CREJ - Property Management Quarterly - July 2017
Owners should have reasonable expectations that their tenants will follow and adhere to the lease provisions regarding lease assignments and subleases. Unfortunately, that is not always the case. Often, the first notice a property manager receives from a tenant is a request for new signage or new access cards. That is a red flag that there is a potential change occurring in the leasehold estate that must be addressed by the property manager and reported to ownership. Another red flag: Rent is paid by a different entity then the actual tenant. As each lease template is different, a thorough review of the applicable lease provisions by the property manager with owner’s legal counsel is the absolute starting point. The following are questions and answers that may improve our understanding when an assignment or sublease is being considered. • Sessions: What is the difference between an assignment and sublease? • Halstead: A sublease is a lease of a tenant’s space from the tenant. A sublease can be for all or part of the premises and for all or part of the balance of a lease term. In contrast to an assignment, where a tenant assigns all of its rights and obligations under a lease, under a sublease the tenant assigns certain rights and obligations while retaining others. Unlike a sublease, which is approved by a landlord, an assignment usually is accomplished through an agreement between the tenant, the assignee and the landlord. This distinction is important as the assignment creates privity of contract with the landlord and assignee, giving the landlord rights against an assignee it may not have against a sublessee. • Sessions: Why should an owner care to have proper documentation? • Halstead: It is important that a sublease or assignment be properly documented for a variety of reasons. A landlord should, at all times, be aware of who is occupying and operating from the leased premises. By way of example, a landlord will want to confirm that the party or parties occupying the leased premises are carrying the requisite insurance and that the landlord has been named as an additional insured. Moreover, in the event of a default, the landlord will want to know who to provide notice to and, should it become necessary, who to evict and/or sue for damages. • Sessions: What can possibly go wrong? • Halstead: How long do you have, Steve? But seriously, it’s not uncommon for tenants to assign or sublease spaces without providing a landlord with notice. This can create a host of issues, particularly if there is a casualty at the property and insurance carriers become involved. An unauthorized occupant may not carry the proper insurance, name the landlord as an additional insured or have included a waiver of subrogation in its policy. Moreover, with no contract between the sublessee or assignee, the landlord may not be afforded the protections set forth in the lease. The original tenant would have a duty to indemnify the landlord from claims arising in connection with an unauthorized assignment or sublease, but the duty to indemnify is only as strong as the original tenant’s financial condition. • Sessions: What due diligence is required for an owner to approve an assignment or sublease? • Halstead: An owner should evaluate a proposed assignee or sublessee in a manner consistent with its evaluation of the original tenant. By way of example, a landlord should request a few years’ worth of tax returns, a sworn financial statement and bank statements. If the proposed assignee or sublessee is an entity, the landlord should also review the governing documents for the entity and financials for the principals of the entity. A landlord also may want to consider the business experience of the proposed assignee or sublessee. The financial strength of a proposed assignee or sublessee and any additional guarantors may carry more or less weight depending on the financial strength of the original tenant and guarantors, and whether the original tenant and guarantors will remain liable for the lease obligations. • Sessions: Who is liable for payment of rent? • Halstead: I’ll give you the classic attorney response, “It depends.” It depends on how the assignment and/or sublease are drafted. Generally, in the case of a sublease, the sublessee pays the tenant and the tenant pays the landlord. In a typical sublease, there is no privity of contract between the sublessee and landlord. Consequently, the landlord’s right of recovery is limited to the original tenant. This can create issues if the tenant accepts money from the subtenant but doesn’t tender the money to the landlord. Almost always, in the case of an assignment, the assignee pays the landlord directly. A typical assignment will require that the original tenant and guarantors remain liable for some period of time after the assignment and that the original tenant and the assignee shall be jointly and severally liable for the lease obligations. In such case, the landlord could recover from both the original tenant and assignee. • Sessions: Have you seen any favorable outcomes? • Halstead: An assignment or sublease could provide the landlord with more pockets to collect from in the event of a default. In some cases, the landlord ends up with a stronger tenant for a longer period of time. • Sessions: Can an owner withhold consent to an assignment or subletting? • Halstead: Yes. The standard for reviewing a proposed assignment or sublease will be determined by the lease. By way of example, a landlord may have the right to withhold its consent in its “sole discretion.” More often, however, a landlord must be “reasonable” in evaluating a proposed assignment or sublease. Some leases specifically define bases that may be considered “reasonable,” while others are silent. In most cases, it is appropriate to consider the financial strength of a prospective subtenant or assignee, their business experience, the tenant mix within a property and the proposed use by the subtenant or assignee. • Sessions: Is it customary for the assignee of a lease to assume the obligations of the assignor/tenant under a lease? • Halstead: Yes. An assignee usually assumes the obligations under the lease accruing on or after the date of an assignment. Ideally, the assignee and assignor will be jointly and severally liable for obligations accruing after the date of the assignment. For clarity, it should be clear which party will be responsible for any common area maintenance, tax or insurance reconciliations that may take place at a later date and who is entitled to the return of any security deposit at the expiration of the lease. • Sessions: Are assignment provisions heavily negotiated? What are the main points at issue? • Halstead: Sometimes. It’s not uncommon for a proposed assignee to try and negotiate a longer lease term or renewal options, particularly if they are buying a business from the original tenant. A landlord may request additional security for the performance of the lease if the assignee’s financials are not as strong. Perhaps the biggest point of contention is whether the original tenant and any original guarantors will remain liable for the lease obligations and, if so, for how long. • Sessions: Is a sublease a safer alternative to an assignment? • Halstead: From a landlord’s perspective, subleases make sense when the subtenant is leasing less than the entire premises and/or for less than the entire term of the lease. Otherwise, creating privity of contract with the party that will be occupying the leased premises by virtue of an assignment while preserving claims against the original tenant is preferred. From a tenant’s perspective, a sublease may be preferred over an assignment given that it provides the tenant with some element of control in the event of a default by the subtenant. By way of example, an original tenant might reenter the premises and reinitiate its business operations following a default by an subtenant. • Sessions: What other provisions of a lease may be modified as a result of an assignment or sublease? • Halstead: Permitted uses, expiration dates, identities of guarantors, nature and extent of renewal options, any number of terms. • Sessions: When should an owner withhold consent for an assignment or sublease? • Halstead: A landlord should be cautious in evaluating a prospective assignment or sublease and would not want to withhold its consent in violation of the standard set forth in the lease. By way of example, a landlord could be exposed to claims for tortious interference with a sale of a business. One way to limit this type of exposure is to include express language in a lease limiting the tenant’s remedies to specific performance in the event a landlord wrongfully withholds its consent. Withholding consent may be appropriate where the proposed assignee or subtenant’s use differs from that of the original tenant, where the proposed assignee or subtenant has limited business experience, weak financials or a criminal history.