In the Spotlight: Selected Landlord Considerations Following a Request to Sublease

In the current economy, businesses are leaving no stone unturned in their pursuit of cost-savings. Many firms facing declining sales, scaled-back operations and leaner staffing are forced to deal with substantial portions of leased real estate that are either underused or vacant. In lieu of significant economic concessions from the landlord, companies with excess leased space are turning to a logical refuge: the sublease market.

Creating a Sublease Strategy

A commercial tenant seeking to sublease its space will have relatively straightforward concerns in creating a sublease strategy. In general, as long as the proposed subtenant is acceptable to the landlord and the sublease rent is sufficient to keep the tenant current on its rent and out of default under its lease, subleasing will be a sound option. After all, in seeking out a candidate for sublease, the tenant is really just looking for a stable surrogate to accept some of its economic burden.

But what about the concerns of the landlord? Often, the tenant will approach the landlord regarding a sublease years into the term of the lease. The lease may have been entered into during a time when the tenant was financially healthy, and at the time the parties may have been focused more on the then-current health and future growth of the tenant ' in the form of expansion and extension rights, rights of first refusal and so forth ' than preparing for a potential sublease. Most commercial leases contain some type of landlord protection with respect to subleasing, in the form of an outright prohibition or the right of the landlord to consent to any sublease. In either instance, when approached for its waiver or consent, the landlord will have ample opportunity to condition its decision on a variety of agreements by both the tenant and the proposed subtenant.

The Prime Lease and the Sublease

When considering whether or not it should consent to a sublease, the landlord should not be content merely with the maintenance of income derived from the prime lease; instead, the landlord should have a thorough understanding of the conceptual and concrete relationship between the prime lease and the sublease and the parties thereto. The landlord should be cognizant of all of the rights with respect to all parties occupying its building, and all of its remedies against such parties in the event of a default under the prime lease.

A foundational tenet of subleasing is that following any sublease, a tenant remains liable for all of its obligations under the prime lease. Still, at the time of consent, if such a provision is not already in the prime lease, the landlord should seek written affirmation from the tenant that the sublease will not release the tenant from any provisions of the prime lease, and that nothing in the sublease will enhance or increase the landlord's obligations under the prime lease. In addition, to protect the landlord against any equivocation of the terms of the prime lease, the landlord should pursue an agreement from both the tenant and the subtenant that the sublease is subject and subordinate to all provisions of the prime lease.

Obtaining an Express Covenant

Ideally, the landlord will obtain from the subtenant an express covenant that it will be bound by all provisions of the prime lease. This agreement may except certain provisions that may be specifically excluded because they are not germane to the subtenant's occupancy, e.g., obligations of the tenant with respect to initial tenant work or limitations on the prime tenant's use of the premises. The subtenant should agree that no provision of the sublease or right of the subtenant thereunder will violate the terms of the prime lease. Notwithstanding any such covenant, in the absence of privity between the landlord and the subtenant, the subtenant will not be permitted to enforce the terms of the prime lease against the landlord. Like any other lease concession afforded to the tenant, consent to a sublease should not be offered unconditionally, and a prudent landlord will only agree to consent if in exchange the tenant and the proposed subtenant agree to certain conditions precedent. For example, the landlord should require that the tenant and subtenant each represent and warrant that a copy of the sublease attached as an exhibit to the consent is a true, correct and complete copy thereof, and that the document contains the entire agreement of the parties with respect to the subject matter therein. These kinds of affirmative statements will enable the landlord to maintain a thorough knowledge of the terms of the sublease and protect the landlord against future claims arising from sublease terms withheld by the tenant and subtenant.

Estoppel-Like Statements

A request for consent might also present an opportunity for the landlord to obtain estoppel-like statements from the tenant. For example, the landlord might have the tenant confirm that the there are no conditions that could mature into a claim for default, that the landlord has performed all of its obligations under the lease, or that the tenant has no defenses or offsets as of the date of the consent. Like an estoppel certificate, the consent document can offer to the landlord valuable protections against future claims by its tenant. A tenant's obligation to pay rent under its lease is unaffected by a sublease of the tenant's space. Still, prior to consenting to a sublease, a landlord should receive three express agreements from the tenant and subtenant. First, the landlord should receive from the tenant an assignment of all sublease rent and any other amounts payable under the sublease. Second, the landlord should authorize and direct the subtenant to pay rent under the sublease directly to the landlord following a default under the prime lease, and the landlord should grant to the tenant a license to collect such amounts from the subtenant prior to any default. Third, the tenant should acknowledge to the landlord that any acceptance of rent from the subtenant does not constitute a waiver by the landlord of any provision of, or rights of landlord against the tenant under, the prime lease.

