In the Spotlight: Structuring Lease Takeovers

I Know What You're Thinking

“Not my problem,” is what a landlord, its leasing representative and counsel would typically respond in this situation. They would expect the tenant to sublet its existing space or assign its lease. Taking such a position at the outset would, in all likelihood, take a landlord out of the running for this prospective tenant.

Today's markets and economy demand a proactive and creative approach. Moreover, a savvy tenant and its broker might include in its RFP or lease requirements a request for a proposal on handling a tenant's existing lease obligations. Faced with the prospect of losing a building to a lender, no landlord can afford to ignore the “lease takeover” options available to the parties.

Some Initial Observations

Here are some observations regarding when a “lease takeover” may come into play. First, the professionals advising the existing tenant need to examine carefully the terms of the existing lease, not only to confirm the rental obligations, remaining term, the existence of any options to terminate, renew or expand in favor of either party and the like, but to ascertain the tenant's rights to assign the lease or sublet the space, as well as covenants in the lease against entering into so-called “takeover agreements” or vacating, deserting or abandoning the space. Even if the tenant's advisers ultimately recommend subletting the space because the existing lease rent is below market, an early and thorough lease review is critical.

Some leases, in fact, prohibit a tenant from entering into a “lease takeover” agreement explicitly, although that term is not defined. For instance: Is a reimbursement agreement, as described later in this article, a “lease takeover” agreement? Does a “lease takeover” agreement require a tenant to turn control over the space to the new landlord (or its designee)?

Likewise, when a prospective tenant broaches the subject of a “lease takeover,” a landlord needs to undertake the same analysis in order to ascertain what options are legally available. For instance, assume ' as discussed later ' that the existing tenant's lease prohibits a subtenant from further sub-subletting space. One option, i.e., having the new landlord sublease the existing tenant's space, is not viable without some concession from the prospective tenant's landlord ' an unlikely event.

A “lease takeover” is much more likely to be a consideration when the leasing market is weak or recovering and tenants have leverage. In a tight leasing market, landlords can generally avoid “lease takeover” obligations.

“Lease takeovers” are generally done with major tenants looking to lease significant space with expansion options. It is difficult to say how large the tenant has to be; suffice to say that, in Manhattan, a “lease takeover” involving less than 100,000 square feet does not occur often.

An existing lease with a considerable remaining term, generally over four years, or a modest remaining term, generally less than two years, is a difficult candidate for a “lease takeover.” A lengthy remaining term means that there is a considerable financial commitment involved making it difficult for the parties to factor into a new lease deal. Moreover, with a term of this length, subleasing the space or assigning the lease by the tenant, without Landlord involvement, is a much more viable option.

Landlord's 'Takeover' Options

The simplest option, at least structurally, available to a landlord is to mitigate the prospective tenant's obligation by contributing financially. This contribution can come in the form of larger rental concessions and “discounting” market rental rates until the existing rental obligations expire. These concessions can be recouped in the later years, with the size of the concessions and recoupment dependent on bargaining power of the parties.

If there is reason to believe that the landlord under the prospective tenant's existing lease would terminate such lease in return for a surrender payment, a landlord can offer to contribute to such surrender payment as an inducement to the prospective tenant. This option requires an upfront financial outlay by the landlord, however, it also may be recouped over the term of a new lease depending on the parties' bargaining power. More importantly, it may distinguish a landlord's building from the pack and be the decisive factor in getting a new lease signed.

In structuring the lease, the landlord will have to factor its “contribution,” whether additional rental concessions or a cash outlay into its credit analysis of the prospective tenant and determination as to the need for guaranties, letters of credit or other forms of security.

Another available option is for the parties to enter into an agreement whereby a landlord agrees to reimburse its new tenant for its existing rental obligations as they become due and payable. Again, the extent of the reimbursement depends on the parties' bargaining power. In this reimbursement agreement, the landlord would condition such reimbursement payments on the performance and payment by the new tenant under its new lease. In fact, the landlord may want to recoup some portion of such reimbursements made if its new tenant does not pay its rent for the full term. The landlord should also consider requiring the new tenant to hire a leasing broker and covenant to mitigate its existing rent by subleasing its existing space or assigning its existing lease. In the alternative, the landlord can negotiate the right to market the space and enter into subleases on behalf of the new tenant, in order to reduce the landlord's obligations under the reimbursement agreement. As you can see, the negotiation of a reimbursement agreement requires attention to many critical issues.

