Assignment and Subleasing – What Your Lease Must Have

Assignment and Subleasing

Below are some simple rules to live by when negotiating sublease and assignment rights from Gregg Pasternak:

The Assignment and Subleasing clause is one of the most heavily negotiated in the Lease. Although most tenants do not expect to effectuate a transfer during their lease term, many do end up needing to shed space at some point.  Tenants who have negotiated favorable assignment and subleasing rights often have far more flexibility to take advantage of their options than those with more restrictive clauses.  A comprehensive review of all of the related issues that arise is too large a topic to be handled here (although Roger and I do a seminar devoted entirely to this topic), but the following are a few key points about some of the most contentious issues.G
Affiliates Clause
Every lease, regardless of the size of the Premises, should have a clause which allows Tenant to sublease or assign to an affiliate without Landlord’s consent.  The definition of affiliate varies, but should generally include any entity that (i) acquires all or substantially all of the stock or assets of Tenant, (ii) is the resulting entity of a merger or consolidation of Tenant with another entity, or (iii) an entity which is controlled by, controls, or is under common control with, Tenant. Landlords typically agree to some sort of affiliates clause, but often try to include a net worth test, which can sometimes be problematic. The standard should be that the transferee’s net worth must be equal to or greater than that of Tenant as of the date immediately prior to the transfer.  As long as Landlord’s position is not worsened by the transfer, Landlord should not require a consent right.  Landlords, however, often want the standard to be that the transferee’s net worth must be equal to or greater than the greater of (A) the net worth of Tenant as of the date immediately prior to the transfer and (B) the net worth of Tenant as of the date of the Lease.  This is an unreasonable requirement since Tenant’s net worth as of the date of the transfer is all that is relevant.  If Tenant was worth $50,000,000 three years ago but is only worth $10,000,000 today, then all Landlord has is a tenant worth $10,000,000.00.  To say, for example, that Tenant cannot change from a Delaware corporation to a Maryland corporation simply because their stock price has dropped in the prior 3 years is unfair and unreasonable.  Worse, it could be potentially devastating to Tenant, who may, for a variety of reasons, need to undergo a corporate restructuring which will have no tangible effect on Landlord. 
Transfer Premium
Most leases provide that in the event Tenant subleases space or assigns the Lease, Landlord is entitled to a portion of the profits. Percentages vary by market, but a 50/50 split is typical.  Regardless of the split, it’s important to ensure that the language which defines “profits” is clear that profits are calculated after deduction of Tenant’s costs.  Any costs incurred by Tenant in connection with the transfer, including legal fees, marketing costs, improvement costs and brokerage commissions must be deducted before Landlord receives anything.  On larger deals, Tenants sometimes can deduct something for downtime, the period of time between when Tenant wants the transfer to occur and when the transfer actually becomes effective.  On the other hand, Landlords should be sure to include language which provides that key money (a cash payment made to a tenant in connection with a transfer ) and any payment in excess of fair market value for services or equipment will be included in the proceeds received by Tenant when calculating profits.  Without such language, a tenant paying $20,000 a month in rent who wants to sublease for $30,000 a month could avoid splitting profits with Landlord by charging the subtenant $20,000 a month in rent and separately make up the difference through a cash payment or above-market purchase of a piece of furniture.
Landlords usually want the right to recapture, or take back, the Premises in the event Tenant proposes a transfer.  The reason given is that if Tenant wants to shed space anyway, Tenant shouldn’t care if Landlord permits an assignment or sublease or takes the space back for their own account – either way, Tenant is relieved of some (or in the case of a recapture), all of its rental obligation with respect to the transferred space.  There is merit to that argument, but there are also concerns regarding recapture rights.  First, larger tenants may want to warehouse space for a period of time, but still control it to provide flexibility for future growth.  A recapture right usually gives Landlord the right to take the space back for the entire lease term, which would obviously forbid a short-term sublease.  Second, the recapture right is often just a way to subvert the transfer premium clause.  If Landlord and Tenant are supposed to split transfer profits, then Landlord recapturing the space simply enables Landlord to keep 100% of the profits.  If Tenant is fortunate enough to have leased space at a rate less than the current market rate, Tenant should be entitled to its negotiated share of the profits of any transfer.  If a recapture right is required, tenants should push for a “ROFO style” right, whereby Tenant notifies Landlord of its intent to transfer before marketing the space.  Landlord has to elect whether to recapture the space at the time of notice, which allows Tenant to avoid wasting time and resources negotiating a transfer which may never be allowed to occur.

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