How To Circumvent A Lease’s Assignment And Subletting Restrictions

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Last week, we alluded to a lease transfer situation that had recently come across our desk, and then Ruminations detoured to its usual ranting to start a discussion about why a landlord should have any right to interfere with its tenant assigning the lease or subletting the leased space. Thanks for the comments we got directly to Ruminations by way of comments, by way of comments posted to LinkedIn, and privately.

That discussion is over. The “norm” for leases is that the landlord will have some control over assignments and sublettings. That’s our starting point today.

We promised to use this week’s posting to tell readers about what “triggered” us to get into the topic of lease transfers. So, here it is.

We were given a lease that permitted the landlord to recapture the leased space in lieu of consenting to an assignment or subletting. We were also given a document describing a particular transaction. After looking at the lease and the “new” papers, we were compelled to tell the landlord that it had no right of recapture and also that its consent wasn’t even required.

Several years earlier, this same landlord consented to a subletting of the entire leased premises. Now, that SUBTENANT was assigning its sublease. Remember the law. A landlord has neither privity of contract nor privity of estate with a subtenant. That means that while the subtenant and the landlord have a “connection” or “bond” through their respective, related interests in the same piece of real estate, there is no legal relationship between them. Arguments can be made, in appropriate circumstances, that the landlord is a “third party beneficiary” of the agreement between its tenant (the sublessor in such a case) and the subtenant. In general, landlords will be unhappy if that is the route by which they have any control over a subtenant.

While the sublease in question was certainly subject to the provisions of the original lease, the original lease only spoke of the need for the landlord’s consent to assignments of that original lease and for the original tenant’s subletting of the leased premises. A lot of leases stop at the same point. Basically, this particular landlord’s form of lease did not bar assignments of subleases.

Now, think about it. Leases typically allow assignments and subletting to a tenant’s affiliates. What happens if a tenant sublets the entire premises to an affiliate (for which no consent is required) and immediately or two years later, that affiliate assigns that sublease to an unrelated party? We think the answer is that, under the lease we looked at (and under a lot of other leases we’ve seen), the landlord gets to stand by and watch it happen. One reason for this kind of outcome is that common law favors “alienability.” In this context that means common law disfavors restraints on assignments and sublettings. As a result, all such restrictions are strictly construed against a landlord. Basically, if a lease doesn’t clearly and specifically include a particular restriction, it will be an uphill battle for a landlord to “expand” on what is actually written in the lease. And, it will be an expensive battle for all parties.

Our conclusion that the assignment of the sublease was outside of the landlord’s control wasn’t a new thought for us, only a reminder. A number of years ago, we wrote an article about circumventing assignment and subletting restrictions. What follows is an excerpt from that article. If this whets your appetite for more, you can click HERE and see the entire article.

The full article has more examples and a lot of background on assignments and sublettings. The additional examples are more complicated (and sneaky) than what Ruminations is listing below. If the list below intrigues you, you might want to go back and find that link we provided at the end of the paragraph above).

LEASE TRANSFERS A LEASE MIGHT NOT CONTROL

• A prohibition against assignment does not prohibit subletting, and vice versa. In most jurisdictions, merely agreeing that there is to be no subletting of the premises does not prohibit subletting of part of the leased premises.

• A bar against assignment in the lease does not bar a subtenant from assigning its sublease. It may not bar a further subletting by a subtenant. Remember, there is no privity between a subtenant and the prime landlord.

• There are a myriad of transfers that happen by operation of law, and not all “triggers” are involuntary. An individual tenant’s death transfers the deceased tenant’s interest to her or his estate and then to one or more beneficiaries. Similarly, dissolution of an entity-tenant results in a distribution of its assets to the tenant’s interest holders – shareholders, members, partners, and the like. Then, there is a matter of reviewing some seemingly innocent “boilerplate” provisions. Doing so may lead to discovering that the lease’s provisions “are binding upon inure to the benefit of heirs, successors, administrators, and personal representatives.” This may not be intended. Further, not all jurisdictions analyze the same set of facts in the same way. Again, without dealing with this form of transfer in a lease, the result may be unsettling. Covering these contingencies wrongly or without giving it much thought can also be upsetting to a tenant’s family if the lease is lost upon the family member’s death causing irreparable injury to the family business.

• And, speaking of transfers by operation of law, what if a creditor levies on a tenant’s particular asset such as the tenant’s interest in its lease and the lease is sold at auction to the creditor?

• A landlord may have joint or co-tenants until one of those tenants assigns to the other.

• Does consent to the first assignment or subletting result in a landlord’s right to vet the next one down the line? That appears to be the majority rule as to assignments, but not as to sublettings. What if the consent was by acquiescence or silence? If an assignee succeeds to the original tenant’s possessory right to the leased premises, but doesn’t assume the lease itself, does it need the landlord’s consent when it wants to further assign its interest in the lease or sublet the leased premises?

• Typically, when a small business is sold, the seller will assign its lease to the buyer and take back “paper” secured by the buyer’s assets. But, what good are those assets if it can’t get the lease back at the same time? How can it do so? Will reserving a reversionary right in the assignment do the trick?

• Similarly, an assigning tenant will be helpless to mitigate its damages if it can’t “get the lease back” when its assignee defaults under the lease. While a conditional reassignment document can be executed in connection with an assignment if the landlord agrees to such an arrangement at the time of the assignment, a lease could cover the same contingency when first crafted. By crafting for such a situation in the first place, a lease could require the landlord to re-let to the original tenant pursuant to an identical lease, for what would have been the remaining lease term (provided the original tenant makes the landlord whole).

• Is a leasehold mortgage an assignment of the lease? If it isn’t, especially because court construe restrictions on assignments very narrowly, can a tenant compel such an assignment on its landlord? Remember, a leasehold lender taking over as tenant under a lease may be hampered in assigning the lease to someone who might be able to use the leased premises. But, what if the lender sells the defaulted mortgage to a party that wants to use the leased property for itself? What if the mortgagee was a “friend” of the tenant?

• Can a tenant assign a single right it holds under the lease, such as its purchase option, without running afoul of a no-assignment provision?

• Imagine that a lease allows assignment but not subletting. What keeps a tenant from assigning the lease to a new tenant and taking back an assignment that becomes effective in three or five years?

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  1. Joel Hall says:

    Ira: Whenever I do a sublease (which is a real brain teaser of an exercise), I try to establish privity of contract between the subtenant and the landlord at the time of creation of the transaction (a 3-party instrument) the in the most obvious subjects. I use a copy of the master-lease and change the word “Tenant” to “Subtenant” or add the word “Subtenant” where appropriate and where it make common sense. As to payment obligations, if the master-tenant fails to turn the lease rent over to the landlord, the subtenant is required to do so (pay lease rent and any “profit” owed, not sublease rent) upon notice from the landlord. With respect to performance obligations, like repairs and the notices required to trigger the performance, the notice would run directly from the landlord to the subtenant and performance would be rendered directly from the subtenant to the landlord. Thus, the “sublease” begins to look more and more like an assignment but some portion of the term is reserved to the master-tenant to preserve the structure of a sublease. Also, if the subtenant defaults, the master-tenant, as sublessor, has standing to bring an eviction action in Landlord -Tenant court. A landlord in the context of an outright assignment may not be able to do so – being relegated to the regular courts in an action in ejectment. As far as other transactions you allude to are concerned, there are many ways a tenant can transfer the lease and many ways a landlord can lock him down – which is beyond the scope of your post.

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