What happens to a lease when property is sold?

QUESTION: I’ve been contacted by the owner of a property who wants to list it for sale with me.  There’s a tenant living in the property under a 1-year lease that still has six months left on the initial term.  The owner and I want to know what effect a sale of the property would have on the lease.  The “Rental/Income/Investment Property” provision in the Additional Provisions Addendum (form 2A11-T) states that “[t]he Property shall be conveyed subject to existing leases and/or rights of tenants.”  Should I interpret that to mean that an existing lease will be terminated by a sale of the property unless the parties agree that it will remain in effect?

ANSWER:  The answer to your question is “no.”  A lease for more than 3 years must be recorded to be valid against purchasers. A lease for 3 years or less does not have to be recorded to be valid against a purchaser if the purchaser has actual knowledge of the lease or if the tenant is in actual possession, since actual possession is treated as the equivalent of notice and as a substitute for recording.  Thus, since the tenant in your situation is in actual possession, the lease will remain in effect unless: (i) the landlord/seller or tenant exercises any contractual right either may have to terminate the lease, (ii) the landlord/seller and tenant enter into an agreement with each other to terminate the lease, or (iii) the landlord/seller or tenant terminates the lease due to a material breach of the lease by the other party.

It is important to use the “Rental/Income/Investment Property” provision in the Additional Provisions Addendum when there are any leases that will remain in effect after the sale.  It serves several important purposes: (i) to make clear the parties’ understanding that any existing leases are a material part of the transaction between them, (ii) to give the buyer the right to obtain and review copies of any leases and any relevant information relating to their status as a part of the due diligence process, (iii) to provide that any security deposit remaining (after being applied in accordance with Section 42-54 of the Tenant Security Deposit Act) will be transferred to the buyer at Settlement, and (iv) to provide whether or not any pet fee/deposit will be transferred to the buyer.  In addition, paragraph 9 of the Offer to Purchase and Contract (form 2-T) provides that any rents for the property will be prorated through the date of Settlement.