Landlord Sublease or Assignment

Many “lease takeovers” take the form of a sublease of the existing lease space or an assignment of the existing lease to the new landlord or its designee by the prospective tenant. A sublease gives the new landlord/subtenant control over the space in mitigating the existing rental obligation and does not make the landlord liable to the existing landlord. Before entering into this arrangement, the new landlord/subtenant will have carefully assessed the market for such space ' the anticipated marketing “down time” (time that the space will be vacant), the rental rates, the brokerage and other costs in securing sub-subtenants and building out the space. This market due diligence and the relative bargaining power of the parties determine the financial aspects of the sublease and the new lease, particularly how much subrent the new landlord can pay.

With a sublease, the new landlord/subtenant will, in most instances, be faced with the need to obtain the consent of the existing landlord to each sub-sublease. Not happy with having lost a tenant, the existing landlord's consent may be problematic and often depends on its business reputation.

Many other issues will have to be negotiated in this sublease. The new landlord/subtenant wants maximum flexibility in dealing with the sublease space and lease that it has “taken over,” while the tenant will be wary, since it continues to have liability to its old landlord. The new landlord/subtenant will want the tenant to take any action under the lease that the new landlord/subtenant requests so long as: 1) the overlandlord consents, if required; 2) the action does not increase the lease obligations; and 3) the new landlord/subtenant is not in default under the sublease. If the new landlord/subtenant negotiates a sub-sublease or perhaps a surrender of all or a portion of the lease to the overlandlord, the new landlord/subtenant will want the tenant to “go along” with such request subject to the conditions described above.

As alluded to earlier, if the existing lease prohibits sub-subleasing by a subtenant, then the new landlord may have to take an assignment of the existing lease to enable it to enter into subleases as a way of mitigating the existing rental obligation. This assignment of lease brings with it direct liability to the existing landlord, joint and several with the original tenant. As a result, with a lease assignment and in any “takeover” structure, it often may be prudent for the existing landlord to use a designee entity. In addition to better insulating the existing landlord's assets from direct liability, the existing landlord may be an SPE (special purpose entity) and may be prohibited by its mortgage loan and organizational documents from entering into these agreements.

In any “takeover” arrangement, a reimbursement agreement, a sublease or an assignment to the new landlord, the tenant will be concerned with a default by new landlord under its sublease or, in the case of the assignment, the existing lease. If such a default occurs, the tenant is losing a critical component of its bargain ' the “takeover” ' and may be forced to make payments under its new lease and old lease. The new landlord typically has only one asset ' the building being leased to tenant. The new landlord will make the case that it has sufficient equity in the asset to secure performance of its obligations under a sublease or lease assignment, which liability would typically not exceed four years. Nevertheless, a tenant will often insist on some other “liquid” security ' such as a letter of credit, guaranty from new landlord's parent company, or a right to setoff under the new lease. This setoff right provides, in essence, that if the new landlord defaults under the sublease or, in the case of an assignment, the existing lease, then the tenant has the right to cure such default (for instance, by making a defaulted payment) and deduct the amounts expended from the rent due under its new lease. This right of setoff will need to be approved by the new landlord's lenders, and the tenant will want the lenders to agree in a non-disturbance subordination and attornment agreement to be expressly bound by this setoff right in the event it forecloses or otherwise becomes the owner and landlord.

Conclusion

In the end, “takeover” agreements may not be a pleasant option for a landlord. They raise many issues that require hammering out in negotiations. Worse, they represent an additional cost of getting a lease deal done. However, a landlord that does not give “takeover” structures due consideration when they are presented in a proposed transaction risks losing a critical lease in a competitive leasing market.

Anthony Casareale is Of Counsel with Greenberg Traurig LLP in New York and Miami, with a real estate practice that is national in scope, representing clients in a broad range of transactions.

A large corporate tenant has outgrown its space in Manhattan and there is not sufficient space in the building coming available to meet its needs. This company sees a market brimming with opportunities. The economy and leasing market are still recovering. Rents are attractive and there are several available blocks of space that suit its needs, many in state-of-the-art new buildings.

