opportunity is only triggered IF the owner decides to sell during the duration of the right, which can be limited in time.

Example

Owner O owns the building in which a dental practice is operating but does not have immediate plans to sell the building. Buyer B buys the dental practice from a retiring dentist and negotiates a new lease with Owner O that includes a ROFR to purchase the building. During the term of the lease, and while the Right is still in force, Party X comes along and offers Owner O one million dollars for the building. Before Owner O can sell the building to Party X, Owner O must first offer to sell the building to Buyer B at the same terms, in this example one million dollars. If Buyer B accepts, he/she buys the building instead of Party X. If Buyer B declines, Party X may now buy the building at the one million dollar price.

Right of First Offer (ROFO, also known as a Right of First Negotiation among other terms) differs from the ROFR above in that the ROFO merely obliges the owner of the real estate to undergo exclusive good faith negotiations with the rights holder (Lessee) before negotiating with third parties. It is merely an agreement to negotiate.  A ROFO also is only triggered IF the owner decides to sell during the duration of the right, which can be limited in time.

Example:

Owner O owns the building in which a dental practice is operating but does not have immediate plans to sell the building. Buyer B buys the dental practice from a retiring dentist and negotiates a new lease with Owner O that includes a ROFO to purchase the building. During the term of the lease, and while the Right is still in force, Owner O decides to sell the building.  Before Owner O can offer the building and negotiate a deal with any third party, Owner O must first negotiate, in good faith, to try to sell the building to Buyer B.  If an agreement is reached, Buyer B buys the building. However, if Owner O and Buyer B fail to reach an agreement, then Owner O is free to market and negotiate with anyone else without any restriction as to price or terms.

Option to Purchase (OTP) is a contractual right granted by the real estate owner (Lessor) that gives the option holder (Lessee) the absolute right to purchase the real estate, at pre-agreed upon terms, upon the option holder’s election to exercise such right.  Unlike the above two descriptions which only are triggered if the owner decides to sell, the OTP is triggered if the buyer decides to buy.  If the buyer exercises his/her option, the owner MUST sell the building at the pre-agreed upon terms.  The OTP, similar to the other rights above, can be limited to duration.

Example:

Owner O owns the building in which a dental practice is operating and is willing to sell the building.  Buyer B buys the dental practice from a retiring dentist. Buyer B is hesitant to buy the building immediately due to financial constraints, but would like to own the building in the immediate future. Owner O and Buyer B negotiate a new lease which includes an OTP, as well as a formula to determine the purchase price for the building if the option is exercised.  During the term of the lease, and while the Option is still in force, Buyer B exercises his/her Option to Purchase. Owner O MUST sell the building to Buyer B at the agreed upon price and terms.

 The following two lease provisions involve situations where a change in the tenant (Lessee) of the space may occur.  In both provisions, Lessor approval is typically required.

Assignment of Lease transfers the right to use leased space from the original Lessee (often referred to as the Assignor) to a new tenant under all existing terms and conditions of the lease. The new tenant (often referred to as the Assignee) acquires the same rights and privileges as the original Lessee.  The biggest misconception by Lessees assigning their lease to an Assignee is the belief their liability ends there.  The assignor remains liable for the full term of the lease unless released by the landlord.

Example

Owner O owns the building in which a dental practice is operating. Buyer B buys the dental practice from a retiring dentist and negotiates a new lease with extremely favorable terms with Owner O.  Two years into a five year term, Buyer B sells the dental practice to Buyer C.  If Owner O consents, Buyer B may assign his/her lease to Buyer C under the exact same terms and conditions.  Unless Buyer B secures a written release from Owner O, Buyer B will remain liable if Buyer C breaches the lease provisions in any manner.

Sublet of Lease in essence is a rental agreement between a Lessee of space and a tenant (Sub-Lessee).  The Lessee rents out all or part of the space to a third party while still maintaining the status as the primary Lessee and contractually bound to the original lease with the Landlord.  Similar to the Assignment of Lease, the original Lessee remains liable for the full terms and conditions of the lease unless released by the landlord.

Example

Owner O owns the building in which a dental practice is operating. Buyer B buys the dental practice from a retiring dentist and negotiates a new lease with Owner O.  During the lease term, Buyer B is forced to attend to personal matters for one year out of state and is approached by Dentist D who would like to rent the space during Buyer B’s absence.  If Owner O consents, Buyer B may sublet the space to Dentist D under terms and conditions agreed to between Buyer B and Dentist D.  Unless Buyer B secures a written release from Owner O, Buyer B will remain liable if Dentist D breaches the lease provisions in any manner.

 When presented a lease agreement containing one or more of the above provisions, always be certain to understand the ramifications prior to acceptance.  As with any and all contracts, we highly recommend you contact your legal advisors to review the agreement and explain the legal meaning prior to executing the document.