Vote Here For No Assignment Or Subletting Restrictions In Leases

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A situation came across our desk this week and we thought we’d work it into a piece about circumventing assignment and subletting restrictions. As we started to scribble some notes, we were forced to rethink some of the whys and wherefores of these restrictions in the first place. And, that’s the plan today, leaving “circumvention” for later, probably next week.

As has been said here and elsewhere, a lease is a conveyance, more particularly of a “non-freehold” estate in land. It has a limited duration and isn’t really an ownership interest. What is does do is give the tenant “exclusive possession” of the land. And, by “exclusive,” it means that even the landlord does not have any right to possess or use the land (or premises).

To Ruminations, this means that when a landlord says: “I don’t want you making money from my property, after all it is mine, not yours,” its tenant should respond,” I’m not interested in making any money from your property, only from my exclusive possession of the premises.” After all, the landlord has absolutely no right to put anyone else into the premises during the lease term and the landlord doesn’t lose anything it hadn’t already lost once it agreed that its tenant had a five, ten or whatever year lease.

“OK,” you say, “but it isn’t just that the premises are going to be occupied anyway, it’s that I picked ‘you’ to be my tenant.” That might be true in a small number of special cases, but in our experience that’s just not the case. In many, many cases, the landlord is thrilled that anyone who could pay the rent is interested in the space. It usually doesn’t matter whether it is Sally or Janet or Gaeta or Yosef. For small spaces, the tenant’s bank account rarely seems to matter. And, as readers will see below, financial tests for assignees or subtenants shouldn’t even matter.

What we are saying is that once a landlord has given possession of the premises to a tenant who has obligated itself to pay rent and maintain those premises until a given date, the landlord gets the benefit of its bargain no matter who is in the space. Of course, there are going to be rules of behavior for that occupant, but they aren’t dependant on the “face” of the tenant. The original tenant remains obligated to pay the rent and remains obligated to see that the rest of the occupant’s lease obligations are met. In fact, when a tenant assigns its lease or sublets its premises, even more people are obligated to stand behind and abide by the lease’s requirements. That should be good for a landlord – an unbargained-for advantage. Yet, landlords think they can restrict their tenant’s ability to pay the rent (by barring or interferring with their tenant’s getting sublease revenue or with finding someone else to take over primary payment liability) and still insist that the tenant remain obligated to pay.

When a landlord leases space, it rolls the dice as to whether its tenant will be able to pay the rent. Landlords make their guess based on the prospective tenant’s financial and operational ability and once a lease is signed, it’s just like bowling. After the ball leaves your hand, there is nothing you (think, landlord) can do to change the ball’s direction (think, enhance the tenant’s financial worthiness). You (the landlord) made your choice and the tenant is going to hit a lot of pins or go into the gutter, so to speak. A landlord can pick a 250 bowler who stays in that range or falls off a cliff. You can pick Circuit City or Apple (today’s darling). More often, however, if the space is “sucking wind” many (most?) landlords will grab anyone short of someone on the wrong side of life support.

What does this all mean? Here’s what Ruminations is thinking. Tenants have committed to paying rent for the premises no matter whether they need the space any longer or not. You can call it “exclusive possession,” but what it really means is that a tenant has exclusive control over the premises during the lease term. It never seems to matter if the tenant runs its business “hands on” by showing up every day or hires people to do that work. Why should it matter if the tenant “hires” a whole company to operate a business within its premises? No landlord asks its tenant: “How do you pay the people who run your business?” Why should a landlord tell someone who has committed to pay rent for ten years that it, the tenant, can’t let someone else run the business within the premises? That “someone else” could be an employee or an assignee or a subtenant.

Now, we know this is getting some readers a little hot under the collar. Some will say, “But, I made my deal with ‘you.’ I expected to see ‘you’ in the premises.” No, they didn’t; in almost all cases, they only really expected “you” to pay the rent. And, in the case of a sublease, that very same “you” will continue to pay the rent. In the case of assignment, that very same “you” is in the role of a guarantor of the rent. In fact, the landlord is never worse off when it comes to financial security; it can only be better off following an assignment or even a subletting. In the case of an assignment, even if the assignee’s net worth is only a dollar, the landlord now has one dollar more of net worth behind the rent than it had immediately before the assignment. In the case of a subletting, its tenant now has its own net worth PLUS the ability to go after its subtenant’s net worth.