A landlord becomes aware of this company's interest in relocating. This landlord's building has been slow to lease up since being completed in 2008, and faces a 40% vacancy and a mortgage loan that will soon be in default if this vacancy rate lingers.

There is, however, a critical obstacle to getting a deal done. The prospective tenant has just under three years remaining on its current lease term. Faced with a significant current lease obligation, how can the company and landlord make a deal? This article explores the “lease takeover” options available to an aggressive, creative landlord looking to get such a critical deal done.

I Know What You're Thinking

“Not my problem,” is what a landlord, its leasing representative and counsel would typically respond in this situation. They would expect the tenant to sublet its existing space or assign its lease. Taking such a position at the outset would, in all likelihood, take a landlord out of the running for this prospective tenant.

Today's markets and economy demand a proactive and creative approach. Moreover, a savvy tenant and its broker might include in its RFP or lease requirements a request for a proposal on handling a tenant's existing lease obligations. Faced with the prospect of losing a building to a lender, no landlord can afford to ignore the “lease takeover” options available to the parties.

Some Initial Observations

Here are some observations regarding when a “lease takeover” may come into play. First, the professionals advising the existing tenant need to examine carefully the terms of the existing lease, not only to confirm the rental obligations, remaining term, the existence of any options to terminate, renew or expand in favor of either party and the like, but to ascertain the tenant's rights to assign the lease or sublet the space, as well as covenants in the lease against entering into so-called “takeover agreements” or vacating, deserting or abandoning the space. Even if the tenant's advisers ultimately recommend subletting the space because the existing lease rent is below market, an early and thorough lease review is critical.

Some leases, in fact, prohibit a tenant from entering into a “lease takeover” agreement explicitly, although that term is not defined. For instance: Is a reimbursement agreement, as described later in this article, a “lease takeover” agreement? Does a “lease takeover” agreement require a tenant to turn control over the space to the new landlord (or its designee)?

Likewise, when a prospective tenant broaches the subject of a “lease takeover,” a landlord needs to undertake the same analysis in order to ascertain what options are legally available. For instance, assume ' as discussed later ' that the existing tenant's lease prohibits a subtenant from further sub-subletting space. One option, i.e., having the new landlord sublease the existing tenant's space, is not viable without some concession from the prospective tenant's landlord ' an unlikely event.

A “lease takeover” is much more likely to be a consideration when the leasing market is weak or recovering and tenants have leverage. In a tight leasing market, landlords can generally avoid “lease takeover” obligations.

“Lease takeovers” are generally done with major tenants looking to lease significant space with expansion options. It is difficult to say how large the tenant has to be; suffice to say that, in Manhattan, a “lease takeover” involving less than 100,000 square feet does not occur often.

An existing lease with a considerable remaining term, generally over four years, or a modest remaining term, generally less than two years, is a difficult candidate for a “lease takeover.” A lengthy remaining term means that there is a considerable financial commitment involved making it difficult for the parties to factor into a new lease deal. Moreover, with a term of this length, subleasing the space or assigning the lease by the tenant, without Landlord involvement, is a much more viable option.

Landlord's 'Takeover' Options

The simplest option, at least structurally, available to a landlord is to mitigate the prospective tenant's obligation by contributing financially. This contribution can come in the form of larger rental concessions and “discounting” market rental rates until the existing rental obligations expire. These concessions can be recouped in the later years, with the size of the concessions and recoupment dependent on bargaining power of the parties.

If there is reason to believe that the landlord under the prospective tenant's existing lease would terminate such lease in return for a surrender payment, a landlord can offer to contribute to such surrender payment as an inducement to the prospective tenant. This option requires an upfront financial outlay by the landlord, however, it also may be recouped over the term of a new lease depending on the parties' bargaining power. More importantly, it may distinguish a landlord's building from the pack and be the decisive factor in getting a new lease signed.

In structuring the lease, the landlord will have to factor its “contribution,” whether additional rental concessions or a cash outlay into its credit analysis of the prospective tenant and determination as to the need for guaranties, letters of credit or other forms of security.

