P R O B A T E   &   P R O P E R T Y  
September/October 2003
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Sublease Due Diligence

By Brent C. Shaffer

Brent C. Shaffer is a partner in Young Conaway Stargatt & Taylor, LLP, Wilmington, Delaware, and is chair of the G-5 Assignment and Subleasing Committee.

Our Cast of Characters: Subtenant, Prime Landlord, Sublandlord

The advertisements seem to be appearing with ever-increasing frequency: "Prime real estate available for sublease—immediate occupancy available." Statistics bear this out. Nationally, office and warehouse space available for sublease remains near the record level set only one year ago. These ads conjure up vastly different images in the minds of clients and their respective lawyers. To the client interested in subleasing, perhaps encouraged by the rampant enthusiasm of a broker trying to earn a living, the ad conjures up beautiful visions of a simple and fast solution to its space problems, free of prime lease trials and tribulations such as waiting for the construction of tenant improvements. The lawyer, however, sees the usual leasing process exponentially complicated by not two, but three, parties and their lenders, all with competing interests. The subtenant's lawyer envisions a sublandlord on the brink of financial ruin, a prime landlord that won't tinker with its "set in stone" prime lease, and a subtenant forced to negotiate without leverage because of an expiring lease or severe space problems.

The true situation likely lies between these two visions; yet, a sublease situation is almost always more difficult to deal with than the client may think. It is the subtenant lawyer's job to "kick the tires" of the sublease and make sure that the client is walking into the situation with eyes open and an understanding of its legal and practical situation. It helps to have an efficient due diligence process in mind so that the possible problems involving the sublease can be brought to light or laid to rest in a rapid, cost-effective manner.

The lawyers for the prime landlord and the sublandlord also need to guide their respective clients through their own due diligence processes. The prime landlord should take a close look at the subtenant to determine whether the sublease would help or hurt the prime landlord on a long-term basis—even if the prime landlord ultimately has the right to "just say no" to the requested sublease. The sublandlord will need to know how strong the subtenant really is and how the sublandlord's prime lease liabilities will be affected.

Due diligence checklists for the prospective subtenant, sublandlord, and prime landlord can be very helpful, and the author's suggestions for checklists are included with this article. These checklists can serve as a starting point but should be tailored by lawyers based on their own experiences, in light of the applicable property use and value of the lease transaction. Explanations of the checklists follow. The section letters in the text below correspond to the lettered items in the checklists.

I. Subtenant's Due Diligence Checklist

The subtenant's approach to evaluating a prospective sublease differs from that for evaluating a direct lease, because a fixed situation is already in place. Instead of a clean slate, the subtenant enters the picture subject to a fully written and negotiated lease, used tenant improvements, and an existing credit history and relationship between the prime landlord and the sublandlord. Therefore, the subtenant needs to ascertain the existing circumstances and try to either fit into them or undertake the additional burden of changing them.

The subtenant's due diligence process should smoke out as early as possible the degree of a prime landlord's reticence to deal with the sublease situation. This task requires an early review of the terms of the prime lease so that the subtenant knows how much of a change in the lease terms it must seek. The subtenant needs to inspect the physical space, as suggested in the checklist, as soon as possible to determine the degree of physical changes the prime landlord must approve. Also, the subtenant should gauge as soon as possible the financial strength of the sublandlord, because ultimately this will determine the degree of cooperation of the prime landlord.

Once the subtenant determines the degree of change that it needs to seek and the level of incentive the prime landlord has to cooperate, the subtenant can decide whether it is worthwhile to enter earnestly into negotiations for the sublease. If changes to the prime lease or alterations are essential, the subtenant or sublandlord will need to convince the prime landlord that such changes are essential to the sublease and that ultimately the sublease will benefit the prime landlord (such as by preventing a monetary default by a financially weak sublandlord).

A. Existing Lease Terms andAmendments

The subtenant's starting point in reviewing the prime lease should be the subleasing provisions themselves. Although most leases contain detailed clauses regarding the requirement of the prime landlord's consent and conditions for the consent, once such consent is given many mechanical problems arise in completing the sublease transaction. For example, often the prime landlord will sign loan documents that require the prime landlord's lender to consent to all leases and subleases. Yet, the sublease clause in the prime lease may say nothing about the lender, and, even if it does, there is usually no time limit for a response from the lender in either the loan documents or the lease. As another example, the subtenant may want the ability to review documents located in the prime landlord's leasing files, such as environmental studies, operating expense records, or exclusivity provisions in other prime landlord leases, but it is the rare prime lease that provides for such access.

