Lease Agreements and Sublets

May 26th, 2015

Few scenarios arising under a tenancy in a commercial lease cause as much friction between landlord and tenant as those involving assignments and subletting.   An unsuspecting tenant may find that his or her inability to secure appropriate transfer rights during negotiations over the lease may curtail, or eliminate, the tenant’s ability to assign or sublet the premises.  Conversely, a landlord who does not appreciate the importance of these transfer rights may find he or she has limited latitude in rejecting a proposed assignee or sublessee.  Regardless of whether your client is the landlord or tenant, it is imperative to address transfer rights when drafting a commercial lease in order to limit future conflict over an assignment or sublease of the premises.

 

A tenant may wish to assign or sublet its premises for many reasons.  One common trigger is the sale of a business operated from the premises.  For example, a tenant operates a car dealership from a building leased by an unrelated landlord.  The tenant decides to sell the dealership to a third party.  Included in the purchase agreement is a contingency that the purchaser will assume the tenant’s lease.  If the purchaser cannot assume the lease, then the purchase agreement for the business terminates.  Whether or not the tenant can effectuate the sale of the dealership will depend on obtaining an assignment of the lease from the landlord.  The assignment, in turn, is predicated on the language of the lease itself.  In this example, depending on the lease, the tenant may or may not be able to sell the business.

 

From the landlord’s perspective, he or she often wishes to curtail transfers or eliminate them altogether.  There are reasons why the landlord may wish to do so.  Some reasons include maintaining the character of the building, reducing expenses by not having to investigate the qualifications of a proposed tenant, simplicity with administering the lease or leases in a multi-tenant building, or the level of comfort with the current tenant.  For example, suppose a landlord owns a multi-tenant shopping mall that is marketed as a high-end shopping venue. If a tenant can freely assign his or her premises, such an assignment may result in a new tenant reducing the reputation and character of the shopping mall, thus driving out other high-end tenants, and further reducing the rents the landlord may charge.

 

In many jurisdictions, the landlord’s consent to an assignment or sublet is not required if the lease is silent regarding the tenant’s transfer rights.  This rule also applies to assignments by operation of law, stock transfers, and mergers.  A majority of jurisdictions allow landlords to withhold consent to a transfer for any reason if the lease does not explicitly require the landlord to act reasonably.  Absent such a requirement, a landlord could, for example, reject a proposed transfer outright, condition approval on additional payment from the tenant, or extract other concessions from the tenant in his or her sole discretion.

 

If the lease requires a landlord to act reasonably when considering whether to consent to a proposed transfer, what constitutes acting reasonably may not be clear.  If the lease lacks clear criteria of what factors the landlord may consider when deciding whether or not to grant consent, the landlord and tenant risk leaving any determination on reasonableness to the courts.  Courts look to several factors when determining if a landlord acted reasonably, including the proposed tenant’s financial capacity, the character of the business the proposed tenant plans to operate from the premises, the compatibility of the proposed tenant’s use of the premises with existing tenants, and the current mix of tenants in a multi-tenant property (such as a shopping mall).  Ambiguity in the lease results in leaving the questions regarding a proposed assignment or sublease to the courts, which leads to further uncertainty for both landlords and tenants.

 

To avoid uncertainty, landlords and tenants should clearly address assignments and subleases in the lease.  If transfers are not permitted, then the lease should clearly state so.  If transfers are permitted, then the landlord and tenant must agree on whether the landlord may withhold consent for any reason, or adopt clear criteria for evaluating a proposed transfer.  Such criteria may include the proposed tenant’s financial wherewithal, a “pre-approval” procedure to avoid uncertainty or delay if the tenant is selling his or her business, and conditions on the proposed tenant using the premises in a manner consistent with the current tenant’s use and the character of the building or neighborhood.

 

Each tenant’s and landlord’s circumstances are unique, and many factors play a role in lease negotiations.  The extent to which tenants and landlords may agreement on transfers depends on each party’s goals and leverage.  Nevertheless, it is important that landlords and tenants alike recognize the ramifications of silent or ambiguous transfer provisions.

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