Top 5 Legal Due Diligence Findings in Dutch M&A Transactions | #5 Real Estate Legal Red Flags

In the dynamic landscape of mergers and acquisitions (M&A) in the Netherlands, the legal due diligence investigation remains one of the most critical phases of any transaction. During this stage, information from the seller is thoroughly validated, potential risks are identified, and the deal value is ascertained or sometimes fundamentally reassessed. A comprehensive due diligence process not only safeguards the purchaser by identifying risks and informing negotiation strategies, but it also benefits the seller and the target company by clarifying obligations, identifying improvements and aligning expectations.

This article marks the fifth and final part of a five-part series on the Top 5 Legal Due Diligence Findings in Dutch M&A Transactions. For this series, we performed an in-depth analysis of the due diligence reports of our recent Dutch M&A transactions and identified the Top 5 Legal Due Diligence Findings. Each article in the series explores one of these findings as well as related topics in detail.

Summary of the article: Real Estate Legal Red Flags in Dutch M&A Transactions
In this final article, we conclude our five-part series by examining several of the most recurrent real estate due diligence findings and analysing their practical implications for M&A transactions.
This article focuses on situations where the target company’s right to make use of key premises is legally or contractually uncertain, including:

• the absence of written lease documentation;
• the existence of unauthorised subletting arrangements; and
• the presence of change of control provisions in lease agreements.

Absence of lease agreement
The absence of a formal lease agreement represents one of the most common findings by our real estate practice in due diligence investigations. This situation arises when a target company uses premises that are essential to its business operations without any written lease documentation in place. There are generally a number of reasons why no written lease documentation exists:

• the parties involved originally relied on an oral arrangement;
• a previously executed lease expired and was tacitly continued; or
• the property is owned by a shareholder or affiliated group entity of the target company and the parties did not consider it necessary to formalise their arrangements contractually.

Particularly in family businesses or long-standing commercial relationships, the parties may operate for years on the basis of mutual trust without considering the legal implications of their arrangements.

Under Dutch law, a lease is not required to be in writing in order to be legally valid. Pursuant to Article 7:201 of the Dutch Civil Code (Burgerlijk Wetboek), a lease arises where one party grants another the use and enjoyment of an asset in exchange for consideration, irrespective of whether the agreement is documented. While factual use may thus constitute a legally enforceable lease relationship even without written documentation, the absence of written documentation gives rise to considerable legal uncertainty. Key commercial and legal parameters of the lease (such as the duration of the lease, grounds for termination of the lease, the rent and any indexation mechanism, maintenance and repair obligations, service charge arrangements, insurance responsibilities, etc.) are in such cases based on conduct and surrounding circumstances (omstandigheden van het geval). This leads to evidentiary uncertainty and may increase the likelihood of divergent interpretations and potential disputes between parties.

From an M&A perspective, the absence of a written lease agreement for premises that are material for the target company’s business constitutes a significant risk. A purchaser will generally require certainty that the target company will continue to have enforceable and clearly defined rights with respect to the premises following closing of the transaction, together with transparency as to the financial obligations associated with the lease. If such certainty is lacking, this must be addressed in the transaction documents prior to closing of the transaction, typically by the negotiation and execution of a written lease agreement on terms acceptable to the purchaser as a condition precedent. Contacting the landlord in this regard not only affects the timing of the transaction, but may bring additional risks if the landlord uses the opportunity to negotiate more favourable terms or even to terminate the lease.

Situations where the target company does not have a direct lease agreement in place are particularly common in carve-out transactions, where a business unit or division is separated from a larger corporate group and sold. In carve-out scenarios, the target business frequently operates from premises that are leased by, or otherwise held in the name of, a group entity other than the entity being carved out. This may result in the target business having no direct contractual relationship with the landlord, relying instead on informal intra-group arrangements that may not have been formalised or that lack the landlord's prior approval.

For the benefit of the carved-out business, the seller will need to secure an independent right for the business to continue using the relevant premises, which will typically require the negotiation of a new lease agreement directly with the landlord or the landlord’s approval of an existing sublease. In the interim, the use of the premises may be covered by transitional services agreements, subject to the exact contractual arrangements under the main lease.

