As business needs change, a tenant may have excess space that could be sublet to generate income to offset the lease expense. In the alternative, the sale of the business may demonstrate that moving to an online presence and assigning the lease would increase profitability. Prior to finding a tenant to take over the leased space, both tenants must review their respective lease agreements to determine their rights under the lease.
As a general rule, if a lease agreement does not expressly preclude an assignment of the lease or a sublease, the tenant is free to transfer its rights in the lease without the landlord’s consent. However, most commercial lease agreements include a clause addressing assignments and subleases. The importance of the assignment and sublease provision in a lease agreement cannot be understated and should be one of the provisions carefully considered by both tenants and landlords when negotiating a lease.
Distinguishing Between an Assignment and a Sublease
There are important differences between an assignment and a sublease.
Assignment
Generally speaking, an assignment of a lease is the transfer by a tenant of its entire leasehold estate for the remaining term of the lease without retaining any reversionary interest. The new tenant or assignee takes on the lease responsibilities of the original tenant or assignor. After the assignment, the landlord may enforce the terms of the lease directly against the new tenant in the event of a default. However, unless an agreement is reached with the landlord, privity of contract is not extinguished between the landlord and the original tenant, and the tenant is secondarily liable under the lease, while the assignee becomes primarily liable.
Sublease
A sublease transfers all or part of a leased property to a subtenant for all or a portion of the remaining term of the lease. The rent and terms and conditions of the sublease may be the same or materially different than the lease. A sublease creates a landlord/tenant relationship between the tenant/sublandlord and subtenant. A key distinction between a sublease and an assignment is that the privity of contract exists between the sublandlord and the subtenant and not between the subtenant and the landlord, absent a written agreement between the landlord and subtenant. In the event of a default, the landlord may enforce the terms of the lease against the tenant, but not the subtenant.
Understanding the Motivation Behind the Parties When Negotiating.
When negotiating an assignment and sublease provision, the perspectives and interests of the parties are important:
Landlords
- Want to recover what they are entitled to under the lease and protect themselves against default
- Want control over the type of business which may follow the original tenant so that the quality and marketability of the property is not adversely affected
- Want to protect their investment, including avoiding increased environmental or other liability exposure, and the welfare of other tenants
- Want control over the use of the property, including the impact on parking, traffic, utilities, and zoning issues
- May have concerns about shared space arrangements such as signage, alternations to the space and increased utility demands
- Want a creditworthy/financially stable tenants
Tenants
- Want flexibility to make changes and create revenue if the business needs change over time
- Prefer to have the ability to freely assign or transfer all or part of its interests in the lease or property without landlord’s consent
- Want flexibility in the event of a change of control, merger or sale
Drafting Issues
Every transaction is different and careful consideration should be given to the specifics of each deal while keeping in mind the perspectives and interests of each party. Several key issues to consider when negotiating assignment and sublease provisions are as follows:
Landlord’s Consent. Obviously tenants would prefer to assign the lease or sublet the property without the landlord’s consent. Landlords reject such unrestrained freedom. The clauses that have been negotiated between these two extremes are endless. An often used phrase is that the landlord’s consent “shall not be unreasonable withheld.” Without additional language, this phrase can be problematic if a landlord ultimately denies a request for an assignment or sublease because the tenant will accuse the landlord of being unreasonable. Parties should consider adding factors such as (a) the credit and net worth of the proposed transferee; (b) the business experience of the proposed transferee; (c) whether the property is suitable for the proposed use; and (d) will the proposed use violate any use restrictions or exclusive use restrictions in other tenant leases.
Recapture Rights. The landlord may want to reserve the right to take back (recapture) the property if the tenant requests an assignment or sublease approval.
Excess Rent. Landlord’s frequently object to a tenant “profiting” off of the landlord’s real estate if the sublease rent is in excess of the lease rent. A compromise is that the excess rent is shared between the tenant and the landlord.
Permitted Transfer for Sale, Merger and Affiliates. Tenants often perceive prohibitions on the transfers of the lease to affiliates or in the event of a sale or merger as a landlord interfering with their business operations. For larger business entities, there is a greater need for flexibility for such transfers. Still, the landlord’s interests in assuring that the new entity is capable of performing under the lease must be considered. Under these circumstances, qualifiers such as the proposed entity or affiliate must have adequate net worth are often included as a compromise to protect both parties’ interests.
Default. The violation of the transfer provision may have serious implications for the landlord and therefore an automatic event of default under the lease.
Conclusion
The need to assign or sublet the property may not be apparent at the initial negotiation stage, but circumstances may change during the course of the lease. Assignment and sublease lease provisions are not one size fits all provisions and can be complex. There is an inherent tension between landlords and tenants with respect to the right to transfer the lease which both parties should recognize. However, with careful consideration at the outset, the framework will be in place to work through the changes that may arise during the term of the lease.