Beyond looking for clauses dealing with the sublease process (and the lack thereof), provisions that the subtenant will need to look out for in the prime lease include use provisions, signage rights, occupancy or continuous operations requirements that may be violated before the subtenant opens up for business, percentage rent provisions that may or may not be affected by the subtenant's income, the ability of the subtenant to sub-sublease or otherwise exit the transaction, and consent requirements for alterations that the subtenant is going to need to make. The subtenant also needs to check for insurance, casualty, and condemnation provisions in the prime lease, which may conflict with the anticipated treatment of those issues in the sublease.

These examples are not exhaustive. All of the prime lease provisions identified in the checklist, as well as others in any particular prime lease, can tie the hands of the sublandlord and render the subleased premises unsuitable for the subtenant unless they are effectively dealt with by prime lease amendments or otherwise. The subtenant cannot risk a default and termination of the prime lease resulting from essential subtenant alterations, uses, hours of operation, and so forth. The subtenant will also need to understand all of the existing pecuniary obligations of the sublandlord under the prime lease so that it knows which of these obligations are likely to be passed along to it by the sublandlord and the extent of these obligations. Only with such knowledge can the subtenant assess whether the subleased premises are appropriate for the subtenant, or the length of the process and degree of difficulty it can expect in negotiating an acceptable sublease and possible amendments to the prime lease.

Perhaps the biggest problems with language in the prime lease occur when the sublease is only a partial sublease of the existing premises. In such a situation, the sublandlord or another subtenant may in essence become co-lessees under the prime lease, making it difficult to include many of the protections that the subtenant would ordinarily require in the sublease from the sublandlord (because the sublandlord continues to have a possessory, as well as pecuniary, interest under the prime lease). The subtenant will need to make sure that it understands each and every obligation of the sublandlord so that the sublease can effectively and fairly allocate those responsibilities going forward as between the sublandlord and the subtenant.

One prime lease provision that is always key to the subtenant will be the length of term. The term of a sublease is, in most cases, less than that of the prime lease. Therefore, the subtenant may want to be able to exercise renewal rights under the prime lease or, if such renewal is unacceptable to the sublandlord, obtain an agreement from the prime landlord to enter into a new direct lease with the subtenant after expiration of the prime lease.

B. Physical Condition of Premises

The subtenant will desire either to use the existing tenant fit-out to the extent possible or to change it to meet its own needs. In either case, the existing condition of the premises and tenant improvements needs to be understood fully by the subtenant so that the subtenant can assess its need to make further alterations, the feasibility of such alterations given the existing structure, the need for future maintenance, and the anticipated cost of all of these concerns. The assessment of the condition must occur before the subtenant seeks any necessary approval from the prime landlord for further alterations. Physical inspections by appropriate experts could include review of existing wiring, telecommunication conduits, load bearing capacity, and major systems that may be required under the prime lease to be maintained by the sublandlord such as heating, air conditioning, plumbing, telephone, fire suppression, security, and card entry systems.

Depending on the nature of the premises, the subtenant may need to obtain comfort on environmental risks and establish a documented environmental baseline to protect itself from future liability. Concerns can include a broad array of problems that may require separate inspections, such as mold, indoor air quality, radon, asbestos, groundwater, underground tanks, and hazardous waste. The subtenant and its inspectors will need to obtain access to the premises, as well as the sublandlord's files and past reports. Although it is often not done, the prudent subtenant and its experts should also review the files and records of the prime landlord, if such access can be obtained or negotiated (prime leases rarely provide for such a right).

C. Compliance of Premises with Laws

The subtenant should make sure that its operations will not be shut down by governmental authorities (or by the prime landlord under the terms of the prime lease) for failure to comply with zoning, land-use, or building codes. The subtenant will also need to know whether alterations are required for the premises to comply with provisions of the Americans With Disabilities Act (ADA) so that the subtenant is not exposed to liability to private plaintiffs or to governmental authorities for such requirements. If the subleased premises did not constitute new construction after the adoption of the ADA, the subtenant may be instituting a new use that now renders the premises a "public accommodation" under the ADA (basically, sites at which goods or services are provided to the public, such as restaurants and retail stores), requiring heightened barrier removal standards for ADA

compliance. Another concern is whether alterations that the subtenant will make might destroy the grandfathered code status of the current

improvements.

