Assignments and Subleases

For many businesses, entering into a lease is an essential and important part of their businesses.  Other than payroll, lease payments are often a business’s largest expense.  However, given the complexity and sheer length of a typical commercial lease, it is a daunting proposition to review and negotiate a lease on your own.  This is the third in a series of articles discussing the major issues to be considered in a typical commercial lease.

This week, we’ll explore assignments and subleases.  While assignments and subleases will have varying terms and conditions on a case-by-case basis, we’ll discuss generally about the issues involved in most assignments and subleases.

An assignment of a lease occurs when an existing tenant (“Assignor”) assigns its rights and obligations under the lease to a new tenant (“Assignee”).  Another form of assignment occurs when a landlord sells the property and a new landlord takes over the lease.  A sublease is often used when the existing tenant (often referred to as “Sublandlord” or “Sublessor”) rents a portion of, or the entire leased premises to another tenant (“Sublessee”), typically for a limited term.  Some leases provide landlords the right to terminate the lease if an existing tenant requests an assignment or lease.

1. Assignment
   A key difference between an assignment and a sublease is that an Assignor in an assignment more or less irrevocably assigns all of its interests in the lease to the premises, whereas in a sublease, a Sublessor still retains certain interests in the premises.  For instance, in an assignment all of the Assignor’s rights and obligations in the lease are “assigned” to another party, the Assignee.  While there are certain circumstances where the Assignor may have a right to take back the premises (such as, if an Assignee is in default of the lease), the assignment generally extinguishes the Assignors rights under the lease, but typically not its obligations.  The Assignee takes the place of Assignor, physically in the premises, as well as on the lease.  However, the Assignor and its guarantors, if any, are usually not released from liabilities until the end of the lease term.  So if the Assignee is unable to pay rent, or defaults otherwise under the terms of the lease, the Assignor and/or its guarantors will be liable to the landlord.

   Assignment clauses may also be triggered unwittingly by change of ownership, or equity transfers, in a corporate or LLC tenant.  Leases frequently state that a transfer of a certain percentage of the shares or membership interest in a corporate or LLC tenant shall be construed an assignment.  A tenant should always check its lease for such provisions prior to entering into an equity transfer transaction.

   An assignment almost always requires the prior written consent of the landlord.  Such consent may be in the landlord’s sole discretion or given under more reasonable terms.  Landlords will usually review the financial information of a prospective assignee, just as it would with a new tenant.  Most leases provide that a landlord may charge a small assignment fee.  Some leases contain language that an Assignor must pay all or a portion of the consideration it receives as a result of the assignment to the landlord.  These types of provisions can be problematic, especially if the assignment is in the context of an asset sale or corporate/LLC merger, since the “consideration” can be construed as the purchase price of the assets or equity of a business.

2. Sublease
   In a sublease, the Sublessor may retain much of the rights and obligations under the lease, the terms of which are governed by a sublease agreement between the Sublessor and the Sublessee.  The Sublessor continues to pay rent to its landlord while receiving rent payments from the Sublessee.  The Sublessor usually has remedies, including the right to evict the Sublessee, upon a default of the sublease.

   As with assignments, the landlord must give prior written consent to a sublease.  In addition, most leases contain clauses where a Sublessor must pay all, or a portion of, the excess rent (amounts over the rent paid by Sublessor to landlord) it collects from the Sublessee to the landlord.

PRACTICAL COUNSEL: In both assignments and subleases, the rights and obligations of the existing and incoming tenants are delineated in the underlying lease document.  A prospective tenant should take care when reviewing a proposed lease to ensure that they understand the implications of an assignment or sublease, as they may be faced with unfavorable consequences.  Whether a business needs to move out of a leased space due to growth, sell itself, or has space that is not being used, the assignment and sublease clauses will come into play and it is imperative to understand their implications.  The actual assignment of lease or sublease agreements should also be drafted and negotiated carefully to conform to the underlying lease, as well as protect the best interests of the Assignor, Assignee, Sublessor or Sublessee.