Practice Pointers in Commercial Real Estate Leasing: Drafting the Assignment, Sublease, or Consent
By Cynthia Thomas
Assignments and sublettings have critical differences in the triumvirate relationship between landlord, tenant and transferee in a commercial real estate lease. In an assignment, the assignee steps into direct contractual privity with the landlord. Either the landlord or the assignee can then sue the other directly to enforce the requirements of the lease. Meanwhile, the tenant in the assignment technically remains liable under its contract with the landlord, unless the landlord and tenant agree otherwise. Note that there is a risk that a modification of the lease made by landlord and assignee may have the unintended effect of releasing the assigning tenant from liability under the lease. By contrast, in a subletting the landlord and subtenant do not enter into contractual privity; rather, a second contract—the sublease—arises. The landlord’s lease with the tenant becomes in effect the “master lease,” and the subtenant is apportioned certain of these rights under the sublease. If the master lease terminates, the sublease terminates as well. It follows from this relationship that the subtenant cannot legally obtain via the sublease any greater rights to the space than the tenant has under its lease with the landlord. More important, in a sublease the only relationship the subtenant has is with the prime tenant (in their own landlord–tenant relationship), and the only relationship the landlord has is with the prime tenant. Thus, absent special contractual agreements, the landlord has to look to the tenant (not the subtenant) if the subtenant is creating problems, and the subtenant must look to the tenant (and not the landlord) if the landlord is creating problems.
Assuming the parties have decided whether an assignment or a sublet suits their needs, the lawyer’s task is then to draft the appropriate documents. Below are some points to consider in that process:
Drafting the Assignment
The tenant or assignor usually drafts the assignment. Landlord’s counsel should resist drafting the assignment, as neither the tenant nor the assignee is his client. The assignment typically includes: (a) basic representations and warranties by the tenant; and (b) an allocation of responsibility for lease obligations between tenant and assignee. Landlord should draft the landlord’s consent to the assignment.
The assignee should request that the tenant provide certain representations and warranties in the assignment (ideally, the assignee would like similar representations and warranties from the landlord, but a landlord is likely to resist such a request). Specifically, the assignee wants tenant’s assurances that tenant has provided the assignee with a true, correct and complete copy of the lease, that the lease is in full force and effect, and that the lease has not been modified, supplemented, or amended except as expressly set forth in the assignment. The assignee wants tenant to warrant that neither tenant nor landlord is in default under the lease and that tenant has no knowledge of any fact or condition which, with notice or lapse of time or both, would constitute such a default. The assignee also wants tenant to warrant that it has not assigned, transferred, or delegated any of its rights or duties under the lease.
Both the tenant and assignee want the assignment to allocate responsibility between the parties. The assignee does not want to take responsibility for preassignment costs, such as an underpayment of common area maintenance (CAM) expenses by tenant. The tenant wants to ensure that the assignee is responsible for all postassignment costs. Both parties are likely to require an indemnification provision in the assignment that protects them from liability for the other party’s negligence or willful misconduct.
The assignment should exclude any provisions in the lease that are solely for the benefit of the tenant. For example, options to extend the lease term, rights of first refusal, and purchase options are often exclusively for the benefit of the tenant and nontransferable and/or the tenant does not wish to transfer them.
Unless the assignment is a permitted transfer that does not require landlord’s consent, the assignment must either include a landlord’s consent clause or be contingent upon execution of a separate landlord’s consent agreement.
