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American Bar Association - Defending Liberty, Pursuing Justice

SPRING 2010

Vol. 6, No. 3

REAL ESTATE

 

The Accidental Impact Overlooked Clauses Affecting Lease Assignments and Subletting

We are all familiar with the standard assignment and subleasing clause in a commercial real estate lease. Consider, however, that there are many other clauses within the balance of the lease that can trip up the tenant who wishes to assign or sublet. Below are some examples. In addition, be aware that there may be tenant-specific provisions in the lease that will affect the landlord or tenant. For example, the lease may delegate responsibility for insuring the building (and rebuilding it following a casualty) to the tenant, which made sense when the tenant was a Fortune 500 company but not when they assign it to a local company which is otherwise completely capable of meeting the other obligations of the tenant under the lease.

Use Clause
The use clause may not cross the parties’ minds in the course of negotiating the tenant’s assignment and subletting rights. However, this clause—which sets forth the allowable purposes for which Tenant may use the space—has important repercussions for a tenant’s ability to sublet or assign the space.

Consider, for example, the following two use clauses in a commercial lease:

Sample 1. Tenant may use the Premises for any purpose.

Sample 2. Tenant may use the Premises solely for the purposes of marketing three-quarter (.75) inch widgets in Siberia via telephone solicitation.

The tenant who enjoys the first sample use clause is much more likely to be able to find a subtenant or assignee than is the tenant who must labor under the second clause, regardless of the qualifications on the landlord’s ability to withhold consent to an assignment or subletting. The same considerations apply regarding the landlord’s right to withhold its consent to a proposed transfer of the lease apply to the landlord’s right to withhold its consent to a proposed change in a tenant’s (or its transferee’s) use of the space. Thus, the tenant may ask the landlord to agree not to unreasonably withhold its consent to a change in use. Both landlord and tenant should think about the use clause and how flexibility or the lack thereof can affect them in the future. There’s no easy answer. The tenant has legitimate issues (if we can’t make it as auto parts store in this location, we won’t find another auto parts store willing to take the chance). As does the landlord (we leased this warehouse to store merchandise for a party store, not for a paint retailer, the hazardous materials risks are completely different).

Signage
The same issues come up here. Generally, the landlord wants complete control over the tenant’s signage but without being able to change the signage, the tenant can’t assign the lease unless it’s a sale of the business with no change in the name.

Trade Name
Same Issues.

Continuous Operations
This is common in retail leases but can pose a practical problem. If the tenant is required to continuously operate, it often won’t be possible, without defaulting, to do the necessary tenant improvements and transition to the new occupant.

Percentage Rent
If the lease provides for percentage rent, again a common attribute of a retail lease, an assignment or sublease raises the additional issue for the landlord of how to maintain parity following the transfer. For example, prior to the transfer, landlord has historically based expectations of percentage rent levels. If the transfer involves the same use but a change in the operator, it can be very difficult to predict the financial impact on the landlord of a transfer unless the transferee has a track record at other similar facilities. One approach used to address this risk is to provide that when there is a transfer, the base rent is increased to ___% (for example, 80%) of the combination of the prior 12 months base rent and percentage rent. This is at best a crude mechanism for all parties. Add to that, the fact that the uncertainty can be magnified may times over if the transfer involves a change in use. Percentage rent is usually a percentage of gross sales. Some retail stores have a high volume and low profit margin (think groceries). Others have a low volume and very high margins (think jewelry stores). Imagine the impact of applying a percentage rent designed for a high volume retailer on a low volume retainer (landlord loses its shirt). And the same differences in margin can apply to stores within the same use category such as clothing (Gucci® vs. Old Navy®). These days we see relatively few percentage rent leases but be sure to think about these issues in drafting the assignment and subletting clause for percentage rent leases. Landlord will want as much control as it can get over the approval of the transfer but that’s just the start of the issues.

Cynthia Thomas is a founding member of the Seattle firm Real Property Law Group, PLLC. She is a member of the American College of Real Estate Lawyers and limits her practice to complex commercial real estate transactions, financing, and leasing. Cindy can be reached at cthomas@rp-lawgroup.com, or 206-625-1717.

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