The landlord's consent may also define the contours of the relationship between the landlord and the subtenant following a default by the tenant. The landlord should require that the subtenant deliver to the landlord all notices of default by the tenant as sublandlord under the sublease and that the tenant deliver to the landlord all notices of default by the subtenant under the sublease.

In almost any instance, the subtenant will request that the landlord agree not to disturb the subtenant's continuing use and occupancy of the premises following a default by the tenant. However, to maintain optimal flexibility, the landlord should maintain the sole option to either terminate the sublease or enter into a direct lease with the subtenant. Depending on the size of the subleased premises, the remaining term and rent under the sublease, the landlord may find it advantageous to terminate the sublease and market the prime lease space in its entirety.

Subtenant Bargaining Power

Record-setting vacancy rates have produced markedly increased subtenant bargaining power, and companies seeking to sublease space will often expect significant concessions, including improvement rights. Landlords should be wary of distressed tenants granting extensive rights to subtenants without consideration of the landlord's interests. From the landlord's perspective, assuming the prime lease contains adequate landlord protection with respect to tenant improvements, the consent document should affirm that all work to be performed by the subtenant in the premises must be done so in accordance with the terms and conditions of the prime lease. The landlord should be permitted to review and approve in advance all plans and specifications with respect to the work and to either select or approve all contractors hired to perform the work. Additionally, the landlord may want the right to supervise the performance of the work in the subleased space, and to impose a fee for doing so.

Restoration Provisions

Restoration provisions may also be of critical importance, particularly where the subtenant is performing substantial work in the premises. A tenant under financial strain will likely pursue an agreement by the subtenant to assume all obligations with respect to restoration of the subleased premises. Conversely, a subtenant wielding greater leverage will push the tenant to retain all duties to restore. To avoid the potential liability associated with such conflicting obligations, the landlord should pursue in its consent document an acknowledgment from both the tenant and the subtenant that each will adhere to the provisions of the prime lease with respect to restoration of the space, and a joint and several indemnity with respect to any restoration.

Conclusion

As many businesses struggle to safeguard their solvency, subleasing has become an increasingly prevalent cost-saving measure throughout all sectors of commercial real estate. Prior to consenting to a sublease, a landlord should be acutely aware of its rights and remedies against the proposed subtenant, and should negotiate a consent document that reinforces those principles.

David Resnick, a member of this newsletter's Board of Editors, is an associate in the Business Transactions Department of Wildman, Harrold, Allen & Dixon LLP. He has experience in a full range of real estate transactions, including acquisitions and dispositions, leasing, development, construction and debt and equity financing.

In the current economy, businesses are leaving no stone unturned in their pursuit of cost-savings. Many firms facing declining sales, scaled-back operations and leaner staffing are forced to deal with substantial portions of leased real estate that are either underused or vacant. In lieu of significant economic concessions from the landlord, companies with excess leased space are turning to a logical refuge: the sublease market.

Creating a Sublease Strategy

A commercial tenant seeking to sublease its space will have relatively straightforward concerns in creating a sublease strategy. In general, as long as the proposed subtenant is acceptable to the landlord and the sublease rent is sufficient to keep the tenant current on its rent and out of default under its lease, subleasing will be a sound option. After all, in seeking out a candidate for sublease, the tenant is really just looking for a stable surrogate to accept some of its economic burden.

But what about the concerns of the landlord? Often, the tenant will approach the landlord regarding a sublease years into the term of the lease. The lease may have been entered into during a time when the tenant was financially healthy, and at the time the parties may have been focused more on the then-current health and future growth of the tenant ' in the form of expansion and extension rights, rights of first refusal and so forth ' than preparing for a potential sublease. Most commercial leases contain some type of landlord protection with respect to subleasing, in the form of an outright prohibition or the right of the landlord to consent to any sublease. In either instance, when approached for its waiver or consent, the landlord will have ample opportunity to condition its decision on a variety of agreements by both the tenant and the proposed subtenant.

The Prime Lease and the Sublease

When considering whether or not it should consent to a sublease, the landlord should not be content merely with the maintenance of income derived from the prime lease; instead, the landlord should have a thorough understanding of the conceptual and concrete relationship between the prime lease and the sublease and the parties thereto. The landlord should be cognizant of all of the rights with respect to all parties occupying its building, and all of its remedies against such parties in the event of a default under the prime lease.

A foundational tenet of subleasing is that following any sublease, a tenant remains liable for all of its obligations under the prime lease. Still, at the time of consent, if such a provision is not already in the prime lease, the landlord should seek written affirmation from the tenant that the sublease will not release the tenant from any provisions of the prime lease, and that nothing in the sublease will enhance or increase the landlord's obligations under the prime lease. In addition, to protect the landlord against any equivocation of the terms of the prime lease, the landlord should pursue an agreement from both the tenant and the subtenant that the sublease is subject and subordinate to all provisions of the prime lease.

