In the Spotlight: The Assignment Provision

In addition, the landlord may attempt to further restrict the tenant's right to assign the lease within the definition of an “assignment” under the lease, and tenants tend to gloss over such provisions without significant review. Nevertheless, definitions of an assignment, which can be located in a section of the lease wholly apart from the assignment provision, are often fully articulated and are commonly very unfavorable to the tenant. Frequently, these definitions include any changes in the control of the tenant, as well as any transfers of ownership interests in the tenant. An example of such language is as follows:

The sale, issuance or transfer of any voting capital stock of Tenant which results in a change in the direct or indirect voting control of Tenant shall be deemed to be an assignment of this Lease. If Tenant is a partnership, limited liability company, trust or an unincorporated association, then the sale, issuance or transfer of a controlling interest therein, or the transfer of any portion of any general partnership or managing interest in Tenant shall be deemed to be an assignment of this Lease.

A close reading of the foregoing reveals how truly detrimental such a provision can be to a tenant's ability to manage its corporate structure. If such a definition is included in a lease, and the landlord has the right to withhold its consent to an assignment in its sole discretion, any alteration in a tenant's corporate or ownership structure would be subject to the approval of the landlord, which can be denied for any reason whatsoever. Regardless of the size or sophistication of the tenant, allowing an external entity to have the ability to exercise such influence and control over both the internal structure and ownership interests in the tenant and its ability to expand and add new partners should be unacceptable in today's business world, where restructuring and ownership transfers are commonplace and necessary to operate a flexible and competitive organization.

Ideally, a tenant would prefer to strike these broad landlord rights from the lease altogether. However, depending on a variety of factors in play during the negotiation of a deal, including each party's leverage and the presence of additional potential tenants, this may not be possible, and the landlord may be unwilling to remove the offending language from the lease. In this situation, a tenant must be creative and craft a provision that includes sufficient protections to allow the tenant to freely operate its business. This often becomes an exercise in determining the landlord's principal motivations and including tenant protections that still allow the landlord's concerns to be addressed.

Tenant Safeguards

A common tenant safeguard provision allows the lease to be assigned without the landlord's consent to any of the tenant's affiliates, including parents, subsidiaries and entities resulting from a merger or consolidation of the tenant, and allows stock of the tenant to be freely exchanged on various markets. An example of such language is as follows:

Anything in this Lease to the contrary notwithstanding, Tenant shall have the right, without the consent of Landlord, to assign this Lease to: (i) a parent, subsidiary or affiliate corporation of Tenant; (ii) an entity succeeding to all or substantially all of the assets of Tenant; or (iii) a successor to Tenant pursuant to a merger, consolidation or other business reorganization. In addition, the transfer of any stock of Tenant on a stock exchange shall not be considered an assignment under this Lease.

This type of provision gives the tenant the flexibility to assign the lease within its existing corporate structure or to any related entities that are formed after the lease is executed, and also allows the tenant to bring in new partners. In the situation where a landlord is seeking simply to ensure that generally the same organization remains as the tenant under the lease, the foregoing should be acceptable, while at the same time providing sufficient protection for the tenant.

However, if a landlord has deeper concerns, the tenant will be forced to find a different compromise that satisfies both parties.

An example of such a compromise is a minimum net worth requirement for the entity that ultimately becomes the new tenant under the lease. Such a provision would allow an assignment without the landlord's consent so long as the resulting tenant has a net worth equal to or greater than an agreed-upon amount. As an alternative, the net worth requirement could also be tied to the then-current net worth of the existing tenant, and allow the free assignment of the lease so long as the new tenant's net worth is equal to or greater than that of the existing tenant.

Often, a landlord's motivation in limiting a tenant's right to assign a lease is to make certain that the new tenant has the financial wherewithal to fulfill the various obligations and liabilities under the lease. This compromise gives the landlord peace of mind by guaranteeing that sufficient capital will be available for the tenant to perform its obligations under the lease, and the tenant is granted the freedom to assign the lease or alter its ownership structure so long as sufficient funds remain available.

Another landlord motivation in restricting the ability to assign a lease is to ensure that a particular use or service is being provided at the subject property. In this situation, the landlord agreed to lease space to a particular tenant because of the specific function or service that the tenant brought to the site, such as a pharmacy leasing space in a medical office building. To alleviate this landlord concern, the tenant can agree to a use restriction that would continue to be imposed upon any party that may be assigned the lease; more specifically, such a provision would state that any assignment of the lease requires landlord's approval, except in the case where the new tenant uses the property for the same or a similar purpose as the existing tenant. In that case, the landlord is guaranteed to maintain the desired service at its facility, while the tenant is guaranteed the flexibility it needs to operate its business as it deems appropriate.