None of this is to say that a landlord doesn’t have a legitimate right as to things like tenant mix or to insist that a lease include provisions setting behavior rules for whoever might be in the premises, such as hours of operation or tenant parking. But, we don’t think that the name over the door matters all that much (and rarely ever in other than retail projects) and certainly don’t think that the “face” of the actual occupant matters at all. That’s not to say that a familiar trade name might not be important, but there is an irony there as well. The better known the trade name or “flag,” the less likely it is that the lease will have many transfer restrictions. Often, the best a landlord can do with a strong bargaining power tenant is to restrict “free transferability” to regional or national tenants. That means that the most onerous assignment and subletting restrictions are found in leases with tenants the initial identity of whom mattered the least when the lease was signed.

Today’s blog posting is intentionally open ended, with no attempt to answer every objection that could be raised. That’s because we’d like to open a dialog, not about how thing are being done, but about the logic behind what we all put in our leases. Help us with this project by posting your comments just under the title to this posting. You can click on “Leave a Comment” or on “Comments,” whichever you see.

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  1. Joel Hall says:

    Ira, I have to respectfully disagree with you. I don’t think arguments grounded in feudal concepts and freehold estates have any credibility today, unless perhaps you’re talking about a freestanding property at the intersection of Noplace & Nowhere. And I think that most of your arguments are directed more at subleases than assignments. In the context of a commercial development or district, landlords have a legitimate interest in maintaining some control on the transferability of the lease, even aside from continued financial security. I think an owner of a single downtown space has a legitimate interest in not permitting free assignment and for any lawful use. And I think there is some reliance that the identity of the tenant continues when the landlord makes his deal. I also think landlords go too far on this point and some balance (if imperfect) is worked out. Even in representing big box retailers who get such provisions in power centers, it is usually not an absolute – some reasonable accommodations are made. That is why assignment clauses are often so long.

    • Norman Krone says:

      Ira-

      I am much more inclined to agree with Joel than with you. My experience indicates that the decision to lease to a particular tenant is based on many factors, not just renal. The nature and quality of the tenants operation is of vital concern and in some instances that “brand name” and its ability to attract other occupants of a project is considered in the rental rate. To have a tenant with lesser impact in the market would bee considered differently. Even in the leasing of office space, I recommend that the compatibility of the tenants be factored into the leasing plan. Freestanding properties which are essentially net leased may be looked a differently, but I am convinced that in any mixed use/multi-tenant facility, limitation on subletting and assignments is a landlord’s prerogative and should be protected.

  2. Frank Dillow says:

    Hey Ira….I’m on your side…and I represent both Landlords and Tenants. Landlords all to often view the assignment and subletting provisions as a “club” to control the Tenant. I’m talking about smaller office and retail Tenants, who often have little leverage. Let’s say a Tenant signs the lease as an LLC with a personal guarentee, and then merges the business, or is acquired by another firm….what is the interest in allowing the Landlord to oversee that change in business organization, by arbitrarily denying the assignment of the lease to the new entity? If the Tenant operates as a contractor, and has multiple subcontractors working within the office, does each subcontractor need to sign the lease, or be a party to it? Does the lease need to be renogiated everytime a new subcontractor joins the group, or an existing one leaves? In this economy does it benefit the Landlord to have an existing Tenant fail to pay the rent while continuing to occupy the space, or leave in the middle of the night without paying, rather than seek to find a subtenant ot assignee to fulfill the terms of the lease. This is an extremely important part of any lease and ther relationship needs to be clearly understood by both parties prior to signing the lease. The Landlord should not be given arbitrary power to reach through the lease to essentially manage the Tenant’s business, and the Tenant needs to know clearly what restrictions the lease may impose on the business.

    By the way…thanks for your thoughtful “ruminations”. Always very thoughtful.

  3. I do agree that way too much time and effort seems to go into this clause. I certainly see both sides, look at how Sears has taken advantage of their leases to sublease etc. to Home Depot et. al. and what of the small retailers that would have been sunk if that big box went dark? I think the smaller the retailer the less the issue represents but the more hasslesome it gets. Let the sublease happen. A :Change in Use” clause deals the issue of product mix, exclusives etc.

