Occasionally, a tenant needs to prematurely vacate their leased premises. When negotiating your lease it may not seem to be a clause of primary importance. However, we don’t always foresee challenging economic times and given the amount of sublease space currently on the market only proves why it is critical to pay special to attention to these rights spelled out in the lease document and to maintain as much flexibility as possible to mitigate your lease obligation should business conditions dictate. There are numbers of reasons why the original tenant may need to do so, and he/she should have some right, not unreasonably withheld, to bring in a new, replacement tenant or a new owner of the business, and “assign” the lease or “sublet” the lease space to a new business entity.
Assignment and subletting are not the same. In an assignment, the original tenant assigns, or grants, his rights and obligations under the lease entirely to the new tenant, who agrees to accept them. The new tenant literally substitutes in for the original tenant, who no longer is bound under the lease.
A sublet situation is one where a new tenant occupies the lease space, but the original tenant remains liable for the lease obligations. Subletting is much less risky for a landlord, because two tenants are liable under the same lease: the original tenant, and the subletting tenant.
There are several major issues in any sublet or assignment situation. They are:
- The parties
- The terms desired by each party
- The original tenant’s obligations
- What each party is agreeable to in the event of name changes, mergers, etc.
- The handling of sublease rental amounts in excess of the scheduled rental amounts
- The handling of deposits, tenant liens, etc.
- Payment of any costs to the landlord when considering a replacement tenant.
Not surprisingly, landlords are traditionally much more reluctant to agree to an assignment because they are inherently more risky for the landlord. The main risk is whether the new tenant is financially able to assume the lease obligations of the original tenant. No landlord will willingly accept a replacement tenant that is weaker financially and thus unable to fulfill the lease requirements. Unless it can be shown that the new tenant is at least as strong financially as the original tenant, the landlord may be reasonable to deny the requested assignment. Additionally, the landlord must determine that the new tenant is desirable, which is subjective to a point. The landlord will be concerned that the new tenant is credit worthy, strong financially, of good reputation, and fits into the existing tenant mix well.
The lease must define the tenant’s rights regarding assigning the lease or subletting the space to another tenant. To be balanced, this language should also include the landlord’s rights to accept or deny an assignment or sublease agreement, with the allowable basis for his acceptance or denial being clearly defined. Both the tenant and the landlord must be careful when negotiating these types of clauses.
Regardless how desirable and/or financially sound the new tenant is, the landlord may insist that the original tenant remain responsible for his/her original obligations under the lease.
Additionally, the landlord may impose other conditions such as:
- The landlord must agree to the proposed use of the lease space by the new tenant
- The replacement tenant will have to execute acceptable documents with the landlord wherein it adopts the original lease and agrees to meet all the obligations therein of the original tenant
- The original tenant must pay the landlord’s expenses and other reasonable costs (legal fees, financial analysis assistance) that may be incurred when considering any replacement tenant, whether or not that replacement tenant is ultimately approved. (Some landlords set a basic fee of $500 to $2,000 to cover his/her due diligence work necessary to evaluate the replacement tenant.)
Instead of these details being set forth in the lease, many tenants seek to simply have the lease provide that “the landlord shall not unreasonably withhold the right of the tenant to sublease or assign his/her interests in this lease.” Landlords are generally more agreeable to the use of this phrase when the potential assignee is an affiliate, parent organization, franchisor, subsidiary or successor corporation, purchaser or merging company of the original tenant rather than an unrelated third party. From the Tenant’s perspective it is important to create as much flexibility as possible for it can have a significant impact on the marketability of your sublease space.
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Assignment clauses are lease provisions that are often not given appropriate consideration by tenants in lease negotiations. Likewise, landlords’ standard anti-assignment clauses may not cover some transfer scenarios that could result in a less creditworthy replacement tenant assuming the lease.
A tenant’s primary concern in negotiating a lease assignment clause is flexibility. The need for flexibility is heightened in long-term leases. If facing economic hardship, a tenant may want the ability to downsize or to obtain help in paying the rent either via subletting a portion of the space or a wholesale assignment of the lease. Likewise, if a tenant’s business is growing, the tenant may need to assign the lease or sublet the premises in order to find a larger, more suitable premises for the tenant’s needs.
In the case of an assignment of a lease or a subletting of a space, a landlord wants to be sure that an entity with sufficient net worth is liable under the lease for the payment of rent and the performance of the other lease obligations. Additionally, a landlord will want to prevent a tenant from competing with the landlord for the leasing of space within the building, shopping center or property (as applicable). Often a landlord will prohibit assignments and subleases with other current tenants of the property or with a prospective tenant with whom the landlord is negotiating for the lease of space at the property.
There are a number of issues that should be considered when drafting and negotiating the assignment provision of a lease.
Landlords should make sure that their anti-assignment provisions are sufficiently broad and capture various types of assignment, subletting and third-party occupancy arrangements, as well as changes of control and other entity-level transfers. Although anti-assignment clauses usually restrict the assignment of the lease and the sublease of the premises, a comprehensive anti-assignment clause should also restrict (1) the sublease or all or any portion of the premises, (2) a shared occupancy agreement or license to use the space by a third party, and (3) sub-subleases of the premises or any portion of the premises. “Transfer” should also be defined broadly to cover a transfer of the equity interests of (and/or the power to control) the tenant entity (or any parent entity if the tenant entity is a subsidiary). A tenant should negotiate for language providing that the landlord will not unreasonably withhold, condition or delay its consent to a proposed assignment or sublease.
- In light of broad anti-assignment provisions, as discussed above, a tenant should develop a list of transfers that constitute “permitted transfers” and that do not require any landlord consent. When negotiating these provisions on behalf of a tenant, it is crucial to understand the tenant’s business and its unique needs. For example, is it likely that, during the term of the lease, the tenant entity will be purchased by another company? If so, the tenant will want to exclude a sale of all or substantially all of its assets or stock from the definition of “transfer” and clarify that such an event will not require the landlord’s consent. Often, a landlord will require a net-worth test in this situation to ensure that the successor entity has a net worth following the transfer at least equal to that of the original tenant immediately prior to the transfer.
- Many landlords’ form leases include language that, in the event of an assignment or sublease, the landlord is entitled to 100 percent of any profits realized by the tenant from any sublease or assignment. As discussed above, a tenant will want to be sure that any profit-sharing requirement does not apply to a preapproved or otherwise permitted transfer. Additionally, the tenant should push for a 50/50 sharing of any sublease or assignment profits.
- A landlord will want to ensure that the original named tenant remains liable under the lease following any assignment, even if the assignment is approved by landlord. If a landlord is willing to consider releasing the original tenant from liability, the landlord will typically want to defer that determination until the tenant actually makes a transfer request. Once the landlord has the proposed assignee’s financial information, the landlord is in a better position to make a decision as to whether the original tenant should be released from liability under the lease. The release of liability language can be added to the form of consent executed by the parties in connection with the transfer.
- An overly restrictive permitted-use clause in a lease can thwart even the most tenant-friendly assignment clause. If the permitted use of the premises under the lease is limited to operating under a specific trade name, the tenant’s ability to assign the lease or sublet the space is severely limited. Tenants should be sure that the use clause of their lease is broad enough to allow the lease to be assigned or sublet to a different named operator, or even for a different type of use.