Due to our active real estate market, we have come across an increasing amount of commercial tenants who are successful in selling their business to a new prospect, however, they fail to review the underlying requirements for “assignment” or “subletting” under their lease agreements. For the Landlord, this clause represents the battle for control of its property. For the Tenant, it has become important in creating asset value for the sale of their business. The Assignment and Subletting clause is contained in virtually all leases, and should be crucial to any buy/sell agreement and negotiation.
Legally, there is a difference between assignment and subletting. An “assignment” constitutes a transfer of all of the existing Tenant’s (assignor’s) interest, rights and obligations, and a “sublet” constitutes a transfer of less than all of the interest, rights and obligations of the Tenant (assignor). Suffice it to say that the complete understanding of the legal differences between these two should be discussed with your attorney, as should any transfer of a business that involves an underlying lease agreement. For the purposes of this discussion I am going to treat both situations simply as a ‘transfer’ of interest and assume there is an existing lease agreement/Landlord to contend with.
The Landlord’s objective is to maintain control of its property. The Landlord will look at entering into a specific lease transaction with a particular Tenant that has met certain requirements through the negotiation process. A new lease evidences that the prospective Tenant that has satisfied the Landlord as to that specific Tenant’s financial strength, credit worthiness, use of the space, ability of the Tenant to pay rent and maintain the property. Most Tenant’s during their negotiation process with a Landlord will insist on reserving the right to ‘transfer’ their lease obligations to someone else in the event the Tenant runs into financial difficulty, desires to sell his ‘business’ or ‘company’ for a profit, or in some cases, finds a need to move to larger space or determines the space is unsuitable for their use. Transfer of the majority interest in corporations or partnerships, acquisition of a company, mergers, etc. typically also require Landlord’s consent. In short, the Tenant’s objective is to preserve a way to dispose of their lease obligation in the event a ‘change’ occurs, as outlined above. The Landlord will closely scrutinize any ‘change of control’ of the rent obligation agreed to being transferred to another who is not financially qualified and capable of fulfilling the terms of the underlying lease already in place.
Historically, most leases state the Tenant has ‘no’ right to transfer its lease interest without the ‘prior consent of the Landlord’. We have continued to see certain leases contain language that provides for unilateral consent on the part of the Landlord, and even the right to withhold that consent. Since the late 70’s most courts would rule such unilateral consent as a potential act of bad faith. Most jurisdictions will rule that the Landlord has the right to prior consent, but that such consent cannot be unreasonably withheld and further that the Landlord has the right to request certain protections and standards exist prior to any such transfer. The lease should spell the required need for prior Landlord approval, the need for the current Tenant to be in full compliance of the lease and not in default, and should set forth guidelines for the right to transfer. These would include financial creditworthiness by any new assignee, experience and reputation, no change in use, no change in use of common facilities that would interfere or inconvenience other Tenants in the complex, i.e. heavy parking. Further protections could involve the transfer of option periods previously negotiated, rent changes to fair market value, increases in annual or percentage rent, etc. Of course, all of these should be outlined in the specific section of the lease regarding the event of transfer. The more detailed the language of this section, the less likely disputes or law suites will arise. An attorney can review your lease agreements to determine if such modifications would be beneficial to you as an owner/Landlord.
What has become a recent occurrence is the Tenant, who is selling their business, assets, etc. ‘prior to obtaining Landlord consent’. That can become a difficult position to be in for the new Assignee/Tenant, who thinks they can just step into place of the original Tenant, call the Landlord or property management company and just make a written or verbal representation as to ‘the change of interest’. A violation of the “Assignment” provisions of a lease may allow the Landlord the option to terminate the original lease. When the issues of assignment arise, it is most often initiated by the Tenant for the Tenant’s benefits. This puts Landlords on the defensive to protect their investment. Markets change, companies change their business plans, a buyer makes an attractive offer to purchase a business and it’s hard to refuse. For these and many more reasons, it is imperative for any new prospect to obtain a copy of the underlying lease agreement and review the document with your broker and attorney to determine the requirements necessary to have a smooth transfer of interest.