Obtaining an Express Covenant

Ideally, the landlord will obtain from the subtenant an express covenant that it will be bound by all provisions of the prime lease. This agreement may except certain provisions that may be specifically excluded because they are not germane to the subtenant's occupancy, e.g., obligations of the tenant with respect to initial tenant work or limitations on the prime tenant's use of the premises. The subtenant should agree that no provision of the sublease or right of the subtenant thereunder will violate the terms of the prime lease. Notwithstanding any such covenant, in the absence of privity between the landlord and the subtenant, the subtenant will not be permitted to enforce the terms of the prime lease against the landlord. Like any other lease concession afforded to the tenant, consent to a sublease should not be offered unconditionally, and a prudent landlord will only agree to consent if in exchange the tenant and the proposed subtenant agree to certain conditions precedent. For example, the landlord should require that the tenant and subtenant each represent and warrant that a copy of the sublease attached as an exhibit to the consent is a true, correct and complete copy thereof, and that the document contains the entire agreement of the parties with respect to the subject matter therein. These kinds of affirmative statements will enable the landlord to maintain a thorough knowledge of the terms of the sublease and protect the landlord against future claims arising from sublease terms withheld by the tenant and subtenant.

Estoppel-Like Statements

A request for consent might also present an opportunity for the landlord to obtain estoppel-like statements from the tenant. For example, the landlord might have the tenant confirm that the there are no conditions that could mature into a claim for default, that the landlord has performed all of its obligations under the lease, or that the tenant has no defenses or offsets as of the date of the consent. Like an estoppel certificate, the consent document can offer to the landlord valuable protections against future claims by its tenant. A tenant's obligation to pay rent under its lease is unaffected by a sublease of the tenant's space. Still, prior to consenting to a sublease, a landlord should receive three express agreements from the tenant and subtenant. First, the landlord should receive from the tenant an assignment of all sublease rent and any other amounts payable under the sublease. Second, the landlord should authorize and direct the subtenant to pay rent under the sublease directly to the landlord following a default under the prime lease, and the landlord should grant to the tenant a license to collect such amounts from the subtenant prior to any default. Third, the tenant should acknowledge to the landlord that any acceptance of rent from the subtenant does not constitute a waiver by the landlord of any provision of, or rights of landlord against the tenant under, the prime lease.

The landlord's consent may also define the contours of the relationship between the landlord and the subtenant following a default by the tenant. The landlord should require that the subtenant deliver to the landlord all notices of default by the tenant as sublandlord under the sublease and that the tenant deliver to the landlord all notices of default by the subtenant under the sublease.

In almost any instance, the subtenant will request that the landlord agree not to disturb the subtenant's continuing use and occupancy of the premises following a default by the tenant. However, to maintain optimal flexibility, the landlord should maintain the sole option to either terminate the sublease or enter into a direct lease with the subtenant. Depending on the size of the subleased premises, the remaining term and rent under the sublease, the landlord may find it advantageous to terminate the sublease and market the prime lease space in its entirety.

Subtenant Bargaining Power

Record-setting vacancy rates have produced markedly increased subtenant bargaining power, and companies seeking to sublease space will often expect significant concessions, including improvement rights. Landlords should be wary of distressed tenants granting extensive rights to subtenants without consideration of the landlord's interests. From the landlord's perspective, assuming the prime lease contains adequate landlord protection with respect to tenant improvements, the consent document should affirm that all work to be performed by the subtenant in the premises must be done so in accordance with the terms and conditions of the prime lease. The landlord should be permitted to review and approve in advance all plans and specifications with respect to the work and to either select or approve all contractors hired to perform the work. Additionally, the landlord may want the right to supervise the performance of the work in the subleased space, and to impose a fee for doing so.

Restoration Provisions

Restoration provisions may also be of critical importance, particularly where the subtenant is performing substantial work in the premises. A tenant under financial strain will likely pursue an agreement by the subtenant to assume all obligations with respect to restoration of the subleased premises. Conversely, a subtenant wielding greater leverage will push the tenant to retain all duties to restore. To avoid the potential liability associated with such conflicting obligations, the landlord should pursue in its consent document an acknowledgment from both the tenant and the subtenant that each will adhere to the provisions of the prime lease with respect to restoration of the space, and a joint and several indemnity with respect to any restoration.

Conclusion

As many businesses struggle to safeguard their solvency, subleasing has become an increasingly prevalent cost-saving measure throughout all sectors of commercial real estate. Prior to consenting to a sublease, a landlord should be acutely aware of its rights and remedies against the proposed subtenant, and should negotiate a consent document that reinforces those principles.

David Resnick, a member of this newsletter's Board of Editors, is an associate in the Business Transactions Department of Wildman, Harrold, Allen & Dixon LLP. He has experience in a full range of real estate transactions, including acquisitions and dispositions, leasing, development, construction and debt and equity financing.