To deal with these issues the prudent subtenant will employ an engineer to survey the premises for compliance. This survey should always include an analysis of the parking provided at the premises. Although the premises may have more than the number of parking spaces required for the sublandlord's use, the subtenant may have a slightly different use. Under some local land-use laws, parking requirements may differ for a fast-food restaurant, a traditional table-service restaurant, and a take-out restaurant (be careful when adding tables to that donut shop!). On the other hand, the subtenant may have the same use but a greater number of employees that could require a greater number of parking spots under the zoning regulations. If at all possible, the subtenant should require production of all certificates of occupancy for the leased premises. The subtenant should also determine whether it needs to obtain a new certificate of occupancy for its possession.

D. Confirm Status of Ownership

The prudent subtenant will obtain a title search on the real property (ideally coupled with a leasehold title insurance policy if the sublease is valuable and can be recorded) and will also obtain a complete UCC financing statement search in the names of both the prime landlord and the sublandlord. The searches should verify that the prime landlord has fee title or an acceptable leasehold interest in the real property and determine if there are any security interests in the personal property included in the sublease. The UCC search will also reveal whether a third party is claiming title to certain goods and only leasing them to the sublandlord. The title search also informs the subtenant of leases of record of the premises to parties other than the sublandlord, whether the premises are free of mechanic's or judgment liens against either the sublandlord or the prime landlord, and whether any lenders have mortgages secured by the premises (in which case the consent of those lienholders to the sublease may be required).

E. Determine Existence and Status ofService Contracts

A great variety of ongoing service contracts may be necessary for operation of the leased premises, including contracts for heating and air conditioning, the sprinkler fire suppression system, property management, satellite or other communications, security, trash removal, and cleaning, as well as basic utility accounts. If these contracts have been entered into directly by the sublandlord, as opposed to the prime landlord, the sublandlord likely will ask the subtenant to assume the contracts or, instead, terminate existing contracts and require the subtenant to enter into new ones.

Knowledge of these contracts and their terms not only helps the subtenant determine operating costs of the premises going forward but also can give an indication of the past maintenance of the premises. Before agreeing to enter into a contract, the subtenant should verify that there are no outstanding obligations of the sublandlord under the contract as well as determine that the terms are acceptable. Because these types of contracts are often informal and oral, the diligent subtenant may need not only to require written representations from the sublandlord listing the contracts and their basic terms but also to verify the existence of the contract terms and their payment and default status with the service providers themselves. If the terms of the contracts are not acceptable, the subtenant should insist on a contractual right to cause the sublandlord to terminate these contracts before commencement of the sublease. Ideally, the subtenant should have knowledge of significant service contracts ahead of time so that they can be covered in the written sublease itself.

F. Determine Whether the PrimeLease Could Be Terminated orSubject Subtenant to UnknownLegal Liabilities

The primary method the subtenant will employ to make sure the prime lease is not terminated, thus terminating the sublease, is to obtain a comprehensive estoppel certificate from the prime landlord and sublandlord. A bit of due diligence in this area beyond obtaining the certificate certainly would not hurt. The prospective subtenant may be able to obtain valuable information from talking with the prime landlord's property manager or leasing broker, as well as talking with the prime landlord itself and other tenants in the particular building or shopping center that contains the premises.

Even if there are no existing defaults under the prime lease, the financial abilities of the sublandlord are of paramount concern to the subtenant. A financially weak sublandlord may fail to meet its obligations under the prime lease, rendering the subtenant compelled to pay higher rent under the prime lease or perform other obligations that may have been allocated to the sublandlord under the sublease to keep the prime lease in effect. This situation may exist especially with a partial sublease, when the sublandlord or another sublessee is sharing payment obligations with the subtenant under the prime lease. Moreover, if the sublandlord files for bankruptcy, both the prime lease and the sublease become executory contracts that could be rejected by thesublandlord.

