The Evolution of a Lease Provision: Sublease and Assignment

Landlords believed that the foregoing simple provision allowed a landlord to grant or withhold its consent at the landlord's whim. However, in cases such as Julian v. Christopher, 320 Md. 1, 575 A.2d 735 (1990), where the Court of Appeals of Maryland held that in the absence of language in the Lease setting forth a standard for approval of sublease and assignment requests, landlords were required to employ a “reasonableness” standard, this belief was shattered. Thereafter, landlords who wanted total control over sublease and assignment requests had to add to their sublease and assignment provisions a standard for granting or withholding approval, such as follows: “Tenant shall not assign this Lease or sublet all or any portion of the Premises without the prior written consent of Landlord, which consent Landlord may grant or withhold in Landlord's sole and absolute discretion.”

Then some landlords agreed to use a standard of reasonableness in granting or withholding consent. This produced some untoward results, so sophisticated landlords sought to head off any potential financial liability for their failure to approve a tenant's sublease or assignment request by inserting the following language into their leases:

Tenant's sole remedy in the event that Landlord shall wrongfully withhold consent to or disapprove any sublease or assignment request shall be to obtain an order by a court of competent jurisdiction that Landlord grant such consent; in no event shall Landlord be liable for damages with respect to its withheld consent to any proposed transfer.

Because of disputes concerning just what constituted “reasonableness” in this context, landlords started to set forth in leases what would be “reasonable.” For example:

Without limitation, it shall be deemed reasonable for Landlord to withhold its consent to a Transfer if any requirement, term or condition of this Section is not complied with or if: (i) the Transfer would cause Landlord to be in violation of its obligations under another lease or agreement to which Landlord is a party; (ii) in Landlord's reasonable judgment, a proposed transferee has a smaller net worth than Tenant had on the date this Lease was entered into with Tenant or is less able financially to pay the Rent due under this Lease as and when it is due and payable; (iii) a proposed transferee's business will impose a burden on the Building's parking facilities, elevators, Common Areas or utilities that is materially greater than the burden imposed by Tenant, in Landlord's sole judgment; (iv) the terms of a proposed Transfer will allow the proposed transferee to exercise or enjoy the benefit of a right of renewal, right of expansion, right of first offer, right of first refusal or similar right held by Tenant; (v) a proposed transferee refuses to enter into a written agreement, reasonably satisfactory to Landlord, which provides that it will abide by and assume all of the terms and conditions of this Lease for the term of any assignment or sublease and containing such other terms and conditions as Landlord reasonably deems necessary; (vi) the use of the Leased Premises by the proposed transferee will not be identical to the use permitted by this Lease; (vii) any guarantor of this Lease refuses to consent to the Transfer or to execute a written agreement reaffirming the guaranty; (viii) an Event of Default exists either at the time of the request or as of the effective date of the proposed Transfer; (ix) when requested by Landlord, the transferee refuses to sign a commercially reasonable non-disturbance and attornment agreement or estoppel certificate in favor of Landlord's lender; (x) Landlord or any mortgagee has sued or been sued by the proposed transferee or has otherwise been involved in a legal dispute with the proposed transferee; (xi) the proposed transferee is involved in a business which is not in keeping with the then current standards of the Building; (xii) the proposed transferee is an existing tenant of the Building or any other property owned by or managed by Landlord, or is a person or entity then negotiating with Landlord for the lease of space in the Building or any other property owned by or managed by Landlord; (xiii) in the event of a subletting, the proposed Transfer will result in a transfer of more than ____,000 rentable square feet of the Leased Premises; (xiv) in the event of an assignment, the proposed Transfer will result in an assignment of less than one hundred percent (100%) of the Leased Premises; or (xv) the terms of a proposed Transfer will allow the proposed transferee to pay a base net effective rent less than prevailing net effective rental rate in the Building at the time of Tenant's request to make such Transfer.

As mergers and acquisitions occurred with increased frequency, landlords realized that tenants could circumvent the landlord approval requirement in the case where a tenant merged or consolidated with another company and a new tenant entity resulted by operation of law. As such mergers are not deemed an “assignment” under common law, in order to retain control over subleasing and assignment in such lease, landlords added the following language to their sublease and assignment provisions: “Tenant shall not assign this Lease or sublet all or part of the Premises voluntarily or by operation of law.”

