In negotiating a commercial lease, the parties typically place the signed lease in a drawer once it is executed, and both parties feel comfortable not only with the terms but also with each other. Often, the parties know each other, leading to an implied level of trust should any dispute or misunderstanding arise. A landlord may have agreed to reduced rent, a lower security deposit, and no personal guaranty based on the tenant’s comfort level. Conversely, a tenant may not have insisted on maintenance or repair obligations because the landlord is perceived as honorable. What happens when the lease permits the tenant to transfer its interest to a third party, and the landlord’s comfort level is compromised? One way to minimize this future risk is to dedicate time upfront to negotiating any assignment and subletting provisions to retain some level of input regarding any future lease parties.
This article discusses several key points to consider when negotiating any assignment of subletting provisions in a commercial lease.
I. Definition of Assignment and Subletting
An Assignment and a Sublease are two entirely different concepts. Under an Assignment, the tenant transfers all its rights, control, and responsibility to another party, which are assumed by the assignee, who steps into the shoes of the new tenant. Upon the assignment, the landlord is now in privity with the assignee but not with the original tenant. Under a Sublease, the tenant transfers its right to use all or a portion of the leased premises to a third party known as the subtenant; however, the landlord’s lease, along with its privity, remains with the original tenant and not with the subtenant. The Sublease between the tenant and the subtenant will be based on different terms and conditions, with the subtenant’s rights under the Sublease being contingent upon the tenant’s compliance with the terms of the lease with the landlord.
II. Assignment Provisions
Since Alabama recognizes that leases are freely assignable and may be sublet by a tenant unless the parties specifically restrict this right, it is essential for these provisions to be included in all commercial leases. A landlord should try to insert a highly limited right for the tenant to assign the lease. The reasons for including this limited assignment right from the landlord’s perspective include:
i. A tenant’s assignment to a third party leaves the landlord with an unapproved tenant and a new tenant who may lack the financial means to make rent payments or rights that were released due to the identity of the original tenant.
ii. The original tenant, due to the landlord’s familiarity, may have been given better terms, such as lower rent, a longer lease term, a reduced security deposit, or limited guaranty with no additional security requirements.
So, how should a landlord attempt to limit any assignment? First, the landlord should aim to restrict any assignment to the landlord’s approval, which can be withheld for “any reason.” This gives the landlord the final word on any assignee and any revised terms in an assigned Lease. The courts in Alabama have recognized that this approval restriction allows a landlord to deny approval for almost any reason, as the covenant of good faith and fair dealing requiring reasonableness, which is implied in every contract, does not apply when the parties to a contract (or lease) negotiate terms inconsistent with such a covenant. In other words, the parties are free to contract and include any standards they wish to govern a landlord’s consent to a proposed sublease or assignment.
If a tenant is unwilling to accept this limited Assignment language, a compromise is to make the landlord’s approval subject to not being unreasonably withheld, conditioned, or delayed. However, a landlord must understand that this standard requiring reasonableness does not grant a landlord the authority to withhold approval for any reason. Specifically, the Alabama courts have recognized that it is reasonable to condition such approval on issues such as the identity of any assignee, the financial backing of any assignee, whether any alteration of the premises is required, the legality of the proposed assignee’s use, and whether the assignee’s use is compatible with those of other tenants. However, a landlord’s personal taste, convenience, or sensibility is not recognized as reasonable by the Alabama courts in rejecting an assignee.
Whether the assignment provision is limited or based on a reasonable standard, the landlord should include several additional conditions in any such provision:
i. Notwithstanding any Assignment, the original tenant remains liable under the Lease;
ii. Certain provisions in the lease, such as options, term extensions, expansion of premises, and rights of first refusal, are personal to the original tenant. Therefore, even if the lease is assigned, these terms are not assignable and may not be exercised by any assignee.
iii. Any assignment approval is conditioned upon the unavailability of other space in the building or development for the assignee; and
iv. The definition of Assignment includes any assignment to:
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- A new entity with the same owners;
- Mergers; and
- The sale of an interest in the Tenant’s company.
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III. Subletting Provisions
Recall that a sublease is a new lease between the tenant and the subtenant. However, since it is only for a portion of the leased premises that the tenant is entitled to use under the lease with the landlord, the sublease cannot expand any rights of the tenant under the lease, such as the term of the lease. When the lease expires or is terminated, the sublease also expires. For this reason, any subtenant must understand the terms under the lease, and if they differ from the sublease, the consent of the landlord or the landlord’s obligation to exercise any extension rights under the lease must be included in any sublease.
Notwithstanding the foregoing, the sublease typically has different provisions, such as rent, which is usually higher than what the tenant pays under its lease with the landlord. Is it fair for a tenant to profit from the use of the leased premises owned by the landlord? One way for the landlord to protect itself from this unfair situation—that is, the tenant not receiving higher rent under the sublease than the landlord receives from the tenant under the lease—is to condition any sub-letting on the landlord’s approval. Additionally, the landlord should include that any sublease providing for rent or additional payments/compensation above that in the lease is to be paid directly to the landlord. A compromise for the tenant, who has found a higher-paying sub-tenant, is for the landlord and the tenant to split any rent received under a sublease that exceeds the amount the tenant pays under the lease.
IV. Summary
Any Assignment and Subletting provision in lease negotiations should not be overlooked simply because a party is satisfied with the lease terms or trusts the other party to be reasonable if issues arise in the future. Neglecting to take the time upfront to negotiate these provisions and articulate them with specificity can lead to disputes in the future with parties completely unknown to the original parties to the lease.
J. Jack Kubiszyn primarily focuses his practice on general real estate matters for national clients, while also representing developers, borrowers and lenders in commercial real estate loan transactions – including landlord and tenants in leasing matters. He actively represents regional clients in the acquiring and disposing of office buildings, retail shopping centers and multi-family apartments, and his experience preserves his clients’ interests while helping them avoid the difficulties, including litigation, that can result from the failure to secure effective, knowledgeable counsel.
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