Finally, and often overlooked, due diligence should be performed by the subtenant to determine the financial stability of the prime landlord. Again, the prime lease could become embroiled in a bankruptcy, affecting or even eliminating the sublease; or the prime landlord may be unable to perform its maintenance or other obligations because of financial weakness. Tools for determining the financial status of the prime landlord and the sublandlord include such things as Dun & Bradstreet reports, credit reports, and financial statements.

G. Determine Authority and Abilityof Parties to Be ContractuallyBound

Lenders, even for very small loans, will go to great lengths to ensure that the loan documents have been duly authorized, executed, and delivered and that the borrower has the power and authority to enter into the loan transaction. Surprisingly, such verification is rarely obtained by landlords in all but the largest lease transactions. The subtenant needs to know that both the sublease and the prime landlord's estoppel certificate are valid, enforceable, binding, and not subject to such defenses as lack of due authorization or the power of the organization to enter into such documents.

At a minimum, the subtenant should obtain a resolution signed by the secretary of a corporation, all members of a limited liability company, or all partners of a general partnership, as applicable. The subtenant should also ask for copies of the applicable filed documents creating the sublandlord and prime landlord entities, as well as their bylaws, operating agreements, or partnership agreements, as applicable, so that they can be reviewed to make sure that the sublease transaction and prime lease transaction are not outside of the organizational power of the entity and have in fact been properly approved in the resolution by the necessary parties. The person signing the sublease or estoppel needs to be specifically authorized either in the resolution or by the terms of the organizational documents of the entity.

II. Sublandlord's Due Diligence Checklist

Due diligence for the sublandlord is critical, despite the sublandlord's familiarity with the leased space and prime lease obligations. The sublandlord's due diligence should be focused on making sure that it achieves its primary objective of having a third party undertake as soon as possible the sublandlord's existing lease obligations through the end of the prime lease term. The sublandlord may view the due diligence process as subversive to its timing objectives; however, a sublease undertaken without the proper investigation can often lead to temporary, rather than extended, relief of the sublandlord's prime lease obligations.

A. Determine Financial Strength ofSubtenant

The subtenant's financial statements certified by an accountant, a credit report on the subtenant, copies of filed tax returns, and a direct inquiry of the subtenant regarding its financial status are all valuable tools. Indeed, except in the very rare circumstance when the prime lease allows the sublandlord to sublease without consent of the prime landlord, the sublandlord should be absolutely sure that the subtenant is a reasonably strong party before the sublandlord expends any political capital in requesting the prime landlord's consent. The sublandlord cannot afford to build up any ill will with the prime landlord during this critical time by wasting the prime landlord's time with a financially weak subtenant candidate.

B. Review Prime Lease to DetermineRights/Leverage of Sublandlord

The sublandlord always needs to take a fresh look at its existing prime lease in light of the current status of the lease and any specific information that the sublandlord has regarding prospective subtenants. This review will allow the sublandlord to predict how cooperative the prime landlord will be in the sublease process and the extent to which the sublandlord, rather than the prime landlord, will be able to continue to control the sublease process. The first provisions to review in the lease are the subleasing and assignment sections, which often spell out the landlord's consent rights and, with increasing regularity, the agreed-upon conditions that render a prime landlord's failure to consent reasonable. But many other lease provisions, such as those listed in the checklist, can interfere with the prospective subtenant's requirements and may force the sublandlord to approach the prime landlord hat-in-hand for prime lease amendments or waivers in the prime landlord's consent document. The sublandlord also needs to know if the prime landlord has the ability to recapture the premises and deal with the subtenant directly under a new prime lease.

C. Determine Ability to MakeRepresentations and Warrantiesand Estoppel Statements Requiredby Subtenant

The sublandlord will undoubtedly need to provide an estoppel certificate to the subtenant that confirms the existing status of the lease. The sublandlord should undertake the same due diligence analysis that it would undertake in providing an estoppel letter to a lender or purchaser of the premises. Therefore, the correct personnel should be questioned and leasing files reviewed to avoid misstatements. Often, these steps are lost in the mad rush to get the sublease executed. Yet there is no reason for this neglect to occur, because the due diligence tasks can be conducted before beginning the subleasing process. Even before receipt of a requested form from the subtenant, the sublandlord can rather easily predict the statements that will be requested, including verification of the lease terms, default status, and the status of rent payments.