So too when shareholders or other holders of interests in a tenant sold a controlling interest in the tenant (which, without more, is not deemed to be an assignment), even though such a sale resulted in virtually a new tenant. Savvy landlords began to add the following language to control such situations:

If Tenant is a corporation, limited liability company, partnership or other entity and if at any time during the term of this Lease the person or persons who own a majority of either the outstanding voting rights or the outstanding ownership interests of Tenant as of the date hereof ceases to own a majority of such voting rights or ownership interests (except as a result of transfers by devise or descent) the loss of a majority of such voting rights or ownership interests shall be deemed to be an assignment of this Lease by Tenant and, therefore, subject to all of the provisions of this Section.

Tenants confronted with the foregoing “operation of law” and change of control provisions quickly realized that such provisions had a significant adverse impact on their business flexibility. For every potential merger, acquisition and sale of a controlling interest, tenants were required to obtain the consent of their landlord in order to proceed without breaking their lease. And so, tenants began negotiating for “permitted transfer” language, allowing them to effectuate a transfer by operation of law or by a sale of a controlling interest without the landlord's consent in certain situations. The following language began to appear in the sublease and assignment provisions:

… except that Tenant may assign this Lease or its interest therein or sublease the Premises to Tenant's parent corporation, Tenant's direct and indirect subsidiaries or entities under common control with Tenant or to Tenant's successor by way of merger, consolidation, sale of stock or assets, joint venture controlled by Tenant, or partnership of which Tenant is the sole general partner without the consent of Landlord.

During the heyday of the leveraged buyout, landlords were concerned about the amount of debt their tenants were suddenly carrying and provisions such as the following began to appear:

The involvement by Tenant or its assets in any transaction, or series of transactions (by way of merger, sale, acquisition, financing, refinancing, transfer, leveraged buy-out or otherwise) whether or not a formal assignment or hypothecation of this Lease or Tenant's assets occurs, which results or will result in a reduction of the “Net Worth” of Tenant as hereinafter defined, by an amount equal to or greater than twenty-five percent (25%) of such Net Worth of Tenant as it is represented to Landlord at the time of the execution by Landlord of this Lease, or as it exists immediately prior to said transaction or transactions constituting such reduction, at whichever time said Net Worth of Tenant was or is greater, shall be considered to be a transfer of the Tenant's leasehold interest. “Net Worth” of Tenant for purposes of this subsection shall be the net worth of Tenant established under generally accepted accounting principles (GAAP).

Changing real estate market conditions also had an enormous impact on the contents of sublease and assignment provisions. Landlords began to realize that tenants were profiting from their transfers during rising real estate markets. In order to capitalize upon rising rent prices, landlords began to insert into their leases provisions such as this:

In the event that any assignee or subtenant pays to Tenant any amounts which (after deducting therefrom actual costs to Tenant, amortized over the sublease or assignment term, of reasonable legal fees, brokerage fees and commissions, and improvements made to the Premises in connection with such sublease or assignment) exceed Base Rent and additional rent payable hereunder, or a pro rata portion thereof on a square footage basis for any portion of the Premises, Tenant shall promptly pay such excess to Landlord as and when received by Tenant.

However, by the process of negotiation, it became common practice for landlords and tenants to split the excess rental on some basis. In order to cut the tenant out of sublease and assignment profits altogether, landlords began to insert into their leases a right to recapture the proposed sublease space (or, in cases of an assignment, the entire demised premises) upon a tenant request for consent to sublease or assign. A typical right to recapture provision is as follows:

Notwithstanding anything to the contrary contained herein, Landlord shall have the option, in its sole discretion, in the event of any proposed subletting or assignment, to terminate this Lease, or in the case of a proposed subletting of less than the entire Premises, to recapture the portion of the Premises to be sublet, as of the date the subletting or assignment is to be effective. This option shall be exercised by Landlord's giving Tenant written notice thereof within ten (10) days following Landlord's receipt of Tenant's written notice of proposed assignment or subletting.