If a transaction involves a target company that was carved out in an earlier transaction and is again being sold, careful review of the lease arrangements of the target company and the arrangements implemented in the earlier carve-out will be required.

Unauthorised subleases
A further frequently encountered due diligence finding is the existence of sublease arrangements entered into by the target company without the consent of the landlord where such consent is contractually required. These situations arise in a variety of contexts, including in cases where the target company sublets surplus space to third parties or allows affiliated group companies to make use of part of the premises without formal approval.

Under Dutch law, a sublease is legally dependent on the main lease from which it derives. The tenant cannot confer more extensive rights than it holds itself, and the continued existence of the sublease is therefore contingent upon the continuation of the principal lease. Lease agreements often contain provisions prohibiting or restricting assignment and subletting of the leased property, in the latter case, often requiring the landlord’s prior written consent for the assignment or subletting of the leased property. If a tenant grants a sublease in breach of such provisions, this constitutes a contractual default which may, depending on the wording of the lease agreement, entitle the landlord to invoke certain remedies including termination of the main lease agreement. Notwithstanding the breach vis-à-vis the landlord, the sublease remains valid and binding between the tenant and the subtenant. This creates a layered legal structure in which the target company, if it is the tenant under the main lease, is simultaneously exposed to enforcement risk under the main lease (by the landlord) while being contractually bound to the subtenant. Since the subtenant’s rights are derivative in nature, termination of the main lease will typically result in the sublease falling away, thereby undermining the legal basis for the subtenant’s occupation.

In the transactional context, unauthorised subletting may have implications for both deal certainty and valuation. From a risk perspective, the existence of an ongoing breach introduces the possibility that the landlord could take enforcement action. From a commercial perspective, subleases may represent a material source of income for the target company or be operationally relevant where affiliated group entities of the target company share the premises. If the sublease is material to the continuation of the business, the purchaser will require assurance that the sublease will continue after closing of the transaction, typically by insisting on including a condition precedent in the transaction documentation requiring that the landlord provide explicit consent to the sublease.

Change of control provisions
We often encounter change of control provisions in lease agreements. Change of control provisions can take various forms, from provisions requiring the target company to notify the landlord in the event of a change of control, to more stringent provisions requiring the target company to obtain the landlord’s prior written consent or allowing the landlord to terminate, amend or renegotiate the lease agreement in the event of a change of control over the target company. If the landlord is not adequately informed or asked to provide consent, this may constitute a breach of the lease agreement, potentially allowing the landlord, depending on the drafting of the lease agreement, to terminate the lease agreement.

For a more detailed analysis of change of control provisions, we refer to the first article in this series, which addresses this topic comprehensively.

Top 3 tips: assessing real estate issues

1. Formalise undocumented arrangements early in the process – if the use of the premises is based on informal or historic arrangements, engage with the landlord at an early stage to assess their willingness to formalise the relationship, as late-stage negotiations may lead to delays in the transaction.
2. Verify the main lease when a sublease is in place – always review the main lease agreement alongside any sublease, as the subtenant’s rights are derivative and cannot exceed those of the tenant, bearing in mind that termination or breach of the main lease agreement may undermine the legal basis of the sublease entirely.
3. Translate real estate findings into specific contractual protections – ensure that identified risks are reflected in tailored conditions precedent, warranties or indemnities rather than relying solely on generic warranties.

Need advice on real estate issues under Dutch law?
Do you want to assess what terms and conditions apply to your (sub)lease of certain premises, or whether a change of control clause might apply – and, if so, what the legal implications could be? Please do not hesitate to contact Friederike Henke or Deniz Xinyi Bussing of our Corporate M&A department, or Ulrich Koeze of our real estate practice, who would be pleased to advise you and provide tailored guidance on these matters.

• Looking for more insights on common legal due diligence findings in M&A transactions? We invite you to explore the earlier parts of our Top 5 Legal Due Diligence Findings in Dutch M&A Transactions series, covering change of control provisions, due diligence findings with respect to articles of association (statuten), employment issues and intellectual property issues.