Drafting the Consent to Assignment
If the lease requires the landlord’s consent, the assignment should be contingent on obtaining such consent on terms acceptable to the tenant and assignee. Sometimes the consent is included in the form of the assignment but generally landlords will require a separate form to address the issues of concern to them and it should be signed by the landlord, tenant, and assignee. For example, the landlord wants language in the consent specifically stating that landlord’s consent to the assignment does not release tenant from liability under the lease, does not waive its right to consent to future transfers, makes both tenant and assignee primarily liable on the lease to landlord, covers any approval of changes to use, signage, etc. The assignee will want the consent to include an estoppel from the landlord (the copy of the lease is complete, there are no other agreements, landlord is not aware of any defaults, etc.). The tenant may also want the consent to provide that the landlord will look first to the assignee in the case of a default, which, of course, the landlord will not want to agree to do. Consider also issues relating to percentage rent. If the lease contains options, the landlord may want to include a statement in the consent that exercise of the options does not constitute a “modification” of the lease and the assignor tenant remains bound during the option term(s). Landlords should review the entire lease in connection with the drafting of the consent, looking for particular provisions that were drafted specifically in light of the original tenant (extra parking stalls, no after-hours HVAC charges because this tenant rarely worked after hours, etc.).
Drafting the Sublease
The tenant or sublandlord usually drafts the sublease using one of three approaches. The simplest approach is for the sublandlord to incorporate the lease in its entirety. This approach, while quick and efficient, is problematic in that it fails to allocate the rights and obligations of the landlord, sublandlord, and subtenant and is likely to incorporate terms into the sublandlord–subtenant relationship that do not belong there (such as the limitation of landlord’s liability to its equity interest in the building/project) and is a particularly poor fit where the sublease is just of a portion of the premises covered by the lease. A second approach is for the sublandlord to create a new sublease that restates all of the applicable terms in the lease and provides new terms. This approach is also problematic in that it is highly inefficient, encourages renegotiation of lease provisions, and increases the risk that a provision in the sublease will contradict the lease. The third and best approach is an approach that incorporates applicable lease provisions, excludes inapplicable lease provisions, and provides new terms that clarify the relationship between the parties, thereby balancing efficiency with efficacy. The following describes some of the new terms commonly provided in sublease agreements.
Sublandlord Representations and Warranties
The subtenant generally requires that the sublandlord provide certain representations and warranties in the sublease. Some of these representations and warranties are comparable to those required by assignees in an assignment. The subtenant wants sublandlord’s assurances that the sublandlord has provided the subtenant with a true, correct, and complete copy of the lease, that the lease is in full force and effect, and that the lease has not been modified, supplemented, or amended except as expressly set forth in the sublease. The subtenant wants the sublandlord to warrant that neither sublandlord nor landlord is in default under the lease and that sublandlord has no knowledge of any fact or condition which, with notice or lapse of time or both, would constitute such a default. The subtenant also wants the sublandlord to warrant that it has not assigned, transferred, or delegated any of its rights or duties under the sublease. In addition, the subtenant wants the sublandlord to represent and warrant that: (a) sublandlord will not commit or suffer any act or omission that will result in a violation of or a default under the lease; (b) sublandlord will use good faith efforts to cause landlord to perform its obligations under the lease with respect to the premises and to give any required consents under the lease for the benefit of subtenant; (c) sublandlord will deliver to subtenant a copy of any notice received by landlord relating to the premises within a specified period of time; (d) subtenant shall have the right to cure any default by sublandlord on or before the date sublandlord’s applicable cure period expires and sublandlord shall reimburse subtenant for any expenses incurred in curing such default; and (e) sublandlord shall not amend or terminate the lease, or surrender any portion of the premises, without subtenant’s prior written consent. The following are some additional details to be addressed:
The sublease should specify that portion of the leased premises that sublandlord is subleasing to subtenant.
The sublease should define the sublease term. The sublease term must be less than the lease term (even if only by one day) to ensure that a court does not reclassify the sublease as an assignment. Practice Tip: Subtenants need to think about and plan for this “gap” issue. Generally the subtenant wants the flexibility to stay in the space under a direct lease with the landlord following the end of the sublease term and they won’t want to move out for one day and move back. There are various ways to work around this but one option is to include a benign holdover provision in the sublease.
Rent and Other Expenses
The sublease should establish the amount of rent and other expenses owed by subtenant under the sublease.
Provision of Services
The sublease should list those services being provided to subtenant and establish whether those services shall be provided by landlord or sublandlord. Practice Tip: If services might be provided by landlord such as after-hours HVAC, the sublease needs to address how the corresponding additional charges will be handled such as after-hours HVAC and what rights subtenant has to arrange those services directly with landlord (since tenant will owe the charges under the lease).