  4. Joel Hall says:

    Frank, when I’m on the tenant’s side of the table, I favor some of your arguments. But I can also empathize with the landlord’s position which inclines one to come to some accommodation. When on the landlord’s side of the table, I’m not convinced that any retailer with a warm body is better than none. If a landlord in a nice mall leases a space to Apple, should he be satisfied with a Radio Shack replacement simply because they are paying the lease rent and selling electronics? I don’t think one can take an absolutist position here. Conceptually, a landlord would be concerned when a successful retailer loses a creative founder and CEO and is replaced by someone else but can do little about it given the realities of modern business structures and transactions. However, a transfer to another operator altogether can make a big difference.

  5. Susan A. Winchurch says:

    Ira makes an excellent point when he observes that “the most onerous assignment and subletting restrictions are found in leases with tenants the initial identity of whom mattered the least when the lease was signed.” My recent experience with lease negotiation is that, other than in cases involving national tenants with considerable leverage, the assignment and subletting restrictions are often so restrictive as to be essentially useless to both parties. I believe that it would serve both sides better if landlord and tenant were able to negotiate commercially reasonable restrictions that would allow the tenant a viable exit strategy if the tenant’s venture becomes economically infeasible, while at the same time preserving a reasonable amount of control, on the landlord’s part, over important issues such as tenant mix and use of the space.

  6. what a timely subject, we have a slightly different issue with this in that we are now
    getting alot of new immigrants buying businesses to qualify for immigration. In the end
    alot of these “Buyers” of Businesses cannot speak a word of english but have to buy
    something of a certain value to apply for a class of immigration and what we are now experiencing is the business owner who is going to get paid alot of money essentially for a business that
    is not worth amount, only cares about getting that assignment……..and not that we the Landlord’s Agent can’t do a credit check as the new immigrant has no credit history in our country, no related work experience to the business they are purchasing let alone can’t speak English..
    this is getting very frustrating as all the Tenant wants out of this is their winfall….with no concern for the Landlord and try to use the Assignment CLause and the Landlord is required to “act reasonably” in approval of such new Tenants/Assignees…i agree that we need better, more clear
    language in the Assignment Clause to now deal with these issues…we are facing

  7. Based on experience, I would claim that the central issue related to subletting and assignment in leases is not the (intertwined issues of) “occupancy” and “income” side which seem to matter most for tenant and landlord alike. I believe that the critical questions are alterations to tenant mix ( for the retail centre) and comparative brand value of the new tenant (subject of assignment or subletting actions). If leases could be designed from the beginning for methods of keeping tenant mix and brand value “intact” dring subletting or assignment, I am sure many ways can be found for sharing the fiancial proceeds (or burden) for such action. How that is possible, is a very tough question.

  8. I love these posts but I think this one misses the mark.

    As a firm that does a lot of commercial leasing but more commercial loan defaults for banks, my perspective is a little different. Big picture, when a landlord enters into a lease, the landlord is betting that this tenant mix will allow the landlord to pay its mortgage and satisfy the financial covenants of the deal. Sure, we are assuming that the assignor-tenant is not released from liability under the lease but, especially for smaller operations, if they do make an assignment, then they might be less likely to be able to make good on that obligation. If given enough time, the assignor-tenant could also set itself up in such a way as to be judgment-proof. The lookback on a fraudulent transfer is 4 yrs. If the lease is long enough, the assignor-tenant could insulate itself with some planning.

    Moreover, the administrative burden that this imposes on landlords with respect to constantly updating any exclusivity provisions as new leases are entered into would be unbearable (if possible at all).

    Where I see this type of issue as problematic (and I believe I emailed Ira about this some time ago) is the “standard” provision in many leases allowing a landlord to recapture space upon a request by a tenant to approve an assignment. I see that as draconian on steroids. The only thing that could be worse than your landlord sandbagging your tenant’s deal to sell your business because it won’t approve an assignment of the lease is your landlord sandbagging your deal to sell your business AND closing down your tenant’s operation through such a provision. I always try to negotiate those clauses out or, at a minimum, make them inapplicable to a proposed assignee in connection with a bona fide sale of the tenant’s business.

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