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Landlord Considerations When Drafting Assignment and Subletting Provisions
Restricting a tenant's right to transfer the property it is leasing to a third party is a key component to any lease. Most landlords want to limit the tenant's ability to encumber the lease so that the landlord has control over who is occupying their property. In addition, a landlord may also need to get its lender involved because many lenders require landlords to obtain lender consent before the transfer is effective. Failure to obtain such consent could lead to a landlord's default under the terms and conditions of the loan documents, so it is imperative for a landlord to review its loan documents each time it receives a request from a tenant to transfer its interest under the lease.
|Types of Transfers
The four ways tenants generally transfer their interest under the lease are via: 1) an assignment of the lease; 2) a subletting of the premises; 3) mortgaging its interest under the lease; and 4) giving a third party a license to occupy space within the leased premises. Landlords typically prohibit the right of tenants to encumber the leased property through a mortgage (except in the case of a ground lease). Although licenses are a method of dealing with the use of a property on a short-term basis, only in rare instances does a "standard" landlord lease form permit a tenant to enter into a license agreement with a third party unless the deal specifically calls for such a transfer. The most common ways a tenant transfers its interest in a lease are by way of an assignment or a sublease.
|Landlord Consent and Recapture Right
Most landlords do not want just anyone occupying their property and require the tenant to obtain the landlord's consent before the leased premises is assigned or sublet. Landlords, in most cases, agree that such consent shall not be unreasonably withheld, delayed or conditioned. Many of the more sophisticated landlords provide, however, that the landlord has the right to recapture (with the option, in some cases to also sublease back) the space that the tenant is leasing.
In any event, many landlords specifically require a tenant to provide the following documents after a tenant submits written notice to a landlord requesting an assignment or sublet: 1) a copy of the proposed assignment or sublease, requiring that the effective date be not less than a certain number of days (typically 30-60 days) and no more than a certain number of days (typically 120-180 days) after the giving of such notice; 2) a statement setting forth in reasonable detail the identity of the proposed assignee or subtenant, the nature of its business and its proposed use of the premises; and 3) current financial information with respect to the proposed assignee or subtenant, including its most recent financial report certified by a certified public accountant.
If a recapture (and in some cases a sublet back) option is desired, then the notice is usually deemed to be an offer to either terminate the lease and recapture the premises or sublet the premises back to the landlord. Note also that landlords often accept, in lieu of a copy of the sublease or assignment agreement, a term sheet from the transferee outlining the material terms of the proposed sublease or assignment, including the proposed use and the effective date of the transaction.
|Conditions for Transfer
If the landlord does not elect to recapture or sublease back the space, it is advisable for a landlord to state that it will not unreasonably withhold its consent to the tenant's request to sublease or assign, provided certain enumerated conditions are met.
Some of the conditions to subleasing or assignment that are often found in leases include: 1) that the proposed assignee or subtenant is engaged in a business and the premises will be used in a manner that is in keeping with the building's standards and/or with the standards of comparable buildings in the vicinity of the building, which use should be limited to the use of the premises for the original use permitted under the lease, which will not violate any negative covenant as to use contained in any other space lease in the building; 2) that the proposed assignee or subtenant is reputable and of good character with sufficient financial worth considering the responsibilities involved; 3) that the proposed assignee or sublessee is not a person with whom the landlord is then negotiating space in the building; 4) that the form of the proposed sublease or instrument of assignment is reasonably satisfactory to landlord; 5) that the tenant reimburse the landlord for the costs that may be incurred by the landlord in connection with such transfer request; 6) that the proposed subtenant or assignee shall not be entitled to diplomatic or sovereign immunity and shall be subject to service of process in, and the jurisdiction of the courts in, the state where the property is located; and 7) that the tenant, and any guarantor, if applicable, shall remain fully liable even after the proposed transfer. In some instances, it may also be prudent to require that any sublease shall be a sublease for all of the premises, especially if the sublet space is very small.
If the landlord does not include any specific conditions that must be adhered to before the landlord consents to a proposed transfer, it could encourage a tenant to contest that the landlord is being reasonable if the landlord denies consent to a proposed transfer. So long as the lease sets forth explicit conditions that must be satisfied, the failure to comply with any of these conditions can give rise to a valid reason why the landlord denied the tenant's request to assign the lease or sublet the premises.
Remember to also state that no subletting shall be for a term ending later than one day prior to the expiration date of the lease, and that the sublease specifically provides that it is subject and subordinate to the lease. Moreover, a tenant should agree, in most instances, to be jointly and severally liable to the landlord for the performance of the obligations of the assignee.
If an assignee or its guarantor has a net worth at least as great as the tenant, a landlord may consider waiving joint and several tenant liability. If a "net worth" standard is used, make sure that net worth is deemed to mean an entity's equity, as reported in such entity's annual financial statements, less the "intangible" assets, including, but not limited to, copyrights, trademarks, trade names, licenses, patents, franchises and goodwill, as the entity's net worth can often be inflated by these intangible items and are hard to quantify.
|Sharing Profits
A landlord may also consider adding that the landlord keeps all or a portion of any "profits" made by a tenant as a result of a sublease or assignment. The rationale is that, unlike a landlord, a tenant is not in the business of renting property, and that any profits that a tenant makes as a result of such a transaction should at least be split with the landlord.
Although it may be tempting for a landlord to seek to keep all of the profits, it may make more sense to share some of the profits with the tenant so as to give the tenant an incentive to assign the lease or sublet the premises and make a profit while doing so.
A landlord should be careful, however, if a portion of only the "net" profits are to be given to the landlord, that a tenant include as part of the consideration paid by the transferee all sums paid for the sale of tenant's furniture, fixtures, equipment and other personal property (less, in the case of a sale thereof, the then net unamortized or undepreciated cost thereof determined on the basis of tenant's federal income tax returns). If the landlord does not include a provision related to the sale of such items, a tenant may be tempted to reduce the rental amount accepted in connection with the sublease or assignment and instead raise the price of items sold to the transferee, thereby reducing the profit that it has to split with the landlord.
|Conclusion
Certainly, there are many other things that can be considered in crafting assignment and subletting provisions, but if the above items are included in a landlord's form lease, a landlord will be well on its way to protecting its interest in the event a tenant seeks to transfer its interest to a third party.
*****
Mark Morfopoulos is a real estate attorney with Wachtel Missry LLP in New York. A member of this newsletter's Board of Editors, he can be reached at 212 909-9541 or [email protected].
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