Condition of Premises
Similar to a lease, the sublease should describe the sublease premises condition and any applicable improvements or allowances to be made by sublandlord. Be sure to consider and address what the required surrender condition is.
Insurance, Waiver of Subrogation
The sublease should require subtenant and sublandlord to maintain insurance during the sublease term that complies with the lease and requirements of the parties to the sublease. Additionally, both sublandlord and subtenant should require a waiver of subrogation; ideally, the waiver of subrogation would include landlord as well.
The sublease should list the addresses to which rent and any notices can be sent.
The sublease should not only add new provisions, but should exclude those provisions in the lease that do not apply to the sublease. Common examples include provisions establishing rent, the lease term, brokerage fees, and any tenant improvement allowance. The subtenant should also request the exclusion of any lease provision that limits landlord’s liability to landlord’s interest in the building or project area. The sublandlord has no interest in the building or project area and would have no liability under such a provision.
Drafting the Consent to Sublease
Unless the sublease is a permitted transfer that does not require landlord’s consent, the sublease must either include a landlord’s consent clause or incorporate a separate landlord’s consent agreement. Landlord will want to draft its own consent and subtenant will have concerns to be addressed there too. Below is a discussion of some of the issues encountered in the consent on behalf of landlord and subtenants, consider also the impact a sublease could have on percentage rent.
Waiver of Subrogation/Claims
Landlord will want subtenant to waive subrogation claims and subtenant will want the same from landlord.
Landlord will want indemnification from the tenant comparable to that given by tenant to landlord under the lease. Generally, landlord will not agree to grant the same indemnification to the subtenant which was granted to tenant (if any) in the lease.
Subtenant will want an estoppel with respect to covering the usual topics mentioned under Sublandlord representations and warranties above. Landlord may or may not be willing to provide this, and if they do, it will generally be just to landlord’s knowledge.
Landlord will want subtenant to agree that if the lease terminates due to default, landlord has the option to require subtenant to in effect allow landlord to preserve the sublease and step into the shoes of the sublandlord on the sublease.
Landlord will want the consent to make clear that landlord retains the right to approve any future assignments of sublease as well as any subsequent subletting by the subtenant and any assignment of the sublease.
Subtenant (and Tenant) Specifics Signage, Use, Approval of Planned TIs
Often the sublease transaction involve a change in signage, new TIs, etc., which require landlord’s consent and this consent document is the logical place to include the details of those approvals. Similarly, the lease sometimes includes provisions tailored to the specifics of the tenant that should be modified with respect to the rights of the subtenant.
Notice and Opportunity to Cure
Often subtenants will want landlord to agree to copy them on default notices and allow them to cure the default. See also the discussion above regarding obtaining a new lease.
Subtenants want landlord to be obligated to recognize their sublease as a direct lease if the lease is terminated due to default by tenant. Needless to say, landlords are generally not too excited about granting such rights, particularly in cases where the sublease rent is less than the rent under the lease and/or the premises is less than all the space covered by the lease. However, in this economic environment, we may be seeing this much more often than in the past.
Approval of Sublease Document
Landlord will want to tie its consent to the actual sublease document, not to the LOI. This is important because as discussed above, the sublease will cover any number of issues which are specific to the sublease itself, including operational issues important to landlord.
Direct Payment of Rent
Landlord will want the right to collect rent directly from subtenant, and subtenant may correspondingly want the right to pay the rent directly to insure that it is applied to the rent due on the lease.
Cynthia Thomas is a founding member of the Seattle firm Real Property Law Group, PLLC. Cindy 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 firstname.lastname@example.org or 206-625-1717.
Please note that all real estate transactions are fact specific, and this article is not intended as legal advice. In addition, the reader should note that this article was written from the perspective of a Washington state real estate attorney. Since real property is one of the most state-specific practices areas, the reader is urged to consult the statutory and common law in her own jurisdiction, in addition to considering the points raised in this article.
© Copyright 2010, American Bar Association.