The use of a commercial lease to rip off minority owners in a closely held business

Transcript

Today we’re going to talk about one of the more common ways that a majority owner can rip off minority owners in a closely held business. And that is by causing the company to enter into a lease with an affiliate of the majority owner. 

The typical fact pattern goes something like this: You have a corporation or LLC that has a majority owner that controls the operations of  the company. That company needs to lease space somewhere to operate the business. Rather than go to a third-party landlord, the majority owner causes the company to enter into a lease with an affiliate of the majority owner. In other words, causes them to lease space that the majority owner has an interest in. 

Now, this could be perfectly legitimate and it’s done all the time, and there’s good reasons for doing so. From the majority owner’s point of view, having a corporation that you control as a tenant at your space can be a wonderful thing. You know that the tenant’s not going to trash the place, you know that they are going to pay the rent because you’re going to be causing him to pay the rent, and you know that they’re going to be an overall solid tenant. 

From the company’s point of view, this arrangement can also be beneficial because the company is entering into an agreement with a friendly landlord. You know that the landlord is going to keep the property together, you know that they’re going to be able to work with the tenant if they get in trouble, so it can be a very beneficial relationship.

The problem arises when the majority owner causes the company to enter a lease on terms that are unfair to the well. So, what does this mean? For example, this can mean the majority owner may cause the company to pay above market rent for space, or it may cause the company to make improvements to a space that the landlord would normally make if it was dealing with a third-party tenant. 

Why would the majority owner do that? Simple, it allows the majority owner to take money out of the company at the expense level rather than have it be distributed as profits. If it’s distributed as profits, it has to be split with the minority owners.

So if you’re a minority owner, how can you tell whether a lease has terms that are fair to the company? Well, it could be tricky, but one of the ways to do it would be to talk to a realtor or real estate appraiser to get a sense of what market rent is in the area where the property is located. That person may also be able to tell you what improvements are typically made by the landlord and what improvements are typically made by a tenant. 

On the other hand, if you’re a majority owner and you want to cause the company to enter a lease for property where you have an interest, what can you do to ensure that you’re not later charged with breach of fiduciary duties? Simple: Disclose, disclose, disclose. You want to disclose the terms of the lease to the minority owners and have them sign off on it. If you’ve done that, it’s going to be very hard for them to come back later and claim that the lease terms weren’t fair to the company.