When entering into negotiations for the leasing of commercial real estate, due diligence often centers on the premises and the inspection of the same by the prospective tenant. However, the landlord has an interest of due diligence of its own: investigation of the financial and legal viability of the prospective tenant. There are a few tools that the can be used by the landlord to verify the good standing and business legitimacy of the future tenant.
A. State Corporation Commission
Once the landlord knows the name of the entity that will be leasing the premises at issue, one of the first and most basic forms of due diligence is a check of the records of the Virginia State Corporation Commission. Even some seasoned corporate attorneys do not take full advantage of the online and telephonic resources provided by the SCC at no charge to the inquirer. The existence and status of an entity can be found online at www.scc.virginia.gov. This site will inform a party of the existence of an entity, its status as a valid entity, its registered agent and directors (if a corporation).
As a means of further due diligence, copies of the entity’s organic document (articles of organization or articles of incorporation, as applicable) as well as a Certificate of Fact can be ordered at a minimal cost.
B. Financial Statements
As a more candid and telling means of due diligence, the landlord can simply require copies of the prospective tenant’s recent financial statements in the period of due diligence among the parties. It is prudent for the landlord’s counsel to turn the statements over to the landlord’s accountants or financial experts to analyze the statements to determine the tenant’s financial viability.
C. Lien Search
Another means of due diligence at the fingertips of the landlord is a search of public records for judgments and liens against the prospective tenant. In addition to entity searches, the State Corporation Commission will provide information on financing statements recorded with the SCC against the tenant. Additionally, a search of a particular county’s circuit court land records will reveal any judgments that have been docketed against the tenant in that particular county.
In the event a question of business legitimacy arises concerning the tenant, the landlord can seek to bolster its financial position by requiring one or more businesses or individuals to guarantee the performance of the lease and the payments thereunder. When a landlord is considering a prospective tenant for its premises, the landlord may discover that the tenant has an unstable or even nonexistent financial history. In some cases, the prospective tenant is simply a shell entity for the sole purpose of leasing the premises from the landlord.
Regardless of the reasons for a lack of financial legitimacy, the landlord may be left with little assets to attach in the event of the tenant’s failure or refusal to perform under the terms of the lease agreement. Therefore, the landlord would be justified in insisting upon a guaranty of the lease either by the parent company or the entity’s principals.
To the contrary, in the event the prospective tenant is able to establish a strong financial history with significant assets, a landlord’s counsel will find it hard to negotiate or even require such a guaranty of the lease. Like all other phases of the negotiations, the tenant may even be willing to compromise on other aspects of the lease to avoid the use of a guaranty. More commonly, if the tenant is willing or able to increase the amount of the security deposit, the landlord may be satisfied with the additional financial security in the event of non-performance by the tenant.