As part of the acquirer's legal due diligence on the target company's assets, real estate leasing defects are often a focal point. This article, set against the backdrop of the acquirer's impending IPO, provides a brief analysis of issues related to real estate leasing defects and their resolution. All references and analyses in this article are based on laws and regulations publicly issued and effective in the mainland People's Republic of China as of October 15, 2017. Additionally, due to specific issues regulated differently in various regions (such as registering residential properties as business addresses, "one license for multiple addresses," "one address for multiple licenses," etc.), this article does not comprehensively cover all variations. In the case of specific projects, consultation with local authorities or professionals is advised to supplement any gaps in this article.
I. Defects in the Signing and Performance of Lease Contracts
(1) Lack of actual, complete authority for the lessor to dispose of the property
Possible scenarios include: the lessor being a co-owner without the consent of other co-owners; the lessor being a sublessor, making the property non-sublettable; the property being mortgaged before leasing; a third party having a priority leasing right; the lessor failing to fulfill obligations determined by legal documents and being declared a dishonest person by the court, among others.
According to the Contract Law, Property Rights Law, Interpretation of the Supreme People's Court on Issues Concerning the Application of Laws in the Trial of Disputes over the Sale and Purchase Contracts, and other legal regulations, the legal consequences of these situations may include:
If the registered owner disposes of the property without the spouse's consent, the contract is valid unless there are other defects. The key to acquiring property rights lies in whether the buyer qualifies as a "bona fide third party" under the law.
If the lessor is, in fact, a sublessor without the original lessor's consent, the original lessor can reclaim the property.
If the company leases a mortgaged property and the mortgage is executed, the mortgagee has the right to dispose of the property, potentially leading to the company losing its usage rights.
If the lessor violates a prior agreement with a third party regarding priority leasing rights, the company faces the risk of losing the property.
If the lessor is listed as a dishonest person for failing to fulfill execution notices, the property may be seized or auctioned by the court.
Based on the above investigation, the target company can prompt the lessor to change the property's ownership status, ensuring complete and sufficient rights for lease contract signing, or choose an alternative business address.
(2) Defects in the Signing of Lease Contracts
Possible scenarios include: a natural person signing without complete and legal authorization, or a third party signing on behalf of another; a legal entity using a seal that is not a public or contractual seal; the lease contract requiring both signature and seal but only one being present, among others.
According to the Contract Law and other legal regulations, the legal consequences of these situations may include:
If there is unjustified use of a seal or a contract is signed by a third party, and this can be ascertained with basic prudence, the contract is considered "not concluded in writing." Without a written contract, the stability and continuity of rights and obligations in leasing relationships are uncertain, and the company may face the risk of losing the property and bearing the associated losses.
If the contract is signed by an unauthorized agent, their actions may constitute "apparent agency," leading to the principal being responsible for completing the transaction or facing breach of contract consequences.
Based on the above investigation, it is recommended that the target company re-sign the contract, specifying signatories and signing methods.
(3) Invalidity of Lease Contracts
Possible scenarios include: the lease term exceeding 20 years; leasing a property without obtaining a construction project planning permit or not following the permit's specifications; leasing an unapproved or not-as-permitted temporary structure; subleasing beyond the remaining term without the original lessor's consent, among others.
According to the Contract Law and the Supreme People's Court's Interpretation of Several Issues on the Specific Application of Laws in the Trial of Disputes over Leases of Urban Houses, the legal consequences of these situations may include:
If the lease contract is deemed invalid, the company must return the property and may be held liable for losses caused by its fault.
It is recommended to urge the target company to eliminate circumstances leading to contract invalidity and re-sign the lease contract.
(4) Violations of Other Administrative Regulations in Property Leasing
Possible scenarios include: flaws in the construction process, such as incomplete construction permits or non-compliance with mandatory safety and disaster prevention standards; changing the property's use without authorization; failure to file or timely update, renew, or cancel leasing records, among others.
According to regulations such as the Urban and Rural Planning Law, the Building Law, the Regulations on the Management of Construction Project Quality, the Management Measures for the Leasing of Commercial Houses, and the Supreme People's Court's Interpretation of Several Issues on the Specific Application of Laws in the Trial of Disputes over Leases of Urban Houses, the legal consequences of these situations may include:
Unlawfully constructed properties without a construction project planning permit may be ordered to be demolished if the impact cannot be eliminated.
Properties not meeting national safety standards or lacking quality supervision procedures may be ordered to be reworked or repaired.
Failure to complete leasing registration does not affect the validity of the lease, but violating registration rules may result in fines and, from an IPO compliance perspective, raise stability concerns in company operations.
It is recommended to set appropriate transaction prerequisites or commitments to prompt the target company to rectify illegal actions or find alternative business premises.
(5) Other Specific Circumstances
Possible scenarios include: the lease term expiring; the leased area not suitable for the company's operations; significantly lower rent compared to the market price, among others.
If the company continues using the leased property after the lease term expires, it may be considered an unauthorized possession. According to the Property Rights Law, the owner can request the return of the property and seek compensation for damages.
If the leased area is inadequate for the company's operations or the leasing environment is unsuitable, it may raise suspicions about the company's actual operational status and business evaluation results.
Additionally, in the case of an IPO issuer engaging in related leasing activities, regulatory authorities will focus on the fairness of rent. If the target company's leased property has an unfair rent, the acquirer needs to reconsider the post-acquisition operating costs. Furthermore, after acquiring the target company, if the acquirer establishes a leasing relationship with related parties or entities with business dealings, it must ensure the fairness of the rent.
It is recommended to urge the target company to revise the lease agreement or find alternative business premises.
Apart from the mentioned scenarios, the target company may also face performance disputes or instability in leasing relationships in the lease contract. In summary, during the legal due diligence process in the context of an acquisition, lawyers need to consider both legal and business risks to lay a solid foundation for subsequent business negotiations, the drafting of transaction documents, and post-closing management.