Ultimately, the landlord's impetus for limiting the right to assign the lease simply may be to ensure that the original tenant remains responsible to fulfill its obligations under the lease, regardless of whether that party maintains an interest in the property. This is especially common in cases where the existing tenant is a strong, well-funded company with a proven track record of financial stability. In this case, the compromise will come in drafting a provision that allows the tenant to assign the lease freely without the consent of the landlord so long as the original tenant agrees to remain liable for its obligations under the lease.

Such language typically satisfies landlords, while giving the original tenant broad capabilities to transfer its interest in the property. Subsequently, the original tenant can protect itself by obtaining a separate indemnity from the new tenant, either in the assignment of the lease or some other separate agreement.

Conclusion

As the foregoing illustrates, the negotiation of the assignment provision should go well beyond the age-old question of whether a landlord will have the right to consent. Tenants must be aware that standard “boilerplate” assignment language could have a profound impact on the operation of their business, not just with respect to one particular location, but also on their ability to develop and maintain a viable corporate structure and freely transfer ownership interests therein. Nevertheless, with ample foresight and a bit of creativity, a tenant can craft terms that give the landlord a sufficient level of comfort, while also allowing the tenant the flexibility to remain competitive in today's business world.

Joseph P. Heins, a member of this newsletter's Board of Editors, is an attorney in the Buffalo, NY, office of Phillips Lytle LLP. He concentrates his practice in the area of commercial real estate, including leasing, sales and acquisitions, project development and more. Mr. Heins can be reached at 716-847-5490 or [email protected].

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Tenants are accustomed to negotiating assignment provisions heavily as they relate to a third-party transfer. However, the effects that such provisions can have on a tenant's corporate autonomy are often overlooked. A thorough consideration of the assignment clause reveals that it can have a profound impact on a tenant's ability to run its business, including any expansion or reorganization. This article explores the strategy of negotiating an assignment provision that protects a tenant's ability to conduct business, and offers practical suggestions that will allow both the landlord and tenant ultimately to arrive at a mutually agreeable result.

Restrictions on Assignment

During the typical lease negotiation, the parties tend to treat assignment rights the same as subletting rights, and fail to recognize that restrictions on assignments can have far greater consequences on a tenant's business operations. From the tenant's perspective, the ideal outcome is for the tenant to have the right to freely assign the lease to any party it deems appropriate, without the consent of the landlord. The landlord will typically insist on having the right to consent to assignments, in which case the tenant's next best option is to require that landlord's consent not be unreasonably withheld, conditioned or delayed. However, especially in situations where a tenant holds significantly less leverage than the landlord, a landlord may refuse to allow any assignment without its consent, and require that it have the right to deny such consent for any reason. Obviously, this is an extremely undesirable outcome for the tenant.

In addition, the landlord may attempt to further restrict the tenant's right to assign the lease within the definition of an “assignment” under the lease, and tenants tend to gloss over such provisions without significant review. Nevertheless, definitions of an assignment, which can be located in a section of the lease wholly apart from the assignment provision, are often fully articulated and are commonly very unfavorable to the tenant. Frequently, these definitions include any changes in the control of the tenant, as well as any transfers of ownership interests in the tenant. An example of such language is as follows:

The sale, issuance or transfer of any voting capital stock of Tenant which results in a change in the direct or indirect voting control of Tenant shall be deemed to be an assignment of this Lease. If Tenant is a partnership, limited liability company, trust or an unincorporated association, then the sale, issuance or transfer of a controlling interest therein, or the transfer of any portion of any general partnership or managing interest in Tenant shall be deemed to be an assignment of this Lease.

A close reading of the foregoing reveals how truly detrimental such a provision can be to a tenant's ability to manage its corporate structure. If such a definition is included in a lease, and the landlord has the right to withhold its consent to an assignment in its sole discretion, any alteration in a tenant's corporate or ownership structure would be subject to the approval of the landlord, which can be denied for any reason whatsoever. Regardless of the size or sophistication of the tenant, allowing an external entity to have the ability to exercise such influence and control over both the internal structure and ownership interests in the tenant and its ability to expand and add new partners should be unacceptable in today's business world, where restructuring and ownership transfers are commonplace and necessary to operate a flexible and competitive organization.

