This article details the safeguards and mechanisms that an operator of a co-working space can negotiate to nullify or mitigate the adverse affects of the sale of such property by the owner to a third party. It is Part III in our series of articles on setting up and operating a co-working space in India.
Part I of the series details the issues addressed by a legal due diligence undertaken in respect of a proposed co-working premises to identifying risks associated with converting the same into a co-working space.
Part II of the series details the typical issues addressed by a technical due diligence undertaken in respect of a proposed co-working space to ensure continuous, safe, and incremental operations from the same.
As with any real estate asset, buildings and premises where co-working spaces are situated may also become the subject matter of sale and transfer from one owner to another. Such sale can be as a result of a business reorganisation of the owner (typically a transfer to a related entity), or as a matter of outright sale to a third party, in which case the owner essentially ceases to be the title-holder of the said property.
Sale of premises comprising a co-working space to a third party in the midst of a contract tenure may affect the operations from such property, and co-working space operators will try to minimise the adverse impact suffered by them in such an event. Similar issues will also come into play in case of a lease of the premises to a third party. This is especially pertinent in case the operator is engaged in merely operating and managing a co-working space as an asset-light business model under an operations and management agreement (‘O&M Agreement’). In such arrangements the operator does not have an ownership or leasehold right in respect to the premises.
Careful considerations are therefore due when addressing operator-centric issues related to sale of premises in the O&M Agreement entered into between the owner and the operator. However, it must be borne in mind that it may neither be possible nor feasible to have an absolute contractual prohibition on the owner from selling a property being operated as a co-working space. However, the O&M Agreement should provide that any sale of such property should be undertaken only with a prior written notice issued to the operator. This would enable the operator to determine the appropriate measures that it is contractually entitled to take under the O&M Agreement, which are feasible and favourable to the operator in case of the transfer going through.
Certain O&M Agreements may entitle the operator to a right of first refusal in respect of the sale of the property. Though such positions are rare, they are typical when the business operation from a particular location is considered commercially important to the operator, and the operator sees a financial viability in continuing with the operations even if it means having to incur significant cash outflow to purchase the premises (thereby also moving to an asset-heavy model of operation). Such right of first refusal requires the owner to first provide to the operator a notice providing therein the details of the proposed sale, including the sale price that has been offered by the third party purchaser for the said property. Upon the receipt of the notice, the operator has the option to accept the said offer within a specified time period by paying the sale price to the owner and taking over the title of the property, or to decline such an offer.
However, not all owners may agree to a right of first refusal as this may tend to depress the sale value of the property. This is because many prospective purchasers may be put off by the prospect of the sale requiring the action of a third party, the results of which may be unpredictable. Also, in some cases, the third party purchaser may have already obtained the requisite funding for the purchase, and may not have the bandwidth to wait for the right-of-first-refusal timeline to expire.
In the absence of such right of first refusal, or in the case the operator does not wish to purchase the property, but nevertheless intends to continue its operations from the property, the operator may retain the right to continue to operate the premises as a co-working space, either (i) on the same terms as in force in the current O&M Agreement, or (ii) on revised terms that may be determined between the new owner and the operator independently. In such cases the O&M Agreement should render an obligation on the exiting owner to obtain and furnish appropriate details of the new owner to satisfy the operator of the financial standing of the new owner, in addition to other requisite information, so as to give adequate comfort to the operator.
However, this might prove to be an issue in the event the new owners are not willing to put themselves in the shoes of the previous owner. Two situations may then arise: (i) wherein the new owners refuse to continue the O&M Agreement, or (ii) revised terms are proposed by the new owner which are onerous or unacceptable to the operator to an extent that operations from the premises become unfeasible. In such cases the O&M Agreement should provide for an exit mechanism for the operator. Operators should in such cases retain the right to terminate the O&M Agreement without bearing any liability in that regards. Additionally, certain operators may also pre-negotiate a lump-sum payable in regards to such a termination. The lump-sum payment should adequately address the business loss suffered by the operator on account of such untimely termination of the O&M Agreement.
The O&M Agreement should also provide that such sale shall not affect the current levels of working capital in the operating account. This is to ensure that in the event of a sale to a third party, where the operator continues to remain as the operator, it has adequate working capital available at its disposal to ensure the smooth operation of the co-working space.
Typical provisions in an O&M Agreement regarding the sale of premises constituting a co-working space attempt to nullify or at the very least mitigate the operational fractures that are created due to such sale. Consequently, the O&M Agreement should be negotiated and provisions put in place to provide for adequate safeguards towards the same.
This article has been authored by Sayanhya Roy, Principal Associate, Ikigai Law.
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Disclaimer: This article is meant for general informational purpose only and is not a substitute for professional legal advice. This article is based on the laws applicable in India as on the date of publication.