In order to retain their rights to collect sublease/assignment profits and to preserve their rights to utilize subleased space for use in the future, tenants began successfully negotiating limits on the landlord's right to recapture. For example, the right to recapture provision might contain the following language:

Notwithstanding the foregoing to the contrary, the provisions of this paragraph shall not apply to any request by Tenant for Landlord's consent to a proposed sublease if the sum of the total number of rentable square feet of the Premises that is subject to the proposed sublease (alone or in combination with previous subleases then in effect) is not greater than forty percent (40%) of the total number of rentable square feet in the Premises.

Modern sublease and assignment provisions can contain many other clauses to address the various needs of both landlords and tenants. Some additional clauses commonly seen in sublease and assignment provisions are: a tenant requirement that landlord's legal and administrative costs for considering sublease and assignment requests be capped; a tenant requirement that landlord consider sublease and assignment requests within a certain number of days, with such requests deemed approved if landlord fails to act in a timely fashion; a landlord counterposition which requires tenant to send a written reminder notice to landlord before such requests are deemed approved; and a landlord requirement that certain documents accompany every sublease and assignment request (eg, a copy of the proposed sublease or assignment or of the letter of intent between the tenant and the proposed subtenant or assignee, and a description of any alterations to be made prior to the proposed subtenant or assignee's occupancy) with landlord not having the duty to commence consideration of any sublease or assignment requests until all of the listed documents have been received.

As time passes, it is inevitable that today's standard sublease and assignment provisions will continue to evolve in order to address the changing needs of landlords and tenants in the marketplace. The simple, one-paragraph sublease and assignment provisions are likely gone forever. In their place will be highly structured, tightly drafted sublease and assignment provisions designed to address virtually every conceivable issue or dispute surrounding a sublease or assignment.

In the absence of a lease provision restricting subleasing and assignment, common law permits a tenant to freely sublease its leased premises or assign its leasehold interest in the leased premises. In order to provide for maximum landlord control over a tenant's ability to sublease or assign its leasehold interest, while at the same time balancing the need of tenants for an exit strategy, modern forms of leases contain extensive assignment and sublease provisions. This article traces the manner in which those provisions have evolved over the years.

Early assignment and sublease provisions were quite basic. Most landlords were satisfied with an outright prohibition, such as: “Tenant shall not assign this Lease or sublet all or a portion of the Premises.”

Then landlords began to acknowledge the possibility of assignment/subletting, but only with their prior written approval. So, there was grafted on to the simple prohibition the following approval requirement: “Tenant shall not assign this Lease or sublet all or a portion of the Premises without the prior written consent of Landlord.”

Landlords believed that the foregoing simple provision allowed a landlord to grant or withhold its consent at the landlord's whim. However, in cases such as Julian v. Christopher , 320 Md. 1, 575 A.2d 735 (1990), where the Court of Appeals of Maryland held that in the absence of language in the Lease setting forth a standard for approval of sublease and assignment requests, landlords were required to employ a “reasonableness” standard, this belief was shattered. Thereafter, landlords who wanted total control over sublease and assignment requests had to add to their sublease and assignment provisions a standard for granting or withholding approval, such as follows: “Tenant shall not assign this Lease or sublet all or any portion of the Premises without the prior written consent of Landlord, which consent Landlord may grant or withhold in Landlord's sole and absolute discretion.”

Then some landlords agreed to use a standard of reasonableness in granting or withholding consent. This produced some untoward results, so sophisticated landlords sought to head off any potential financial liability for their failure to approve a tenant's sublease or assignment request by inserting the following language into their leases:

Tenant's sole remedy in the event that Landlord shall wrongfully withhold consent to or disapprove any sublease or assignment request shall be to obtain an order by a court of competent jurisdiction that Landlord grant such consent; in no event shall Landlord be liable for damages with respect to its withheld consent to any proposed transfer.