D. Determine Whether FutureActivities of Subtenant CouldRender Prime Lease in Default

In a true sublease situation, the prime landlord will not release the sublandlord from any obligations, past or future, under the prime lease. Because the sublandlord enters into a sublease either to have another party undertake the existing obligations of the sublandlord under the prime lease or to capitalize upon the economic value of its interests under the prime lease, the last thing the sublandlord wants is any default situation created by the subtenant under either the prime lease or the sublease. Due diligence also plays a role in this determination of the likelihood of future subtenant defaults and the prevention of prime lease default situations.

The sublandlord should conduct a thorough inquiry of the subtenant to understand the subtenant's future use of the premises. To be properly done, this requires asking the subtenant a series of probing questions about the subtenant's plans regarding use, alterations, hours of operation, and so forth. The inquiry also requires gaining at least a general understanding of the subtenant's business so that the sublandlord can envision where that business is headed in the future. The sublandlord needs to gauge the likelihood of future pressures that might change the subtenant's operations in ways that could lead the subtenant to default under the prime lease or abandon the sublease. For example, a retailer might have to enter into new lines of business to stay competitive. Engaging in these new lines may violate use provisions or require alterations that are unfeasible for the premises. As another example, the subtenant may want to add signage that is permitted under land-use laws but that is prohibited under the prime lease. Once the sublandlord understands what the subtenant's operations are likely to be, the sublease can be drafted with covenants that fully guard against future prime lease defaults. This drafting requires more than a blanket covenant that the subtenant will comply with all terms of the prime lease, because prime lease provisions can be ambiguous when applied to specific situations. This ambiguity and the resulting headaches can be prevented by explicit language in the sublease.

To best protect its interests, the sublandlord should monitor the subtenant's performance throughout the term of the sublease. The due diligence undertaken by the sublandlord to understand the subtenant's operations before the sublease is signed will make this ongoing monitoring process more effective.

E. Determine Authority and Abilityof Subtenant to Be ContractuallyBound

As discussed above in the context of the subtenant's checklist, the sublandlord will want to make sure that the subtenant has the power and authority to enter into the sublease and that a proper person has executed the sublease with authority to bind the subtenant. The degree of diligence undertaken to verify these facts, which in theory should be the same for all transactions, will vary as a practical matter according to the size of the transaction.

F. Determine Status of ExistingService Contracts

The sublandlord is well advised to take a look at its existing service contracts for such things as sprinkler and fire suppression systems, heating and air conditioning maintenance, alarm systems, trash removal, cleaning, and so forth—in fact, all contracts directly entered into by the sublandlord instead of the prime landlord—before beginning sublease negotiations. After all, the sublandlord should want relief from these contractual liabilities and expenses as much as from the prime lease obligations. The focus of this review should be upon those service contracts that the sublandlord is not required to keep in effect under the terms of the prime lease. The sublandlord will use its review to classify these contracts into two categories: those that can be terminated at or before the sublease (which the sublandlord should almost always terminate, so that subtenant enters directly into replacement contracts); and those that cannot be terminated before the sublease (either by their terms or by negotiations with the service provider). With knowledge of the contracts that must continue, the sublandlord can commence sublease negotiations by requiring the subtenant contractually to assume these obligations. The sublandlord should also determine whether it has any outstanding payments or other obligations under these contracts.

As to those services that the sublandlord is required to keep in effect under the prime lease terms, the sublandlord will need to decide whether it is better off keeping these contracts in its own name (which, although not relieving the sublandlord from direct liability, will provide greater control in avoiding a prime lease default) or, instead, terminating them and requiring the subtenant to carry them. The sublease can best be drafted to protect the sublandlord in this regard if the sublandlord determines its strategy up front.

III. Prime Landlord's Due Diligence Checklist

The prime landlord is often drawn kicking and screaming into the sublease transaction. After all, the prime landlord has already drafted and negotiated the prime lease and has already incurred the transaction costs for the prime lease, which it expected to spread over the entire length of the prime lease term. In addition to time, the prime landlord may have invested capital in the form of tenant improvement allowances for the sublandlord. The prudent prime landlord, however, will use the sublease opportunity to protect or better its position in several ways. It may improve the credit position it has with a failing sublandlord; it may perhaps facilitate a prime lease renewal or set the stage for a new prime lease because of the subtenant's continued need for the space; it may possibly even improve the prime lease terms by virtue of the sublandlord's need for the prime landlord's consent. Thus, the prime landlord is faced with key business decisions that can be properly made only after exercise of requisite due diligence.

