Better the Tenant You Know Than the Tenant You Don’t –
Negotiating Assignment and Subletting Provisions in Retail Leases
By: Scott Timpe
While the golden rule of treating others as you wish to be treated arguably applies to Landlord/Tenant relationships, there is another lesser-known “Golden Rule” which also applies: the one with the gold gets to make the rules. In many retail leasing situations, the Landlord is the one typically making the rules. One common rule made by Landlords with the power to dictate Lease terms is that a Tenant may not assign its interest in its Lease or sublet its Premises without the consent of the Landlord. However, certain Tenants have the so-called ‘gold’ - the financial strength and negotiating leverage - to demand exceptions to this rule, including the right to assign their Lease or sublet their Premises without Landlord consent. In negotiating assignment and subleasing clauses with Tenants holding some of the gold, Landlords must exercise great care to avoid being stuck with assignees or subtenants that do not fit the merchandising of their shopping center or are less creditworthy than the original Tenant. In particular, Landlords should consider the following:
Seek to impose control over creditworthiness. More often than not, a Landlord’s first and foremost concern is the ability of a Tenant to pay rent, in full, on a timely basis. It should come as no surprise that once a Landlord determines a Tenant is acceptable from a credit standpoint, the Landlord typically does not want such Tenant to assign its Lease or sublease its Premises to another Tenant without having the right to approve the proposed transferee. In instances where a Tenant has enough leverage to reject an assignment and subletting provision which gives Landlord sole and absolute discretion, there are many other compromises a Landlord can try to reach so as to maintain a modicum of control over the financial strength of a transferee. For example, a Landlord can negotiate requirements that a prospective assignee or subtenant must meet, such as a minimum net worth requirement, a minimum gross sales requirement, or a minimum number of stores requirement.
Demand the right to recapture the premises. If a Tenant seeks to assign its Lease or sublet its Premises, one way that a Landlord may protect itself is to exercise a right to recapture the Premises. A recapture right allows the Landlord essentially to block the assignment or subletting by terminating the Lease and retaining possession of the Premises. Following termination, the Landlord can elect to lease the Premises to whomever it chooses so as to retain control over its real estate.
Keep the original Tenant on the hook. Landlords should strongly oppose any assignment provision which relieves the original Tenant of its obligations under the Lease upon an assignment. Having a Tenant with a truly vested interest in the ability of an assignee to meet its obligations under the Lease is very helpful to ensure that a Lease is not assigned to an assignee with weak credit. If a Tenant knows it is still on the hook, then it will have a strong incentive to scrutinize the ability of a potential assignee to meet the financial and other obligations under the Lease, thereby mitigating the Landlord’s exposure to default risk. Additionally, in the event the assignee does ultimately default, if the original Tenant’s liability has been preserved, then the Landlord’s chances of recovery are improved.
Limit use rights. Landlords must also be mindful of the rights of an assignee or subtenant to use the subject Premises. Particularly in the case of Tenants who have the leverage to negotiate broad use clauses in their Leases, it is crucial that a Landlord negotiate to limit the acceptable uses of a subsequent assignee or subtenant. A Landlord should always seek to protect its right to control the mix of Tenants in its shopping center, and the permitted uses of those Tenants. Further, the impact of exclusives and use restrictions negotiated by other Tenants at the center must be considered in conjunction with a potential change in use that may occur upon assignment or subletting.
Make other rights personal to Tenant. It is common for Landlords to offer highly sought-after Tenants extra perks, such as expansion rights, options to extend, and rights of first refusal/rights of first offer, in order to entice them to take space at their shopping center. In doing so, Landlords should also consider the impact of an assignment or sublease on these rights, and whether any such rights should terminate upon assignment or sublease.
Seek to share in excess rent. In instances where a Tenant assigns its Lease or subleases its Premises, it may be paid an amount which exceeds the amount the Tenant is obligated to pay the Landlord under the Lease. If the assignment or sublease had not been entered into, then in theory, those same financial accommodations (i.e. higher monthly rent payments) would have been available to the Landlord if it had leased directly to the assignee or subtenant. Accordingly, a Landlord should seek the right to share in this excess financial consideration along with the Tenant, or, if it has the leverage, to obtain 100% of such excess.
The aforementioned issues are just a sampling of what a Landlord should consider when negotiating assignment and subletting provisions with a prospective Tenant. Of course, the Landlord should always seek to impose provisions in the Lease requiring that Landlord approve, in the Landlord’s sole and absolute discretion, any assignment or sublease. If a Tenant has sufficient leverage to push back on this point, then the Landlord would be remiss to not consider the foregoing issues and should attempt to address these issues, either in the letter of intent stage, or in the Lease itself.
Cox, Castle & Nicholson LLP is a full service law firm offering comprehensive legal services to the business community and specialized services for the real estate and construction industries. Reproduction is prohibited without written permission from the publisher. The publisher is not engaged in rendering legal, investment, business or insurance counseling through this publication. No statement is to be construed as legal, investment, business or insurance advice.