Because of disputes concerning just what constituted “reasonableness” in this context, landlords started to set forth in leases what would be “reasonable.” For example:

Without limitation, it shall be deemed reasonable for Landlord to withhold its consent to a Transfer if any requirement, term or condition of this Section is not complied with or if: (i) the Transfer would cause Landlord to be in violation of its obligations under another lease or agreement to which Landlord is a party; (ii) in Landlord's reasonable judgment, a proposed transferee has a smaller net worth than Tenant had on the date this Lease was entered into with Tenant or is less able financially to pay the Rent due under this Lease as and when it is due and payable; (iii) a proposed transferee's business will impose a burden on the Building's parking facilities, elevators, Common Areas or utilities that is materially greater than the burden imposed by Tenant, in Landlord's sole judgment; (iv) the terms of a proposed Transfer will allow the proposed transferee to exercise or enjoy the benefit of a right of renewal, right of expansion, right of first offer, right of first refusal or similar right held by Tenant; (v) a proposed transferee refuses to enter into a written agreement, reasonably satisfactory to Landlord, which provides that it will abide by and assume all of the terms and conditions of this Lease for the term of any assignment or sublease and containing such other terms and conditions as Landlord reasonably deems necessary; (vi) the use of the Leased Premises by the proposed transferee will not be identical to the use permitted by this Lease; (vii) any guarantor of this Lease refuses to consent to the Transfer or to execute a written agreement reaffirming the guaranty; (viii) an Event of Default exists either at the time of the request or as of the effective date of the proposed Transfer; (ix) when requested by Landlord, the transferee refuses to sign a commercially reasonable non-disturbance and attornment agreement or estoppel certificate in favor of Landlord's lender; (x) Landlord or any mortgagee has sued or been sued by the proposed transferee or has otherwise been involved in a legal dispute with the proposed transferee; (xi) the proposed transferee is involved in a business which is not in keeping with the then current standards of the Building; (xii) the proposed transferee is an existing tenant of the Building or any other property owned by or managed by Landlord, or is a person or entity then negotiating with Landlord for the lease of space in the Building or any other property owned by or managed by Landlord; (xiii) in the event of a subletting, the proposed Transfer will result in a transfer of more than ____,000 rentable square feet of the Leased Premises; (xiv) in the event of an assignment, the proposed Transfer will result in an assignment of less than one hundred percent (100%) of the Leased Premises; or (xv) the terms of a proposed Transfer will allow the proposed transferee to pay a base net effective rent less than prevailing net effective rental rate in the Building at the time of Tenant's request to make such Transfer.

As mergers and acquisitions occurred with increased frequency, landlords realized that tenants could circumvent the landlord approval requirement in the case where a tenant merged or consolidated with another company and a new tenant entity resulted by operation of law. As such mergers are not deemed an “assignment” under common law, in order to retain control over subleasing and assignment in such lease, landlords added the following language to their sublease and assignment provisions: “Tenant shall not assign this Lease or sublet all or part of the Premises voluntarily or by operation of law.”

So too when shareholders or other holders of interests in a tenant sold a controlling interest in the tenant (which, without more, is not deemed to be an assignment), even though such a sale resulted in virtually a new tenant. Savvy landlords began to add the following language to control such situations:

If Tenant is a corporation, limited liability company, partnership or other entity and if at any time during the term of this Lease the person or persons who own a majority of either the outstanding voting rights or the outstanding ownership interests of Tenant as of the date hereof ceases to own a majority of such voting rights or ownership interests (except as a result of transfers by devise or descent) the loss of a majority of such voting rights or ownership interests shall be deemed to be an assignment of this Lease by Tenant and, therefore, subject to all of the provisions of this Section.

Tenants confronted with the foregoing “operation of law” and change of control provisions quickly realized that such provisions had a significant adverse impact on their business flexibility. For every potential merger, acquisition and sale of a controlling interest, tenants were required to obtain the consent of their landlord in order to proceed without breaking their lease. And so, tenants began negotiating for “permitted transfer” language, allowing them to effectuate a transfer by operation of law or by a sale of a controlling interest without the landlord's consent in certain situations. The following language began to appear in the sublease and assignment provisions:

… except that Tenant may assign this Lease or its interest therein or sublease the Premises to Tenant's parent corporation, Tenant's direct and indirect subsidiaries or entities under common control with Tenant or to Tenant's successor by way of merger, consolidation, sale of stock or assets, joint venture controlled by Tenant, or partnership of which Tenant is the sole general partner without the consent of Landlord.