A. Determine Financial Strength ofSublandlord

If the sublandlord is fully capable of continuing to perform its lease obligations, the prime landlord may not want to deal with a subtenant that it does not know or did not originally seek. If, however, the financial ability of the sublandlord has diminished to the extent that future compliance with the lease terms is in jeopardy, or if a bankruptcy filing of the sublandlord looks possible, the prime landlord may become highly motivated to see that the sublease occurs. If the prime lease is not in default and the sublandlord is still occupying the premises, the prime landlord also needs to determine the likelihood that the operation will be closed down in the future and the space vacated, with the resulting effects on other tenants of the property (especially in a retail situation). In a retail situation with percentage rent, the prime landlord will also need to determine how future economic performance of the sublandlord will affect the amount of percentage lease payments in the future. Financial statements, Dun & Bradstreet reports, credit reports, and bankruptcy searches can all be obtained and provide useful information for the prime landlord.

B. Determine Financial Strength ofSubtenant

Once it has a handle on the current strength of the sublandlord, the prime landlord should then determine if the financial strength of the proposed subtenant is acceptable, because with a failing sublandlord the subtenant may become the primary credit for the prime lease. In addition, if the prime lease gives the prime landlord the right to receive any sublease rent in excess of prime lease rent, the prime landlord will want to determine the ability of the prospective subtenant to pay the sublease obligations. As an additional party to the lease situation, the new subtenant raises yet another prospect of a bankruptcy filing that could result in further loss of control by the prime landlord. Again, financial statements, credit reports, and other financial information regarding the subtenant may prove invaluable.

C. Determine Whether Subtenant'sUse Will Render Premises inViolation of Zoning and Land-UseRequirements

The new operations by a subtenant in the premises may lead to changes that affect the property's compliance with zoning and land-use requirements, for which the prime landlord may ultimately be liable. This situation could occur because of a change in use, a change in the number of employees (because of a possible effect on parking requirements), and a change resulting from alterations that the subtenant wishes to make. With a sublease of only a portion of the premises, the addition of multiple parties using the space may cause even greater land use compliance problems. As discussed above in connection with the subtenant's checklist, ADA compliance is also a concern.

D. Review Prime Lease to DetermineRights and Leverage of PrimeLandlord

The prime landlord will need to refresh itself on the terms of the prime lease to determine its rights and leverage in dealing with the sublease approval process. Primary, of course, are the sublease provisions that state the level of consent required. The prime landlord will need to consider case law, which in a slight minority of jurisdictions implies that the prime landlord's consent can not be unreasonably withheld, unless there is express language setting forth a stronger standard for consent. In most jurisdictions (Texas being a notable exception [see TEX. PROP. CODE ANN.§ 91.005]), if the lease is silent on subleasing, subleasing is permitted without consent. The prime landlord will also need to look for provisions giving it an ability to recapture space in the given situation, the right to receive sublease rents in excess of prime lease rents, the right to prevent the subtenant's desired use, and the right to prevent the subtenant's requestedalterations.

E. Determine Ability to MakeRepresentations and Warrantiesand Estoppel Certificates Requiredby Subtenant

A prime landlord that wants the sublease transaction to take place will need to conduct certain due diligence to enable it to issue the estoppel certificate that will be required. The prime landlord should review relevant lease provisions to confirm that there are no lease defaults, to confirm the terms of the lease, and to verify the status of rent payments. To accomplish these tasks, the prime landlord will need to make inquiry of its property managers, employees, and maintenance people, and to review its leasing files.

F. Obtain Contractual Agreement ofSublandlord to Pay PrimeLandlord's Expenses

This item becomes a due diligence requirement only in the sense that the prime landlord needs to remember to obtain an agreement of the sublandlord, or possibly the subtenant, to pay the prime landlord's expenses in the review of the sublease and the cost of its due diligence. Prime leases rarely provide for this payment, but it could be requested in return for the prime landlord's consent.

