Commercial Tenants Need Flexibility – Here’s How to Get It
As recent events have unfortunately shown us, there may be times when a business needs to vacate a commercial space before the expiration of its lease. A business may decide to close, sell its assets, merge with another company or move to a larger space to accommodate expanding needs. Simply put, business conditions can and do change; therefore, it is important that commercial leases contain as much flexibility as possible to help tenants mitigate any potential exposure arising from obligations within the lease. This protection is often best achieved by negotiating the inclusion of fair sublease and assignment clauses in a lease, as well as avoiding the use of open-ended terminology which favors the landlord.
First, it is important to note that subleasing and assignment are different legal concepts. An assignment occurs when a business decides to sell, merge, or consolidate a portion or all of the shares of the business, and in doing so, “assigns” all of its obligations and rights as a tenant under a commercial lease to the new partner or business owner.
Ideally, an assignment effectively removes the original tenant/guarantor from the lease, erasing any further obligations by the original tenant and leaving the new entity to assume its place under the lease. However, assignment provisions can pose risks for landlords since the new entity may be unknown to them in terms of its background, financial strength, or reputation. As a result, in almost all commercial leases, landlords will condition their consent to an assignment upon conditions such as the proposed new tenant meeting certain minimum financial requirements, and ensuring that it “fits” into the existing tenant mix without triggering any exclusivity clauses (a blog for another day) that the landlord may have with other tenants. Because of these risks, , many landlords will not agree to a full release of an existing tenant’s lease obligations even if consent to the assignment is granted. If this is the case, commercial tenants should seek to secure a guaranty for themselves from the new entity.
Sublease provisions are a bit more straightforward. When subleasing a commercial space, the original tenant finds another company to sublease a portion or all of its space, while remaining contractually bound under the terms of the lease. Therefore, if the sublessee does not pay rent or defaults, the landlord can seek payment from the original tenant for any rent or damages owed to it. In this way, subleases are much less risky for a landlord and consequently, easier for a tenant to negotiate into a commercial lease.
Preserving flexibility within a commercial lease also requires a close examination of the language used within the document. A tenant should always negotiate for the removal of terminology that leaves unfettered decision-making in the hands of the landlord. For example, assignment and/or subletting clauses often include the phrase “in landlord’s sole discretion.” This language gives the landlord complete decision-making authority over whether or not to consent to a tenant’s request to assign its lease or sublet the space. By agreeing to such unrestricted discretion, the tenant basically negates any rights given to it under these clauses. In this situation, the tenant should seek a reasonable modification to this phrase, such as “landlord shall not unreasonably withhold, condition or delay its consent…,” followed by an enumeration of very specific, attainable conditions which, if met by the tenant, will virtually bar landlord from denying its consent.
Another example of open-ended language favoring the landlord is use of the phrase “and other consideration payable to tenant.” Typically, a landlord will include this phrase to protect its interests in the event of an assignment or sublease by the tenant as part of a sale, consolidation, or merger of the tenant’s business. By including this catch-all term, the landlord seeks to prevent the tenant from skirting its obligation to turn over excess rent to the landlord (as per the assignment or sublease clause) by means of creative accounting by the tenant with respect to its transaction with the new entity. For instance, if the existing tenant charges the new tenant less per square foot than it is paying under the original lease, with the intention of bolstering its profit elsewhere, perhaps by selling other assets at a price higher than fair market value (and in effect skirting its obligation to turn over excess rent), the landlord would legitimately face a loss. Despite the legitimacy of the landlord’s concern, as written, this clause is much too broad. Basically, it would allow the landlord to make a good faith argument that, in the event the tenant sells its business, the landlord is entitled to excess rent and part of the sales price (i.e. and other consideration payable to tenant) in connection with the transaction. If presented with a lease containing this language, the tenant should request a slight modification to it – “and other consideration payable to tenant in lieu of rent” – to prevent the landlord from unfairly making a claim to the tenant’s sale proceeds.
At the end of the day, it is virtually impossible to predict what will happen with a client’s business in the future, whether 3, 5, or 10 years from now. However, negotiating flexibility into commercial real estate lease is a tried and true way to minimize their potential exposure, especially in a fluid business environment.
If you are contemplating a new commercial lease for your business, or have specific question about an existing lease agreement, please feel free to contact Jamie Duberman at [email protected] or 973-768-0117 for assistance.
Jamie Duberman is a Member with our New York-area team and brings over 25 years of legal and business experience in the real estate sector. He regularly handles a wide range of transactions relating to residential, commercial, industrial and new development real estate matters. Previously, Jamie co-founded and served as General Counsel of a regional title insurance company and mortgage company. He can be reached at [email protected] or 973-768-0117.
This publication should not be construed as legal advice or a legal opinion on any specific facts or circumstances not an offer to represent you. It is not intended to create, and receipt does not constitute, an attorney-client relationship. The contents are intended for general informational purposes only, and you are urged to consult your attorney concerning any particular situation and any specific legal questions you may have. Pursuant to applicable rules of professional conduct, portions of this publication may constitute Attorney Advertising.