During the heyday of the leveraged buyout, landlords were concerned about the amount of debt their tenants were suddenly carrying and provisions such as the following began to appear:

The involvement by Tenant or its assets in any transaction, or series of transactions (by way of merger, sale, acquisition, financing, refinancing, transfer, leveraged buy-out or otherwise) whether or not a formal assignment or hypothecation of this Lease or Tenant's assets occurs, which results or will result in a reduction of the “Net Worth” of Tenant as hereinafter defined, by an amount equal to or greater than twenty-five percent (25%) of such Net Worth of Tenant as it is represented to Landlord at the time of the execution by Landlord of this Lease, or as it exists immediately prior to said transaction or transactions constituting such reduction, at whichever time said Net Worth of Tenant was or is greater, shall be considered to be a transfer of the Tenant's leasehold interest. “Net Worth” of Tenant for purposes of this subsection shall be the net worth of Tenant established under generally accepted accounting principles (GAAP).

Changing real estate market conditions also had an enormous impact on the contents of sublease and assignment provisions. Landlords began to realize that tenants were profiting from their transfers during rising real estate markets. In order to capitalize upon rising rent prices, landlords began to insert into their leases provisions such as this:

In the event that any assignee or subtenant pays to Tenant any amounts which (after deducting therefrom actual costs to Tenant, amortized over the sublease or assignment term, of reasonable legal fees, brokerage fees and commissions, and improvements made to the Premises in connection with such sublease or assignment) exceed Base Rent and additional rent payable hereunder, or a pro rata portion thereof on a square footage basis for any portion of the Premises, Tenant shall promptly pay such excess to Landlord as and when received by Tenant.

However, by the process of negotiation, it became common practice for landlords and tenants to split the excess rental on some basis. In order to cut the tenant out of sublease and assignment profits altogether, landlords began to insert into their leases a right to recapture the proposed sublease space (or, in cases of an assignment, the entire demised premises) upon a tenant request for consent to sublease or assign. A typical right to recapture provision is as follows:

Notwithstanding anything to the contrary contained herein, Landlord shall have the option, in its sole discretion, in the event of any proposed subletting or assignment, to terminate this Lease, or in the case of a proposed subletting of less than the entire Premises, to recapture the portion of the Premises to be sublet, as of the date the subletting or assignment is to be effective. This option shall be exercised by Landlord's giving Tenant written notice thereof within ten (10) days following Landlord's receipt of Tenant's written notice of proposed assignment or subletting.

In order to retain their rights to collect sublease/assignment profits and to preserve their rights to utilize subleased space for use in the future, tenants began successfully negotiating limits on the landlord's right to recapture. For example, the right to recapture provision might contain the following language:

Notwithstanding the foregoing to the contrary, the provisions of this paragraph shall not apply to any request by Tenant for Landlord's consent to a proposed sublease if the sum of the total number of rentable square feet of the Premises that is subject to the proposed sublease (alone or in combination with previous subleases then in effect) is not greater than forty percent (40%) of the total number of rentable square feet in the Premises.

Modern sublease and assignment provisions can contain many other clauses to address the various needs of both landlords and tenants. Some additional clauses commonly seen in sublease and assignment provisions are: a tenant requirement that landlord's legal and administrative costs for considering sublease and assignment requests be capped; a tenant requirement that landlord consider sublease and assignment requests within a certain number of days, with such requests deemed approved if landlord fails to act in a timely fashion; a landlord counterposition which requires tenant to send a written reminder notice to landlord before such requests are deemed approved; and a landlord requirement that certain documents accompany every sublease and assignment request (eg, a copy of the proposed sublease or assignment or of the letter of intent between the tenant and the proposed subtenant or assignee, and a description of any alterations to be made prior to the proposed subtenant or assignee's occupancy) with landlord not having the duty to commence consideration of any sublease or assignment requests until all of the listed documents have been received.

As time passes, it is inevitable that today's standard sublease and assignment provisions will continue to evolve in order to address the changing needs of landlords and tenants in the marketplace. The simple, one-paragraph sublease and assignment provisions are likely gone forever. In their place will be highly structured, tightly drafted sublease and assignment provisions designed to address virtually every conceivable issue or dispute surrounding a sublease or assignment.