G. Determine the Authority andAbility of Parties to BeContractually Bound

As discussed for the subtenant and sublandlord, the prudent prime landlord should verify the authority of the subtenant to enter into the sublease. It is possible that the prime landlord may already have resolutions on hand for the sublandlord; however, obtaining updated certificates of goodstanding for the sublandlord may be prudent.

Conclusion

The inherent complexity of subleases makes them anything but a quick and easy exercise. The checklists serve as a due diligence framework to make sure the assumptions and expectations of the parties to the sublease transaction are valid.



I.Subtenant's Sublease Due Diligence Checklist.

A.Review existing prime lease provisions to identify issues that could be problematic for the subtenant and determine if they can be amended in prime landlord consent or in prime lease amendment.

1.Landlord consent requirement to sublease.

2.Prime landlord recapture right upon attempted sublease.

3.Use provisions.

4.Lack of exclusivity provisions.

5.Continuous operation.

6.Percentage rent provisions that are unclear in sublease context.

7.Insurance—effect of additional layer of coverage, use of proceeds.

8.Length of term.

9.Expense pass-throughs.

10.Consent requirements to further alterations.

11.Parking (especially if partial sublease).

12.Lack of prime landlord estoppel/representation requirements.

13.Prohibition of subleasing.

14.Damages/remedies.

15.Tenant responsible for compliance with laws/Americans with Disabilities Act.

16.Signage provisions.

17.Title to tenant improvements/ability to remove.

18.Casualty and condemnation proceeds.

B.Determine physical condition of premises/expenses to be incurred in connection with condition.

1.General property inspection.

a.General physical condition of premises.

b.Shared facilities outside of subleased premises (right of entry?).

c.HVAC/major systems—remaining life and ability to upgrade for subtenant needs.

d.Feasibility of desired alterations given existing tenant improvements.

e.Usefulness and condition of personal property included with sublease.

2.Environmental inspection.

a.Phase I update or new inspection.

b.Sublandlord's file/inspection report review.

c.Prime landlord's file/inspection report review (if possible).

d.Indoor air quality.

C.Determine compliance of premises with laws.

1.Compliance of existing premises with building codes.

2.Compliance of existing premises with Americans with Disabilities Act/public accommodation standards.

3.Compliance of tenant's anticipated alterations with governmental laws and regulations/terms of lease.

a.Building code.

b.Local zoning/land-use requirements.

c.Americans with Disabilities Act.

d.Prime landlord consent.

e.Prime landlord's mortgagees' consent.

f.Sublandlord consent.

4.Certificates of occupancy.

5.Zoning and land-use status and requirements.

a.Proposed use.

b.Parking for proposed use.

c.Compliance with/violations of existing improvements.

d.Existing and additional signage.

D.Confirm status of title ownership to real estate and personal property to be used by subtenant (title and UCC searches on prime landlord and sublandlord).

1.Verify prime landlord fee ownership of real property/prime landlord or sublandlord ownership of personal property.

2.Verify existence of lienholders that may require consent.

3.Determine expiration date of prime landlord's financing (to indicate prime landlord's need for extension of lease term).

4.Verify no other leases of premises of record.

5.Verify free of mechanic's/judgment liens.

6.Verify no covenants or restrictions of record that adversely affect proposed use.

E.Determine status/existence of service contracts affecting premises.

1.In name of sublandlord or another party.

2.Terms of contracts.

3.Assignability to subtenant.

4.Verify no existing sublandlord defaults.

F.Determine whether prime lease could be terminated or subject subtenant to unknown legal liabilities.

1.Prime landlord's estoppel.

a.No default of sublandlord.

b.No disputes with sublandlord.

c.No anticipated payments due from sublandlord for annual CAM/expense payment reconciliation.

d.Confirm terms of lease/no amendments.

e.No violation of exclusives in prime landlord's other leases.

2.Sublandlord's estoppel.

a.No default of prime landlord.

b.No default of sublandlord.

c.No disputes with prime landlord.

d.Confirm terms of lease/no amendments.

e.Sublease not a violation of other contractual obligations of sublandlord (other subleases, among other things).

3.Right of subtenant to pay rent directly to prime landlord and/or subtenant notice and cure rights regarding prime lease defaults.

4.Determine prime landlord's financial strength and likelihood of bankruptcy.

5.Determine sublandlord's financial strength and likelihood of bankruptcy.