Ideally, a tenant would prefer to strike these broad landlord rights from the lease altogether. However, depending on a variety of factors in play during the negotiation of a deal, including each party's leverage and the presence of additional potential tenants, this may not be possible, and the landlord may be unwilling to remove the offending language from the lease. In this situation, a tenant must be creative and craft a provision that includes sufficient protections to allow the tenant to freely operate its business. This often becomes an exercise in determining the landlord's principal motivations and including tenant protections that still allow the landlord's concerns to be addressed.

Tenant Safeguards

A common tenant safeguard provision allows the lease to be assigned without the landlord's consent to any of the tenant's affiliates, including parents, subsidiaries and entities resulting from a merger or consolidation of the tenant, and allows stock of the tenant to be freely exchanged on various markets. An example of such language is as follows:

Anything in this Lease to the contrary notwithstanding, Tenant shall have the right, without the consent of Landlord, to assign this Lease to: (i) a parent, subsidiary or affiliate corporation of Tenant; (ii) an entity succeeding to all or substantially all of the assets of Tenant; or (iii) a successor to Tenant pursuant to a merger, consolidation or other business reorganization. In addition, the transfer of any stock of Tenant on a stock exchange shall not be considered an assignment under this Lease.

This type of provision gives the tenant the flexibility to assign the lease within its existing corporate structure or to any related entities that are formed after the lease is executed, and also allows the tenant to bring in new partners. In the situation where a landlord is seeking simply to ensure that generally the same organization remains as the tenant under the lease, the foregoing should be acceptable, while at the same time providing sufficient protection for the tenant.

However, if a landlord has deeper concerns, the tenant will be forced to find a different compromise that satisfies both parties.

An example of such a compromise is a minimum net worth requirement for the entity that ultimately becomes the new tenant under the lease. Such a provision would allow an assignment without the landlord's consent so long as the resulting tenant has a net worth equal to or greater than an agreed-upon amount. As an alternative, the net worth requirement could also be tied to the then-current net worth of the existing tenant, and allow the free assignment of the lease so long as the new tenant's net worth is equal to or greater than that of the existing tenant.

Often, a landlord's motivation in limiting a tenant's right to assign a lease is to make certain that the new tenant has the financial wherewithal to fulfill the various obligations and liabilities under the lease. This compromise gives the landlord peace of mind by guaranteeing that sufficient capital will be available for the tenant to perform its obligations under the lease, and the tenant is granted the freedom to assign the lease or alter its ownership structure so long as sufficient funds remain available.

Another landlord motivation in restricting the ability to assign a lease is to ensure that a particular use or service is being provided at the subject property. In this situation, the landlord agreed to lease space to a particular tenant because of the specific function or service that the tenant brought to the site, such as a pharmacy leasing space in a medical office building. To alleviate this landlord concern, the tenant can agree to a use restriction that would continue to be imposed upon any party that may be assigned the lease; more specifically, such a provision would state that any assignment of the lease requires landlord's approval, except in the case where the new tenant uses the property for the same or a similar purpose as the existing tenant. In that case, the landlord is guaranteed to maintain the desired service at its facility, while the tenant is guaranteed the flexibility it needs to operate its business as it deems appropriate.

Ultimately, the landlord's impetus for limiting the right to assign the lease simply may be to ensure that the original tenant remains responsible to fulfill its obligations under the lease, regardless of whether that party maintains an interest in the property. This is especially common in cases where the existing tenant is a strong, well-funded company with a proven track record of financial stability. In this case, the compromise will come in drafting a provision that allows the tenant to assign the lease freely without the consent of the landlord so long as the original tenant agrees to remain liable for its obligations under the lease.

Such language typically satisfies landlords, while giving the original tenant broad capabilities to transfer its interest in the property. Subsequently, the original tenant can protect itself by obtaining a separate indemnity from the new tenant, either in the assignment of the lease or some other separate agreement.

Conclusion

As the foregoing illustrates, the negotiation of the assignment provision should go well beyond the age-old question of whether a landlord will have the right to consent. Tenants must be aware that standard “boilerplate” assignment language could have a profound impact on the operation of their business, not just with respect to one particular location, but also on their ability to develop and maintain a viable corporate structure and freely transfer ownership interests therein. Nevertheless, with ample foresight and a bit of creativity, a tenant can craft terms that give the landlord a sufficient level of comfort, while also allowing the tenant the flexibility to remain competitive in today's business world.

Joseph P. Heins, a member of this newsletter's Board of Editors, is an attorney in the Buffalo, NY, office of Phillips Lytle LLP. He concentrates his practice in the area of commercial real estate, including leasing, sales and acquisitions, project development and more. Mr. Heins can be reached at 716-847-5490 or [email protected].

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