Another available option is for the parties to enter into an agreement whereby a landlord agrees to reimburse its new tenant for its existing rental obligations as they become due and payable. Again, the extent of the reimbursement depends on the parties' bargaining power. In this reimbursement agreement, the landlord would condition such reimbursement payments on the performance and payment by the new tenant under its new lease. In fact, the landlord may want to recoup some portion of such reimbursements made if its new tenant does not pay its rent for the full term. The landlord should also consider requiring the new tenant to hire a leasing broker and covenant to mitigate its existing rent by subleasing its existing space or assigning its existing lease. In the alternative, the landlord can negotiate the right to market the space and enter into subleases on behalf of the new tenant, in order to reduce the landlord's obligations under the reimbursement agreement. As you can see, the negotiation of a reimbursement agreement requires attention to many critical issues.

Landlord Sublease or Assignment

Many “lease takeovers” take the form of a sublease of the existing lease space or an assignment of the existing lease to the new landlord or its designee by the prospective tenant. A sublease gives the new landlord/subtenant control over the space in mitigating the existing rental obligation and does not make the landlord liable to the existing landlord. Before entering into this arrangement, the new landlord/subtenant will have carefully assessed the market for such space ' the anticipated marketing “down time” (time that the space will be vacant), the rental rates, the brokerage and other costs in securing sub-subtenants and building out the space. This market due diligence and the relative bargaining power of the parties determine the financial aspects of the sublease and the new lease, particularly how much subrent the new landlord can pay.

With a sublease, the new landlord/subtenant will, in most instances, be faced with the need to obtain the consent of the existing landlord to each sub-sublease. Not happy with having lost a tenant, the existing landlord's consent may be problematic and often depends on its business reputation.

Many other issues will have to be negotiated in this sublease. The new landlord/subtenant wants maximum flexibility in dealing with the sublease space and lease that it has “taken over,” while the tenant will be wary, since it continues to have liability to its old landlord. The new landlord/subtenant will want the tenant to take any action under the lease that the new landlord/subtenant requests so long as: 1) the overlandlord consents, if required; 2) the action does not increase the lease obligations; and 3) the new landlord/subtenant is not in default under the sublease. If the new landlord/subtenant negotiates a sub-sublease or perhaps a surrender of all or a portion of the lease to the overlandlord, the new landlord/subtenant will want the tenant to “go along” with such request subject to the conditions described above.

As alluded to earlier, if the existing lease prohibits sub-subleasing by a subtenant, then the new landlord may have to take an assignment of the existing lease to enable it to enter into subleases as a way of mitigating the existing rental obligation. This assignment of lease brings with it direct liability to the existing landlord, joint and several with the original tenant. As a result, with a lease assignment and in any “takeover” structure, it often may be prudent for the existing landlord to use a designee entity. In addition to better insulating the existing landlord's assets from direct liability, the existing landlord may be an SPE (special purpose entity) and may be prohibited by its mortgage loan and organizational documents from entering into these agreements.

In any “takeover” arrangement, a reimbursement agreement, a sublease or an assignment to the new landlord, the tenant will be concerned with a default by new landlord under its sublease or, in the case of the assignment, the existing lease. If such a default occurs, the tenant is losing a critical component of its bargain ' the “takeover” ' and may be forced to make payments under its new lease and old lease. The new landlord typically has only one asset ' the building being leased to tenant. The new landlord will make the case that it has sufficient equity in the asset to secure performance of its obligations under a sublease or lease assignment, which liability would typically not exceed four years. Nevertheless, a tenant will often insist on some other “liquid” security ' such as a letter of credit, guaranty from new landlord's parent company, or a right to setoff under the new lease. This setoff right provides, in essence, that if the new landlord defaults under the sublease or, in the case of an assignment, the existing lease, then the tenant has the right to cure such default (for instance, by making a defaulted payment) and deduct the amounts expended from the rent due under its new lease. This right of setoff will need to be approved by the new landlord's lenders, and the tenant will want the lenders to agree in a non-disturbance subordination and attornment agreement to be expressly bound by this setoff right in the event it forecloses or otherwise becomes the owner and landlord.

Conclusion

In the end, “takeover” agreements may not be a pleasant option for a landlord. They raise many issues that require hammering out in negotiations. Worse, they represent an additional cost of getting a lease deal done. However, a landlord that does not give “takeover” structures due consideration when they are presented in a proposed transaction risks losing a critical lease in a competitive leasing market.

Anthony Casareale is Of Counsel with Greenberg Traurig LLP in New York and Miami, with a real estate practice that is national in scope, representing clients in a broad range of transactions.