G.Determine authority/ability of parties to be contractually bound.

1.Sublandlord's resolutions/review oforganizational documents.

2.Sublandlord's certificate of good standing.

a.Jurisdiction where organized.

b.Jurisdiction of premises.

3.Prime landlord's resolutions/review of organizational documents.

4.Prime landlord's certificate of good standing.

a.Jurisdiction where organized.

b.Jurisdiction of premises.

II.Sublandlord's Sublease DueDiligence Checklist.

A.Determine financial strength of subtenant.

1.Ability to pay subtenant's rent obligations to prime landlord, any additional obligations to subtenant to sublandlord, and complete tenant improvements.

2.Likelihood of bankruptcy.

3.Future prospects of percentage rent (retail) (to satisfy subtenant's obligations to primelandlord).

B.Review prime lease to determine rights/leverage of sublandlord.

1.Ability to sublease without consent/consent not unreasonably withheld/exception to consent requirement.

2.Use provisions.

3.Prime landlord ability to recapture space.

4.Financial covenants.

5.Prime landlord right to sublease rents in excess of prime lease rents.

6.Alterations provisions.

C.Determine ability to make representations and warranties/estoppel statements required by subtenant.

1."No lease defaults"—question personnelon-site regarding prime landlord defaults or disputes.

2."No lease amendments"—check leasing files for amendment letters, work letters, commencement date letters, and existing estoppel certificates, including lender SNDAs.

3."Rent payments current"—check CAM/tax/insurance payments and annual reconciliations.

D.Determine whether future activities of subtenant could render prime lease in default.

1.Lease use provisions.

2.Lease alterations provisions.

3.Continuous operation/hours of operations covenants.

4.Signage requirements.

5.Compliance with governmental laws covenant.

a.Use permitted under land-use laws.

b.Building codes and permits, tenant alterations.

c.Parking requirements.

d.Violation of Americans with Disabilities Act from change to public accommodation.

E.Determine authority/ability of subtenant to be contractually bound.

1.Subtenant's resolutions/review of organizationaldocuments.

2.Subtenant's certificate of good standing.

F.Determine status of existing service contracts.

1.Obtain service provider's consent to assignment and release of sublandlord's liability for contracts subtenant wants to assume.

2.Terminate service contracts subtenant does not want.

III.Prime Landlord's Sublease Due Diligence Checklist.

A.Determine financial strength of sublandlord.

1.Ability to continue to pay rent obligations.

2.Likelihood of bankruptcy.

3.Likelihood of going dark (if it hasn't already).

4.Future prospects for percentage rent (retail).

B.Determine financial strength of subtenant.

1.Ability to pay rent obligations if sublandlord cannot pay/ability to pay rent in excess of prime lease.

2.Likelihood of bankruptcy.

3.Future prospects for percentage rent (retail).

C.Determine whether subtenant's use will render premises in violation of zoning and land-use requirements.

1.Change in use.

2.Change in number of employees (may affectparking).

3.If partial sublease, possible effect from changing single-tenant space to multiple-tenant space (may affect parking).

4.Affect of subtenant's desired alterations.

D.Review prime lease to determine rights/leverage of prime landlord.

1.Ability to withhold consent to sublease.

2.Ability to recapture space.

3.Rights to sublease rents in excess of prime lease rents.

4.Right to prevent subtenant's change in use.

5.Right to prevent subtenant's requested alterations.

E.Determine ability to make representations andwarranties/estoppel statements required by subtenant.

1."No lease defaults"—question personnel on-site regarding subtenant defaults or disputes.

2."No lease amendments"—check leasing files for amendment letters, work letters, commencement date letters.

3."Rent payments current"—check CAM/tax/insurance payments and annual reconciliation.

F.Obtain contractual agreement of sublandlord to pay prime landlord's expenses in connection with consent review, including legal fees (if not in prime lease).

G.Determine authority/ability of parties to be contractually bound.

1.Subtenant's resolutions/review of organizational documents.

2.Subtenant's certificate of good standing.

a.Jurisdiction where organized.

b.Jurisdiction of premises.

3.Sublandlord's resolutions/review of organizational documents.

4.Sublandlord's certificate of good standing.

a.Jurisdiction where organized.

b.Jurisdiction of premises.


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